Protecting Your Investments from Russian Retaliatory Measures

Protecting Your Investments from Russian Retaliatory Measures

March 2, 2022, Covington Alert

Geopolitical tensions have reached their highest levels in decades after the U.S., the EU, the UK, Canada, Australia, Japan, and Korea imposed a swath of unprecedented sanctions against Russia following its invasion of Ukraine. Among other measures, Russia has been prevented from using its foreign reserves, the Nord Stream 2 gas pipeline has been halted, airspace closures have been imposed on Russian aircraft, major Russian banks have been excluded from the SWIFT global financial network, and a freeze on the personal assets of the Russian President Vladimir Putin, Russian Foreign Minister Sergey Lavrov, and other members of President Putin’s inner circle has been put in place. As a result, a growing list of multinationals, including energy giants, global banks, auto-makers, and shipping companies have recently announced their decision to exit Russia.

The Kremlin reacted to these measures by announcing that it is preparing retaliatory actions, the nature of which it has not yet disclosed. This reaction serves as a reminder that investments in Russia are subject to a meaningful political risk. Companies would thus be wise to consider how they can mitigate the exposure to their investments in Russia. What can these companies do? The answer is to consider both how their investments are structured and how any agreements governing their investments address dispute resolution. These considerations are critical to ensuring that companies invested in Russia have remedies available if they find themselves in a dispute with the Russian government or with their Russian counterparties.

The Importance of Access to International Arbitration

Companies with investments in Russia are appropriately wary of relying on Russia’s courts to uphold their rights in the event of a dispute with the state, with state-owned enterprises, or with other companies closely aligned with the Kremlin. Indeed, the rubber-stamping of the Kremlin’s controversial expropriation of the Yukos Oil Company by Russia’s courts demonstrated that the country’s courts cannot be relied upon to dispense impartial justice in politically sensitive cases.

Thus, for most foreign companies, the preferred dispute-resolution mechanism is international arbitration, which provides the neutral forum that Russia’s courts do not. But forethought is required to ensure that international arbitration is even an option. And getting the most of international arbitration requires still more forethought.

Securing a Gateway to International Arbitration

To arbitrate a dispute against a sovereign in an international forum, a foreign investor must be able to establish that the sovereign has consented to arbitration. Without such consent, the investor will not have a jurisdictional basis to pursue its claim. Thus, when investing in Russia, foreign companies should consider how they will demonstrate Russia’s consent to arbitration if a dispute later arises.

Foreign investors typically have two options for establishing Russia’s consent. First, an investor can include a dispute-resolution clause providing for international arbitration in any investment agreement the investor has with Russia. Second, in the event of a dispute, they can avail themselves of the protections of an investment treaty with Russia providing for arbitration of investment disputes. Such treaties include bilateral investment treaties (BITs), and in the case of energy companies, the Energy Charter Treaty (ECT). With respect to the ECT, however, although Russia signed the treaty in 1991 and thereby became subject to its provisional application, an investor should expect Russia to argue that the period of provisional application was terminated by Russia’s declaration in August 2009 that it did not intend to ratify the treaty.

While either of these avenues—i.e., an investment agreement or treaty—on its own may be sufficient to confer arbitral jurisdiction, they are not mutually exclusive. Indeed, in some circumstances, an investor may be able to demonstrate Russia’s consent to arbitration both in an applicable treaty and in the provisions of the governing contract.

Treaty-Based Jurisdiction

While Russia has BITs with many countries,[1] it does not have a BIT with the United States—a crucial fact for any U.S. company invested in Russia. In the BITs to which Russia is party, however, Russia has committed, for example, to treat investors from its treaty partners’ countries in a fair and equitable manner, not to discriminate against investors from those countries on the basis of nationality, and not to expropriate their investments except under certain conditions and upon payment of adequate compensation.

That said, it is important to note that in many of its BITs, Russia has consented to arbitral jurisdiction for certain kinds of investment disputes but not others. Indeed, the scope of Russia’s consent to arbitration varies from treaty to treaty, with some treaties providing for arbitral jurisdiction over a greater variety of disputes than others. For example, many of Russia’s BITs are legacies from the late Soviet era and provide for arbitration only for limited types of disputes. By contrast, many BITs negotiated by Russia in the late 1990s provide investors with much broader arbitral rights, reaching a wide variety of disputes.

These variations mean that the nationality of the investor can have a significant effect on the quality of dispute resolution available. Without a U.S.-Russia BIT or an Australia-Russia BIT, a U.S. or Australian company that invests directly in Russia lacks altogether the protection of BIT-conferred arbitral rights. But Spanish investments in Russia, for example, would obtain the arbitral protections set forth in the BIT entered into by Spain and the Soviet Union in 1990, which include the right to arbitrate disputes concerning “the amount and method of payment of compensation for expropriation.” Better still, Danish investors in Russia can avail themselves of the BIT entered into by Denmark and Russia in 1998, which extends to “[a]ny dispute which may arise … in connection with an investment on the territory” of Russia. Thus, multinational companies invested in Russia should consider structuring their investments with care, with an eye toward protecting the investment should a dispute arise with Russian authorities.

Other provisions may also be relevant to determining whether international arbitration is available to a foreign investor in Russia. Some Russian BITs require more substantial contacts with the investor’s State of nationality than others in order to obtain the protections of the BIT. For example, the Russia-Switzerland BIT’s definition of “investor” requires not only that a Swiss company invested in Russia be formed under the laws of Switzerland, but also that it have its “seat” in Switzerland and that it be engaged in real economic activity there.

Contract-Based Jurisdiction

U.S., British, European, Canadian, Australian, Japanese, or Korean companies or their foreign-based subsidiaries that have entered into an investment agreement directly with Russia—whether with Russia’s federal government, a local government, or a governmental agency—should consider whether they have included a dispute-resolution clause in their investment agreements that provide for international arbitration of disputes arising from their investments. This is especially important not only for U.S. companies investing directly in Russia and therefore without the protection of a BIT, but also for any company that can avail itself only of a BIT containing Russia’s consent to arbitrate a limited category of disputes. With an appropriately drafted investment agreement, a company can remove some of the barriers or limitations to arbitral jurisdiction that may exist under a BIT.

Effective Protection for Existing Investments

The best time for a company investing in Russia to consider its dispute-resolution options is before making its investment. But if a company has already invested in Russia and is either not covered by a BIT or covered by a BIT that grants inadequate access to international arbitration, the company may still be able to improve its options in the event that a dispute arises. Indeed, there may be a range of ways in which companies can achieve this objective.

It is important to note, however, that any such measures should be taken before a dispute with Russia arises. Companies that seek to restructure their investments to improve their access to arbitration after a dispute has crystallized run the risk that their claims may be rejected for lack of jurisdiction. It is therefore imperative for companies to consider access to treaty and other investment protections well in advance of an actual dispute. Given the state of relations between Russia and the West in light of Russia’s invasion of Ukraine, that time is now.

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