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ICSID panel holds Venezuela in breach of international law for failing to negotiate in good faith for expropriation compensation

On 3 September 2013, a tribunal constituted under the auspices of the International Centre for Settlement of Investment Disputes (“ICSID“) (the “Tribunal“) issued its Decision on Jurisdiction and the Merits in ConocoPhillips Petrozuata B.V. and others vs. Bolivarian Republic of Venezuela (ICSID Case No. ARB/07/30) (the “Decision“). The Tribunal held that it did not have jurisdiction to determine claims by ConocoPhillips Petrozuata B.A. and its co-claimants (“ConocoPhillips” or the “Claimants“) under Venezuelan Investment Law, but that it did have jurisdiction to hear claims related to the Netherlands-Venezuela bilateral investment treaty (the “BIT“).

While the Tribunal unanimously rejected ConocoPhillips’ claim that Venezuela breached the fair and equitable treatment provisions of the BIT, a majority (Arbitrators Yves Fortier and Kenneth Keith) held that Venezuela breached its BIT obligations by failing to negotiate in good faith for compensation for expropriating ConocoPhillips’ assets (with Arbitrator Georges Abi-Saab dissenting). The Tribunal reserved certain issues, including an award on damages and costs, for future determination.

Background

The Decision concerns the claims initiated by ConocoPhillips against Venezuela in relation to ConocoPhillips’ interests in three oil extraction projects located in Venezuela. ConocoPhillips’ interests in the projects were held by companies incorporated in the Netherlands and in the USA (collectively referred to as the “Claimants“). Two of these projects involved the extraction of extra-heavy oil from the Orinoco Oil Belt in Venezuela. The third was an offshore project for the extraction of light-to-medium crude oil.
The Claimants’ allegations arose out of a number of measures adopted by the government of Venezuela, including: (i) increasing the royalty rate applicable to extra-heavy oil production from 1% to 33.33%; (ii) increasing the tax on income derived from extra-heavy oil production from 34% to 50%; and (iii) cancelling the exploration, production and commercialisation rights to the projects and transferring operational control to the State-owned petroleum company Petróleos de Venezuela SA (“PdVSA“).
On 2 November 2007, the Claimants submitted their Request for Arbitration to ICSID, seeking approximately US$ 30 billion in compensation.

The Decision’s findings on jurisdiction

The Claimants submitted that Venezuela gave its consent to ICSID jurisdiction under the Article 22 disputes clause of Venezuela’s Investment Law (the “Investment Law“) and under Article 9 of the BIT. The Respondent objected to both the Investment Law and the BIT as bases for jurisdiction, arguing that its domestic law did not provide consent to international arbitration and that the Claimants were not foreign investors under international law for the purposes of the BIT.

Determination of jurisdiction under domestic law turned on the meaning of ambiguously worded Article 22 of the Investment Law. In particular, the Tribunal was required to determine whether Article 22 provided a “standing offer to foreign investors under the ICSID Convention”. The Tribunal reasoned that both Venezuelan and international law require interpretation based on the ordinary terms of text, which “points strongly to the conclusion” that Article 22 did not establish a “clear and unambiguous” intention that Venezuela provided standing consent to international arbitration under the ICSID Convention. The Tribunal therefore declined jurisdiction under the Investment Law.

With respect to jurisdiction under the BIT, Venezuela contended that the Claimants could not gain access to ICSID because: (i) they were “corporations of convenience” created in anticipation of litigation against the Respondent for the sole purpose of gaining access to ICSID, thereby abusing the BIT; (ii) the Claimants’ investments were owned or controlled by subsidiaries of Dutch nationals and therefore “indirect investments” that fell outside the definition of an investment; and (iii) the increased royalty rate and income tax were enacted in domestic law before the Claimants had an interest in the relevant investments.

The Tribunal rejected Venezuela’s first and second arguments. It upheld the Claimants’ submission that there was no rule against the restructuring of assets to improve investment protection prior to an arbitration claim being made. The Tribunal also emphasised that the “plain meaning” of the BIT’s express words “every kind of investment” are “clear beyond question” as to their scope.
The Tribunal partially agreed with Venezuela’s third jurisdictional challenge, upholding the royalty rate claim, but dismissing the income tax claim. The Tribunal emphasised that, although the date of enactment of the law that increased the tax occurred before the relevant investment was made, a “breach of obligation does not occur until the law in issue is actually applied… and that cannot happen before the law in question is in force” – which occurred “some months” after the investment.

