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The European Arbitration Review 2018

Ukraine

Negotiations and pre-arbitration settlement in investor-state disputes from a Ukrainian perspective

Ukraine is still in the process of establishing the rule of law. Its courts are not fully independent. Judgements may often be influenced by bribes or executive intervention. In large cases involving significant financial, regulatory or political implications for Ukraine, judges normally favor state’s interests on account of such reasons as loyalty or carrier prospects. Moreover, judges normally apply the rules of domestic law even if such rules are unfair or discriminatory to foreign investors and are contrary to treaty obligations of Ukraine under bilateral investment treaties (BITs).

Ukrainian courts, therefore, often may not be relied on or trusted by foreign investors to protect or remedy an injustice caused by arbitrary or discriminatory measures in high value disputes involving political influence.

To protect their rights in challenging domestic environment, international companies increasingly resort to international instruments, such as investor-state dispute settlement (ISDS) mechanisms under BITs,1 to resolve disputes with Ukraine through investor-state negotiations or investment arbitration.

Ukraine’s government, in recent years, has become more open to resolving investment disputes through negotiations, especially, during a cooling-off period.

One notable case of a successful pre-arbitration settlement in Ukraine is a recent resolution of an investment dispute between Gilead Sciences Inc (Gilead), a US-based global pharmaceutical company, and Ukraine concerning violation of Gilead’s IP rights. On 22 February 2017, Ukraine and Gilead signed a Settlement Agreement to resolve amicably the IP-related investment dispute initiated by Gilead under US-Ukraine BIT.2

Gilead’s case illustrates an example of a relatively prompt resolution of an investment dispute to the mutual benefits of the US investor and the government of Ukraine: Gilead’s legitimate IP rights were restored, Ukraine avoided multimillion investment claims and Ukrainian patients received access to innovative HCV medicine at an an affordable price.

This is the fourth publicly known and second pre-arbitration settlement by Ukraine in 16 investment disputes. Ukraine has previously settled amicably in Lemire v Ukraine,3 Western NIS v Ukraine4 and Laskaridis Shipping v Ukraine.5

In this article we discuss certain aspects of investor-state negotiations and pre-arbitration settlement of investment disputes from the Ukrainian perspective.

Investment disputes and prospects of pre-arbitration settlement

BIT protections

Apart from domestic remedies,6 under ISDS provisions of Ukrainian BITs a foreign investor has the right to initiate and pursue an investment dispute against Ukraine claiming that Ukraine violated its BIT obligations.

Ukraine’s treaty obligations to foreign investors and their investments in Ukraine under Ukrainian BITs include, among others, the following:

  • to accord fair and equitable treatment to investments of foreign investors in Ukraine and to protect them against unreasonable or discriminatory measures,7 including regulatory and tax measures;8
  • to protect their investments in Ukraine against direct or indirect expropriation;
  • to provide full protection and security to their investments in Ukraine;
  • to observe any obligation, including any contractual obligation, of Ukraine with regards to their investments in Ukraine (an umbrella clause); and
  • to provide foreign investors with effective means of asserting their claims and enforcing their rights with respect to their investments in Ukraine.

Notice of investment dispute, cooling-off period and investment arbitration

To initiate an investment dispute under a BIT a foreign investor is normally required to send a notice of investment dispute to Ukraine. Such notice usually describes the background of an investment dispute and specific measures, which violate investor’s substantive protections under a BIT.

A notice of investment dispute must be sent to the Ministry of Justice of Ukraine (MoJ), a government agency acting for Ukraine in investment disputes and investor-state negotiations.9 As a matter of practice, a notice is also sent to the President of Ukraine and the Prime Minister of Ukraine.

A notice of investment dispute starts an investment dispute and triggers mandatory investor-state negotiations between an investor and Ukraine under investor-state dispute settlement (ISDS) provisions of Ukrainian BITs.

If an investment dispute is not settled amicably by negotiations between an investor and Ukraine during a cooling-off period (lasting for a minimum of six months under most Ukrainian BITs), the investor has the right to submit the investment dispute for resolution by an independent arbitral tribunal. Most Ukrainian BITs establish the jurisdiction of arbitral tribunals to consider investment disputes under the arbitration rules of ICSID or UNCITRAL and less often under the rules of ICC, SCC and LCIA.10

Local remedies: ISDS under BITs v ECHR

Investors, under most BITs, do not need to exhaust local remedies to start an investment dispute, which may go in parallel to related domestic proceedings.

