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22 October 2009
On July 30 2009 Prime Minister Vladimir Putin issued a decree that ordered the termination of Russia's provisional application of the Energy Charter Treaty, extinguishing any remaining hopes that Russia might ratify it.(1) The termination came two weeks after the signing of the Nabucco Inter-governmental Agreement on a pipeline that will bypass Russia in supplying gas to Europe. The decision is particularly significant in light of the imminent ruling on jurisdiction by the tribunal seized of the arbitration between Russian oil company Yukos and the Russian state.(2)
This update discusses the jurisdictional issues facing the tribunal and considers whether these, together with Russia's dismissal of the treaty, will have a bearing on the utility of investment arbitrations against Russia in future.
The treaty came into force in April 1998. Its aim is to "establish a legal framework in order to promote long-term cooperation in the energy field" with respect to energy investment, energy trade and energy efficiency.(3) Under this multilateral treaty, host states agree to provide investors with reciprocal investment protection(4) and, in particular, compensation for expropriation.(5) Each contracting state consents unconditionally to submit disputes between investors and contracting states to international arbitration.(6)
In February 2005 Group Menatep, the majority shareholder in Yukos, filed a $28.3 billion claim against Russia under Article 26 of the treaty. Steven Theede, then Yukos chief executive officer, stated the essence of their case: "We believe the merits of our case are strong and simple. Our assets were illegally seized. We want them back and/or damages paid."(7)
Group Menatep is seeking to use the consent to arbitrate articulated in the treaty, but the Russian government denies that such consent was ever given - it never ratified the treaty, having agreed only to provisional application under Article 45. The arbitrators must decide whether provisional application of the treaty transfers binding obligations to its signatories and, by implication, jurisdiction to the tribunal.(8)
Russia signed the treaty in December 1994, agreeing under Article 45(1) to apply the treaty provisionally "to the extent that such provisional application is not inconsistent with its constitution, laws or regulations". This so-called 'domestic exception' lies at the heart of Article 45's ambiguity.
Provisional application of a treaty is a common way to give rapid effect to its obligations before a signatory state completes ratification. Russia never ratified the treaty, its appetite ruined by failed negotiations with Europe on the treaty's Transit Protocol. Russia proposed an alternative agreement in July 2009, motivated in part by the treaty's failure to resolve the annual conflict between Russia and Ukraine over transit tariffs. Shortly afterwards, Russia declared under Article 45(3) of the treaty that it would no longer provisionally apply its terms.
Russia's declaration will not silence the disagreements regarding the meaning of provisional application of the treaty. The question has been considered by various arbitral tribunals in Petrobart v Kyrgyzstan,(9) Plama v Bulgaria(10) and, most recently, Kardassopoulos v Georgia.(11) Although there is no binding principle of precedent in international arbitration, arbitral tribunals tend to consider, if not necessarily follow, previous decisions. The cases involving Yukos are the first to confront this issue with respect to Russia, piquing the interest of would-be litigants against Russia under the treaty.
The debate has been extensively discussed, with some scholars arguing that provisional application under Article 45 implies a duty to comply fully with the treaty, while others suggest that the obligations are tempered by the domestic exception.(12)
There is much for the arbitration tribunal to consider. It is unclear how the domestic exception is intended to operate. At the time of signing, other signatories declared under Article 45(2)(a) that they were unable to apply the treaty provisionally. Russia, perhaps in part due to the urgent need for foreign capital after the collapse of the Soviet Union in 1991, made no such derogation. Some scholars believe that Russia thereby waived its right to raise a domestic law exception indefinitely, interpreting the wording of Article 45(1) as a direct reference to the incompatibility declaration under Article 45(2)(a).(13)
The tribunal in Kardassopoulos held that Article 45(1) required Georgia to apply the whole treaty as if ratification had already occurred. However, the domestic exception was held to operate so that a host state is obliged to apply the treaty only to the extent that it does not contravene its laws - an interpretation that calls for a cumbersome analysis of all host state legislation touching on relevant treaty obligations.
The domestic exception has also been interpreted to mean that the concept of provisional application must comply with the signatory's constitution and national laws.(14) In Russia's case, Article 23 of the 1995 Federal Law on International Treaties explicitly permits the provisional application of treaties.
It could be said that that giving any effect to the domestic exception would be a violation of international customary law, which ranks treaty obligations above national laws and establishes that a nation may not use its national laws to derogate from its treaty obligations. Article 15(4) of the 1993 Constitution explicitly gives effect to that principle. In addition, customary international law arguably demands that the reach of provisional application of the treaty be extended by interpreting it in accordance with the treaty's object and purpose.(15)
However, to hold a state fully bound without ratification undermines the state's constitutional processes.(16) Article 86(b) of the Constitution gives the president the right to negotiate and conclude international treaties, but ratification lies with the State Duma and Council of the Federation under Articles 71, 105 and 106(d).
Like all states, Russia is reluctant to be a party to international arbitral proceedings, regardless of whether they arise from provisional application of the treaty or bilateral investment treaties. Nevertheless, official termination of the provisional application will not immediately seal off the treaty as a conduit for arbitration claims, as is noted by Group Menatep's counsel.(17) Article 45(3)(b) of the treaty states that a signatory which provisionally applied the treaty must continue to observe its investment protection and dispute settlement provisions to investments made during that period for 20 years from the date on which the provisional application is cancelled. Given the 15 years of investment in Russia's energy sector - by investors that may seek to claim the benefits of provisional application until 2029 - Russia will remain susceptible to the treaty for some time and the debate over the meaning of provisional application will continue.
