Although finding largely in favour of Venezuela, ICSID tribunal awards US$1.4 billion to Exxon-Mobil for 2007 expropriations
Venezuela Holdings, B.V., Mobil Cerro Negro Holding, Ltd., Mobil Venezolana de Petroleos Holdings, Inc., Mobil Cerro Negro, Ltd., and Mobil Venezolana de Petroleos, Inc. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/27
An arbitration at the International Centre for Settlement of Investment Disputes (ICSID) brought by a group of Exxon-Mobil subsidiaries against the Bolivarian Republic of Venezuela has reached the award stage.
The claimants failed to convince the tribunal that Venezuela’s 2007 expropriation of two oil projects had been unlawful. The tribunal also sided with Venezuela in its quantification of compensation owing due to the nationalizations.
Nonetheless, the claimants were awarded US$1.4 billion (significantly less, though, than the initial ask of US$16.8 billion). The award is subject to being offset by an earlier award in a related, contract-based arbitration.
The five claimants are all subsidiaries of Exxon-Mobil, the international oil major. In February 2006, Exxon-Mobil restructured its Venezuelan business under the Netherlands–Venezuela bilateral investment treaty (BIT). In its 2010 Decision on Jurisdiction, the tribunal affirmed jurisdiction only over disputes arising after the 2006 re-organization.
The claimants were investors in a joint venture in the Cerro Negro heavy oil project with Venezuela’s national oil company, PDVSA. They also entered into an income-sharing agreement with Venezuela in relation to the La Ceiba medium crude project.
In 2001 Venezuela amended its Hydrocarbon Law to expropriate foreign investors in the oil and gas industry, to the exception of Cerro Negro, La Ceiba and others. In August 2006, Venezuela amended its Income Tax Law such that Cerro Negro was no longer eligible for the general corporate rate and instead had to pay the higher rate applicable to the oil industry. From late 2006 through the first part of 2007, Venezuela imposed a series of production and export curtailments on Cerro Negro.
In January and February 2007, a series of public announcements, including by then President Hugo Chávez, made it clear that Venezuela would nationalize both projects. Venezuela did not dispute in the arbitration that it had ultimately expropriated the Cerro Negro and La Ceiba projects in June 2007. The arbitration dealt with the lawfulness of the takings and on the amount of compensation owing.
Claimants fail to establish that nationalization was unlawful
The claimants submitted that, as the expropriation was unlawful, they were entitled to full reparation for damages caused under international law. By contrast, Venezuela contended that the expropriation was lawful and that the claimants were entitled only to the investments’ market value as of the date of expropriation, as provided for in Article 6 of the BIT.
The tribunal considered the three prongs of the claimants’ submission on the unlawful nature of the expropriation, namely, that the measures complained of did not follow due process of law, were contrary to Venezuela’s undertakings, and were not taken against any compensation, let alone just compensation.
In terms of due process, the tribunal considered that the expropriation was a result of laws enacted by the National Assembly and of decisions taken by the President of Venezuela, which prompted four months of negotiations with affected oil companies. Although the claimants characterized these negotiations as coercive, the tribunal noted that the negotiations had been successful with other companies, such as Chevron, Total, Statoil, Sinopec and BP. The tribunal ultimately found that this process, which enabled the claimants to weigh their interests and make decisions during a reasonable time, was compatible with the due process obligation of Article 6 of the BIT.
Moving on to the issue of the undertakings, the claimants alleged that the 2001 Hydrocarbon Law specifically provided that it would not apply to additional projects, such Cerro Negro or La Cieba. However, the tribunal observed that regulatory approvals associated with the specific projects made clear that the 2001 Hydrocarbon Law neither imposed any obligations on Venezuela nor restricted its sovereign power. The tribunal found no indication that Venezuela later committed not to exercise its sovereign right to expropriate; accordingly, the expropriation was not carried out contrary to undertakings given in this respect to the claimants.
Finally, with regards to compensation, the tribunal observed that the mere fact that the investors had not received compensation could not in itself render the expropriation unlawful. Rather, an offer of compensation may have been made to the investors and, in such a case, the legality of the expropriation depended on the terms of that offer. As the burden of proof fell on the investors, the tribunal found that the evidence submitted failed to demonstrate that the proposals made by Venezuela were incompatible with the requirement of “just” compensation of Article 6(c) of the BIT.
