In an award notified to the parties on 5 October 2012 (the Award),
the majority of a three-member arbitral tribunal established under the
ICSID Convention has directed the Republic of Ecuador (Ecuador or the Respondent) to pay US companies Occidental Petroleum Corporation (Occidental) and Occidental Exploration and Production Company (OEPC)(collectively, the Claimants)
damages in the sum of approximately USD1.77 billion (if interest is
taken into account it has been reported that this sum would exceed
USD2.3 billion)1. It
has been reported that this is the largest sum ever awarded by a
tribunal under the ICSID Convention and, unsurprisingly, will be
challenged by Ecuador.
The dispute arose out of Ecuador’s decision to terminate in April 2006 by way of a decree (the Decree) the contract (the Participation Contract)
under which the Claimants were undertaking oil operations in an area
known as Block 15 (which covers 200,000 hectares situated in the Oriente
Basin, in the Ecuadorean Amazon rainforest).
Notwithstanding the fact that the
Claimants breached the Participation Contract (and, according to one
member of the tribunal, acted illegally), Ecuador was found to have
acted disproportionately and therefore had violated the US-Ecuador
bilateral investment treaty (the BIT). In particular, the tribunal held that Ecuador failed “to
accord fair and equitable treatment to the Claimants’ investment, and
to accord to the Claimants treatment no less than that required under
international law“; and breached the BIT “by expropriating the Claimants’ investment in Block 15 through a measure ‘tantamount’ to expropriation.” [876]
Whilst the tribunal –comprised Yves
Fortier QC (presiding arbitrator), David AR Williams QC and Professor
Brigitte Stern –was unanimous in respect of liability, the impact of the
Claimants’ breach of the Participation Contract upon the calculation of
damages divided the arbitrators. The majority concluded that due to
their breach of the Participation Contract, “the Claimants have
contributed to the extent of 25% to the prejudice they suffered when the
Respondent issued the Caducidad [termination] Decree.” [687] Prof Stern, in a strongly-worded dissenting opinion, considered that a 50/50 split would have been justified as she concluded that “the Claimants have acted both very imprudently and illegally.” [7]
The Award is significant for both States and investors for the following reasons:
- The tribunal considered it within its power to review the suitability of the administrative decisions of Ecuador, particularly on the basis of the principle of proportionality (considered by this tribunal as an aspect of the fair and equitable treatment (FE) standard).
- Also taking into account the principle of proportionality, the tribunal found that misbehaviour on the part of the investor did not preclude it from obtaining redress against the State. The breach of the Participation Contract was punished by a reduction in the damages instead.
- The Award also highlights the importance of dissenting opinions: it is no surprise that Ecuador reportedly plans to rely upon Prof Stern’s dissenting opinion to seek the annulment of the Award.
Background
In 1993, Ecuador amended its Hydrocarbons Law (the HCL) to
allow the negotiation of participation contracts (a type of production
sharing agreement under which the State and contractors share in the
production of crude oil, with all expenditures borne by the contractor).
In May 1999, OEPC and Ecuador (through
PetroEcuador) concluded the Participation Contract. The Participation
Contract provided that it could be terminated, inter alia, by a declaration of forfeiture or termination (in Spanish, caducidad)
under the HCL or by reason of the transfer of rights and obligations in
the Participation Contract without the relevant Ministry’s
authorisation.
The HCL provided that the Ministry of Energy and Mines (the Ministry) may declare the termination of
Participation Contracts if the contractor transferred rights or entered
into private contracts or agreements for the assignment of one or more
of its rights, without the Ministry’s authorisation.
In October 2000, OEPC and Alberta Energy Corporation Ltd (AEC)
(of Chinese ownership at the time of the Award) concluded an agreement
whereby OEPC committed to transfer to AEC 40% of future legal title
corresponding to 40% interest in the Participation Contract (the Farmout Agreement).
The tribunal found that, notwithstanding the confusing nature of
communications from OEPC to the Ministry concerning the nature of the
agreement, Ecuador was aware of the Farmout Agreement at that time. The
tribunal also found that OEPC had wrongly concluded that authorisation
was not required at that time.
