Yukos Arbitration Awards Annulled

April 20, 2016

Cleary Gottlieb successfully represented the Russian Federation in annulling three arbitral awards, totaling more than $50 billion, obtained by the former majority shareholders of Yukos Oil Company, based on their allegations that the Russian Federation had unlawfully expropriated Yukos in violation of the protections afforded to foreign investors under the Energy Charter Treaty (ECT).

In a judgment issued on April 20, 2016, the District Court of The Hague in the Netherlands accepted Cleary’s arguments on behalf of the Russian Federation that the arbitrators lacked jurisdiction over the claimants’ claims because the Russian Federation never ratified the ECT, and agreed (in accordance with Article 45(1) ECT) to apply it on a provisional basis only “to the extent that such provisional application is not inconsistent with its Constitution, laws or regulations.” The Dutch court agreed with Cleary’s argument that arbitration of the claims under the ECT’s investor-State dispute settlement clause is inconsistent with Russian law and the separation of powers under the Russian Federation’s Constitution, and that the arbitral tribunal therefore had no jurisdiction to hear the dispute.

Unless this ruling is reversed on appeal, it provides the Russian Federation with a complete victory in proceedings that were commenced in 2005, and resulted in the largest damages ever awarded in an international arbitration.

Yukos was principally indirectly owned and controlled by Russian oligarchs, led by Mikhail Khodorkovsky, who attempted to internationalize their dispute with the Russian tax authorities by asserting expropriation claims under the ECT. Their claims in fact involved a domestic Russian tax dispute concerning Russian tax assessments against a Russian company that was owned and controlled by Russian nationals. The Russian tax authorities and multiple levels of Russia’s courts found that Yukos had evaded billions of rubles in Russian taxes by misrepresenting that profits which had actually been earned by Yukos in Moscow had instead been earned by sham entities established by Yukos in regions where business income was taxed at a lower rate. After the Russian authorities uncovered Yukos’ tax evasion scheme, Yukos refused to pay its assessed taxes and was ultimately placed in bankruptcy, and its assets auctioned in order to satisfy the company’s tax and other related obligations. The underlying tax assessments were based on fundamental principles of tax law that are commonly used to combat tax evasion around the globe, and were unanimously upheld (with limited exceptions relating to fines and penalties) by two separate chambers of the European Court of Human Rights.

Because the Dutch court ruled that the tribunal lacked jurisdiction to hear the parties’ dispute, it did not address the other defects in the tribunal’s awards that Cleary identified and developed in support of the Russian Federation’s annulment petition, including (a) that the ECT cannot be invoked to protect investments in a state by nationals of that same state, (b) that the Russian oligarchs acquired their majority ownership of Yukos by unlawful means, (c) that the ECT’s investment protections do not apply to the taxation measures at issue, (d) that the arbitrators failed to comply with the ECT’s requirement that they obtain the views of the relevant tax authorities, (e) that the tribunal’s damages award was based on the its own deeply flawed methodology, which had not been advocated by any of the parties and resulted in substantial double counting of the claimants’ purported losses, and (f) that the tribunal improperly delegated its duties to its assistant, who was shown to have drafted substantial portions of the awards, contrary to applicable law.

Cleary Gottlieb represented the Russian Federation in this dispute from the commencement of the arbitrations in 2005. The arbitral proceedings involved the submission of extensive pleadings, briefs, witness statements and expert reports, thousands of exhibits and several weeks of evidentiary hearings, concerning both jurisdictional and merits issues.

The annulment proceeding was brought before the District Court in The Hague because The Hague was the seat of the arbitration. The Russian Federation’s briefs were prepared by Cleary with important input on Dutch law from Dutch counsel, Hanotiau & van den Berg, who pleaded the Russian Federation’s case before the District Court, and Houthoff Buruma.