Ambitious expansion plans for largest asset fail to stick with tribunal in net cash flow determination
The tribunal noted that Article 6 of the BIT requires that “just compensation” be paid to the claimants and that such compensation must “represent the market value of the investments affected immediately before the measures were taken or the impending measures became public knowledge, whichever is the earlier.” In the present case, the tribunal found that the market value must be determined immediately after the failure of the negotiations between the parties and before the expropriation, and that it must correspond to the amount that a willing buyer would have been ready to pay to a willing seller.
With respect to Cerro Negro, the parties agreed that the above evaluation must be made in accordance with a discounted cash flow (DCF) analysis. However, they diverged in their estimates of the appropriate net cash flow and discount rate. In terms of net cash flow, the tribunal rejected the claimants’ projection of expanded production on the basis that a prospective buyer in 2007 could not have taken for granted the required regulatory approval. As a result, the claimants’ estimates of production volume were divided by a factor of three, in a major reduction in the amount of compensation. The tribunal further deducted 50 per cent towards income taxes.
Discount rate must include all aspects of country risk including confiscation
The next step in the DCF analysis was the application of a discount rate to the present value. The tribunal agreed with Venezuela that the claimants’ proposed 8.7 per cent discount rate was too low. Instead, it was appropriate to factor in country risks and especially the risk of confiscation in the case of an international oil project. The tribunal was not sympathetic to the claimants’ position that the confiscation risk should not be a factor, as the BIT explicitly sets out a requirement for compensation in case of confiscation.
The tribunal observed that all of the models, including confiscation risk, produced a discount rate between 18 and 24 per cent. It further observed the discount rates adopted by other arbitral tribunals in comparable circumstances, ranging from 18 to 21 per cent. These included an International Chamber of Commerce (ICC) tribunal, which had decided a contractual dispute between related parties over Cerro Negro. The ICC tribunal had applied a discount rate of 18 per cent, which the ICSID tribunal decided to adopt.
Parallel arbitration under contract means that double recovery must be avoided
As noted above, prior to the conclusion of the ICSID arbitration, an ICC tribunal issued an award in relation to Cerro Negro. This tribunal found for Exxon-Mobil; as a result, PDVSA pledged to indemnify the relevant Exxon-Mobil subsidiary. The ICSID tribunal was at pains to ensure that there was no double-recovery, and stated for the record the claimants’ representation that, if they were awarded compensation in the ICSID case, they would reimburse the losing party in the ICC case.
In absence of discounted cash flow analysis, tribunal calculates compensation based on investment sunk in smaller project
The tribunal also determined compensation for expropriation of La Cieba, which had not advanced to the production stage. Here, the parties agreed that a DCF analysis was inappropriate. The tribunal declined Venezuela’s suggestion that compensation be based on an earlier negotiated settlement with Exxon-Mobil’s former partner. As a result, it based its calculation on the total sunk investment of US$179 million made by the claimants.
Pre-expropriation fair & equitable treatment claims fall flat
Although the claimants sustained certain narrow breaches of the BIT’s fair and equitable treatment (FET) obligation, the tribunal dismissed most of those claims. Of particular interest, it found that the BIT’s FET provision does not protect foreign investors against tax measures.
Claimants fail to recoup costs
Finally, without giving reasons, the tribunal ordered each party to bear its own costs and fees. Interestingly, the ICC tribunal had adopted the same approach.
Notes: The tribunal was composed of Gilbert Guillaume (President appointed by the Chairman of the Administrative Council, French national), Gabrielle Kaufmann-Kohler (claimants’ appointee, Swiss national), and Ahmed Sadek El-Kosheri (respondent’s appointee, Egyptian national). The award of October 9, 2014 is available at: http://italaw.com/sites/default/files/case-documents/italaw4011.pdf
ICSID tribunal orders Venezuela to pay damages and finds denial of justice by the country’s highest court
Flughafen Zürich A.G. and Gestión e Ingeniería IDC S.A. v. Bolivarian Republic of Venezuela (ICSID Case No. ARB/10/19)
Martin Dietrich Brauch [*]
In an award dated November 18, 2014, an ICSID tribunal ordered Venezuela to pay damages for the expropriation of the General Santiago Mariño international airport, Venezuela’s second largest. The claimants were Swiss-based Flughafen Zürich A.G. (Flughafen) and Chile-based Gestión e Ingeniería IDC, S.A. (IDC).
