OVERVIEW OF THE YUKOS ARBITRATION
Few arbitration awards in the past years have attracted as much attention as the Yukos arbitration between shareholders of the company and the Russian Federation. After 10 years of proceedings, on 18 July 2014, the Tribunal issued a 600-page award awarding USD 50 billions in damages, legal fees of USD 60 millions and costs of USD 5.6 million. These enormous figures make the dispute the largest investment treaty ever although the Claimants only received 44% of the amount initially claimed.
Factual background of the Yukos arbitration
Yukos Oil Company was one of the symbols of the privatization of the Russian industry after the dissolution of the Soviet Union, incorporated in 1992 and fully privatized by 1996.
The size of Yukos increased significantly from the mid 1990s to the early 2000s; by 2002, it became one of the top 10 oil companies worldwide and number 1 in terms of production of crude oil in Russia. At its peak in 2003, Yukos had 100,000 employees, 6 refineries and market capitalization of USD 33 billions.
In early 2003, Yukos engaged in merger talks with Sibneft which would have made YukosSibneft the fourth biggest oil companies in the world after BP, Exxon and Shell. The merger did not materialize.
In the 1990s, Russia instigated a low-tax-region program to foster economic development in poorer regions according to which local authorities could exempt corporations of some of the corporate profit tax (partially or fully). Yukos availed itself of this tax regime and relocated its trading companies to the low-tax-regions. Yukos then extracted the oil through its extracting companies, sold the crude oil to its trading companies at very low prices which, in turn, either sold it abroad at market price or sold it back to Yukos refineries, re-bought it once refined at a reduced price once and sold it abroad at market price. The Russian Federation asserted that Yukos “increased prices step by step, from sham shell to sham shell to create profit artificially through non-armslength transactions” (Final Award, para. 78). These profits would then be taxed at a very low rate because of the geographic location of the trading companies in the low-tax-regions.
The Federation of Russia accused Yukos of having fraudulently evaded billions of dollars of Russian profit tax from 1999 to 2004 while Yukos contends that it was merely taking advantage of the legislation in place (Final Award, para. 78) but not abusing it.
The Tribunal found that Yukos partially abused the legislation in place but that the Russian Federation’s reaction was far worse as it “launch[ed] a full assault on Yukos […] in order to bankrupt Yukos and appropriate its assets while, at the same time, removing Mr. Khodorkovsky from the political arena” (Final Award, para. 515).
Three shareholders together owned about 70% of Yukos Oil Company and brought separately three arbitrations against the Russian Federation early 2005 (Hulley Enterprises limited owned 56.3%, Yukos Universal Limited owned 2.6% and Veteran Petroleum Limited owned 11.6% of Yukos Oil Company). Three separate awards were issued on 18 July 2014.
The expropriation process
The Tribunal found that the Russian Federation took the following steps to expropriate Yukos:
- Step 1: Respondent first paralysed Yukos through criminal proceedings brought against directors of the shareholders of Yukos Oil Company for fraud, tax evasion and embezzlement. Respondent also carried out interrogations, searches and seizures. In light of these criminal proceedings, the merger with Sibneft did not take place.
- Step 2: a series of tax revaluations carried out by the Russian authorities which led to finding that, by 2006, Yukos owed USD 24 billions in taxes, which of course it was not prepared to pay (USD 11.5 billions in arrears, USD 12.5 billions of interests and fines over a very short period of time (2000 to 2004)). The Tribunal eventually concluded that “the primary objective of the Russian Federation was not to collect taxes but rather to bankrupt Yukos and appropriate its valuable assets” (Final Award, para. 757).
- Step 3: The Russian Federation then seized Yukos’s shares and, in order to pay Yukos’s taxes, sold its main production subsidiary, YNG, in an auction with only one bidder, Baikal, a fake entity bought by the State-owned Rosneft shortly after. YNG was sold for about half of estimates of the Dresder Bank and JP Morgan. The Tribunal found that this was the “fatal blow” to the survival prospects of Yukos (Final Award, para. 1038).
