Expropriation of Investments and Russia

Authors: Anna-Maria Tamminen, Pontus Ewerlöf, Ricardo Gomes, and Aapo Heinäsmäki

1 Introduction

The vast majority of the countries in the world have condemned Russia’s and Belarus’ unprovoked acts of war and violations of international law, human rights, and national sovereignty of Ukraine. The European Union and several other countries have imposed severe financial sanctions on certain Russian individuals, exports, and imports. The imposed sanctions broadly target the Russian political leadership, companies with ties to the Russian state, and the Russian banking sector. Belarus has been targeted with similar sanctions. Effectively, the sanctions either 1) target specific entities, in which case all exports to these entities are affected; or 2) target specific sectors, in which case all exports of such products are affected. As the sanctions regimes contain several exceptions and are frequently updated, it is important that companies take particular care to stay updated on the current sanctions.

The imposed sanctions have had an immediate effect on the Russian economy. Russia has stated that it will respond to these sanctions with countersanctions of its own and has further stated that it does not rule out the nationalisation of foreign investors’ assets located in Russia.

Despite Russia’s disregard for international law, as evidenced by its conduct, Russia remains bound by the investment treaties it has entered into. Both Finland and Sweden have entered into investment treaties with Russia. These treaties provide safeguards to foreign investors, for instance, against discriminatory behaviour by the host state or, for instance, expropriation. In this blog post, we examine some of the key treaty provisions covering Finnish and Swedish investments in Russia.

2 Briefly on Expropriation

Expropriation (commonly also referred to as nationalisation) refers to the deprivation by state organs of a right of property either as such or by permanent control of the power of management and control.

Expropriation can take many forms:

The most clear-cut form of expropriation is the so-called direct expropriation, i.e. expropriation where government authorities directly take control and ownership of an investment for themselves, possibly by using force. Direct expropriation has become increasingly uncommon. However, with the economic sanctions affecting the Russian economy, it cannot be ruled out that Russia would not directly expropriate foreign investors’ assets. In fact, after the announcement of several international companies that they are initiating a departure from the Russian market, there have been some reports that the Russian ruling party has suggested nationalising foreign businesses’ assets.

Nowadays, a more typical form of expropriation is the so-called indirect or creeping expropriation, i.e. measures that have the same effect as direct expropriation without the direct transfer of ownership. In indirect expropriation, the owner of the assets formally keeps their title and ownership rights, however, in practice the host state of the investment might nevertheless prevent the owner from utilising their assets or destroy the value of the assets. The Yukos case, in which an arbitral tribunal found that the Russian government indirectly expropriated the investors’ assets by destroying the value of the company prior to acquiring its shares, is a classic example of indirect expropriation. In the Yukos case, the investors were awarded USD 50 billion. The award has been undergoing challenges in Dutch courts, which have found in favour of both the investors and Russia. The case is currently pending a final decision from Dutch courts.

Should the above-mentioned countermeasures by the Russian authorities be confirmed, it is arguable that those measures could already constitute indirect expropriation or be in breach of Russia’s other foreign investment protection obligations.

However, it must be noted that not all state measures that lower the value of an investment qualify as indirect expropriation. For example, arbitral tribunals have held that state measures that aim, in good faith, to decrease emissions or enhance working conditions of people should not be considered indirect expropriation, even if as a result of said measures, the value of some investments lowers.

Next, we examine some key rules applying to Finnish and Swedish investments in Russia.

3 International Law and Expropriation

As a starting point, it is an agreed part of state sovereignty that states have the right to expropriate foreign property. However, in order to draw investments in, states have entered into various investment protection treaties that set out limitations to the states’ sovereign right to expropriate property.

Generally, these investment protection treaties set out that expropriation can only be lawful if it is (1) for public purpose; (2) carried out in a non-discriminatory fashion; (3) carried out with due process; and (4) the expropriating state provides prompt, adequate, and effective compensation. In practice, expropriation can only be lawful if the expropriating state provides full compensation of the value of the assets prior to any bad faith measures the state has undertaken to destroy the value of the investment.

Currently, Finnish and Swedish investments in Russia (and vice versa) are protected by the respective bilateral investment treaties between Finland and Russia, and Sweden and Russia: The Finland – Russia Bilateral Investment Treaty, which was originally signed between Finland and the USSR but to which Russia has since succeeded; and the Russia – Sweden Bilateral Investment Treaty. Moreover, the Energy Charter Treaty (ECT), which Russia signed, but never ratified, and to which Finland and Sweden are contracting parties, covers some investments made into Russia in the field of energy

Finland – Russia Bilateral Investment Treaty (BIT)

The Finland – Russia BIT covers a wide category of different investments, e.g. movable and immovable property; holdings, stocks and shares in the assets of juridical persons; claims having a financial value; and IP-rights. Article 4 of the BIT contains provisions on the protection of investments, and correspondingly, a limitation on the signatory states’ right to expropriate foreign investments:

Article 4(2): Neither Contracting Party shall adopt in its territory compulsory measures of nationalization, requisition or other measures to expropriate investments made in its territory by investors of the other Contracting Party, except in cases where the interests of the State so require. Should this occur, the procedure established by the legislation in force in that territory shall be applied and appropriate compensation paid.

