THE AUTHORS: Katerina Daskalopoulou, Associate at Lenz & Staehelin
Natalia Mouzoula , Trainee Associate at Sidley Austin LLP
This is the third part of a series that discusses the implications of the Russian invasion of Ukraine under international law. The first article of the series addresses the issue of the use of force under international law, whilst the second article focuses on the implications of the Russian-Ukraine war under international criminal law. This third article focuses on potential claims that may be raised against Russia in investment arbitration proceedings in view of the measures Russia recently proposed or adopted.
Protecting the ‘Unfriendly’: Foreign Investors Against Russia in International Arbitration
The invasion of Ukraine prompted the immediate reaction of the international community, as evidenced by the array of sanctions adopted against Russia including the freezing of the Central Bank assets, import and export bans, and measures targeting individuals (see, g., European Commission, EU sanctions against Russia following the invasion of Ukraine; US Department of Treasury, Ukraine-/Russia-Related Sanctions). In response, Russia has proposed and/or adopted several measures (“Measures”) targeting foreign companies from States and territories that commit “unfriendly” actions against Russia, its companies and its citizens (“Unfriendly States”) (see, TASS, Russian government approves list of unfriendly countries and territories, 7 March 2022). Following the pandemic, Russia, a traditionally large home country for foreign direct investment (“FDI”), had announced plans to modernize the system of special investment contracts, and expected to sign up to 1,000 such agreements covering 185 billion USD worth of investment by 2024 (see, UNCTAD, World Investment Report 2021: Investing in Sustainable Recovery, pp. 67, 69). However, the Measures put on the line billions of dollars in accumulated FDI and discourage foreign investors’ activity in Russia (see, UNCTAD STAT, General Profile: Russian Federation). The Measures may also have serious repercussions for investors from Unfriendly States and their existing investments, and trigger claims against Russia under its existing international investment agreements (“IIAs”). After providing an overview of the adopted and/or proposed Measures, this article discusses potential claims that may be raised in investment arbitration proceedings against Russia.
Russia’s Measures Against Foreign Investors
The Measures affecting investors from Unfriendly States include the following:
- External management/administration. The lower house of the Russian Parliament has adopted a Law on external administration, which provides for the establishment of a special interdepartmental commission with broad powers to impose external administration on any company. Under this Law, the management of a targeted company may be taken over by an external administrator by way of a court decision. External administrators are tasked with liquidating the company and subsequently creating a new company in which all the assets of the original company would be transferred. The shares of this new company would then be sold in a special public auction.
This Law targets companies in Russia:
(i) that are owned or controlled, directly or indirectly by a foreign investor from an Unfriendly State,
(ii) that have material significance for Russia’s financial stability and the protection of rights and interests of its citizens, and
(iii) whose management has left the territory of Russia after 24 February 2022 without obvious economic reasons.
- Limitations on patents and IP rights. Decree No. 299 authorizes local companies and individuals to use patents of patent holders from Unfriendly States without their consent and with no compensation for the use of their inventions, models, or designs if such use is required to ensure the defense and security of the Russian State and the protection of citizens’ life and health. Further, Decree No. 322 sets forth a temporary procedure for fulfilling obligations arising from the use of intellectual property products. Law No. 46-FZ also authorizes the Russian Government to suspend certain intellectual property rights, including certain exclusivity-related protection.
- Limitations on repaying debt. Decree No. 95 establishes a special temporary debt settlement procedure, under which Russian debtors can temporarily satisfy debts owed to creditors from Unfriendly States in rubles, in an amount equivalent to the value of obligations in foreign currency, calculated at the official exchange rate of Russia’s Central Bank on the date of payment.
- Transaction approval requirements. Decree No. 81 “On Additional Temporary Economic Measures to Secure the Financial Stability of the Russian Federation” of 1 March 2022 sets out special procedures for transactions of Russian residents with persons connected to Unfriendly States. Russian residents are, for example, prohibited from granting foreign currency loans to non-residents under loan agreements without the prior approval of the Governmental Commission. Granting loans and credits by Russian residents to Specific Foreign Persons in rubles also requires prior approval of the Governmental Commission. Moreover, Decree No. 295 subjects the transfer of funds from Russian accounts held by foreign investors to the approval of the Board of Directors of the Central Bank of Russia.
- Transfer of aviation assets. Law No. 56-FZ allows Russian airlines to place airplanes leased from foreign companies on the country’s aircraft register.
- Restrictions related to obligations by Russian credit institutions. Decree No. 529 provides for a special procedure for the performance of obligations by Russian credit institutions subject to sanctions, and restrictive measures such as that Russian credit institutions may be entitled to suspend the fulfilment of obligations under bank account agreements with their clients. This Decree also allows Russian debtors to perform their obligations towards resident Eurobond holders by crediting money in rubles to bank accounts opened with Russian credit institutions.
