Autumn 2011

Pyrrhic Victory For Yukos As European Court Of Human Rights Rejects Discrimination And Political Motivation Allegations Made Against Russia

On 20 September 2011, the First Section of the European Court of Human Rights (“ECHR” or the “Court”) delivered its long-awaited judgment in OAO Neftyanaya Kompaniya Yukos v Russia (“Yukos”). While the Court held that Russia had committed violations of the European Convention for the Protection of Human Rights and Fundamental Freedoms (the “Convention”), the ECHR was unanimous in dismissing allegations of discrimination against Yukos or, indeed, the suggestion of any political motivation on the part of Russia in bringing domestic judicial proceedings. This would seem to be a blow to Yukos’ litigation strategy and could well backfire against their former shareholders who are still involved in proceedings at the Permanent Court of Arbitration. Indeed, the findings of the ECHR could have serious repercussions for the determination and size of any future arbitral award.

Background

Yukos was a publicly-traded private company incorporated under Russian law. It was established by Russia in 1993 in order to own and control a number of stand-alone entities specialising in oil production. Yukos remained fully State-owned until 1995-1996 when, through a series of tenders and auctions, it was privatised.
The present case originated from an application filed with the ECHR by former Yukos senior representatives on 23 April 2004 concerning the tax and enforcement proceedings imposed by Russia which led to Yukos’ eventual liquidation. Yukos was declared insolvent on 4 August 2006 and liquidated on 12 November 2007.
Parallel Proceedings not “substantially the same”

Russia informed the ECHR of the arbitration proceedings also being brought against it in the Permanent Court of Arbitration by Yukos’ former majority shareholders for alleged breaches of the Energy Charter Treaty. In light of those proceedings, Russia invited the Court to discontinue the case in accordance with Article 35(2)(b) of the Convention which states:

2. The Court shall not deal with any individual applications submitted under Article 34 that:

(b) is substantially the same as a matter that has already been examined by the Court or has already been submitted to another procedure of international investigation or settlement and contains no relevant new information.

The ECHR stated that the aim of Article 35(2)(b) was to avoid several international bodies simultaneously dealing with applications which are substantially the same. However, in the present case, it was clear to the majority of the Court (Russian Ad hoc judge Bushev dissenting) that the cases in question here were not “substantially the same”. In the view of the majority, despite concerning the same subject-matter, the claimants in the arbitration proceedings were the shareholders of Yukos acting as investors, not Yukos itself. By contrast, the proceedings before the ECHR had been brought by Yukos in its own name. Consequently, the Court held that it was not barred from examining the merits of the case.

Yukos Did Not Receive a Fair Trial

Between 2002 and 2003, Yukos was subject to a tax inspection by the Russian tax office. In late 2003, this was followed by a further inspection from the tax ministry. The ministry concluded that Yukos had carried out its business activities through 22 trading companies which were, in actual fact, sham entities serving the purpose of screening the real business activity of Yukos. The tax ministry adopted a decision stating that Yukos possessed a large outstanding tax liability for the year 2000 and that it had failed to properly declare its operations in its tax declarations and pay the corresponding taxes. In 2004, the tax ministry applied to the Moscow City commercial court requesting the attachment of Yukos’ assets as security for the claim. Various hearings and proceedings in the Appeals Court, Federal Commercial Court and Supreme Commercial
Court of Russia followed.

Before the ECHR, Yukos claimed that it had been given insufficient time to prepare its defence and to familiarise itself with the evidence before the domestic court. The ECHR emphasised that the question to be determined was whether the national proceedings brought against Yukos as a whole were fair, not to deal with errors of fact or law allegedly committed by a national court.

In the Court’s view, the first instance proceedings against Yukos did not comply with the requirements of Article 6 of the Convention. For example, Yukos was not given access to the documents in the court file until 17 May 2004. These documents amounted to at least 43,000 pages. The first instance hearings then commenced on 21 May 2004; only four days later. These difficulties faced by Yukos were, when taken as whole, in contravention of the principle of a fair trial and violated Article 6(1) and 6(3)(b) of the Convention.

