Yukos Expropriation: At What Cost to Russia?

During the privatization auctions following the Soviet Union's demise Mikhail Khodorkovsky put   together Yukos, an oil and gas company that became the largest privately held energy company in Russia. Ten years later the Russian government launched what some aptly described as "a prosecutorial assault" on the company based on "trumped up tax charges". As a result its stock collapsed and Yukos went bankrupt. Several years later it was disbanded. Its assets were sold off at a questionable auction and eventually acquired by Rosneft at a fraction of their market value.

In a trial widely claimed to have been politically motivated, Khodorkovsky, the company's CEO  and an important political opponent of Vladimir Putin, was convicted of embezzlement and tax fraud. He was handed a lengthy prison sentence and released ten years later after being pardoned by the Russian president in December 2013.

Two cases

Among the numerous legal procedures lodged against the Russian state in connection with the liquidation of Yukos two stand out. Both were brought before independent adjudicative bodies: one before an international arbitral tribunal by the company's major shareholders under the Energy Charter Treaty (ECT), the other before the European Court of Human Rights (ECtHR) by its (50.000) minor shareholders under the European Convention on Human Rights. Both piblished their awards in July.

The first procedure, the arbitration, took place under the auspices of the Permanent Court of Arbitration (PCA) in The Hague and was conducted in accordance with the UNCITRAL Rules of Procedure. In effect it consisted of three separate arbitrations initiated by the shareholders of three companies registered offshore. In the final award(s) gleened from the PCA's website the arbitral tribunal(s)... "unanimously held that the Russian Federation had taken measures with the effect equivalent to an expropriation of Claimants’ investments in Yukos and thus had breached Article 13(1) of the Energy Charter Treaty. As a result, the Russian Federation was ordered to pay damages to compensate Claimants. At the same time, the arbitral tribunals found some contributory fault on behalf of Claimants, leading them to reduce the amount of damages awarded." The tribunal(s) ordered the Russian Federation to pay to the shareholders an amount of approximately $50 billion as compensation to the shareholders for their losses.

The candor with which the arbitrators describe Russia's actions with regard to Yukos is remarkable: “...The primary objective of the Russian Federation was not to collect taxes but rather to bankrupt Yukos and appropriate its assets.” “Russia’s total failure to engage with any of Yukos’s settlement proposals raises significant doubt in the tribunal’s mind as to whether respondent’s true and sole concern in its dealings with Yukos after the tax reassessments were issued was the collection of taxes.” “The totality of the bankruptcy proceedings . . . were not part of a process for the collection of taxes but rather, as submitted by claimants, indeed ‘the final act of destruction of the company by the Russian Federation and the expropriations of its assets for the sole benefit of the Russian state and state-owned companies Rosneft and Gazprom’”. The full text of the arbitral award(s) can be found on the PCA's website (www.pca-cpa.org).

In its judgement on just satisfaction the European Court of Human Rights in Strasbourg ( ECtHR), in turn, ordered the Russian Federation to pay almost €1,9 billion to the shareholders of (OAO Neftayanaya Kompaniya) Yukos in compensation for their losses. In 2011, the Court had already ruled on the merits and found the Russian Federation in violation of certain provisions of the European Convention on Human Rights (ECHR). It did not address the expropriation of the company.

The ECtHR found Russia to have been in violation of Article 6 para's 1 and 3 (b) of the European Convention on Human Rights (right to a fair trial) concerning the tax assessment proceedings for the year 2000 against Yukos because it had had insufficient time to prepare its case before the lower courts. The Court also found violations by Russia of Article 1 of Protocol No. 1 to the Convention (protection of property). It held that "the assessment of the penalties relating to 2000 and the doubling of the penalties for 2001 had been unlawful and that in the enforcement proceedings against Yukos the Russian authorities had failed to strike a fair balance between the legitimate aim of these proceedings and the measures employed – in particular by being inflexible regarding the pace of the proceedings and obliging Yukos to pay excessive fees." For the full text of the 2011 and 2014 judgements readers should go to the Court's website (www.hudoc.echr.coe.int).

Although the amounts of compensation might be justified given its market value at the time of liquidation of Yukos, they constitute historical highs in both cases. Even in the realm of international investment arbitration where high compensation awards are common an award of $50 billion is unparalleled. It is understandable therefor that the arbitral award grabbed the headlines last July. Yet, the ECtHR's judgement is in certain ways more exceptional still and not just because of the high award on damages which, admittedly, is unprecedented in the human rights field.

