Energy Charter Treaty ruling clarifies effect of Russia’s “provisional application” accepting jurisdiction to hear Yukos’ claim

Summary and business impact

On 30 November 2009, a tribunal sitting at the Permanent Court of Arbitration in The Hague and constituted under the UNCITRAL Rules, ruled that former Yukos shareholders can proceed to the merits phase of their arbitration against the Russian government. Yukos’ expropriation claim is valued at between US$50 and US$100 billion, making it potentially the largest arbitration in history from a quantum point of view.

The claim was brought under the Energy Charter Treaty (the “ECT”), a multilateral instrument which binds over 50 state parties and provides substantial protection to investors in the energy sector, including a standing offer to arbitrate. Russia signed but did not ratify the ECT. In clarifying that Russia is bound by its "provisional application" of the treaty, the tribunal has provided a fundamental precedent for other investors in the energy sector, particularly those with interests in Russia who invested prior to Russia’s withdrawal on 19 October 2009.

Background

The facts of the case will be familiar to many. In 2004, Yukos, Russia's then largest oil company, and its main shareholder, Mikhail Khodorkovsky, were accused of tax evasion and ordered to pay tens of billions of dollars in back-taxes. In December of that year, the Russian Government ordered the sale of Yukos’ main production unit, Yuganskneftegas, at auction and it was sold, allegedly at an undervalue, to state-controlled oil company Rosneft. Yukos finally went bankrupt in 2007.

It is a well established principle of public international law that states shall not expropriate foreign investments, save where such expropriation is effected for a public purpose, in a non-discriminatory manner, and, crucially, is accompanied by the payment of prompt, adequate and effective compensation.

In 2008, the former shareholders of Yukos, (GML Limited - the Gibraltar-registered vehicle formerly known as Menatep, Hulley Enterprises Limited, Yukos Universal Limited and Veteran Petroleum Limited, the Yukos pension fund), brought their expropriation claims against Russia under the ECT. These claims were later linked as one arbitration.

Application of the Energy Charter Treaty

The tribunal in the case was asked to consider:

1. whether Russia is bound by its provisional application of the ECT; and
2. whether the various Yukos shareholders were entitled to its protection.

Although Russia signed the ECT in 1994, it opted only to apply it provisionally (from when it entered into force in 1998) rather than as a fully-fledged member, pending negotiation of a specific protocol on transit. The tribunal’s key finding was that Russia is nonetheless bound by the treaty. Therefore, the tribunal's decision will be significant not only in terms of a potential pay-out for Yukos, but in the way in which it clarifies the effect of "provisional application".

Generally, provisional application of treaties is permitted under the Vienna Convention (Article 25(1)). In the case of the ECT it is permitted specifically by Article 45(2). Although provisional application of treaties is common practice with regard to intergovernmental treaties, it does not usually arise in the context of investment protection. In particular, it was unclear until now, whether a state which has signed the ECT without ratifying it can be said to have consented to its international arbitration clause (Article 26).

Previously, in the case of Ioannis Kardassopoulos v Georgia, an ICSID tribunal held that in principle, provisional application means that signatories are bound by all of the ECT's provisions immediately on their signing of the treaty. An exception arises where such provisions would be inconsistent with the state's constitution, laws or regulations (Article 45(1)). From what we understand — we do not have full details as the Award has not been published and is likely to remain confidential — this exception was not found to apply to Russia.

Furthermore, although Russia went on  formally to withdraw from the ECT on 19 October 2009 (in the wake of the Russia/Ukraine gas transit stand-off in January 2009), according to treaty provisions (Article 45(3)(b)), its obligations with respect to investments made prior to that date, including those that are the subject of this arbitration, remain in effect for 20 years.

As regards the second aspect of the decision on jurisdiction, we understand that the tribunal did not accept Russia's assertions that the various shareholder entities were effectively Russian entities. Rather it ruled that they had sufficient connections with other state parties to the ECT - GML, for example, was held to be a Gibraltarian entity. In so doing, the shareholders were considered to be foreign investors entitled to protection under the ECT.

What does this mean for investors?

In addition to the protections which exist under the 56 Bilateral Investment Treaties which Russia has entered into, investors in Russia's energy sector now have more comfort that their investments are protected under the ECT. This of course applies only to:

1. investors whose home states have signed the ECT, China and the US being notable exceptions; and
2. investments made prior to 19 October 2009.

A successful claim also relies upon successful enforcement against the Russian State before the Russian courts. Arguments about sovereign immunity against execution could provide a further obstacle at that stage. Enforcement of awards against assets held in other New York Convention jurisdictions might offer one way around such problems. The Yukos shareholders have therefore spoken of seizing Russian assets abroad, such as Gazprom's gas and Aeroflot planes. A precedent for this was set in 2008 when a German investor Franz Sedelmayer successfully enforced a 4.9 million Euro damages claim awarded by the Stockholm Chamber of Commerce, leading to the confiscation of real estate owned by the Russian government in Germany.

What does this mean for the ECT?

Not only has this award clarified the effect of provisional application, it may effectively have bolstered the long term effectiveness of the ECT. Three months prior to the termination of Russia's provisional application of the ECT, it delivered a proposal to its European counterparts to replace the ECT with a new instrument. It seems unlikely, given the tribunal's ruling, that Russia will continue to pursue such an alternative.