The Empire Strikes Back: Yukos-Russia, 1-1

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In the latest chapter to the ever fascinating Yukos dispute, Russia recently secured a victory in the District Court of The Hague, which set aside the US $ 50 billion awards issued two years ago by an arbitral tribunal constituted under the Energy Charter Treaty (ECT). The crucial issue was whether Russia was bound to arbitrate under the ECT’s provisional application clause. The arbitral tribunal, comprised of Y. Fortier, C. Poncet, and S. Schwebel, said ‘yes’; three Judges of The Hague District Court, D. Aarts, I.A.M. Kroft and H.F.M. Hofhuis, said ‘no’. It will be argued here that the District Court put too much emphasis on the domestic constitutional legality of the ECT’s provisional application, at the expense of investors who were entitled to believe that Russia had agreed to such provisional application.

Earlier Episodes of the Dispute

The dispute between the now defunct oil company Yukos and Russia has grown into a protracted legal battle, involving a number of investment arbitration tribunals, the European Court of Human Rights, and domestic courts in various jurisdictions. At one point the largest oil company in Russia, Yukos was liquidated in 2006 by the Russian authorities in the process of enforcing tax reassessments, which allegedly demonstrated that Yukos had engaged in large-scale tax evasion. According to Yukos and many international observers, the tax reassessments were a pretext for regaining control over the Yukos imperium and bringing down its influential CEO Mikhail Khodorkovsky.

Foreign shareholders of Yukos have brought investment arbitration claims against Russia under various treaties, including the 1989 UK-Russia BIT (award), the 1991 Spain-Russia BIT (award), and the ECT. The investors have been largely successful, obtaining their biggest win on 18 July 2014, when a tribunal constituted under the auspices of the Permanent Court of Arbitration issued three awards granting a total of US $ 50 billion to the claimants, on the ground that Russia had breached the expropriation provision of the ECT (Article 13). These awards have now been set aside by The Hague District Court (some reactions here and an analysis of the consequences here).

Provisional Application

Whereas previous battles focused on whether the Russian tax reassessments and subsequent enforcement measures were mala fide, the crucial issue at the current stage is whether the arbitration clause of the ECT (Article 26) was actually applicable with regard to Russia, which signed but never ratified the treaty, and withdrew from it in 2009 (not the only Member State to do so).

Pursuant to Article 45 ECT, a signatory State agrees to apply the treaty provisionally ‘pending its entry into force’, ‘to the extent that such provisional application is not inconsistent with its constitution, laws or regulations’ (para. 1) and if that State had not objected to provisional application at the moment of signing (para. 2(a)). Given the fact that Russia had not issued such an objection (unlike Norway, Iceland and Australia), the dispute focused on whether a provisional application of the ECT was consistent with Russian law.

Consistency of What: the Piecemeal v. the All-or-Nothing Approach

In spite of its apparently casual wording, Article 45(1) or ‘the Limitation Clause’ raises complicated questions of interpretation. A first point of disagreement between the arbitral tribunal and the Hague District Court is what exactly needs to be consistent with Russian law: the idea of provisional treaty application as such, or the provisional application of specific treaty provisions. According to the court (5.18), the issue of consistency should be assessed separately for any treaty provision to be applied provisionally (‘piecemeal approach’), and not for the entire treaty as a whole (‘all-or-nothing approach’), as the tribunal had found (like the tribunal in Kardassopoulos v. Georgia). While the tribunal and the court emphasized different textual elements of Article 45(1), their conclusions also demonstrate different preoccupations. According to the tribunal, the piecemeal approach would ‘create unacceptable uncertainty in international affairs’, allowing a State to opt out of provisional application at any time, in particular after a dispute had arisen (para. 315 Interim Awards). The court, on the other hand, emphasized that Article 45(1) serves to avoid conflicts between domestic law and international obligations (5.19). The provision might indeed cause some uncertainty, but this was the choice of the States party to the ECT and apparently justified by the wish to prevent inconsistencies between international and domestic law.

What Constitutes an Inconsistency?

On the basis of its piecemeal approach, the Hague District Court focused on whether the arbitration clause of the ECT was consistent with Russian law. In this context, the Yukos shareholders argued that an inconsistency between Article 26 and domestic law could only exist in the form of an explicit prohibition under Russian law. The court took a wider approach, ruling that a provisional application of the ECT’s arbitration clause would also be inconsistent with Russian law if there would be no legal basis for this type of dispute settlement. The court would also find an inconsistency if investor-state arbitration did ‘not harmonise with the legal system’ or if it were ‘irreconcilable with the starting points and principles that have been laid down in or can be derived from legislation’ (5.33).

