Contributed by Coronel & Pérez
After a long
and protracted litigation an International Centre for Settlement of Investment
Disputes (ICSID) tribunal found Ecuador liable under domestic and international
law when it terminated unilaterally an oil contract that it had signed with
Occidental Petroleum Corporation (Oxy), the US petroleum multinational, and
took over its installation without compensation.(1) The majority of the arbitrators ordered Ecuador to pay $1.77
billion in damages ($2.3 billion with interest applied). It is possibly one of
the largest investment awards in investment arbitration history. The tribunal
found that while Oxy had violated certain domestic legal provisions, Ecuador
had responded disproportionately. In doing so, Ecuador breached not only its
domestic law but also international law. The arbitrators also found that
Ecuador's seizure of the company's installations was tantamount to unlawful
expropriation.
Oxy had been operating in Ecuador since the mid 1980s under a service
contract model. In response to depressing oil prices, in 1993 Ecuador passed a
new legislation allowing the government to enter into production sharing
agreements with oil companies. On May 21 1999, after long negotiations, Ecuador
and Oxy signed a new contract under the new model. Under the contract, in return
for its investments Oxy was to receive a share of the crude oil that it
extracted, which it was free to dispose of. Oxy assumed the full risk of the
oil price.
On October 19 2000 Oxy entered into a farm-out agreement with Encana
Corporation, a Canadian oil company already operating in Ecuador. By virtue of
this agreement, which is common in the oil industry, Oxy secured from Encana a
flow of capital for its operation in exchange for its commitment to provide the
Canadian company with 40% of its oil production. Oxy also agreed that on
certain conditions, and subject to the authorisation of the Ecuadorean minister
of energy, it would assign to Encana 40% of its legal rights on its
participation contract with Ecuador.
In August 2001 the Ecuadorean tax authorities issued a ruling reversing
a prior regulation on the application of value added tax (VAT). As a result,
oil companies were ordered to make significant payments to the Ecuadorean
treasury. In response to this action in November 2002, Oxy commenced an
arbitral proceeding under the US-Ecuador bilateral investment treaty. On July 1
2004 the tribunal issued a $75 million VAT award in Oxy's favour, finding
Ecuador's conduct unfair and discriminatory. However, this conflict affected
Oxy's contractual relationship with Ecuador.
Under pressure from certain political quarters, the government offered
to scrutinise Oxy's operations. On August 24 2004 the attorney general
requested that the Ministry of Energy initiate a proceeding to declare the
unilateral termination of the Oxy participation contract, alleging that the
farm-out agreement amounted to an assignment of rights. Under the Hydrocarbon
Law the assignment of rights of oil contracts to a third party requires prior
ministerial authorisation. The lack of such authorisation may cause the
contract to be terminated and the company to lose its installation to the
government without compensation.
On May 15 2006, after months of increasing political pressure, street
rallies and threats of impeachments, the minister of energy declared the
termination of the Oxy contract and ordered the seizure of its installations
without compensation. Two days later Oxy filed a request for arbitration with
the ICSID.
In its ruling the tribunal found that the arrangement between Oxy and
Encana involved an assignment of rights. Although executives of both companies
had a meeting with the minister and other authorities to inform them of the
agreement, the tribunal felt that they were not candid enough with regard to
its scope. While the tribunal found that Oxy had violated the Hydrocarbon Law
by failing to secure ministerial authorisation before signing the farm-out
agreement, it also ruled that Ecuador had acted disproportionately in
terminating the oil contract and taking over Oxy's installations without
compensation. The tribunal held that the termination of the contract must have
been the last option, not the first one.
In imposing the penalty on Oxy, the tribunal held that Ecuador should
have weighted the principle of proportionality, which is recognised by its own
constitution and applied by its courts. Not only was the penalty not mandatory
but, as Ecuador had conceded during the proceeding, the farm-out agreement had
caused no harm to the country. The tribunal went on to say that proportionality
is a principle widely recognised by international law and applied by
international arbitral tribunals, especially in the context of investment
disputes under treaties such as the US-Ecuador one.(2)
In setting the quantum of damages, the tribunal addressed the following
complex issues:
·
the
consequences of Oxy's actions (contributory negligence);
· the effect of
Law 42 that Ecuador passed after it terminated Oxy's contract with the purpose
of modifying the economics of the participation contracts in response to high
oil prices; and
·
the impact of
the farm-out agreement on Oxy's recovery.
The tribunal was not unanimous in dealing with these issues. The
majority found that Oxy's actions had contributed to the (disproportionate)
penalty from Ecuador, and therefore it reduced the damages recoverable by Oxy
by 25%. With regard to Law 42, the tribunal's majority found that it
represented a unilateral modification of the participation contracts in its
favour, a move from which Ecuador might not benefit. Thus, in calculating the
damages the tribunal did not take that law into consideration.
Finally, the tribunal's majority rejected Ecuador's position that
because the farm-out agreement involved the assignment of 40% of Oxy's rights
to Encana, Oxy's recovery was limited to 60% of the damages. The tribunal noted
that under Ecuadorean law, the assignment of rights of oil contracts without
ministerial authorisation was considered non-existent, an act vitiated by
radical nullity, for which there was no need for a judicial declaration. The
majority found Ecuador's request that the assignment should be given full
effect was unattainable. It was Oxy's contract which was, after all, terminated
by Ecuador. Oxy's claim for compensation for the losses it suffered in its
investment into a consortium that had built and was operating a heavy crude oil
pipeline in Ecuador was rejected as speculative.
On the issue of expropriation, the tribunal did not share Ecuador's
position that seizing Oxy's installations without compensation was not unlawful
because the Hydrocarbon Law contemplated such action as a result of a
unilateral termination decision, and therefore it was part of the contract that
Oxy had agreed to. The tribunal found that it was in breach of the US-Ecuador
bilateral investment treaty. With regard to interests, the tribunal opted for
composite interests.
The ruling covers a wide range of issues at the centre of the ongoing
debate on international investments disputes. Of particular relevance is the
subject of proportionality as an element of the fair and equitable treatment
that foreign investors are expected to receive from the host states under
existing bilateral investment treaties. The principle has gained significant
acceptance in the domestic systems of most countries during the past decade,
especially in the field administrative law. It is now marking its presence in
the arena of international investment litigation.
For further information on this topic please
contact Hernán Pérez Loose at Coronel
& Pérez by telephone (+593 4 2519 900), fax (+593 4 2320 657) or email (hperez@coronelyperez.com).
Endnotes
(1) Occidental Petroleum Corporation, Occidental
Exploration and Production Company v Republic of Ecuador (ICSD Case No ARB/06/11).
(2) The
tribunal relied on, among other cases, MTD Equity SDN BHD v The Republic of Chile (ICSID Case No ARB/01/07); LG & Energy Corp v The Argentine Republic (ICSID Case No ARB/02/1); Tecmed SA v The United Mexican States (ICSID Case No ARB (AF)/00/2); and Azurix Corp v The Argentine Republic (ICSID Case No ARB/01/12).
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