Due diligence and proportionality under scrutiny in latest ICSID liability finding

Summary

In a decision dated 21 February 2017, a tribunal acting under the auspices of the International Centre for Settlement of Investment Disputes (“ICSID”), the World Bank’s arbitration institution, in Ampal-American Israel Corp. et al v Arab Republic of Egypt found the Respondent liable (1) for failing to exercise due diligence in protecting against repeated terrorist attacks on a gas pipeline through which the Claimants’ investment company exported natural gas from Egypt to Israel, and (2) for expropriating the Claimants’ property interests in a free-zone tax license and a gas sales and purchase contract. In its merits analysis, the Tribunal considered, as a preliminary matter, whether, and if so to what extent, the decisions of an ICC tribunal in a related arbitration involving the Claimants’ investment company bind the Claimants.

Facts

The Claimants were shareholders of East Mediterranean Gas Company S.A.E. (EMG), a free-zone company created to purchase natural gas from Egypt and to export it to Israel through a pipeline crossing the North Sinai in Egypt. Egypt conferred to EMG tax-free status under its free zones system until 2025. EMG entered into a long-term upstream supply contract with the state-owned Egyptian General Petroleum Corporation (EGPC). Some years after the signing of the gas supply contract, the Egyptian government revoked EMG’s tax-exempt status. Following the Arab Spring, the Egyptian pipeline system used to deliver gas to the EMG pipeline suffered a series of sabotage attacks, which the Claimants argued that the Respondent failed to prevent and remedy within a reasonable time. Eventually, EGPC terminated the gas supply contract for alleged non-performance by EMG. EMG argued that the termination amounted to a repudiation and sought damages before an ICC tribunal. In parallel, the Claimants commenced investment treaty claims before ICSID based on the US-Egypt Bilateral Investment Treaty (BIT). The ICC tribunal issued its award while the ICSID arbitration was pending and the ICSID Tribunal invited the parties to comment on the relevance and impact of the ICC award on the investment dispute.

Decision

The Tribunal found that the binding effect of the ICC award extends not only to the parties in that contract arbitration, but also to those who were in privity with the parties: “in the context of investment arbitration, a shareholder is entitled to pursue a claim for investments that are indirectly held through a corporation, [the shareholder claimant] must also be subject to defences that would be available against the corporation, including the defences of estoppel based on a prior judgment.”

The Tribunal found that the ICC tribunal’s findings in relation to the attacks and the termination of the gas supply contract were binding on the parties in the ICSID arbitration. Nevertheless, the Tribunal conducted its own evaluation of the evidence on those matters and concluded that the ICC tribunal’s findings were correct.

The Tribunal considered that, while Egypt could not have prevented the first terrorist attack on the pipeline, it could have taken preventive or reactive measures in relation to 13 subsequent attacks and its failure to do so constituted a breach of the full protection and security standard under the BIT.

The Tribunal also considered whether the wrongful termination of the gas supply contract amounted to an unlawful expropriation under the BIT. The Tribunal found that the contract’s termination was a disproportionate act attributable to Egypt. In particular, the amount of US$ 37 million, the non-payment of which EGPC invoked as the reason for termination, was “a very relatively small amount having regard to the potential economic benefits to Egypt and EMG’s investors…which amount to billions of dollars.” The Tribunal noted that “it is well settled that the ‘irreparable cessation’ of an investment activity caused by a disproportionate act of a State is tantamount to expropriation” and found that the Claimants’ interest in the gas supply contract had been unlawfully expropriated by Egypt.

The Tribunal also found that the revocation of EMG’s tax exemption was tantamount to an expropriation, falling outside the realm of the ordinary exercise of the State’s regulatory power because it “took away a defined and valuable interest that had been validly conferred according to Egyptian law at the time that the investment was made and that had been guaranteed by the State for a defined period.”

Comments

The Tribunal based its merits analysis on two relatively well-settled notions that prescribe or limit a State’s sovereign powers under international law: due diligence and proportionality. The decision in this case serves as a useful reminder that international investment law can sanction a State’s failure to exercise due diligence and to act proportionately regardless of political circumstances. The decision also underscores a relatively unexplored point: shareholder investors claiming standing based on their indirect interest in corporate assets cannot shield themselves from defences that may be invoked against their investment company, such as the binding effect of an award made in a prior arbitration.