Some investors need not rely on the treaty's 20-year tail in order to bring an arbitration claim, as such rights are provided in many of Russia's existing bilateral investment treaties. However, the rate at which Russia signs new bilateral investment treaties is decreasing.(18) Furthermore, the protections that Russia will accept in new agreements are likely to be restricted to the resolution of disputes related to the amount or mode of payment of compensation for expropriation, rather than allowing for the arbitration of disputes over whether expropriation has taken place. Russia's 2001 model bilateral investment treaty does not provide for national treatment, fair and equitable treatment or most favoured nation provisions.(19) This is probably a response to Rosinvestco UK v Russia, in which a most favoured nation clause in the UK-Soviet treaty successfully incorporated arbitration rights found in the treaty between Russia and Denmark.(20) Having revoked the Energy Charter Treaty, Russia may seek to do the same with regard to arbitration rights in existing bilateral investment treaties.
Nevertheless, investment arbitration rights may continue to arise in conjunction with Russia's foreign policy agenda. The Russia-Venezuela treaty gives investors a right to compensation at market value for expropriation and grants them a range of arbitration options. Even though this is regarded predominantly as an incentive for Russian investment in Venezuela, such treaties and terms are reciprocal. Russia has approved a draft agreement of the Eurasian Economic Community designed to encourage investment in the region.(21) The agreement includes provisions on protection against expropriation, compensation and dispute resolution by international arbitration. This could lead to the channelling of investments through companies incorporated in jurisdictions that are covered by the agreement in order to provide a platform for arbitration.
The right to arbitrate against a host state for failure to observe investment protection obligations is a significant factor for potential investors. However, as arbitral proceedings against Russia have shown, foreign investors should be circumspect about the practical benefit of such rights. Of the six known investment treaty arbitrations brought against Russia, only one has led to a successfully enforced award - after 10 years of dogged pursuit.(22)
Russia's withdrawal from the Energy Charter Treaty may have exacerbated general mistrust of Russia, which will resonate in commercial arbitrations. Investors are likely to place greater emphasis on political risk analysis and would be well advised to do so, not only at the investment planning stage, but also throughout the life of the investment in order to keep track of shifting political alliances.
Cautious investors may turn away from direct arbitration against the host state and look to more traditional means of protection. Political risk insurance policies covering expropriation are available from government agencies, such as the Multilateral Investment Guarantee Agency (part of the World Bank) and the Export-Import Bank of the United States. Private insurance companies, such as Lloyds and AIG, also offer policies which can be obtained for old and new projects. While such policies are expensive, they guarantee compensation for the investor; some policies offer insurance against non-enforcement of an award. Such policies also allow an investor to preserve the relationship with the respondent government, as the insurer brings the arbitration claim (using subrogation rights in the relevant bilateral investment treaty). In Russia, where good relations with the government are crucial to a viable business, this is an attractive feature. Russia's termination of provisional application of the treaty is likely to boost the appeal of such policies - and with it their premiums.
Ultimately, Russia's vast natural resources will ensure that inward investment continues, regardless of political risk.(23) As such, Russia may see no need to improve its investment climate. However, this approach may be short-sighted. Foreign investors are likely to 'price in' their mistrust when negotiating an investment;(24) foreign investors may also shy away from long-term commitments in order to reduce their exposure to unpredictable political activity. Russia's reluctance to provide investment protections on its own territory may also harm the prospects of those Russian investors abroad which have taken advantage of investment arbitration against foreign governments.(25) Gazprom, in which the Russian state has a majority holding, has ambitious expansion plans to access Western European and American markets. Treaty signatories enjoy reduced energy financing costs, giving them an advantage over Russian firms in foreign territories.
Russia's energy-reliant economy may not be assisted by the government's abandonment of the treaty,(26) but its impact on the main characteristics of investments and investment arbitration in Russia is likely to be minor. In ar, after the dust has settled on the Yukos jurisdictional award, investment arbitration against Russia will remain an unpredictable source of protection.
For further information on this topic please contact Francesca Albert or Robert Rothkopf at Herbert Smith CIS LLP by telephone (+7 495 363 6500), fax (+7 495 363 6501) or email (email@example.com or firstname.lastname@example.org).
(1) Government Ordinance 1055-r was issued by Prime Minister Putin on July 30 2009. A draft notice addressed to the Government of Portugal, the depository of the Energy Charter Treaty, was attached to the ordinance. Provisional application of the treaty will cease 60 days after notice is received by Portugal (under Article 45(3)).
(8) In a speech to the International Conference on Energy Security in Moscow on March 14 2006, Secretary General of the Energy Secretariat Andre Mernier said: "The extent to which provisional application of [the treaty] creates firm legal rights and obligations for Russia is not entirely clear under international law."
(12) Matthew Belz, "Provisional Application of the Energy Charter Treaty: Kardassopoulos v Georgia and Improving Provisional Application in Multilateral Treaties", 22 Emory International Law Review, 2008.
(24) Walde, The Energy Charter Treaty, page 314 suggests that governments would have to prove that provisional application is outside their powers and in conflict with national law. "This provides investors with a powerful instrument of bargaining leverage, as of now."
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