Newly Released Arbitration Award Says Yukos Was Expropriated

An arbitral tribunal in Stockholm concluded in an award released yesterday that tax assessment measures taken against Yukos were arbitrary and discriminatory. The proceedings were instituted by a group of Spanish investors in 2007. The award also confirmed that the claimant’s expenses in the arbitration were entirely funded by the Menatep Group (Yukos’ majority shareholder) which explains how a group of shareholders which owned c. USD 2 million in Yukos shares was able to finance the arbitration.  The claim was likely used as a “template” for future claims by Yukos’ foreign minority shareholders (which held c. 30% of its shares) potentially covered by Russian BITs.

The tribunal comprising of Jan Paulsson, Charles Brower and Toby Landau QC considered the case Quaskar de Valores SIVA V.S.A. et al. v The Russian Federation under the rules of the Arbitration Institute of the Stockholm Chamber of Commerce. The case arose out of the various state actions taken against OJSC Neftenaya Kompaniya Yukos (“Yukos”), once the largest private oil company in the Russian Federation. After its ultimate majority shareholder, Mr Khodorskovsky, was jailed various tax claims eventually amounting to over USD 20 billion were brought against it.

Eventually the company was declared bankrupt and its assets auctioned with the major part of them ending up with Russian state-owned companies.

The tribunal largely agreed with the award rendered in RosInvestCo v The Russian Federation, where a different panel had concluded that the actions of the Russian authorities amounted to expropriation (in a dispute brought by a UK shareholder of Yukos). The Quaskar tribunal was far more critical of the ECHR judgment in Yukos v Russian Federation, distinguishing it on the basis of a different standard having been applied and at one point stating that the ECHR “appears… to have entirely missed the point being made [with respect to VAT refunds]”.

The award comes only a few months before the merits hearing in the three arbitrations initiated by Yukos’ majority shareholders under the Energy Charter Treaty. According to the Investment Arbitration Reporter the hearings will take place in October.

Taxation as Expropriation

The tribunal in Quaskar began with the familiar proposition that bona fide taxation does not constitute expropriation. It stressed that the good faith of states in such cases should be presumed. However, it went on to note that this presumption may be, and indeed was, rebutted in the case.

The award looked cumulatively at three aspects of the Russian Federation’s actions against Yukos – the tax claims; enforcement of those claims; and overall purpose of the actions (including bankruptcy) – to assess whether their purpose was the genuine collection of taxes or concealed expropriation of the investment.

With respect to the tax claims the tribunal began by disagreeing with the ECHR and holding that the Russian Federation should have been aware of the use of internal tax havens by Yukos to reduce its tax liabilities.

It went on to observe that the structure used by Yukos (selling oil to shell companies located in Russian low-tax regions at low prices with those companies then selling oil to ultimate customers) should have been challenged by the authorities on the basis of transfer pricing regulations rather than blank characterisation as an “abuse”. The arbitrators stressed that they saw nothing reproachable in a taxpayer using loopholes in the tax legislation to obtain an advantage.

Furthermore, the tribunal took issue with the Russian tax authorities’ decision to treat the intermediary companies as “shams” and Yukos as the real owner of the oil (and thus the payer of profit tax) holding that such an argument had no support in Russian law. Finally, the arbitrators criticised the authorities’ refusal to grant Yukos a VAT refund for the oil exported by the intermediary companies which the authorities themselves claimed was effectively owned and exported by Yukos.

Turning to the enforcement of the tax claims against Yukos the tribunal took issue with the authorities’ refusal to consider Yukos’ requests for deferral of payment or settlement of claims as well as the auction of shares in Yuganskneftegaz (the principal oil-producing subsidiary of Yukos).

With respect to the deferral the arbitrators noted that given Yukos’ prominence and size the Russian authorities should have at least considered those proposals instead of ignoring them. The tribunal’s stance may have been affected by the fact that Rosneft (a Russian state-owned company, which purchased a major part of Yukos’ assets) was subsequently able to obtain a deferral with respect to similar liabilities.

With respect to the auction of Yuganskneftegaz, the award questioned (i) the necessity of selling the shares in that company given that the revenue derived from it could have been used to repay the tax arrears, (ii) the speed with which the sale was completed and (iii) the buyer (an unknown company which was acquired by Rosneft shortly after the auction). On this basis the tribunal concluded that the auction was not a bona fide enforcement measure.

Turning to the Yukos’ eventual demise the tribunal asked the question “Was Yukos’ tax delinquency a pretext for seizing Yukos assets and transferring them to Rosneft?”. The award then considers three sets of circumstances.

First, the arbitrators concluded that the commencement of bankruptcy proceedings against Yukos was not really necessary because at the time the bulk of its debts were owed to the Russian tax authorities and state-owned Rosneft. Hence there was no need to guarantee and balance the interests of all the creditors (the purpose of legitimate bankruptcy proceedings).

Second, the award criticised the rejection of the restructuring plan submitted by the management of the company during the bankruptcy proceedings.

Finally, the tribunal stated that the liquidation auctions in which a major part of the assets was acquired by Rosneft “were part of the same overall scheme of confiscation”. In considering the various actions of the Russian authorities during the bankruptcy proceedings the tribunal repeatedly stressed that, even though they may have been technically legal, the task of the tribunal was to look at their effect.

Amount of Compensation

With the claimants being portfolio investors the tribunal decided to use the market value of the shares to determine the amount of compensation. It then decided that the value should be calculated as of the date of expropriation, which was held to be 23 November 2007 (the date of liquidation of Yukos). While the Russian Federation contested this date (arguing that according to the claimants’ own argument the expropriation took place earlier) the tribunal dismissed its objections noting that it had failed to suggest an alternative.

To arrive at the market value of Yukos shares on 23 November 2007 the claimants relied on an expert report, which used the price of Yukos shares in June 2004 and then projected it onto 2007 based on performance of the shares of four other Russian oil companies (Lukoil, Surgutneftegaz, Bashneft and Tatneft). The tribunal noted that the calculation of a possible market value was not a precise science and that the Russian Federation did not produce an alternative valuation.

In the end it reduced the claimants’ valuation by 23% and ascribed an approximately USD 60 billion dollar value to Yukos as at 23 November 2007. The tribunal then went on to dismiss the respondent’s objection based on the time of the purchase of the shares (which for some claimants was after the original steps against Yukos had been taken). According to the tribunal, the investors were not required to foresee that the Russian Federation would expropriate Yukos.

Funding by Menatep

During the course of the proceedings claimants’ counsel admitted that the costs of arbitration were funded by Yukos’ majority shareholder Menatep. In the end these costs amounted to over USD 14.5 million.

The Russian Federation relied on this fact to argue that the proceedings were an abuse of the BIT’s remedies and the claimants indeed had no independent interest in the prosecution of their claims. However, the tribunal dismissed this argument, noting that there was nothing abusive about a “Good Samaritan” offering his assistance.

However, the tribunal denied the claimants’ requests to recover costs that were incurred from the Russian Federation. It was careful to distinguish the case from the usual third party funding arrangement, where the funder has a legal entitlement to recovery. In the case before the tribunal however claimants’ counsel conceded that the claimants had nothing more than a “moral obligation” to share their recovery with Menatep.

The award is available here.

About the Author:

Sergey Usoskin is an advocate (member of the Russian bar) and a senior associate at Ivanyan&Partners. He has experience advising clients on and representing them in commercial and investment arbitration matters as well as before the Russian court (including the Supreme Commercial Court). He is a graduate of St Petersburg State University, Faculty of Law and University College London Faculty of Laws.

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