According to some observers the amount awarded in the just satisfaction case doesn't logically follow from the earlier judgement on the merits and would have benefitted from more in-depth reasoning. This would have also avoided the mischievous type of questions circulating after the award's publication such as whether there had been, perhaps, some sort of institutional competition between the judges and the arbitrators. Some observers opine that in the merits case the ECtHR "avoided the obvious truth that Russia expropriated Yukos, while finding a few seemingly marginal violations of human rights (and deferring the question of damages)". One commentator even criticized the Court for having failed "the test of speaking truth to power, and for lacking the arbitrators' nerve". Although this criticism might have some merit this commentator's interpretation that the high award on damages might be an overcompensation for "its earlier cowardice by getting historically tough on damages" seems to be stretching it.

Enforcement

Judgements of the ECtHR become final three months after they are issued unless a reference is made to the Grand Chamber for review or appeal. The Russian government has announced it will appeal the decision on just satisfaction. If the panel of the Grand Chamber rejects the request for referral, the judgment of the Chamber of the Court becomes final. The Court’s decisions on just satisfaction are binding on the state parties since these have, in acceding to the Convention, undertaken to abide by the Court’s judgments. The Committee of Ministers supervises the execution of these judgments. Time will tell if the Russian Federation will comply. Many observers expect it will not. Non-compliance can lead to (further) damage of Russia's reputation in the Council of Europe and the ECtHR. On the other hand, if Russia is indeed successful in its appeal it might well be the ECtHR that suffers the most damage.

The award of the arbitral tribunal cannot be appealed. That is simply put the way international arbitration works. It can, however, be challenged on a limited set of grounds before domestic courts in the place of arbitration. In this instance it could be challenged in Dutch courts as the place of arbitration was The Hague. This is what the Russian government has announced it will do. One may assume that, among other things, it will argue that the arbitral tribunal had no jurisdiction since the Russian Federation never ratified the Energy Charter Treaty. Such logic would dovetail the reasoning of its earlier attempt to challenge jurisdiction before the arbitral tribunal itself. This challenge revolved around article 45 of the Convention dealing with immediate provisional application (in other words: pending ratification) and the interpretation of this article's "limitation clause". Russia's challenge failed, however, and was dismissed by the arbitral tribunal in an interim award on admissability and jurisdiction.

With its more than 230 pages the interim award is as comprehensive as it is thorough, with extensive witness testimony offered by a long list of international law experts including Prof. James Crawford (Cambridge) and Prof. Michael Reisman (Yale). The full text of the interim award is available on the PCA's website. Russia's challenge before Dutch courts on these and/or other grounds is unlikely to succeed in light of the high quality and extensive experience of the arbitrators (including a former president of the International Court of Justice).

Enforcement of the arbitral award has a greater chance of success than that of the ECtHR judgement on just satisfaction. Procedures are expected to focus on attempts of claimants to seize respondent's assets abroad. This practice is possible under the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards but the procedures in question could run into difficulties due to the doctrine of state immunity. Although state immunity is not one of the explicit grounds to refuse enforcement, Russia could counter legal actions of claimants with an immunity defense through the public policy exception in Article 5 (2)(b) of the Convention.

And this is where article 3 of this Convention becomes relevant. Article 3 provides that states parties to the convention shall "enforce arbitral awards in accordance with the rules of procedure of the territory where the award is relied on". In other words: claimants will have to consider the domestic immunity laws of the places where possible assets are located very carefully. Based on earlier experience in the Noga case claimants will seek enforcement of the award in a jurisdiction where defense of state immunity from enforcement is "limited" to clearly defined State assets (e.g. embassy properties) and excludes from state immunity defense assets that whilst state-controlled clearly function in the commercial realm.

Certain practioners argue that in attempts to seize assets of the Russian Federation abroad, claimants should start with Rosneft and Gazprom. Given the findings of the arbitral tribunal regarding the role of these two companies in the Yukos expropriation (see above), seizure of their assets might well be the most appropriate way to serve justice. Whatever the outcome of these proceedings, any publicity about their progress (or lack thereof) is already bound to add to a further decline of investor confidence in a country where the most basic features of the rule of law are woefully lacking.