Murphy Exploration & Production Company – International v. Republic of Ecuador, PCA Case No. 2012-16 (formerly AA 434)
In the proceeding brought by U.S.-based company Murphy Exploration & Production Company – International against Ecuador, a tribunal under the auspices of the Permanent Court of Arbitration (PCA) held that Ecuador breached the fair and equitable (FET) treatment under the Ecuador–United States bilateral investment treaty (BIT) by enacting Law 42 and Decree 662, which established a levy on oil profits resulting from sales above a certain reference price.
This was not the first time an arbitral tribunal ruled on a case brought by Murphy against Ecuador. In December 2010, after a proceeding that took nearly 3.5 years, the majority of a tribunal at the Centre for Settlement of Investment Disputes (ICSID) had declined jurisdiction to hear the case (ICSID Case No. ARB/08/4).
The Participation Contract
The starting point of the dispute is a Participation Contract signed in 1996 between Corporación Estatal Petrolera Ecuatoriana, the predecessor of the state-owned Petroecuador, and a consortium of foreign investors for oil exploration and production (Consortium). Murphy controlled one of the companies participating in the Consortium until March 2009.
Under the Participation Contract, Consortium members had ownership rights over their shares in oil production. The shares were calculated using a formula, which, according to Murphy, did not include oil price as a variable. According to Ecuador, however, “the price of oil was an integral part of the formula for calculating the parties’ shares in participation” (para. 74).
The global rise in oil prices, Law 42 and Decree 662
In early 2002, global prices of crude oil began to rise, reaching a peak of US$75 per barrel in July 2006, nearly four times the medium price of the two earlier decades (approx. US$20 per barrel).
In that scenario, Ecuador enacted Law 42, amending the country’s Hydrocarbons Law to allow “the State to receive from oil companies with participation contracts what was described as ‘participation in the surplus of oil sale prices’” (para. 82). Said differently, Law 42 provided that Ecuador would participate in the Consortium’s extraordinary income resulting from the sale of crude oil above the reference price—namely, the oil price that prevailed when the Participation Contract was concluded. Through Law 42 Ecuador set its participation at a minimum of 50 per cent of the extraordinary profits resulting from prices exceeding the reference price; in 2007, through Decree 662, Ecuador changed it to 99 per cent.
Murphy alleged that Law 42 had been a unilateral modification of the Participation Contract and that, because of the law’s detrimental effects on the investment, “it had no choice but to forego its investment by selling its interest in the Consortium” (para. 5). Ecuador, on the other hand, replied that Law 42 was a “matter of taxation” explicitly carved out from the BIT, implemented in view of an exceptional rise in oil prices, and that Law 42 aimed to maintain the agreements with petroleum sector operators while protecting public interest in natural resources.
The tribunal’s jurisdiction: the meaning of “taxation”
Ecuador submitted that Law 42 was a “matter of taxation,” which Article X of the BIT excludes from dispute resolution, unless related to certain specific claims (for instance, expropriation). The tribunal rejected Ecuador’s assertion. Following the approach taken in EnCana v. Ecuador, Occidental v. Ecuador and Duke Energy v. Ecuador for interpreting the meaning of “matter of taxation,” the tribunal considered it necessary to assess “whether that measure comes within the State’s domestic tax regime” (para. 166) and whether the measure could be characterized as tax at international law.
According to the tribunal, Law 42, unlike the challenged measure in EnCana, was “not enacted as a tax or otherwise part of the national tax regime” (para. 175), but enacted as an amendment to the Hydrocarbons Law under the President’s power to submit emergency draft legislation. Relying on Burlington v. Ecuador, the first tribunal to rule on whether Law 42 was a tax-related measure, and Occidental II v. Ecuador, which also analyzed the issue, the tribunal held that Law 42 did not constitute a matter of taxation within the meaning of the BIT. It considered the measure “a unilateral change by the State to the terms of the participation contracts that were governed by the Hydrocarbons Law” (para. 190).
The breach of FET
As for the merits of the dispute, the tribunal did analyze whether the FET provision of the BIT reflected an autonomous standard above the customary international law one. Instead, it considered “that there is no material difference” (para. 208) between them and proceeded to the analysis of whether Law 42 and Decree 662 breached Murphy’s legitimate expectations.
The tribunal accepted the notion, suggested by Murphy, that legitimate expectations “are grounded in the legal framework as it existed at the time that the investment was made” (para. 249). Thus, it considered that Murphy could legitimately expect that the terms of the Participation Contract would not change and that changes would only be made “within the confines of the law and pursuant to a negotiated mutual agreement between the contractual partners” (para. 273).
The tribunal disagreed with Murphy’s assertion that the Participation Contract contained a stabilization clause, which would prevent regulatory and legislative adjustments even in exceptional circumstances, such as a significant rise in oil prices. It found that Law 42, not having altered the Participation Contract in a fundamental way, had not breached Murphy’s legitimate expectations.
The tribunal did, however, found that Decree 662, which raised the state’s participation in the extraordinary income to 99 per cent, breached Murphy’s legitimate expectations. In the tribunal’s understanding, Decree 662 transformed the Participation Contract in a service contract, changing “the foundational premise upon which the Participation Contract had been agreed” (para. 282), namely, the Consortium’s ability to participate in the upside of high oil prices. It also referred to the “hostile and coercive investment environment” (para. 281) prevailing when Decree 662 was adopted as an element that reinforced the conclusion that Ecuador had breached its FET obligation.
The tribunal condemned Ecuador to pay nearly US$20 million in compensation to Murphy for damages incurred as a result of the payments, plus pre-award (approx. US$7.2 million) and post-award interest.
It also ordered Ecuador to pay the difference between the price at which Murphy was sold in 2009 (US$78.9 million) and the company’s fair market value as if Murphy had continued to make payments under Law 42 at 50 per cent, plus interest. If the parties do not agree on the latter value within three months, “the Tribunal will then make the necessary findings” (para. 504).
Notes: The arbitral tribunal was composed of Bernard Hanotiau (President appointed by the co-arbitrators), Kaj Hobér (Claimant’s appointee), and Yves Derains (Respondent’s appointee, appointed following the resignation of Georges Abi-Saab in December 2013). The award of May 6, 2016 is available at http://www.italaw.com/sites/default/files/case-documents/italaw7489_0.pdfhttp://www.italaw.com/sites/default/files/case-documents/italaw7336.pdf.
Inaê Siqueira de Oliveira is a Law student at the Federal University of Rio Grande do Sul, Brazil.