Investment Treaties May Provide a Remedy for Foreign Investors Against Russia’s Retaliatory Measures

Following the unprecedented international response to Russia’s invasion of Ukraine, Russia is laying the groundwork to expropriate, damage, or otherwise impair the investments of companies from “unfriendly” countries—including the U.S., UK, Canada, all EU member states, Japan, Singapore, and South Korea.[1] On Thursday, Russia announced that the assets of foreign investors that have suspended operations in Russia could be transferred to others—a step that could well constitute an uncompensated expropriation, for which investors could seek redress under Russia’s network of bilateral investment treaties (BITs).[2] Other steps announced by Russia that could violate its treaty obligations and give rise to investment claims include:

• Suspending transfers of funds outside of Russia by entities and individuals residing in countries that have placed sanctions on Russia[3];
• Forcing Russian residents, including Russian subsidiaries of foreign companies, to sell to the Russian Central Bank and exchange into rubles at least 80% of their foreign currency proceeds from export activities[4];
• Imposing a pre-authorization requirement on foreign currency transfers to the foreign accounts of Russian residents (including Russian subsidiaries of foreign companies), and restricting certain of their transactions with non-Russian entities and individuals residing in unfriendly countries[5];
• Allowing Russian citizens and companies, as well as the Russian state, its regions, and its municipalities to make payments of foreign currency-denominated debt to foreign creditors from unfriendly countries in rubles, converted at an official exchange rate set by the Russian Central Bank, and deposited in a special account that can be used only for limited purposes[6];
• Restricting sales by foreign holders of the shares and bonds of Russian companies, and preventing Russian companies from paying dividends on such shares[7]; and
• Eliminating the obligation of users in Russia to pay compensation to patent holders for the users’ unauthorized use of patents associated with "unfriendly" countries.[8]

In a prior Covington alert, we discussed how foreign investors in Russia can protect their investments from Russian retaliatory measures by ensuring that they have access to international arbitration, including through BITs. In this alert, we focus on key protections afforded in Russian BITs that may provide recourse to foreign investors affected by Russia’s recent measures.

Key Protections in Russian BITs

Russia has BITs in force with over 60 countries, including many EU members (such as Austria, Belgium, Bulgaria, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Lithuania, Italy, Luxembourg, the Netherlands, Romania, Slovakia, Spain, and Sweden) and countries such as Canada, Japan, Korea, Switzerland, the UK, and Ukraine. There is no BIT between Russia and the United States, but U.S. companies may nonetheless benefit from BIT protection if they hold their investments in Russia through a third country that does have a Russian BIT.

In its BITs, Russia has committed to, among other things, treat investors from the relevant countries in a fair and equitable manner, not to discriminate against such investors on the basis of nationality, not to expropriate their investments except under certain conditions and upon payment of adequate compensation, and to guarantee their right to freely transfer payments related to their investments out of Russia. All of these protections are relevant in the present context.

Russia’s Retaliatory Measures in Breach of Free Transfer Provisions

Many of Russia’s BITs guarantee that investors from the relevant countries will be able to freely transfer out of Russia payments related to their investments. The guarantee that a foreign investor shall be able to remit the proceeds of their investment, including any proceeds resulting from a sale or liquidation, is a fundamental protection for foreign investors.

Although the language of free transfer provisions may vary among BITs, most free transfer provisions in Russian BITs include a non-exhaustive list of payment categories covered by the free transfer guarantee. These typically include:

• the amount of the initial investment and subsequent investments over time;
• income from the investment, including profits, dividends, and interest;
• funds required for loan repayments;
• royalties;
• proceeds of the partial or complete liquidation or sale of an investment;
• compensation for expropriation, nationalization, or equivalent measures; and
• wages or other remuneration of expatriate personnel.

Most free transfer provisions in Russian BITs also require that transfers be permitted “in freely convertible currency” and “at the exchange rate applicable on the date of the transfer.”[9] In addition, several of Russia’s BITs require that transfers be made promptly or without delay, or within pre-set timeframes.

Several of Russia’s recent retaliatory measures appear to be at odds with Russia’s free transfer obligations. These include, in particular:

• Suspending transfers of funds outside of Russia by legal entities and individuals residing in sanctioning countries, particularly to the extent that suspension is extended or becomes permanent;
• Allowing foreign currency-denominated debt repayments to foreign creditors from “unfriendly” countries to be made in rubles, at an official exchange rate established by the Russian Central Bank, and to be deposited in a restricted account; and
• Requiring Russian residents, including Russian subsidiaries of foreign companies, to sell to the Russian Central bank and exchange into rubles at least 80% of their foreign currency proceeds from export activities.

In addition, the pre-authorization requirement imposed on certain foreign currency and other transactions by Russian residents, including Russian subsidiaries of foreign companies, may also constitute a breach of Russia’s free transfer obligations to the extent that the required authorizations are not provided in a timely manner.

Russia’s Retaliatory Measures in Breach of Other BIT Protections

Several of Russia’s recent retaliatory measures may also constitute breaches of other protections accorded to foreign investors under Russia’s BITs, including protections against expropriation and discriminatory treatment. For example:

• All of Russia’s retaliatory measures affecting companies or their investments in Russia based on their shareholders’ “unfriendly” nationality would appear to be in breach of Russia’s obligation of non-discrimination, as well as Russia’s obligation to refrain from arbitrary, unfair, and inequitable treatment.
• By requiring Russian subsidiaries of foreign companies to sell to the Russian Central Bank and exchange into rubles at least 80% of their foreign currency proceeds from export activities, and by authorizing foreign currency-denominated debt to be repaid to creditors in rubles, Russia may be substantially reducing the value of corporate receivables and loan assets, resulting in unfair and inequitable treatment or, potentially, expropriatory treatment.
• By restricting the ability of foreign holders of shares and bonds of Russian companies to sell those shares and bonds, and preventing Russian companies from paying dividends on such shares, Russia may in effect be expropriating the relevant shares, bonds, and dividends without compensation, or may be substantially affecting their value in a manner that constitutes unfair and inequitable treatment.
• By eliminating the obligation by Russian users to pay compensation to foreign patent holders for the use of their patents in Russia, Russia may be depriving such patent holders of the value of their patent rights (which are expressly recognized as protected investments under Russia’s BITs with countries it considers “unfriendly”),[10] and this measure may also be deemed equivalent to an unlawful expropriation of such patent rights, without compensation.

Plainly, should Russia make good on its threat to more broadly nationalize or transfer the assets of firms that have suspended their operations in Russia, this too may constitute an expropriation in breach of Russia’s treaty obligations.

Access to International Arbitration under Russia’s BITs

Russia’s BITs with many of the countries it considers “unfriendly” allow investors from such countries to pursue investment arbitration claims against the Russian government. As discussed in our prior alert, the scope of Russia’s consent to arbitration varies from treaty to treaty, with some treaties providing for access to international arbitration over a greater variety of disputes than others.

International arbitration under investment treaties may be the only effective remedy for many foreign investors with investments in Russia to recover the losses caused by Russia’s retaliatory measures. Arbitral awards may be enforced against certain types of Russian government assets overseas, and firms may also be able to work with their home governments to explore opportunities to enforce awards. U.S. government actions involving Afghan assets and the assets of state sponsors of terrorism point to possible paths, among others, that could be explored.

As Russia’s retaliatory measures continue to intensify, investors should actively analyze available protections and consider acting to preserve their rights under Russia’s BITs.

If you have any questions concerning the material discussed in this client alert, please contact the members of our International Arbitration practice.