The Decision’s findings on merits

The Claimants asserted that Venezuela’s actions failed to accord fair and equitable treatment and amounted to unlawful expropriation of the Claimants’ investments, thereby breaching the terms of the BIT and various provisions of the Investment Law.

Fair and equitable treatment
The Claimants argued that the changes to Venezuela’s tax and royalty regimes were a violation of the State’s obligation to provide fair and equitable treatment under Article 3 of the BIT.

The Tribunal rejected the Claimants’ arguments, adopting the Respondent’s reasoning that the obligation to provide fair and equitable treatment in Article 3(1) of the BIT did not apply “with respect to taxes, fees, charges, and to fiscal deductions and exceptions”, nor to royalties, which fall within the scope of “fiscal deductions”. Such matters were, instead, governed by the provisions of Article 4 of the BIT, pursuant to which Venezuela was also required to accord nationals of the Netherlands most-favoured nation treatment and national treatment (but which provision was not invoked by the Claimants).

Unlawful expropriation
The Claimants submitted that, under the BIT, Venezuela was obliged not to expropriate without providing compensation corresponding to the market value of the investments.

Of particular interest was the Tribunal’s determination as to whether Venezuela failed to negotiate in good faith and thereby breached its obligation to provide compensation at market value in accordance with Article 6(c) of the BIT.

On this point, the Claimants argued that they had negotiated in good faith about the possible relinquishment of their rights in exchange for fair, prompt and adequate compensation, but that Venezuela, as a condition for any compensation: (i) refused to offer compensation representing more than a fraction of the value of those interests; and (ii) insisted that ConocoPhillips execute a waiver of rights, including the right to have recourse to international arbitration. The Claimants further asserted that, under the terms of the draft contracts it received in relation to the transfer, it would, among other things, “have a reduced stake”, be required to inject extra capital into PdVSA, transfer all assets, waive all claims and receive no compensation.

The Respondent, for its part, claimed that “ConocoPhillips refused to participate in the negotiation process in any meaningful manner” and that the Claimants various proposals were based on “unrealistic assumptions regarding valuation and legal issues”.
As a starting point for its analysis, the Tribunal recognised that it is “commonly accepted that the Parties must engage in good faith negotiations to fix the compensation in terms of the standard set, in this case, in the BIT, if a payment satisfactory to the investor is not proposed at the outset”. It considered evidence, including letters from ConocoPhillips to Venezuela rejecting a “valuation based on book value”, that would “not adequately compensate it”. It further noted that Venezuela had not responded to essential points raised by ConocoPhillips, nor made a “proposal for compensation” for certain of the investments.

The Tribunal consequently upheld the Claimants’ argument that Venezuela failed to meet the expropriation standard and concluded that “the Respondent breached its obligation to negotiate in good faith for compensation for its taking of the ConocoPhillips assets in the three projects on the basis of market value as required by Article 6(c) of the BIT”.

Comments

The Decision highlights and reaffirms a number of established principles in international law, including that: (i) a State’s expropriation of foreign investments without fair compensation or negotiations for compensation conducted in good faith will be unlawful; and (ii) international law permits investment restructuring so as to take advantage of investment treaty protection. Indeed, the Decision confirms that well-advised investors should plan carefully the structure of their overseas investments.

It is also worth noting that the case has, since the Decision, taken an interesting procedural turn. Following the Decision, Venezuela sent an open letter to the Tribunal in relation to a number of matters. In particular, Venezuela indicated its objection to the majority’s finding that Venezuela had failed to negotiate in good faith the compensation for the expropriated investments. Venezuela cited in its defence evidence of settlement talks in US diplomatic cables released by Wikileaks. Venezuela also requested a hearing specifically to address the issue of good faith negotiations, which it claims is “both essential for the quantum phase and necessary as a matter of fundamental due process”.

On 1 October 2013, the Secretary of Tribunal sent a letter to the parties on behalf of the Tribunal, inviting them, inter alia, to file submissions on the Tribunal’s power to reconsider the Decision. The parties have now exchanged their written submissions on the point. It appears, however, that Venezuela’s request for an additional hearing (on an issue which has already been decided by a majority of the Tribunal) lacks legal basis under the ICSID Arbitration Rules. If the Tribunal finds against it, Venezuela’s open letter, which invokes Venezuela’s “fundamental due process” rights, may be a harbinger of a potential future application for annulment of the Tribunal’s ultimate award.