Article4(3): Such measures shall not be discriminatory in nature.

Article 4(4): The compensation referred to in paragraph 2 of this article shall amount to the real value of the investment expropriated and shall be calculated on the basis of world prices in force at the time immediately prior to the adoption of measures to expropriate the investment or immediately before the decision to adopt such measures became public knowledge. (…)

As can be seen, the Finland – Russia BIT contains essentially the same basic requirements for lawful expropriation as many other international treaties do: public purpose, non-discrimination, due process, and full compensation. Any expropriation that does not comply with these requirements is unlawful.

Russia – Sweden Bilateral Investment Treaty (BIT)

The Russia – Sweden BIT is in many ways similar to the Finland – Russia BIT and also covers the same categories of investments. Article 4 of the BIT concerns expropriation:

(1) Neither Contracting Party shall expropriate or nationalize investments made by investors of the other Contracting Party or take any other measure having effect equivalent to expropriation or nationalization (…), except where the expropriation is:

(a) in the public interest;

(b) not discriminatory;

(c) carried out under due process of law; and

(d) accompanied by the payment of prompt, adequate and effective compensation.

The Russia – Sweden BIT contains the same requirements for lawful expropriation as the Finland – Russia BIT.

Energy Charter Treaty (ECT)

The ECT is a multilateral investment treaty that only covers investments in the field of energy, and for investments made in Russia, only those that were made prior to 2009. Although Russia never ratified the ECT, it still became bound by its investment protection provisions through provisional application provided for in the ECT. Finland and Sweden are contracting parties to the ECT.

In 2009, Russia announced that it does not intend to ratify the ECT. This announcement, in accordance with the ECT, put a halt on the provisional application of the ECT to Russia. However, the ECT also contains a sunset clause that provides that the investment protection provisions remain in force for 20 years after such an announcement. Thus, the investment protection provisions, including those concerning expropriation, still cover the Finnish and Swedish energy investments in Russia that were made prior to October 2009. This protection ceases in 2029.

Article 13 of the ECT concerns expropriation:

(1) Investments of Investors of a Contracting Party in the Area of any other Contracting Party shall not be nationalised, expropriated or subjected to a measure or measures having effect equivalent to nationalisation or expropriation (…) except where such Expropriation is:

(a) for a purpose which is in the public interest;

(b) not discriminatory;

(c) carried out under due process of law; and

(d) accompanied by the payment of prompt, adequate and effective compensation.

The requirements of lawful expropriation are similar under ECT as well. Furthermore, it is noteworthy that while the ECT provides for exceptions for many investment protections, it does not contain exceptions for expropriation — any expropriation that does not fulfil the criteria is unlawful.

4 Practical Questions

The relevant provisions of the respective bilateral investment treaties and the ECT are rather clear on the requirements of lawful expropriation, and it is evident that if Russia were to expropriate foreign assets without full compensation, it would be in breach of international law. In such a situation, an investor can seek compensation through the dispute resolution mechanisms in the BIT, such as recourse to investment arbitration.

Should Russia unlawfully expropriate foreign assets and the investor successfully protect their rights through Investor State Dispute Settlement (ISDS arbitration), then how would the investor be able to enforce such award? Russia has already been effectively cut out of Western finances and would likely have no interest in complying with an arbitral award — states generally perform the awards so as not to discourage future investments, however, Russia has already very strongly discouraged any investments. The solution to this question might be the continuous freezing of Russian state assets around the world — an investor could plausibly seek the enforcement of an award in any New York Convention signatory state in which Russia has (frozen) assets.

5 Concluding Remarks

The international law covering Finnish and Swedish investments in Russia is clear — any expropriation by the Russian government would have to fulfil the aforementioned requirements and be accompanied by full compensation in accordance with the international treaties signed by Russia. While seeking compensation from Russia is neither fast nor straightforward, companies should consider securing their rights in this regard.

The situation is constantly changing and there are numerous questions for companies to consider at the moment. Hannes Snellman is available to assist Finnish and Swedish companies with contractual questions related to the sanctions against Russia and investment protection matters.