Applying this framework of analysis, the court found that Russian law did not provide ‘a separate legal base’ for investor-State arbitration (5.58). It did not attach much weight to the fact that in 1996 the Russian government had stated that the provisions of the ECT were ‘consistent with Russian legislation’ (5.60). Instead, the court pointed at the history of the ratification of some other investment treaties, demonstrating a parliamentary concern that Russian law did not contain a legal basis for investment arbitration (5.64).

State Sovereignty v. the Legitimate Expectations of the Investor

Provisional application is an exception to the normal rules on how treaties enter into force (reports of the ILC’s Special Rapporteur here). Whereas the period between signing and ratifying normally allows States to reconsider the matter and verify whether domestic law needs to be adapted, a provisional application provision purports to bind States already while these assessments are being made. This is a serious intrusion into State sovereignty, which explains why the ECT contains a Limitation Clause and why it allows signatories to opt out by means of a declaration.

State sovereignty, however, is not the only interest at stake in the context of provisional application, and needs to be balanced against the legitimate expectations of other parties and, in the case of the ECT, investors. When Russia signed the ECT without making a declaration under Article 45(2), it might be thought that it created a presumption of compatibility between the ECT and domestic law. Neither the tribunal nor the court followed the shareholders’ argument that the absence of a declaration under Article 45(2) precluded Russia from invoking the Limitation Clause. However, Russia’s choice not to signal any objections to provisional application but to wait until a claim was filed, sheds doubts on the credibility of the defence. This is even more problematic because the alleged inconsistency concerns ambiguous provisions that seem to allow for legitimate disagreement as to whether they allow investor-State arbitration.

The Hague District Court put a strong emphasis on the importance of the domestic separation of powers. Noting that only the Russian Parliament possesses legislative powers, the court concluded that parliamentary approval was necessary for the creation of a form of dispute resolution which did not have a legal basis in Russian law (5.93). This argument seems to revert back to the question of whether the principle of provisional application is acceptable as such. One could reply that the choice to adopt a provisional application provision in a treaty already means that the signatory States temporarily circumvent the domestic separation of powers, and that they may have good reasons to do so.

Tribunals v. Courts

It is tempting to consider other, more fundamental reasons why the Hague District Court might have decided to set aside the awards. First, since Article 45(1) makes provisional application conditional on domestic law, the court may have felt a need to defer to Russia’s interpretation of its own laws and to follow its argument of inconsistency. Second, it is probable that a court in the Netherlands – with its strong tradition of parliamentary sovereignty – is relatively susceptible to Russia’s arguments concerning the domestic separation of powers. Third, and perhaps most importantly, it is striking that the arbitral tribunal on the one hand and the District Court on the other seem to approach the State in a different manner. The court appears well-disposed towards the State, sharing Russia’s alleged concern over the domestic constitutionality of the provisional application of the ECT, whereas the tribunal is more critical, suggesting doubts as to whether Russia’s invocation of Article 45(1) is sincere and credible. Arguably, the different approaches demonstrate differences between the preoccupations of arbitral tribunals and courts (not only within host states) and the ways in which they balance State sovereignty against investor interests.

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Pieter Booij says

May 26, 2016

Very interesting!

Sergey Usoskin says

May 26, 2016


A very interesting piece and I think that they distinctions between the court and the tribunal you identify definitely played their role in the eventual outcome.

I am a bit unclear about your argument on provisional application and investor's legitimate expectations in particular the extent to which they apply to Article 45 of the ECT.

Generally, treaties that apply provisionally apply irrespective of whether they are contrary to national law, but doesn't Article 45(1) of the ECT create a lex specialis regime?

Similarly, generally investors may have legitimate expectations, but does not Article 45(1) undermine the legitimacy of their expectation that the ECT will apply? Your argument appears to be that Russia should have made a declaration, but in this case what is the purpose of Article 45(1) at all? Any state could have at any time make a declaration under Article 45(2). Besides, how can an investor legitimately expect a declaration under Article 45(1) if Article 45(2) requires a declaration, while Article 45(1) does not?