- Currency controls. Decree No. 126 authorized the Russian Central Bank to set the maximum value for transfer of funds held in accounts of foreign investors to accounts abroad. On 16 May 2022, the Russian Central Bank established restrictions on the amounts of money transfers made to accounts opened abroad. For example, residents of Russia and residents from friendly countries may transfer up to one million US dollars or the equivalent in any other foreign currency per calendar month from their accounts with Russian banks to their accounts or other individuals abroad (see, Bank of Russia, Bank of Russia eases further earlier introduced FX restrictions, May 16, 2022).
- Import and export restrictions on raw materials.
- Transaction bans in the energy sector. Decree No. 520 prohibits the selling and restructuring of interests of foreign investors from Unfriendly States in, among others, certain energy and mining projects and companies. This restriction applies until 31 December 2022. Any transaction undertaken contrary to Decree No. 520 shall be deemed null and void, except in instances where the President has issued a license in this regard (see, Decree No. 100 of 8 March).
Potential Claims of Foreign Investors Against Russia
In view of the Measures’ impact on foreign businesses operating in Russia, foreign investors may raise claims against Russia for violation of its obligations under Russian IIAs.
There are currently 27 bilateral investment treaties (“BITs”) in force between Russia and Unfriendly States (seeInvestment Policy Hub, Russian Federation). Russia had also signed the Energy Charter Treaty (1994) (the “ECT”) and accepted its provisional application, which was terminated in 2009 (see, International Energy Charter, Russia and the Energy Charter Treaty, 7 August 2014). However, under Article 45(3) of the ECT, the latter continues to apply provisionally for a period of 20 years regarding investments made during the latter period. Accordingly, foreign investors may initiate investment arbitration proceedings against Russia based on these treaties, provided that they include an investor-State arbitration clause.
Both the ECT and Russian BITs contain several substantive protections for foreign investors. This article will focus on provisions on expropriation, most-favored-nation (“MFN”), national treatment, and free transfer of funds.
Notably, Russia has signed but not ratified the Convention on the Settlement of Investment Disputes between States and Nationals if Other States (1965) (the “ICSID Convention”), and thus foreign investors cannot bring arbitration proceedings on this basis. Nonetheless, several BITs provide for ad-hoc investor-State arbitration under the Arbitration Rules of the United Nations Commission on International Trade Law (“UNCITRAL”) or other arbitration rules.
a. Unlawful Expropriation
Most Russian BITs prohibit the taking of direct and indirect expropriation measures, unless such measures are taken in the public interest under due process of law, are not discriminatory, and are accompanied by prompt, adequate, and effective compensation.
Direct expropriation is a State measure that removes the investor’s legal title to the investment and/or results in the investment’s legal seizure (see, Mobil and others v. Venezuela, 294). Indirect expropriation, on the other hand, leaves the investor’s title unaffected, but deprives the investor of the possibility of utilizing the investment in a meaningful way.[1] As such, measures resulting in the government’s interference with investors’ rights, substantial deprivation, or loss of value of its investment may amount to indirect expropriation (see e.g., Eco Oro v. Colombia; Manolium Processing v. Belarus; Infinito Gold Ltd. v. Costa Rica). As stated in Stabil v. Russia, in these cases, “it is the measure’s economic impact on the investment that matters, whereas an open and unequivocal intent to expropriate may not be present.”
In view of the Measures, Russia may face claims for direct or indirect expropriation. Indicatively, measures similar to the law introducing the regime of external management on affected companies have been found to deprive investors of their property and to constitute unlawful expropriation. Russia has already faced similar claims in PrivatBank and Finilon v. Russia following the invasion and subsequent annexation of Crimea from Ukraine. In this case, one of the measures adopted by Russia was the transfer of the Bank’s assets into a trust controlled by a depositor fund under State control by court order. Russia was held liable for unlawful expropriation under the Russia-Ukraine BIT (1998). Similarly, in Phillips Petroleum Co. Iran v. Iran, the Iranian authorities had taken several measures against the Claimant including the replacement of the management by directors appointed by the Iranian authorities and nullification of the joint venture agreement. The Tribunal held that the government’s interference deprived the Claimant of its fundamental rights of ownership, and the relevant measures were thus expropriatory.
Any other substantial devaluation of assets may amount to indirect expropriation. One example of such devaluation may prove to be the law allowing Russia to register planes leased from foreign companies in Russia, preventing the leasing companies from reclaiming their assets.
