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

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.