On the basis that the conditions for
the transfer of legal title under the Farmout Agreement were fulfilled,
in July 2004, OEPC requested that the Ministry approve the transfer of
OEPC to AEC of legal title to a 40% interest in Block 15. [168]
The approval sought was not granted.
Instead, on 24 August 2004, on the basis that OEPC had already
transferred part of its interest in Block 15 to AEC in 2000, the
Attorney General of Ecuador ordered the Minister of Energy and Mines
(the Minister) to terminate the Participation
Contract.[169] It is suggested in the Award, that the Attorney
General’s decision was influenced by the fact that OEPC had earlier that
year secured a USD75 million award against Ecuador (in relation to a
VAT refund issue). [175]
Strong political pressure was put on
the Minister to issue a decree terminating the Participation Contract in
2005 and 2006. In April 2006, the Minister issued the Decree
terminating the Participation Contract. As a result, on 17 May 2006,
the Claimants filed with ICSID a Request for Arbitration invoking
Ecuador’s consent to ICSID arbitration in the BIT and PetroEcuador’s
consent to ICSID arbitration in the Participation Contract. The
Claimants argued that the termination of the Participation Contract was
made without legitimate cause and therefore would amount to a breach of
the Participation Contract and the BIT. The Claimants argued that no
termination event had taken place under the Participation Contract but,
even if it had, the Decree would still be in breach of Ecuador’s
obligations under the BIT and Ecuadorean law because it “was unfair, arbitrary, discriminatory and disproportionate.” [206]
Ecuador argued that the Decree was
fully compliant with Ecuadorean law because OEPC’s conduct amounted to
grounds for the termination of the Participation Contract.
The Award
FET and principle of proportionality
The tribunal’s decision on liability
largely rests on its analysis of the principle of proportionality. The
tribunal concluded that the Farmout Agreement amounted to an
unauthorised transfer of rights under the Participation Contract but
that OEPC’s failure to request the Ministry’s approval “while imprudent and ill advised, did not amount to bad faith.” [384]
The tribunal then discussed the
principle of proportionality under Ecuadorean law and within the context
of international investment disputes. The tribunal concluded (based on
expert evidence) that, under Ecuadorean law, administrative acts must
be in accordance with the principle of proportionality. In respect of
investment arbitration law, the tribunal indicated that “the
obligation for fair and equitable treatment has on several occasions
been interpreted to import and obligation of proportionality.” [404]
The tribunal acknowledged that the
Minister had discretionary authority to terminate the Participation
Contract under the HCL. However, the tribunal considered that the
exercise of the authority’s discretion should be proportionate to the
relevant violation.
The tribunal considered that the fact
that the Participation Contract provided for termination in the event of
an unauthorised transfer of rights did not dispose of the Minister’s
duty to act proportionately. [422] It added that, in any event,
termination had not been sought under the machinery of the Participation
Contract and therefore “whatever OEPC agreed in the Participation
Contract is only relevant to actions taken under or pursuant to the
contract – it cannot be relevant to action which is taken independently
of the contract and which does not proceed in reliance upon it. It is a
matter of central importance in this case that the Caducidad Decree was
issued pursuant to the provisions of the HCL.” [423].
The tribunal reasoned that the
consequences of the Decree, i.e. the loss of an investment of hundreds
of millions of US dollars “was out of proportion to the wrongdoing alleged against OEPC” [450]. As a result, the tribunal concluded that
“the
Caducidad Decree was not a proportionate response in the particular
circumstances, and the Tribunal so finds. The Caducidad Decree was
accordingly issued in breach of Ecuadorian law, in breach of customary
international law, and in violation of the Treaty. As to the latter,
the Tribunal expressly finds that the Caducidad Decree constituted a
failure by the Respondent to honour its Article II.3(a) obligation to
accord fair and equitable treatment to the Claimants’ investment, and to
accord them treatment no less than that required by international law.” [452]
Expropriation
The tribunal’s decision in respect of
expropriation appears to rest on its conclusions on FET. In this
regard, the tribunal stated that:
“Having
found in the previous Section of the present Award that the Caducidad
Decree was issued in breach of Ecuadorian law, in breach of customary
international law and in violation of the Respondent’s Article II.3(a)
obligation to accord fair and equitable treatment to the Claimants’
investment, the Tribunal now has no hesitation in finding that, in the
particular circumstances of this case which it has traversed earlier,
the taking by the Respondent of the Claimants’ investment by means of
this administrative sanction was a measure “tantamount to expropriation”
and thus in breach of Article III.1 of the Treaty.” [455]
Quantum
The tribunal concluded that a Net
Present Value approach of the Claimants’ investment should be used to
determine the quantum of the compensation to be awarded to the
Claimants.
