By 26 January, 2021 0 Comments Read More →

UK court enforced Tatneft’s award despite illegality defense

Ukraine has failed to overturn the enforcement of the investment treaty award won by Tatneft despite a finding by the Commercial Court in London (the „Court”) that a significant portion of the damages awarded related to an illegal purchase of shares.

The Court found that under Ukrainian corporate law Tatneft illegally obtained the investments, and therefore the dispute partly fell outside of the tribunal’s jurisdiction. It refused to set aside an earlier enforcement order, saying the state had raised the objection too late.

Tatneft won the award in 2014 resulting from the loss of its investment in Ukrtatnafta, a joint venture with the Ukrainian government that owned Ukraine’s largest oil refinery. Ukrainian bailiffs seized the refinery in 2007 and a series of court decisions stripped Tatneft and other investors of their shares in Ukrtatnafta. The arbitral tribunal constituted under UNCITRAL 1976 Rules awarded Tatneft US$112 million plus interest over the seizure, which it said amounted to a violation of the Russia-Ukraine BIT (the “BIT“).

This article analyses the Court’s assessment of the parties’ positions regarding the illegality defence.

The Tatneft’s share acquisitions in Ukrnafta

The award comprised $31 million in damages for shares that Tatneft directly acquired in Ukrnafta, and $81 million relating to shares that Tatneft acquired through Seagroup and Amruz (an US and a Swiss company). The last acquisition was made via promissory notes issued by Seagroup and Armuz back in 1999. Later in 2008, the Ukrainian Supreme Court found that the shares’ acquisition via promissory notes was illegal under Ukrainian law.

Illegality argument in enforcement proceedings before English courts

Ukraine argued that the BIT contained a legality requirement, defining the investment as assets made by investors in accordance with the host state’s legislation. Ukraine contended that its offer to arbitrate, and so the arbitration agreement, related only to investments made in accordance with Ukrainian legislation. It further noted that the shares were not so issued to Seagroup and Amruz, relying on the evidence of the State’s expert. This objection concerned only the $81 million claim.

The illegality argument suggested that at the relevant time, the Law on Business Entities specified how members and founding members of a company might make contributions to it. Also, it specified that it was not permissible to do so by way of promissory notes. The evidence brought by Ukraine referred, among others, to a Joint Resolution of the Cabinet Ministers of Ukraine and the National Bank of Ukraine. That resolution restricted the legitimate use of promissory notes for payment and excluded their use to contribute to a company’s charter fund.

Tatneft’s timing defense and the conformity requirement

Tatneft argued that, even if it was apparent from the Ukrainian Supreme Court decisions of 2008 that the shares were issued to Seagroup and Amruz unlawfully, it did not mean that the investments giving rise to the $81 million claim were not made in accordance with Ukrainian legislation. Tatneft submitted that the conformity requirement had to be satisfied at the time of the investment, and there was no contravention of Ukrainian law as it stood at the time of Tatneft’s investment.

Tatneft submitted that, under the definition of “Investments” of the BIT, the question whether an investment complies with domestic legislation was to be assessed at the time that it was made. It does not fall outside the definition if it ceases to be lawful later. Even if such a legal development is relevant at all, it goes only to the merits of a claim, and not to the arbitrators’ jurisdiction. Tatneft also said that, when it made its investment, the acquisition was in accordance with Ukrainian legislation.

Tatneft went on to submit that, therefore, its investment was made at a time when the law of Ukraine held them to be lawful, and the later decisions of the Courts in 2008 did not affect the position as far as the jurisdiction of the Tribunal is concerned. The Court did not accept Tatneft’s objections. According to the Court, the investments that gave rise to the $81 million claim were the investments made by Seagroup and Amruz in 1999. The question of whether they conformed with the legislation of Ukraine in force when Tatneft bought the shares of Seagroup and Amruz was beside the point. 

Finding the illegality argument by the Court

The Court found that for two reasons it could determine the illegality argument without deciding the differences between the parties’ submissions about the meaning of Ukrainian legislation. First, the task was not to interpret the relevant provisions of the Ukrainian legislation but to determine how Ukrainian courts have interpreted and would interpret them. Ukrainian courts would hold that payment by way of promissory notes is contrary to the Law on Business Entities. For this reason, they would so decide the question.

Second, the Ukraine Supreme Court had reached a clear decision that the share purchases of Seagroup and Amruz were contrary to Ukrainian legislation. The English court was not bound in all circumstances to apply a decision of a foreign court. However, when there is a clear decision of the highest foreign court on a question of the interpretation of its legislation, it will be given very great weight against other evidence. According to the Court, there were no special circumstances that would justify a preference for evidence of expert witnesses over the evidence provided by the decisions of the Ukraine’s Supreme Court. Even if there were merit in the criticisms of the Supreme Court, it would not invalidate the reasoning of the Supreme Court’s judgments.

The Court, relying on the Supreme Court decisions, found that the investments were not conforming to Ukrainian legislation, and therefore out of the material scope of protection of the BIT.

Conclusions

The Court accepted Ukraine’s submission that issuing a promissory note did not equate to advance payment for the value of the Ukrnafta shares, which took place at a later date. It, therefore, accepted Ukraine’s argument that the US$81 million claims were based on a purchase of shares that was illegal under the country’s laws and fell outside of the arbitration agreement.

However, as for Ukraine’s sudden introduction of the illegality issue in enforcement proceedings both in the UK and in the US, the Court found it was difficult to accept that the State was pursuing a proper litigation strategy. It appeared that Ukraine had kept the illegality argument “in reserve”, declining to raise it during its earlier sovereign immunity challenge and deploying it at a later stage. Therefore, according to the Court, it would be “unjust” to allow Ukraine to raise the illegality argument at this stage, as it amounted to a collateral attack on the court’s earlier finding that Ukraine had agreed to arbitrate the US$81 million claim. The Court, therefore, rejected the state’s application, saying it was an abuse of process barred by issue estoppel.

About the Author:

Sorin Dolea is a Moldovan lawyer, who obtained Geneva LLM in International Dispute Settlement-MIDS. He graduated with a bachelor degree and LLM in International Law from Moldova State University, Arbitration Academy in Paris and the Hague Academy of International Law (course on the international private law). He specializes in international commercial and investment arbitration and has experience working in a major Austrian law firm for two years.

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