If we borrow from the analysis of legitimate expectations under the FET standard the investor must point to a clear unambiguous and specific statement from a state that served as the basis for its expectations; if a state made less than clear statement (which arguable may be the case with ECT) this may not be best practice, but would not appear to create a basis for legitimate expectations under FET. Should not the same logic apply to the analysis of legitimate expectations for jurisdictional purposes (if they play a role)?

More fundamentally perhaps what is the role of investor's 'legitimate expectations' for the purposes of interpretation of ECT under the rules for treaty interpretation?

Johannes Hendrik Fahner says

May 28, 2016

Thanks for your interesting comment, Sergey. I agree with you that the treaty text suggests an independent function for Article 45(1). I would be inclined to think, however, that on its own, Article 45(1) can only block provisional application if there is an inconsistency that is so clear that other parties can be easily aware of it. I don't think Russia should be able to invoke Article 45(1) with regard to ambiguous domestic provisions when it did have the opportunity to clarify matters under Article 45(2).

I do not mean to rely on the FET version of 'legitimate expectations' per se. I want to argue that in the absence of a declaration under 45(2) and of an evident inconsistency, and in the light of Russia's statements and conduct after signing (up to withdrawal), the investors were entitled to expect that Russia applied the ECT provisionally.

It might be thought that other signatories share these expectations, in line with their wish to create a functioning treaty regime (even pending ratification).

André de Hoogh says

May 30, 2016

Dear Mr. Fahner,

In your comment below the contribution, you claim that "I would be inclined to think, however, that on its own, Article 45(1) can only block provisional application if there is an inconsistency that is so clear that other parties can be easily aware of it. I don’t think Russia should be able to invoke Article 45(1) with regard to ambiguous domestic provisions when it did have the opportunity to clarify matters under Article 45(2)."

Your claim here is that Russia is invoking "ambiguous domestic provisions". In looking at the relevant provisions of the Russian Federal Law on International Treaties, most particularly article 23, I do not quite see what's ambiguous there: it indicates that in case of provisional application of a treaty, the treaty shall be submitted to the State Duma within six months of the start of that provisional application and that its provisional application may be extended by federal law. That means that we should be able to pinpoint the date on which provisional application started (presumably, the date of signature), and then see whether the Duma extended such application by Federal Law within the six months indicated.

There isn't much ambiguity here. Your argument appears to be that Russia should have made a declaration under article 45(2) of the Energy Charter, but that reading would make the reference to provisional application being required only "to the extent that such provisional application is not inconsistent with its constitution, laws or regulations" redundant. Indeed, article 45(2) would allow a signatory to refuse provisional application even if this were consistent with its constitutions, laws or regulations. Yet it seems obvious that provisional application after the relevant period was inconsistent with Russia's Federal Law on International Treaties.

All in all then, a more detailed argument appears to be necessary to support your claim that there is no "evident inconsistency" between the provisional application of the Energy Charter and Russia's Federal Law on International Treaties.

Johannes Hendrik Fahner says

May 30, 2016

Dear Mr. De Hoogh,

Thank you for your comment. When speaking of ‘ambiguous domestic provisions’, I was referring to Articles 9 resp. 10 of the Law on Foreign Investments 1991 resp. 1999. These are the provisions that, in the court’s view, constitute the primary inconsistency between the ECT and domestic law.

Your comment instead focuses on Article 23 Law on International Treaties (applied retroactively), concluding that Russia applied the ECT provisionally during the six months term, in spite of the alleged inconsistencies mentioned above. I agree that this understanding seems reasonable when Article 23(2) is read independently, but there is room for debate in the light of Article 23(3). Moreover, Art. 23(2) does not explicitly state that the provisional application ends after the 6 months term. Indeed, apparently Russia’s representatives held at some point that ‘if six months (…) have expired and the State Duma has not discussed the issue of this treaty, its provisional application continues until the relevant decision is taken by State Duma’ (Interim Awards, para. 389).

I agree that Article 45(1) ECT has a function independent of Article 45(2). However, neither the Laws on Foreign Investments nor the Law on International Treaties seem to provide an evident inconsistency between the ECT and domestic law. The ECT provided Russia with the means to create clarity under Article 45(2) but instead Russia stated repeatedly that it applied the ECT provisionally (Interim Awards, para. 389). In these circumstances, it seems to me that the alleged inconsistencies were not sufficiently intelligible as to block provisional application under Art. 45(1).