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The Value of Expropriated Oil Assets Arbitrated at ICDR Y&I Seminar in Moscow

oil filedOn 26 September the International Centre for Dispute Resolution Young & International (ICDR Y&I) held a seminar on damages in international arbitration on the premises of the Independent Arbitration Chamber, Moscow. The discussion focused on two issues: (i) valuation date and (ii) pre-award interest.

Ms Noradèle Radjai (member of the Executive Board of ICDR Young & International) and Mr Alexey Kostin (Chairman of the International Commercial Arbitration Court at the Chamber of Commerce and Industry of the Russian Federation) welcomed the participants.

Ms Radjai gave a general overview of the ICDR Y&I, which consists of 2,300 associates all over the world and has already organised more than a hundred events in 35 cities. Mr Kostin noted that he was very impressed by the list of participants and expressed his hope that the role of Moscow as a global meeting point for arbitration lawyers will increase in the future.

The Arbitration

The panel discussed “Damages in International Arbitration: Is It All About the Money?” in the form of a mock arbitration hearing. Ms Laura Hardin (Vice-President of Charles River Associates) moderated the session and acted as the “sole arbitrator”. Ms Maria Kostytska (Winston & Strawn LLP, Paris) represented the claimant and Ms Hagit Elul (Hughes Hubbard Reed LLP, New York) – the respondent.

Ms Hardin started with a description of the facts of the mock case Titan Petroleum v. The Republic of Neftistan. The case dealt with the government’s alleged expropriation of the claimant’s oil and gas property in the south-eastern part of Neftistan named Glubokaya Yama Field. The investor, Titan Petroleum (a resident of neighbouring state Grubiland, with a logo pretty similar to that of British Petroleum) experienced some “little tax problems”. They arose after Neftistan adopted the new tax on revenue law that introduced a 60% revenue tax rate for every oil and gas company that lacked legal presence in every major city of the country (further increased to 95% later).

Titan challenged the new law. Meanwhile, the State Tax Service advised the company that it owed $95 mln in unpaid taxes and started collecting the tax later the same year. Furthermore, it commenced a criminal investigation against the company’s management and imprisoned the CEO of Titan’s subsidiary. Later, Brutoil, a company majority-owned by Neftistan, took over the oil field. Titan together with its subsidiary commenced arbitration against Neftistan under the Grubiland-Neftistan BIT.

The Valuation Date

The first issue of the mock case was to determine the assets’ valuation date for the purposes of the damages calculation, i.e. whether it should be the date of alleged expropriation, or the current date or the date on which the creeping expropriation commenced.

For the claimant, Ms Kostytska argued that the tribunal should adopt current date valuation. The current valuation amounted to $2.1 bln, i.e. three times the original investment. She claimed that the expropriation was illegal and therefore pursuant to the famous holding of the Permanent Court of International Justice in the Chorzow Factory case the claimant was entitled to full compensation of the incurred damages.

The actions of Neftistan constituted illegal expropriation. First, it failed to pay compensation. Second, the state applied the tax law in a discriminatory manner. Finally, the expropriation could not have served any public interest, since a private company, Brutoil, took over the assets. Alternatively, the claimant requested compensation in the amount of $1.4 bln, the price a Chinese buyer offered for the company’s assets in 2008.

Ms Elul for the respondent argued that Nefitstan legally expropriated the assets and therefore the valuation date should be the date of expropriation. Accordingly, the compensation should amount to $128 mln. She also dismissed the alternative valuation approach suggested by the claimant and based on the Chinese buyer’s offer.

She claimed that the tribunal should not rely on the offer, since both the CEO of Titan and the Chinese investor were imprisoned for fraud and tax evasion, and the market value of similar assets ranged in hundreds, not billions of dollars. The Forum’s Russian readers will find the names of the other assets (oil fields) quite entertaining. They were “Poteryannaya Molodost”, “Spyashiy Vulkan”, “Malenkaya Yama”, “Spokoiny Nochi”, “Zolotoy Telenok” and to my mind the most obscure one “Shastlivaya Cheburashka”.

After half a minute of deliberation, the Tribunal ruled for the State on the valuation date, finding that it preferred the date of expropriation as the valuation date. However, it found that the valuation must pay due regard to the offer made by the Chinese buyer, since the State failed to disprove the bona fide nature of the offer.

Pre-Award Interest

The Tribunal next had to decide whether it should award pre-award interest, which compensates the claimant for being deprived of funds for the period between the valuation date and the award. The pre-award interest rate is hard to determine. The difficulty is to choose between the risk-free rate, borrowing rate for the claimant, borrowing rate for the respondent (so called “coercive loan approach”) or rate of return expected by the claimant from the investment.

Titan asked for the average rate of return on other companies’ projects (with the minimal return of 4% and the maximum of 25%, the average being 17%). Among the other possible amounts of the pre-award interest, counsel for the claimant asked for the sum of the company’s alternative investments during the same period of time that could have happened but for the expropriation. The government’s borrowing rate equal to the interest rate on the government’s bonds could have served as another benchmark. The company’s borrowing rate represented the fourth alternative (although no loans were taken for Glubokaya Yama Field exploration, Titan carried out other projects and borrowed money for them).

Neftistan argued that under the “just compensation” provided by the BIT no interest should be awarded. Any interest would amount to unenforceable punitive damages that are expressly banned under the ICDR Rules.

The Tribunal expressed uncertainty about the exact method and asked for the expert advice of Mr Vasily Anurov (Moscow State Law Academy, Moscow). Mr Anurov started with a review of the application of interest rates in prior cases involving Russia and other CIS states. He then gave a general overview of the treatment of compound interest and punitive damages under Russian law. The Russian Civil Code does not mention compound interest, but currently the State Duma is considering amendments to the Code, which will permit compound interest to be applied where parties have agreed to it. In turn, punitive damages are currently not enforceable under Russian law as expressly stated in the Review of Practice on Public Policy adopted by the Supreme Commercial Court on 26 February 2013.

On the second issue, Ms Hardin expressed only her expert view. She told the audience that she considered the rate of return on similar investments as the optimal rate, because it better suits the purpose of putting the investor whole. A risk-free rate reflects the floor-limit of the possible losses, whereas the cost of borrowing for the claimant rate may dependent on a number of unrelated factors (such as the general standing of the claimant) and does not necessarily accurately reflect the claimant’s actual loss.

Maxim Usynin

Student, Russian School of Private Law

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