The tribunal awarded damages of more than US$32 million, including interest, if paid by Venezuela by the end of 2014. Venezuela was also ordered to pay almost US$2.4 million in costs and legal expenses.
In comparison with recent investment treaty awards, the legal grounds in this case might be considered unsurprising, and the amount of compensation, unimpressive. Yet the award contains a particularly notable element: a majority finding of a denial of justice in a decision of the Tribunal Supremo, Venezuela’s highest court.
Factual background and claims
The Venezuelan state of Nueva Esparta and a consortium formed by Flughafen and IDC began discussing the privatization of the airport in 2001. Under the Venezuelan Constitution, to enter into a public interest contract with a foreign enterprise, Nueva Esparta was required to obtain approval from the national parliament. The state requested the approval, but time passed without a definitive response. Flughafen and IDC decided to establish offices in Venezuela. In February 2004, by both a strategic alliance contract and a state decree expressly authorizing the contract, Nueva Esparta awarded to the consortium the administration, control and operation of the airport.
The investors took over the airport in March 2004, and legal battles started already in November in the same year. The newly elect governor initiated several proceedings to invalidate or revoke the concession, ordered an intervention, and ultimately took control of the airport by force. The investors, in response, regained control through court injunctions that safeguarded their contractual rights. In mid-July 2006, the state changed its strategy. It revoked its previous acts and enacted Decree 806: invoking a contract clause, it took over the airport and terminated the contract for reasons of public interest, recognizing the investors’ right to compensation.
The Venezuelan Supreme Tribunal first came into play in 2005, when the investors sought relief from the court. It removed all cases between the investors and the state to its own docket, as it considered that the state acts had created a situation of legal insecurity affecting the public interest. It also created an intervention board to manage the airport while the cases were pending. In 2007, the investors asked the court to invalidate Decree 806, claiming that it was unconstitutional and illegal. While in 2008 the court had indicated that it would decide the challenge, in March 2009 it issued an order remanding the cases to a lower administrative court, extinguishing the intervention board, and handing the airport over to the federal administration.
The investors sought to clarify the Supreme Tribunal’s ruling, to determine whether the handover was interim or definitive. In its clarification, the tribunal stated that, given the circumstances of the dispute, the airport could not be given back to either of the parties. It indicated that the handover to the federal administration would last until the administrative proceedings before the administrative court were concluded, but highlighted that the federal administration could adopt other measures within its authority over airports. The tribunal had recognized federal authority over all airports just a few months earlier, in separate proceedings for the interpretation of a constitutional provision. Once the parliament enacted a law based on the tribunal’s decision on federal authority over the airport, the Santiago Mariño airport was consolidated in the hands of the federal administration.
The investors initiated arbitration against Venezuela in mid-2010, based on the Switzerland–Venezuela and the Venezuela–Chile bilateral investment treaties (BITs). They claimed that Venezuela breached the BITs by expropriating their investment, failing to meet the fair and equitable treatment (FET) standard, and subjecting the investment to arbitrary and discriminatory measures. They also advanced a claim of denial of justice, in breach of customary international law. Flughafen and IDC asked for compensation of roughly US$40 million each, plus interest and legal costs. Venezuela requested that the tribunal declared its lack of jurisdiction or, in the alternative, denied all claims.
Corruption. Venezuela argued that the investors had obtained the airport concession by corrupting the governor of Nueva Esparta, and therefore failed to comply with the general requirement that investments, to be protected by the BITs, must be made in accordance with the law of the host state. Citing to Plama v. Bulgaria, Phoenix v. Czech Republic and Saur v. Argentina, the tribunal emphasized that, even if the requirement were not expressly mentioned in the BITs, it is an implicit condition in any BIT. Examining the evidence brought before it, the tribunal considered that Venezuela did not meet its burden of proving corruption.