Russia deprived Yukos of the Peaceful Enjoyment of its Possessions

Between December 2003 and January 2005, Russia subjected Yukos to several measures in connection with an alleged failure to pay the correct amount of tax for the years 2000-2003. In particular, Yukos was found guilty of repeated tax fraud and was ordered to pay an overall sum of at least RUB 572 billion (approximately €16 billion) in outstanding taxes, default interest and penalties. Yukos complained that the imposition of these tax assessments was unlawful, arbitrary and disproportionate, violating Article 1 Protocol No. 1 (“A1P1”) of the Convention, which states:

“Every natural or legal person is entitled to the peaceful enjoyment of its possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.”

It was not in dispute between the parties that the measures taken by Russia were an interference with the property rights of Yukos, as protected by A1P1. The ECHR had to satisfy itself, however, that each instance of interference was lawful, pursued a legitimate aim and was proportionate.

The Court reiterated that any interference by a public authority with the peaceful enjoyment of possessions must be lawful. This meant that any interference must comply with domestic law and that the law itself be of sufficient quality to enable an applicant to foresee the consequences of his or her conduct. Yukos complained that the Russian domestic courts had failed to apply a statutory time-bar in prosecuting tax evasion set out in the Russian tax code and had acted retroactively following a decision of the Constitutional Court on 14 July 2005.

The ECHR observed that this 2005 decision changed the rules applicable at the relevant time by creating an exception which previously had not existed. Further, this was not a change which could reasonably have been foreseen. Consequently, despite the wide margin of appreciation afforded to States in passing domestic laws to secure the payment of taxes, the ECHR found Russia in violation of A1P1.
In addition, the Court held that the Russian authorities were “unyieldingly inflexible as to the pace of enforcement proceedings”. The authorities had acted quickly and repeatedly refused to concede to any of the demands made by Yukos for additional time. In light of the pace of these proceedings, the ECHR concluded that Russia had failed to strike a fair balance between the legitimate aims sought and the measures employed, constituting a further violation of A1P1.

No Evidence of Discrimination

Yukos submitted that the Russian domestic courts’ interpretation of the relevant laws had been “unique, selective and unforeseeable” and that the Russian authorities had even tolerated and endorsed the tax optimisation techniques used by Yukos, thus violating the prohibition on discrimination contained within Article 14 of the Convention.

The ECHR dismissed this complaint. The Court stated that there was nothing in the case file to suggest that Yukos’ tax arrangements were known to the Russian authorities or that these arrangements had been previously upheld as lawful. Consequently, it could not be said that the authorities had passively tolerated their activities. In addition, Yukos had failed to submit any “specific and reliable evidence” that other companies were in a similar position but only Yukos had been singled out.

Political Motivation in Bringing Proceedings not Proven by Yukos

Yukos alleged that the proceedings brought against it were abusive and that Russia had wanted to destroy the company and take control of its assets.

The Court emphasised that, in order for a State to be held liable under Article 18 of the Convention, “incontrovertible and direct proof” must be provided by an applicant in support of its allegations. However, while the ECHR conceded that the case had attracted “massive public attention”, there was no further evidence which enabled the Court to conclude that a breach of Article 18 had occurred.

A Pyrrhic Victory

The decision of the First Section is a victory for Yukos. However, there are at least three reasons why the overall impact of this decision should not be overstated.

First, while Yukos successfully established several breaches of the Convention, the ECHR was unanimous in dismissing the allegations of discrimination or political motivation on the part of the Russian authorities in bringing domestic proceedings against Yukos. This was not, therefore, a landslide victory entirely in Yukos’ favour. In fact, the findings of the Court may prove to be counter-productive in the ongoing arbitration proceedings taking place at the Permanent Court of Arbitration.

Second, it is well documented that the Yukos claim is the largest ever brought before the ECHR. Yukos has claimed a lump sum of €81 billion, a daily interest payment of €29,577.48 for pecuniary damage, no less than €100,000 for non-pecuniary damage and €177,444.60 in respect of costs and expenses. Interestingly, however, this was an issue reserved by the Court which determined that this was not an issue yet ready for decision.
Third, it is important to note that this decision is not (yet) final. For the three-month period following the delivery of this Chamber judgment, any party may request that the case be referred to the Grand Chamber for further consideration. If such a request is successfully made, there may be several more interesting developments to come.