On May 7, 2009, Venezuela’s National Assembly approved an Organic Law which grants President Hugo Chavez the power to seize... Read more
On May 7, 2009, Venezuela’s National Assembly approved an Organic Law which grants President Hugo Chavez the power to seize control of oil service companies operating in the country. The law extends the state’s control to all activities related to the oil industry. Venezuela’s legislature has declared that service firms be paid the book value of any expropriated assets, less unspecified deductions for labor and environmental considerations. A further wrinkle is that the legislature has said that the Venezuelan government would have the option of paying for the assets with bonds instead of cash. The law “reserves for the state, the goods and services connected to primary hydrocarbon activities.” Although Energy Minister Rafael Ramirez has denied that oil drillers will be subject to the law, the law’s vague wording means that these companies could still be affected.
The Venezuelan government immediately mobilized troops to seize 13 drilling rigs, 39 maritime terminals, 300 shipping vessels, and 30 tugboats, and two gas compression facilities. So far, the government has nationalized 74 firms under the new law, spanning industries including water, gas, and steam injection, gas compression, and transport of oil workers.
In an attempt to avoid paying the full market value compensation required under international law, the legislature also declared that all controversies under the new law must be resolved by Venezuelan courts. Government officials have stated that the new law gives local courts exclusive jurisdiction, shielding the government from international arbitration. However, under international law, and the contracts governing the seized investments, arbitration is not only available, but may well prove the best option for recovering fair compensation.
When a state enters into an enforceable contract, under principles of international law, it must respect its contract obligations. While a state has the power to expropriate or nationalize property, the state must compensate the investor for the market value of the nationalized investment. The United Nations has affirmed this understanding of international law in Resolution 1803, which declared that nationalizations must be in the public interest, foreign investors shall receive “appropriate compensation,” and that settlement of disputes should be through arbitration if the parties agree.
Despite Venezuela’s attempt to substitute book value for market value compensation, there is a clear precedent in arbitral decisions. The history of international law shows that the remedy for nationalization of investor property has consistently been full compensation based on market value. Prior to World War II, the standard of full compensation for expropriation was almost unquestioned in customary international law. In one study of 60 international claims tribunals ruling on damages to foreign investors from 1840-1940, none of the arbitral panels held that the appropriate measure of compensation was less than the full value of the property taken, and many specifically affirmed the rule of full compensation. While the determination of full compensation associated an expropriation may be subject to debate, an arbitrary rule that book value or something other than fair market value is not the standard under international law. Full compensation has been held to mean prompt, adequate, and effective compensation in the amount of the full market value of an investment as a going concern.
Following World War II, well-known arbitration decisions have awarded full compensation for the expropriation of oil concessions. The arbitrations resulting from the Libyan oil nationalizations in the 1970s confirmed the standard of full compensation for expropriation. The decisions of the Iran-U.S. Claims Tribunal following the nationalizations of the Iranian revolution also required full payment of compensation based on market value. Recent arbitral decisions that have considered the issue have affirmed that customary international law requires a state expropriating the property of a foreign national to pay the full value of that property, generally measured, by the market price. U.S. State Department spokesman Noel Clay has recently affirmed this international standard, stating that “in the event of expropriation, we expect the Venezuelan government to provide U.S. companies with prompt, adequate and effective compensation in accordance with international law.”
A state can make its actions subject to international law in several ways: by enacting a bilateral investment treaty with a trading partner state, by ratifying an arbitration treaty, or by explicitly agreeing in a contract that disputes will be governed by arbitration.
A bilateral investment treaty (“BIT”) is a treaty concluded between two states in which each agrees to offer specific protections to investors of the other state. Most BITs provide that any expropriation shall be non-discriminatory, for a public purpose, and that full compensation should be paid. Governments attract foreign investment by promising in the BIT that compensation for a nationalized investment will be based on the fair market value of the investment.
Venezuela has entered into 22 BITs with countries including the Netherlands, Canada, Germany and the United Kingdom. While Venezuela does not have a BIT in effect with the United States, many companies have made Venezuelan investments by incorporating in countries that do have BITs with Venezuela. These investments benefit from the favorable terms of BITs that Venezuela has ratified. For example, Exxon Mobil’s pending arbitrations are over Venezuelan investments made through a Dutch parent corporation and covered by Venezuela’s BIT with the Netherlands.
The International Centre for the Settlement of Investment Disputes (“ICSID”) provides an impartial international forum to decide disputes independently of national courts. It is a self-contained system of administrative and procedural rules that operates to the exclusion of other means of dispute settlement, including domestic courts. In order to arbitrate a dispute through ICSID, both parties must be from ICSID member countries and must consent to ICSID jurisdiction. A BIT will usually provide consent to ICSID jurisdiction. Without a BIT, parties can provide for ICSID jurisdiction by an express clause in the contract.
Although Venezuela claims that the new law precludes arbitration, if the contract was formed under a BIT or contained an appropriate arbitration clause, it is a valid consent to arbitrate disputes. ICSID arbitration is available for any legal dispute arising directly out of an investment. ICSID tribunals have repeatedly accepted concessions for the exploitation of minerals and hydrocarbons as within their jurisdiction. ICSID arbitration is desirable for several reasons, including limitations on appealing, questioning or re-opening an arbitral decisions.
Once made, an arbitral award becomes immediately enforceable in any of ICSID’s 155 member states. If a nationalizing state’s assets are located in an ICSID member country, the ICSID award may be presented to the member country so that the assets may be seized as payment.
The International Chamber of Commerce (“ICC”) is another institution that provides for international arbitration. Its awards are similarly enforceable under the New York Convention, of which 143 countries are members.
Venezuela has considerable international assets to attach, including refineries and tankers loaded with crude oil landing in United States and other ports. Venezuela must export goods in order to support its economy. The country relies on oil for 93 percent of its export revenue. The government of Venezuela owns significant assets in the United States through Citgo, as well as significant resources that move through the U. S. financial system. These are assets that could conceivably be subject to an arbitration award. Additionally, large commercial transactions mostly go through New York or London banks. It would be very difficult to for Venezuela to move a significant stream of oil exports outside the U.S. stream of commerce. If a company prevails in arbitration, it will have access to Venezuelan assets moving through international commerce.
Investors that fail to resist unlawful changes in their contract rules risk sending themselves and the industry down a slippery slope with countries demanding increasingly greater concessions. What happens in Venezuela is heard in around the world and affects the behavior of other countries. Investors need to weigh the benefits of granting concession after concession to expropriating countries to maintain a smaller and smaller slice of their expected gain versus asserting their legal and commercial rights and insisting that expropriating countries honor their commitments, comply with international law, and fully pay for the property that is expropriated or nationalized.
A country’s sovereign power to expropriate is limited to certain lawful circumstances, and an expropriating country must comply with international law and provide “prompt, adequate and effective compensation.” As in the past, investors that assert their rights will ultimately prevail and countries will again realize that the power to expropriate is not a license to steal. If an investor can pursue international arbitration, they are likely to recover an award for the market value of the expropriated investment. Since Venezuela must participate in international commerce, an arbitration award can provide significant value for the investor.
Andrew B. Derman is a partner in the Dallas office of Thompson & Knight LLP.
Emily A. Miskel is an Associate in the Dallas office of Thompson & Knight LLP.