Noncompliance with Venezuelan law. According to Venezuela, the concession contract did not comply with the federal and state constitutions and relevant statutes, in breach of the requirement that concessions must be granted in accordance with the public law of the host state in order to be considered covered investments. After analyzing the applicable laws, the tribunal found that the contract was not awarded in breach of any of them. In particular, it interpreted that Venezuelan law did not require legislative authorization for Nueva Esparta to enter into the contract, given that Flughafen and IDC had established offices in Venezuela. It also agreed with the investors that, since the Venezuelan courts had never invalidated the contract, it had to be considered valid.
Breach of contract, not of international law. Venezuela contended that the investors were merely attempting to “relabel” the dispute: rather than a dispute about internationally wrongful acts in breach of the BITs, Venezuela stated that it was a contract law dispute, concerning an alleged breach of the strategic alliance contract. It also stated that the investors could only bring the dispute before the tribunal if the BITs contained umbrella clauses. The tribunal, however, dismissed these objections, pointing out that the investors never claimed that Venezuela had breached the contract, but that it had breached its international obligations by expropriating their investment. Whether the BITs contained umbrella clauses was, therefore, irrelevant.
Venezuela objected to the tribunal’s jurisdiction on various other grounds—arguing that the investors did not make significant economic contributions nor assume investment risks; that Flughafen (as an enterprise partly owned by the Swiss Confederation) was a public instrumentality exercising governmental functions rather than a covered private investor; and that Venezuela had not consented to the consolidation of the claims. The tribunal, however, dismissed all objections and upheld its jurisdiction.
The tribunal held that the measures taken by Nueva Esparta and the Supreme Tribunal constituted a direct expropriation—specifically, a nationalization—of Flughafen and IDC’s investment in the airport, in breach of Venezuela’s obligation under the BITs. It also held that the expropriation was unlawful, given that it was not carried out in accordance with due process of law and that the investors did not receive the compensation to which they were entitled.
Fair and equitable treatment
The investors asked the tribunal to declare that the same conduct characterized as an expropriation also constituted a breach of the FET standard, but claimed no additional compensation. While they stated that the acts of the new governor of Nueva Esparta were arbitrary and discriminatory, in violation of FET, Venezuela counterargued that the administrative proceedings were corrected by the courts of law, attesting to the proper functioning of the rule of law in the country. Here, the tribunal sided with Venezuela: it held that, by effectively defending internal legality, the administrative courts prevented Venezuela from committing an international illicit. Accordingly, the tribunal dismissed the claim of FET violation.
Denial of justice
The tribunal characterized the Supreme Tribunal’s decision of March 2009, which remanded the proceedings back to the lower court and handed the airport to the federal administration, as a long document with “rather precarious” reasoning. It stringently criticized the handover of the airport to the federal government. In this regard, and seeing no reasonable expectation that the pending appeals could restore the investors as administrators of the airport, the majority tribunal held that the Supreme Tribunal’s decision consisted in a denial of justice.
According to the majority, the Supreme Tribunal’s decision was procedurally flawed, as it was delivered in the absence of a petition by any of the parties, and without giving them—either the investors deprived of their right of managing the airport or the federal government charged with running it—an opportunity to intervene. Furthermore, the tribunal affirmed that the decision lacked grounds and reasoning, in that it failed to refer to its supporting law, and contradictorily justified the handover of the airport to the federal executive power on the same grounds that had been earlier used to justify the creation of the intervention board. Finally, for the tribunal, the real reason behind the Supreme Tribunal’s decision was “the objective of consolidating the policy of centralizing in the National [Executive] Power the authority over airports” (para. 692).
Arbitrator Raúl Emilio Vinuesa concurred in the finding of expropriation, but on different grounds, dissenting from his co-arbitrators with respect to the finding of denial of justice. According to him, an expropriation did occur when the airport was consolidated definitively in the hands of the national administration. However, he found that this happened not by force of the Supreme Tribunal’s decision, but by a federal decree that, enacted twenty days later, established federal authority over the airport.
Notes: The ICSID tribunal was composed of Juan Fernández-Armesto (President appointed by the Chairman of the Administrative Council, Spanish national), Henri C. Álvarez (claimants’ appointee, Canadian national) and Raúl Emilio Vinuesa (respondent’s appointee, Spanish and Argentine national). The final award of the tribunal and the partial dissent by Raúl Emilio Vinuesa are both available in their Spanish originals at http://www.italaw.com/cases/1524.
