THE YUKOS CLAIM AND THE RUSSIAN FEDERATION
LESSONS LEARNED IN GETTING THE BALANCE RIGHT BETWEEN PUBLIC RIGHTS AND PRIVATE INTERESTS
By Châu Huy Quang – Managing Partner of R&T LCT Lawyers
Recently, investor-state dispute resolution have played a vital role in the promotion of foreign investment among states. Within many of the thousands of international investment agreements (bilateral and multilateral), involving almost all countries across the world, are mechanisms in place that hold states accountable for their breaches of their commitments in these agreements – particularly, mechanisms that pave way for recourse by foreign investors against the state (often through arbitration in the final instance).
Vietnam is no exception, and its adherence to its international commitments in the context of the recent rise in investor-state arbitrations internationally should prompt a thorough review by the country of its practices and treatment towards foreign investors.
Otherwise, the potential repercussions can be devastating – both directly and indirectly.
A prime example, which has hit headlines across the world and prompted interest within the legal and business community, is the recent case between the former majority shareholders of the Yukos oil group and the Russian Federation.
Those interested in the decision of this case can access the awards, totalling US$50 billion in compensation, which are publically available on the website of the Permanent Court of Arbitration (PCA). The author provides a condensed rundown of the case and the expensive lessons learned for countries like Russian and possible lessons for Vietnam in the context of the case and its recent conduct.
Yukos and Russia
In April 2007, the claimants, former shareholders of the now-defunct Russian oil and gas giant, Yukos, commenced their claims against the Russian Federation at the PCA. The claims, which were based on Russia’s unlawful expropriation of investments in Yukos, resulted in an award of US$50 billion in favour of Yukos – the largest award ever rendered by an international arbitral tribunal.
The disputed facts arose in 2003, when Yukos was privatised and led by Russian tycoon, Mikhail Khodorkovsky, as CEO. Yukos had enjoyed financial success in the early 2000s. However, this success, coupled together with Khodorkovsky’s political activities, had allegedly threatened Russia’s political interests.
As a result, the Tribunal determined that Russia had undertaken multiple measures to cripple and eventually destroy Yukos altogether.
One measure was the imprisonment of Khodorkovsky for alleged fraud and tax evasion. The decision to incarcerate Khodorkovsky was the result of a trial that, according to the Tribunal, “did not comport with the due process of law”.
Other measures included the commencement of criminal proceedings against Yukos’ employees, the imposing of fines and tax penalties amounting to approximately US$27 billion, the freezing of assets and the eventual forced sale of Yuko’s core oil production assets.
These measures collectively culminated in Yukos having to file for bankruptcy in August 2006. Yukos then had to transfer almost all of its remaining assets to the state and state-owned enterprises.
As a result these measures, the three-member Tribunal unanimously ruled that Russia had breached its obligations under Article 13(1) of the Energy Charter Treaty (the “ECT”) by engaging in conduct that was essentially equivalent to the expropriation of the claimants’ investments in Yukos.
Although, Yukos was not entirely guiltless, as it was held that it was actually “vulnerable on some aspects of its tax optimisation strategies” which would ordinarily have subjected it to legitimate tax penalties. However, while this had the effect of reducing Russia’s liability by 25% (through contributory fault on part of Yukos), the Tribunal determined that the actions of the Russian authorities went beyond that of a mere tax collection expedition. Russia had launched a “series of politically motivated attacks”, the true objectives of which were to bankrupt Yukos and appropriate its valuable assets.
Roots of the Arbitration: The Energy Charter Treaty
The dispute arose from the ECT, a multilateral agreement signed or ratified among 54 countries. The ECT is a unique, legally binding treaty aimed at promoting inter-governmental cooperation in the energy industry, and covers matters including trade, investment, efficiency and transit of commercial energy activities.
The ECT lays out comprehensive rules governing the protection of foreign investments in the energy sector, including protections against unlawful expropriation and the affording of fair and equal treatment among signatories. It also contains a dispute resolution clause.
The provisions against unlawful expropriation under the ECT were triggered in the arbitration, as the claimants alleged that Russia had unlawfully expropriated their investments in Yuko. While the ECT allows the Russian government to nationalise or otherwise take over the assets, licenses or property of a foreign investor, it must fairly compensate investors if such nationalisation was implemented for a public interest purpose.
The Tribunal determined that while Russia did not directly expropriate the claimants’ investments, its actions were equivalent to it.
An Uphill Battle in Enforcement
Despite the awards being final and the recourse in setting aside the PCA awards being extremely limited, the claimants face another battle in actually enforcing the award. With the Government under Vladimir Putin’s administration indicating that the country will exercise all possible means of defending its position, enforcement in Russia would not necessarily be ideal as the risk of political pressure to resist the award is high.
It currently remains to be seen how the claimants will therefore enforce the award and be monetarily compensated. There have been suggestions that the claimants may monetise the awards by selling them on the secondary market.
Other avenues involve enforcing the awards against the assets of Russia in other parts of the world. That is, there is a possibility that if Russia attempts to set aside the award in its territory, Yukos may attempt to have the award recognised in other jurisdictions where Russia owns assets or interests. However, the enforcement process will take considerable time and expense, given the complexity and significant scale of the amounts awarded.
