Bank Raiders on Cyprus Hill

Cypriot investors have sued Russia in the past. Will Russians turn the tables after this weekend’s bank bailout?

The New York Times is reporting that Cyprus has approved parts of a bank bailout package.  Cyprus lawmakers will decide later this weekend whether to go forward with a 25 percent tax on uninsured bank deposits, which Germany and other power players have deemed the best route for financing the package. If the tax doesn’t pass, Cyprus may impose strict capital controls – as Iceland did several years ago.

Either route will be bad news for Russian depositors, who have an estimated four percent of their national income stashed in Cypriot financial institutions. And some commentators are calling for blood, and for the Russian government to pick up the tab.

But Russians aren’t helpless in the matter. In 1997, the Russian Federation signed an investment treaty with Cyprus that allows investors from one country to sue the government of the other country. Both countries are also party to the Energy Charter Treaty, which has a similar procedure.

Yukos shareholders incorporated in Cyprus have used these pacts to challenge Russia’s infamous treatment of that energy company. Cyprus investors have also successfully sued other governments under similar treaties.

The investment treaty requires that any expropriation by Cyprus of Russian investments be promptly compensated, and that the “amount of compensation should correspond to the real value, which the expropriated investments had, immediately before the time when official information was obtained concerning actual or impeding expropriation. Compensation shall be paid without undue delay in convertible currency” (Article 4). Investments are defined to include “financial assets as well as shares, deposits and other forms of participation…” (Article 1) The deal also guarantees that Cyprus will allow Russian investors “free transfer abroad of payments in connection with their investments” including revenues, “after they have paid appropriate taxes and charges” (Article 6)

If Russians were to challenge the Cyprus tax, they could argue that it constituted an expropriation or a restriction on free transfers. If they did the former, they would have to convince arbitrators that a 25 percent reduction in the value of their deposits rose to a level of expropriation. If they did the latter, they would have to show how the tax was somehow not an “appropriate” tax or charge.

Neither argument is a shoe-in, but they’re also not nothing. In a case by Spanish investors in Yukos last year, an arbitral tribunal ruled that the pace of changes in Russian tax policy and the failure to negotiate with interested parties led to a violation of the Spain-Russia investment treaty (para. 127). The panel went on…

The notion that states have a considerable margin of discretion in enacting and enforcing tax laws should not lead to any confused idea that they have a discretion as to whether or not to comply with an international treaty. True enough, as Rosinvest put it, “States have wide latitude in imposing and enforcing taxation laws even if resulting in substantial deprivation without compensation”. Yet there is a world of difference between incidental detriment, even of a substantial nature, and purposeful disposession. It is no answer for a state to say that its courts have used the word “taxation” – any more than the word “bankruptcy” – in describing judgements by which they effect the disposession of foreign investors. If that were enough, investment protection through international law would likely become an illusion, as states would quickly learn to avoid responsibility by dressing up all adverse measures, perhaps expropriation first of all, as taxation. When agreeing to the jurisdiction of internatinoal tribunals, states perforce  accept that those jurisdictions will exercise their judgment, and not be stumped by the use of labels. (para 179)

Thanks to the Russia-Cyprus treaty, Cyprus has also agreed to allow arbitrators (that are paid by the case, picked in part by Russian investors, and not experts in banking or taxation) to second guess what its lawmakers are deciding this weekend. And more than just Russian investors may have recourse, as Cyprus has a few dozen investment treaties with various countries, many of whom may also have offshore deposits on the island.

This could be a costly weekend.

POSTSCRIPT added here.

CORRECTION AND CLARIFICATION on 3/27: The Russia-Cyprus treaty was signed but did not enter into force. So, Russians wanting to go after Cyprus will have to claim a nationality from a treaty that is in force… like the Cyprus-Greece treaty, which IAReporter says is already being used for a similar purpose!