Expropriation claims dismissed: Hungary terminated concession on good-faith contractual grounds
Vigotop Limited v. Hungary (ICSID Case No. ARB/11/22)
Martin Dietrich Brauch [*]
Expropriation claims against Hungary were dismissed in a case concerning the investment of Cyprus-based claimant Vigotop Limited (Vigotop) in King’s City (KC), a project to build a large tourist resort. In its award of October 1, 2014, the ICSID tribunal noted that the investor had breached the concession contract, and that Hungary terminated it on contractual grounds without abuse of right.
Considering Hungary as a potential location for the KC Project, Vigotop first approached the Hungarian authorities in mid-2007. The investor owned plots of land in Albertirsa and Pilis, in Central Hungary, but identified a better site for the project in government-owned lands in Sukoró, on the shores of Lake Velence in the Central Transdanubian region. In mid-2008, the investor and the government concluded a land swap agreement: the investor exchanged its plots for the Sukoró site, and paid a difference in value, considering an assessment of a specialized valuation company retained by the government. The government justified the land swap without a public tender based on the public interest related to a road project affecting the Albertirsa and Pilis lands.
As Hungary was required by law to retain ownership of a lakeshore strip of land, a “tract formation” process was needed for 4 of the 20 Sukoró plots. However, the process was never concluded. The land registry office and the county court rejected independent registration of the 16 unaffected plots, because the swap agreement did not provide for the possibility of partial fulfilment. Therefore, the investor was never able to register the title to Sukoró.
Hungary offered financial and tax incentives to support the KC Project, conditioned on performance requirements to be established in an incentive agreement. The offer was initially valid for three months, but Hungary extended its validity twice at Vigotop’s request. Recognizing the KC Project as one of special importance for the national economy, the government also granted it special project status, to reduce the administrative formalities for its implementation.
In 2009, the government published a call for tenders for a concession contract regarding a casino in the Central Transdanubian region. In parallel, however, the parliament and the media started to question the land swap transaction. Different investigations by government agencies suggested that the Albertirsa and Pilis had a significantly lower value than initially appraised, and that the land swap agreement was “null and void,” as the public interest justification did not exist for the totality of the area exchanged. The tender committee accepted Vigotop’s application and recommended its announcement as the winner, but noted that investigations were underway. To address the uncertainty about the ownership status of Sukoró, the concession contract between Hungary and Vigotop, concluded on October 9, 2009, listed Sukoró along with 132 alternative sites where the KC Project could be located.
Soon after the concession contract was concluded, Hungary initiated judicial proceedings that culminated in establishing—by a county court decision confirmed by both the appellate court and Hungary’s highest court—that the land swap agreement was void due to a disproportionality of value, and restoring the initial status. It also postponed the signing of the incentive agreement and revoked the special project status that had been granted to the KC Project. In early 2011, Hungary terminated the concession contract with immediate effect, requesting payment of a cancellation penalty, on the grounds that the investor had breached three contractual provisions.
Claims in the ICSID arbitration
Vigotop initiated arbitration in mid-2011, arguing that Hungary—particularly after the election of the Fidesz government in 2010—had taken a series of unlawful measures, by preventing Vigotop from securing land for the project, withdrawing the incentives offer, revoking the special project status and, as a culmination, terminating the concession contract. For the investor, the measures amounted to an expropriation in breach of the Cyprus–Hungary bilateral investment treaty (BIT). It asked for compensation ranging from €278.3 million to €312.6 million, depending on the methodology.
Direct or creeping expropriation?
Vigotop advanced claims for both direct and indirect expropriation. Here the claimant argued that even if Hungary’s termination of the concession contract was not considered a direct expropriation, the cumulative effects of Hungary’s acts would amount to an indirect and creeping expropriation. The tribunal found that Vigotop could not establish that Hungary’s pre-termination actions had an expropriatory effect, but decided to take them into account as it focused its expropriation analysis on the termination.
Is FET relevant for a finding of expropriation?
The Cyprus–Hungary BIT limits jurisdiction to claims of expropriation. Even so, Vigotop argued that violations of other provisions, particularly the fair and equitable treatment (FET) standard, could inform the tribunal’s analysis of whether an unlawful expropriation occurred. By contrast, Hungary submitted that the FET and the expropriation provisions were and should be treated as “separate and independent” standards (para. 294).