Accordingly, foreign investors may have grounds to argue that the regime of external management does not satisfy the criteria for a lawful expropriation, including those of
(i) due process, since investors from Unfriendly States are treated differently from other investors; and
(ii) compensation, since the expropriation would be uncompensated.
b. Transfer of Funds
Typically, Russian BITs guarantee the free transfer of payments in connection with the investments, provided that foreign investors have satisfied their tax obligations under host-State laws. Such transfers must take place without delay, in a convertible currency, and at the exchange rate applicable on the date of the transfer under the currency regulations of the host-State. As stated in Biwater Gauff v. Tanzania, provisions on free transfer of payments target measures “such as currency control restrictions or other measures taken by the host State which effectively imprison the investors’ funds, typically in the host State of the investment.”
Measures imposing the use of a State’s currency and prohibiting the release of foreign currency have been found to be in breach of transfer of funds provisions. In von Pezold v. Zimbabwe as well as in Border Timbers v. Zimbabwe, the Tribunal ruled that the refusal of the State to release foreign currency in order to allow the investor to repay certain loans was a breach of the transfer of funds guarantee.
Accordingly, Russian measures imposing currency controls, transfer restrictions or licensing requirements for the transfer of funds, and payment of debts to foreign creditors in rubles could trigger claims for breach of transfer of funds provisions. Where licensing requirements are imposed, investors must demonstrate they have complied with the relevant procedures established under host-State laws before raising a claim of breach of a transfer provision (see, Metalpar v. Argentina).
c. Most-Favoured Nation and National Treatment
Most Russian BITs include MFN and national treatment As explained in UPS v. Canada, to substantiate violations of these obligations, investors must demonstrate that they are in “like circumstances” with domestic investors or investors of a third State, and that the host-State treated the latter more favorably without providing justification for this differentiation based on legitimate public welfare objectives.
Most Measures constitute typical examples of de jure discrimination, as they explicitly target investors from Unfriendly States and do not apply to domestic investors or investors from third States. For instance, the Law on external administration applies to companies owned or controlled by a foreign investor from an Unfriendly State. Similarly, Decree No. 299 allows the use of patents of patentholders from Unfriendly States without compensation. Therefore, claims based on national treatment and MFN provisions may be raised in view of these stipulations.
Investors should, nonetheless, be aware of potential exceptions included in Russian BITs in respect of these standards. Concerning national treatment, certain agreements reserve the host-State’s right to reserve certain branches of the national economy and spheres of activities to domestic investors (see, g., Russia-Ukraine BIT (1998)). Other IIAs stipulate that States reserve the right to make or maintain exceptions regarding national treatment obligations (see, e.g., Russia-Greece BIT (1993)). Similarly, MFN provisions in certain Russian BITs envisage that they do not apply to benefits under free trade agreements, customs or economic unions (see, e.g., Russia-Lithuania BIT (1999)).
Conclusion
The international sanctions against Russia and Russia’s responsive economic measures come with unprecedented challenges for investors and their investments. Investment treaty arbitration may well be an adequate relief and a unique opportunity for investors to vindicate their rights during this challenging time. Given the quite large number of investment cases filed in view of Russia’s annexation of Crimea,[1] there is a high probability that a new wave of investment arbitrations might be close.
To fight prospective investor claims, Russia will likely argue that the Measures are justified under customary international law. It already seems that Russia perceives its conduct as a legitimate countermeasure to wrongful measures of investors’ home States (see, Verfassungsblog, Are We in for a New Wave of Investment Arbitrations?, 21 March 2022). The outcome of potential investment cases against Russia on the basis of the aforementioned claims would of course be uncertain at this stage.
ABOUT THE AUTHORS
Katerina Daskalopoulou works as an Associate in the Geneva office of Lenz & Staehelin and is a member of the Private Clients group. Her practice focuses on employment disputes between international organizations and their staff. Prior to joining the firm, she worked as a Junior Associate in a Geneva-based boutique law firm, specializing in international commercial and investment arbitration proceedings as well as economic sanctions.
Natalia Mouzoula is a Greek-qualified lawyer working as a Trainee Associate at Sidley Austin LLP in Geneva, focusing on international commercial and investment arbitration, and regulatory and compliance issues in the Life Sciences sector. Prior to joining Sidley Austin, Natalia worked with leading international law firms in Zurich and Paris.
[1] Ukrnafta v. Russia; Stabil and Others v. Russia; PrivatBank and Finilon v. Russia; Lugzor and others v. Russia; Everest and others v. Russia; Aeroport Belbek and Mr. Kolomoisky v. Russia; Oschadbank v. Russia; Naftogaz and others v. Russia; DTEK v. Russia; Ukrenergo v. Russia.