A Vulnerable State
The PCA arbitration between Yukos’ former shareholders and Russia is a strong reminder to states that sovereignty is not a shield against claims by private investors. Indeed, the recent US$3.75 billion arbitration brought against the People’s Committee of Binh Thuan Province by a US investor is a testament to this.
Fortunately, Vietnam had prevailed in the case on the finding that the Tribunal lacked jurisdiction over the dispute as a matter of legal procedure. However, it serves to demonstrate the vulnerability of the country if it fails to maintain a balance between the rights of investors and its public interests under its international investment treaty regimes. As the number of recorded investor-state disputes rises, Vietnam needs to ensure that its conduct aligns with its bilateral and multilateral commitments.
However, currently, the maintenance of this balance has been less than ideal as demonstrated in recent case studies.
Vinalines v SK Engineering and Construction
One hotly debated case that arose just recently concerned a contractual dispute between Vinalines, a Vietnamese state-owned enterprise, and SK Engineering and Construction, a Korean contractor, over the construction of the Van Phong International Harbour. The dispute concluded with the Vietnam International Arbitration Centre issuing an award for US$3 million in favour of the Korean party after Vinalines had unilaterally terminated the construction contract.
Faced with the unfavourable outcome, Vinalines commenced procedures at the Hanoi People’s Court to suspend the award. Pending an outcome from the People’s Court, the Korean party successfully obtained an arrest order from the South Korean court to arrest numerous ships owned by Vinalines in South Korea.
Vinalines sought intervention to expedite the court proceedings in Vietnam. In this matter, the court of Hanoi City decided to reject the request for refusal of recognition of the arbitral award, a position that is arguably in line with other arbitration-friendly jurisdictions. This is supported by the general finality of arbitral awards and the determination of fault on part of the state-owned company.
Huyen Nhu v. VietinBank
In another controversial case, which occurred in early 2014, Vietnamese state-owned bank, VietinBank, enjoyed specific immunity from vicarious liability as a result of criminal conduct of its employee, Huyen Nhu.
Nhu was accused of forgery and self-arranging illegal, high-interest transactions with consumers. At the court of first instance, VietinBank succeeded in avoiding vicarious responsibility for the conduct on the sole basis that it was unaware of Nhu’s activities – a decision that drew the ire of investors who had been the victims to the case and now faced with limited recourse.
The decision of the first instance court was appealed at the Supreme Court on all grounds. The Supreme Court partially overturned the first instance decision to release the bank’s financial obligation pending further investigation under the new legal proceedings. The controversy that will stir if VietinBank succeeds is expected to land a blow to investor confidence in Vietnamese credit institutions.
The Consideration of ISDS Clauses
While Vietnam is not a member of the ICSID Convention yet, the inclusion of an investor-state dispute settlement clause (ISDS) in several of Vietnam’s international treaties (e.g., the Bilateral Investment Treaty between Vietnam and Korea (1993) and the US-Vietnam Bilateral Trade Agreement (2001)) provides recourse for foreign investors hit by inapposite behaviour of state bodies.
Importantly, Vietnam is in negotiations to become a member of the Trans-Pacific Strategic Economic Partnership Agreement (TPP), to which system of policies and laws compatible with the requirements of the agreement (as well as international and regional common practices) should be in place in order to improve Vietnam’s investment environment and protect the legitimate rights of investors. In particular, during the TPP negotiations, Vietnam should prepare a clear report on the state of the legal system and policies as it previously did during negotiations for the WTO Trade Agreement.
In the context of recent conduct, these clauses play a vital role in Vietnam’s commitments because they equip foreign investors with a tool to manage their political legal risks associated with investing in the country.
Therefore, the inclusion of ISDS clauses ultimately benefits the investors. Without them, investors will face difficulties in enforcing their rights under investment treaties, which will essentially erode the attraction of foreign investment due to the added factoring of political risk. This would often mean there is no clear recourse for investors or that investors will need to navigate through the Vietnamese court system to enforce their rights against the state – a route that many investors will regard as unideal.
However, as investor-state disputes have increased in volume and monetary scale over the past several years (including the colossal $50 billion award by the PCA against Russia), some hesitation or apprehension will likely be felt by Vietnam in the consideration of ISDS clauses in future international treaties.
Nevertheless, it is cases like Yukos which demonstrate the utility of ISDS clauses and mechanisms. In a country like Vietnam, whose treatment of foreign investors is not always faultless in practice (partially a result of overly protectionist regimes for state-owned enterprises), ISDS clauses have the indirect effect of boosting foreign investment by inspiring investor confidence.
Therefore, it is hoped that cases like Yukos will serve as not a warning, but a reminder of the importance of having in place a mechanism to finally resolve disputes between private investors and states should one occur. This further encourages countries like Vietnam to take efforts to ensure that it complies with its international commitments to the fullest extent in avoiding conduct such as improperly nationalising or expropriating the investments of investors (or, as demonstrated in Yukos, conduct of equivalent effect).