- The Tribunal also found that the bankruptcy proceedings which followed were “the final act of the destruction of the company by the Russian Federation and the expropriation of its assets for the sole benefit of the Russian State and State-owned companies Rosneft and Gazprom” (Final Award, para. 1180).
Finally, in November 2007, Yukos was struck off the register of legal entities and seized to exist.
The Tribunal was composed of:
– Charles Poncet, appointed by Claimant
– Stephen Schwebel, appointed by Respondent
– Yves Fortier, appointed by the PCA
The arbitration was conducted under the auspices of the Permanent Court of Arbitration. The Tribunal applied to UNCITRAL arbitration rules. The seat of the arbitration was The Hague, Netherlands. The claims are based on the Energy Charter Treaty (ECT).
Art. 26 ECT contains the arbitration clause and gives the investors of one contracting state the opportunity to sue either in the national courts or in arbitration.
Claimant claimed that the measures taken by Responded amounted to expropriation under Art. 13 ECT. The Tribunal agreed and thus stated that it did not have to decide whether Art. 10 ETC (fair and equitable treatment) was also breached.
Emmanuel Gaillard, lead counsel for Claimant called this dispute a “mega arbitration”; the Tribunal uses the word “mammoth arbitration” (Final Award, para. 4). The highest claim was for USD114 billions, the proceedings lasted 10 years, there were 6,500 pages of submissions, 11,000 exhibits, 37 days of hearing (21 of which were on the merits), 0 witnesses produced by Claimant and 2 by Respondent at the jurisdiction phase, 8 witnesses produced by Claimant and 0 by Respondent at the merits phase, 4 experts produced by Claimant and 17 by Respondent at the jurisdiction phase, 3 experts produced by Claimant and 11 by Respondent at the merits phase, Eur8.5 millions in arbitration costs, USD 80 millions of legal fees incurred by Claimant’s counsel Shearman&Sterling and USD 27 millions of legal fees incurred by Respondent’s counsel Cleary Gottlieb.
Yukos is likely to target two types of assets at the enforcement stage. First, the assets used by the Russian Federation for commercial purposes can be attached. Second, instrumentalities of the State provided that such instrumentalities are the alter-ego of the State. This second option appears more promising as Rosneft and, in part, Gazprom may be considered as such. The Tribunal gave its view that Rosneft was the alter-ego of the Russian State and stated that “while proof of specific State direction is lacking, it may reasonably be held that the highest officers of Rosneft who at the same time served as officials of the Russian Federation in close association with President Putin acted in implementation of the policy of the Russia Federation” (Final Award, para. 1480).
Moreover, after Rosneft’s acquisition of YNG, President Putin stated to the press on 23 December 2004 that “Today, the state, resorting to absolute legal market mechanisms, is looking after its own interests. I consider this to be quite logical” (Final Award, para. 43).
Setting aside proceedings
The Russian Federation has brought setting aside proceedings before the Dutch Courts arguing the absence of a valid arbitration agreement (that it was not an international arbitration but a domestic tax dispute between Russian oligarchs), that the Tribunal failed to comply with his mandate because it used a new damages calculation which had not been pleaded by the parties nor put to the parties for their comments, that the Tribunal did not personally fulfil its duty as the administrative assistant to the Tribunal spent significantly more time on the award than any of the arbitrators.
In particular, the set aside proceedings brought by Respondent relating to the quantum rely on the ground that the Tribunal did not use an industry standard terminology to value Yukos on 30 June 2014 and neither experts had the chance to comment on Tribunal’s model. Had the experts being given such chance, they would have ensured that the Tribunal’s valuation was consistent in economic and valuation terms, in particular regarding the use of the Oil and Gas Index to reduce the equity value of Yukos before adding hypothetical dividends which are far higher than dividends paid to companies in the Oil and Gas Index. This does not make economic sense as the capital value of the company is linked to its dividends; The tribunal seems to have used one index to determine the value of Yukos and a different index to evaluate hypothetical dividends.
– Olivier Marquais