Unauthorized transfer or assignment of interests or shares in investor-state arbitration
By Borzu Sabahi and Diora Ziyaeva
Contracts for exploitation of natural resources are usually awarded to foreign investors following demanding bidding processes during which the host government carefully vets qualifications of foreign investors. The process is designed to ensure that the investor has, among other things, sufficient expertise and resources to work on the project. Usually, such contracts and the relevant legislation require foreign investors to obtain approval or authorization from the host government before transferring or assigning the shares or farming-out any interest in the project to third parties. Moreover, from the host government perspective the authorization provisions are important for a variety of reasons, be it the national interests or compliance with the host State’s laws and regulations. While transactional and corporate lawyers are familiar with these provisions, the international investment arbitration community has not delved into this issue until recently.
Significantly, these provisions have been at the center of at least two investment treaty arbitrations raising questions as to whether failure to comply would be a basis for dismissal of claims. The ICSID tribunals in Vannessa Ventures Ltd v Venezuela, Award, ICSID Case no. ARB(AF)/04/6; IIC 572 (2013), 16 January 2013 and Occidental Petroleum Corporation v Ecuador, Award, ICSID Case No. ARB/06/11; IIC 561 (2012), 5 October 2012 took contradicting positions on this issue.
In Vannessa Ventures, a Canadian company, Placer Dome, had acquired a gold concession from the Venezuelan government. Immediately after the company started exploitation, global gold prices significantly dropped making the operation unprofitable. Placer Dome then first suspended the project (by entering into an Extension Agreement for a year with Corporacion Venezolana de Guayana or CVG, a Venezuelan government agency) and then sought various ways to transfer its shares in its local subsidiary (PDV) which was party to the concession to a third party. In order to transfer its stake though, under various agreements that Placer Dome and PDV had entered into with CVG, Placer Dome required prior approval of CVG. For example, a 1991 Shareholder Agreement provided that: “Except as otherwise provided in this Agreement, neither party may assign any of its rights or delegate any of its duties under this Agreement without first obtaining the prior written consent of the other party which shall not be unnecessarily withheld…” Placer Dome ultimately transferred its shares to a Canadian company, Vannessa Ventures (Vannessa), without obtaining approval of CVG leading to CVG terminating the concession. Vannessa then filed a claim against Venezuela alleging that Venezuela’s termination of the gold concession violated various provisions of the Canada-Venezuela Bilateral Investment Treaty.
The tribunal first held that Placer Dome’s contracts with CVG had an intuitu personae nature, meaning that due to the complex selection process the identity of Placer Dome was a material element in the conclusion of the contracts. Further, Vannessa had a radically weaker technical and financial profile than Placer Dome. But, the majority still considered Claimant’s ownership of PDV shares as qualifying investments within the meaning of the Bilateral Investment Treaty. Nevertheless, the tribunal ultimately held that because of the unauthorized transfer of the shares the claims must fail and dismissed the case in its entirety. The tribunal noted that, under the Extension Agreement, Placer Dome was supposed to work together with CVG to find a third party to join them but Placer Dome did not consult with CVG. This breach justified Venezuela’s subsequent decision to terminate the concession.
In Occidental v. Ecuador, Occidental Petroleum, a US company, entered into a Participation Contract (a type of production sharing agreement) with Petroecuador in order to explore and exploit hydrocarbons in Block 15 of the Ecuadorian Amazon region. A year later, Occidental sought to explore ways to finance the expansion of its operations in Ecuador and entered into a farm-out agreement whereby it assigned a 40% economic interest in Block 15 to another energy company (AEC) in return for certain capital contributions. Such assignment, however, both under the Contract and Ecuador’s Hydrocarbons Law required government approval. As a result, Ecuador subsequently terminated the Participation Contract by issuing a Caducidad Decree as contemplated in the Contract and the Law for violation of the prohibition against assignment.
Occidental argued that it was not in breach because it remained the legal owner in the contract vis-a-vis the State, and it had only transferred the equitable interest. Occidental lost on that issue. The tribunal noted that the assignment, although not in bad faith, violated Clauses 16.1 and 16.2 of the Contract and Ecuador’s Hydrocarbons Law, which required prior government approval.
Despite the above ruling, the tribunal held that the termination of the Participation Contract was a disproportionate response to Occidental’s assignment of rights; there were a number of alternatives to terminating the Participation Contract and the latter should have thus been a measure of last resort. The tribunal also found that Ecuador did not suffer “any quantifiable loss” from the assignee’s taking an economic interest in the relevant block under the Concession. Applying these findings, the majority awarded Occidental damages in the amount of US$1.77 billion plus interest. Ecuador filed a request to annul the decision, which is currently pending.
At the center of both disputes are transfers of shares (Vannessa Ventures) and beneficial interests (Occidental) without government approval. The outcomes of the two cases, however, are worlds apart, as in the former investors went home with nothing and in the latter with an award worth more than US$2 billion.
The divergent outcomes warrant a closer look at the main issues in the two cases. Contracts and domestic laws generally contain sanctions for non-compliance with such provisions. For example, in the case of Ecuador, the Participation Contract as well as the Ecuadorian Hydrocarbon Law granted the right of Caducidad or cancellation of the contract to the State Party. Similarly, in Vannessa, the State party to the contract had a right to terminate the concession for the breach. Both tribunals held that Claimant’s failure to secure government approval violated the respective contracts and or the laws.
A more complex issue, however, is determining the effect of such violations in international law or more specifically on the Claimant’s right to bring a claim. The majority of both tribunals did not see any reason to dismiss the case for lack of jurisdiction. The concurring arbitrator in Vannessa had suggested that such violation would breach the treaty provision requiring investments to be made in accordance with the laws of the host State. The Vannessa tribunal appears to have treated the issue as one of admissibility, dismissing the case at the merits stage. Occidental did not dismiss the case for lack of jurisdiction either, but engaged in another layer of unprecedented analysis examining whether the State’s termination of the Participation Contract was a proportionate response to the assignment, ultimately finding that it was not.
The diverging outcomes of the two cases do not provide consolation either for foreign investors or the host governments. It remains to be seen whether the Occidental award will survive the annulment proceedings. The issues to consider are, among others, what effect the breaches and subsequent terminations have on the property interests that had been transferred. The majority in Occidental considered the transfer “inexistent” or void as a result of Ecuador’s termination of the Participation Contract, which worked for the investor because, although the investor was in breach of the Participation Contract due to unauthorized assignment of 40% interest to AEC, it still recovered damages for 100% of its interest in the project. Professor Stern criticized the position of the majority, stating that the farm-out should have been considered valid and binding until declared otherwise by the competent court and that Occidental was only eligible for 60% of the damages.
Dr Borzu Sabahi and Ms Diora M. Ziyaeva are both Associates at Curtis, Mallet-Prevost, Colt & Mosle LLP.
Disclaimer: The authors are attorneys at Curtis, Mallet-Prevost, Colt & Mosle LLP. The views expressed in this note are exclusively those of the authors and shall not be attributed to Curtis, Mallet-Prevost, Colt & Mosle LLP or its clients.
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