The majority applied a 25% discount (with which Prof Stern disagreed) to the sum of USD2,359,500,000 which corresponded to “the
Net Present Value of the discounted cash flows generated by the Block
15 OEPC production as of 16 May 2006 [i.e. the date of the Decree]“. [824] This formula yielded a sum of approximately USD1.77 billion in damages.
Interest
The tribunal awarded the Claimants
pre-award interest at the rate of 4.188% per annum, compounded annually
from 16 May 2006 until the date of the Award. [848] The tribunal also
awarded post-award interest at the US 6 month LIBOR rate compounded on a
monthly basis. [849]
Prof Stern’s dissenting opinion
In her dissenting opinion, Prof Stern
stated that while she concurred that the Respondent acted in a
disproportionate manner in its reaction to the “serious violation of
its laws by the Claimants, I am in complete disagreement with the way
damages have been calculated, which I consider to be resting on grossly
incorrect legal bases.” [1]
Prof Stern has found that the contribution of the Claimants to the damage had been underestimated by the majority because:
“as the Claimants deliberately took
the risk of caducidad by their behaviour – meaning that caducidad could
happen or not happen, and there were indeed more chances that it could
happen than not, considering the text of the law and the reference to
caducidad in the contract. It is interesting to note that in the MTD
case both the tribunal and the ad hoc committee have endorsed a 50/50
split on the sole ground that the claimant had acted imprudently from a
business point of view though not illegally. Here the split 50/50 would
have been even more justified, as the Claimants have acted both very
imprudently and illegally.” [2]
Prof Stern also disagreed with a
finding of the majority that the Claimants were entitled to recover a
100% of the established value of Block 15. The majority found that the
assignment to AEC was invalid under New York law (governing the Farmout
Agreement) and Ecuadorean law. As a result, the majority concluded that
Ecuador “is obliged to compensate the Claimants for 100% of their
interest in Block 15 which it acquired upon the issuance of the
Caducidad Decree.” [651] In this respect, Prof Stern stated that the most serious “gross error of law” committed by the majority, “is
the manifest excess of power of the Award nullifying a contract
concerning a company which not only was not a party to the arbitration,
but moreover – even if it had been a party – could not be considered,
being a Chinese company, as an investor over which the Tribunal had
jurisdiction under the US/Ecuador BIT.” [5]
Initial reaction in Ecuador
On 7 October 2012, at a press
conference in Quito, Ecuador, Mr Diego García Carrión, Ecuador’s
Attorney General, announced that Ecuador will seek the annulment of the
Award on three grounds: excess of power on the part of the tribunal;
lack of reasons; and violation of procedural rules. He added that the
request for annulment will also rely upon the points raised in Prof
Stern’s dissenting opinion.
Comment
As indicated above, the Award is
important for a number of reasons. First, it illustrates how the
tribunal was willing to review administrative decisions of a sovereign
by reference to the FET standard, but more particularly by reference to
the principle of proportionality.
Second, also on the basis of the
principle of proportionality, the Award suggests that misbehaviour on
the part of an investor does not necessarily preclude it from obtaining
redress against a State. It appears that some tribunals might be
willing “to offset” the liabilities of investors and States when it
comes to calculating damages.
Third, the statements made by the
Ecuadorean Government in respect of an attempt to annul the Award, are
yet another testament to the impact that dissenting opinions can have on
the outcome of an investment dispute.
For further information, please contact Christian Leathley (Partner) and Alejandro I Garcia (Senior Associate).
1 References in square brackets are to paragraphs in the Award or the Dissent, as applicable.
Source: http://hsf-arbitrationnews.com/2012/10/15/record-award-against-ecuador-demonstrates-willingness-of-tribunal-to-review-state-decisions-on-grounds-of-proportionality/#more-1207
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