#ISDS Meets Its Maker?

Dutch courts have set aside the record-breaking $50 billion Yukos award against Russia. The case was brought under the Energy Charter Treaty, a regional pact that allows investor-state dispute settlement (ISDS).

As Global Arbitration Review reports:

In a decision released early this morning, The Hague District Court accepted Russia’s reading of Article 45 of the Energy Charter Treaty on provisional application and held the state – which never ratified the treaty – was only bound by those provisions reconcilable with Russian law, including the 1993 Russian Constitution. The constitution requires that where Russia signs up to treaties that supplement or amend existing law, new laws must be passed to reflect the treaty provisions.

The court said that based on its signature of the ECT alone, Russia was not bound by the treaty’s Article 26 and its unconditional offer to arbitrate any disputes. The shareholders’ notice of arbitration on Russia accordingly did not constitute a valid arbitration agreement and the tribunal composed of Yves Fortier QC, Charles Poncet and Stephen Schwebel was not competent to hear the case.

As under traditional private sector arbitration, national courts supervise ISDS. Because both arbitration systems outsource key judicial functions to non-state adjudicators, it is up to state judges to decide whether arbitration decisions should stand or not. Typically, the national courts will defer to the arbitrators on the merits of the decision, but will more closely scrutinize whether the parties both agreed to the arbitration in the first place. In legal terms, they ask whether there is consent that paved the way for the arbitral tribunal to have jurisdiction over the case.

Dutch arbitrator Albert Jan van den Berg was counsel for Russia in the case, and had this to say to GAR:

Albert Jan van den Berg, partner at Hanotiau & van den Berg in Brussels, was lead counsel to Russia in the Hague court proceedings, assisted by Dutch firm Hauthoff Buruma. He says that given a long list of errors in the awards, he is “grateful” that the Dutch courts have intervened to reverse them.

Elaborating, van den Berg says the case should never have been brought under the ECT as it was “a Russian tax dispute between Russian nationals and the Russian Federation concerning Russian tax assessments against a Russian company that Russian oligarchs owned and controlled.”

“If the Yukos awards had been held valid and enforceable, the integrity and credibility of investment arbitration would have been seriously jeopardised,” he says.

It seems van den Berg is on a one-man mission to save ISDS from itself. As arbitrator, he has criticized colleagues for being overly partisan in their rulings. In his other hat as counsel (more relevant to today’s decision), he has shown willingness to consort with national court supervisors when arbitrators go too far.

His crusade will be hampered by investment treaties’ design, however. GAR quotes Yukos counsel Yas Banifatemi as saying: “The claimants will continue moving forward with their worldwide efforts to enforce the Russian Federation’s international obligations, as recognised by the arbitral tribunal. Under the 1958 New York Convention, enforcement courts will be at liberty to assess the award for themselves, irrespective of what the Dutch courts have to say on the matter.” In other words, the investors don’t need Dutch courts. They can also go to U.S, U.K., and other courts in a search for attachable assets. Moreover, the claimants will still be able to appeal to higher Dutch courts.

The  combination of ad hoc arbitration with cross-national enforcement opportunities means that – when investors lose in one forum – they can shift to another.

Most national courts have shown minimal willingness to review arbitration decisions. I only know of three instances in treaty-based investment arbitration. In 2015, a Paris court set aside an award against Madagascar because of a failure to take party submissions on damages into account. In 2013, Swedish courts set aside an award against Russia when the investor failed to collect on it. Only in one case – Metalclad v. Mexico (2001) – did a Canadian court revisit the merits of the decision. This is an outlier, and one dismissed by arbitrators ever since.

What about the U.S.?  Before Antonin Scalia’s death, a Supreme Court majority of 7-2 declined to review an ISDS decision against Argentina. Presumably, that comes down to 6-2 with his passing – still a comfortable majority.

The question I would have is whether the particular facts of this case might make national courts more sympathetic to  Russia’s plight. Particularly, will they conclude that the proper venue for citizens to sue their own government is in home country courts?

We may soon have a test. Carolyn Lamm, herself a top counsel and arbitrator, is the lead attorney representing Russia in U.S. courts. In October of 2015, she filed a motion with U.S. District Court for D.C., arguing that:

1. Russia never ratified the ECT, so there was no consent to arbitrate.
2. The claimants were Russians, so shouldn’t have been able to access the ECT.
3. The arbitral process was flawed, because a secretary had effectively served as a fourth arbitrator in the case. (In my research, I found that top arbitrators are very in demand, and so consequently delegate much of the work to assistants. It’s not clear to me that this is inherently objectionable.)
4. The investors had engaged in tax fraud. The arbitrators had dismissed the relevance of this, saying that the notion that investors should have “clean hands” was not yet a general principle of international law.
5. Arbitrators adopted an idiosyncratic valuation method to get at the $50 billion figure, a method not endorsed by either party.
6. The European Court of Human Rights – hearing a parallel case by Yukos – was unwilling to find that Russia’s behavior was politically motivated, as the arbitral tribunal stated matter of factly.
7. U.S. courts should use their discretion under national and international arbitration law to set aside the award because it goes against U.S. public policy. As support for this claim, Lamm and company cite U.S. legal cases requiring parties to not behave fraudulently, requiring arbitrators to avoid bias, and forbidding imposition of punitive damages in arbitration awards. They also argue that the tribunal violated Russia’s right to be heard on damages valuation.

If there were ever a case where U.S. courts might be willing to take a second look at an ISDS arbitration, this could be it. The sum is record-breaking, and the implications for treasuries immense. Moreover, to the extent that judges like the political and legal cover of a herd, they might take solace in the ECHR and Dutch court findings. On the other hand, the Yukos fiasco did not win Russia many points in international public opinion. If the less structured rules in ISDS allowed Fortier and company to call foul on shady government behavior (while other courts would be more hamstrung by challenging legal hurdles), maybe courts will find that a useful function.

Stay tuned. Judge Beryl A. Howell is the judge assigned to the U.S. case, which continues to proceed in District Court.