Both parties cited to earlier cases in support of their views, but the tribunal found that there were no clear and relevant precedents. Noting that the violation of FET is “neither a necessary nor sufficient basis for finding an expropriation” (para. 310), it decided not to resort to other treaty standards in analyzing whether an expropriation had occurred. Still, it would consider the principle of good faith in the analysis of Hungary’s conduct.
Did Hungary have public policy reasons to terminate the concession?
The tribunal’s analysis began by focusing on whether Hungary terminated the contract while acting in its sovereign capacity, to further a “hidden political agenda,” as Vigotop phrased. It found that the corruption allegations regarding the land swap—even though never proven—constituted legitimate public policy reasons for the government to oppose the KC Project at Sukoró. It also found that policies to support environmental ecotourism in the the Lake Velence region after the conclusion of the concession contract also constituted a public policy reason behind its termination.
Did Hungary have contractual grounds to terminate the concession?
The tribunal went on to analyze whether, in addition to the public policy reasons, Hungary had contractual grounds for termination. In its termination letter to Vigotop, Hungary had specified three grounds: the investor’s non-compliance with the obligation to establish headquarters in the area where the concession activity would be exercised; the investor’s failure to secure rights to the land for establishing the project; and temporal and pecuniary limitations of the guarantee offered by Ronald Lauder, one of the investors in Vigotop.
According to the tribunal, the failure to secure land for the project was Hungary’s main ground for termination, while the others were “additional, more formalistic grounds” (para. 515). After an analysis of the latter, the tribunal concluded that neither justified the immediate termination.
The tribunal analyzed the land swap agreement independently of the analysis of the Hungarian courts, but ultimately agreed with the courts’ conclusion that the land swap was not necessary for the state, the public interest requirement was not fulfilled, and the land agreement was indeed invalid. Therefore, the tribunal found that Vigotop had not secured possession and the right to build on the land for the project by the established deadline, thus giving Hungary contractual grounds for termination.
Did Hungary act in good faith or did it abuse its contractual rights?
Having found that Hungary had parallel causes (both public policy reasons and contractual grounds) for termination, the tribunal examined whether the contractual grounds were exercised in a manner consistent with the principle of good faith, or in an abuse of Hungary’s contractual right.
In its analysis, the tribunal considered that Vigotop, when signing the concession, “must have known” that the lack of a resolution for the issue of the Sukoró lands would lead to court proceedings, and that “it must have been clear” to the investors that these proceedings would concern both the disproportionality of the values and the potential invalidity of the land swap (para. 611). The tribunal also considered that Hungary did not frustrate Vigotop’s search for an alternative site (para. 615), and that the investor had “a realistic opportunity to secure an alternative site within the contractual deadline” (para. 624). In view of these circumstances, the tribunal held that Hungary did neither demonstrate a lack of good faith nor abuse its rights by terminating the contract or by refusing to extend the deadline.
Tribunal dismisses expropriation claims—but denies declaring that no expropriation occurred
Considering that Hungary terminated the concession on contractual grounds and acted in good faith, the tribunal held that the termination did not amount to an expropriation, and therefore dismissed all of Vigotop’s claims. Interestingly, the tribunal “denied” Hungary’s request to declare that it did not expropriate Vigotop’s investment “as being unnecessary in that such declaration is implicit in the Tribunal’s decision to reject Claimant’s claims in their entirety” (para. 632).
Vigotop’s claims dismissed—but each party bears its own costs
For the tribunal, it was “fair and appropriate” that the parties shared arbitration costs in equal parts, and that each party bore its own costs and legal fees. In reaching this conclusion, the tribunal considered that, although Vigotop did not prevail in its claims, it “raised reasonable issues in good faith and presented an arguable case” (para. 639).
Notes: The tribunal was composed of Klaus Sachs (President appointed by the parties, German national), Doak Bishop (claimant’s appointee, U.S. national) and Veijo Heiskanen (respondent’s appointee, Finnish national). The award is available at http://www.italaw.com/sites/default/files/case-documents/italaw4047.pdf.
[*] Martin Dietrich Brauch is an international lawyer and associate of the International Institute for Sustainable Development’s program on foreign investment and sustainable development, based in Brazil.