While Article 1 of Protocol 1 to the European Convention on Human Rights (ECHR) also protects foreign investors against unlawful interference with their property rights in Ukraine, article 35 of the ECHR requires to exhaust domestic remedies in national courts before an investor may apply to the European Court of Human Rights. For this reason, the ECHR, unlike ISDS mechanism in BITs, does not provide effective means for negotiations and reaching a pre-judicial settlement of disputes with Ukraine or, for that matter, any other host state. By the time all local remedies are exhausted in national courts, an investor, in most cases, will be deprived of its property rights or harmful measures, such as discriminatory tax charges, will be enforced by a host state upon a final judgement of its highest court. At that stage, it will be very hard to convince a host state to return property or collected taxes to a foreign investor, especially, if large amounts are involved.

This feature of ISDS mechanism allows foreign investors to negotiate with host states at early stages of investment disputes. Investor-state negotiations often go in parallel with domestic court proceedings and in close interaction with the national courts. Such interaction may be important for reaching an amicable settlement of an investment dispute for a number of reasons. For example, to suspend domestic court proceedings, often upon consent of a host state’s government, to prevent a hostile measure from entering into force.

Investment disputes and their cooling-off impact

Cooling-off impact may be illustrated by a recent tax-related investment dispute, in which Marchenko Danevych has acted for US and French investors. Their Ukrainian subsidiary, engaged in manufacturing and export of home goods to EU states, experienced long delays in VAT refunds in Ukraine. After the subsidiary organised a public protect, the company received its VAT, but it was immediately audited by the tax inspection, which imposed arbitrary fines in the amount equal to the refunded VAT claims.

To make matters worse, on request of the Security Service of Ukraine the Ministry of Economy imposed a provisional ban on company’s export-import operations, while the tax inspection completely stopped refunding VAT to the subsidiary and started enforcing the arbitrary fines against its assets.

At that point, the US and French investors sent a notice of investment dispute to Ukraine. The notice and related actions had the following cooling-off impact (which permitted to avoid harm to and a potential destruction of the fast-growing manufacturing business in Ukraine):

  • the tax authority (the Revenue Service) within a few weeks suspended all enforcement proceedings against the assets of the Ukrainian subsidiary;
  • the Ministry of Economy terminated the export-import ban;
  • the cassation court expediently (in six weeks) after the Ukrainian subsidiary filed cassation claims in a related domestic case revoked judgements of lower courts and remanded the case for a new consideration; and
  • the Revenue Service within a few months started timely confirmations of VAT refunds to the Ukrainian subsidiary with delays no more than a few days.

Investor-state negotiations

Leverage

The prospects of an investment dispute against Ukraine to be considered by an independent arbitral tribunal, over which Ukraine and its government do not have influence, high costs of arbitration proceedings, potential damages to be paid to an investor under an arbitral award and the negative impact of a growing number of investment disputes against Ukraine on its reputation internationally may all create strong leverage for engaging in effective direct negotiations between a foreign investor and the government of Ukraine.

Moreover, a foreign investor may engage its home government into investor-state negotiations with Ukraine to create diplomatic pressure on the government of Ukraine to settle an investment dispute amicably.

The investor’s home government may be engaged in one of the following ways:

  • The ambassador of investor’s home government or other high-ranking diplomatic officer may handle, on a convenient occasion, a copy of a notice of investment dispute personally to the President of Ukraine and the Prime Minister of Ukraine and may discuss with them in person the importance of an amicable settlement with a foreign investor. 

  • Diplomatic officers may participate in meetings and negotiations between an investor and the MoJ, a responsible agency and other authorities.
  • Diplomatic officers of investor’s home state may arrange meetings between an investor and high ranking government officials of Ukraine.
  • Diplomatic officers may participate as observers in domestic court proceedings if they are pursued in parallel to an investment dispute.

Settlement options

An investor and the government of Ukraine have different options to reach an amicable settlement of an investment dispute during a cooling-off period.

  • An Interagency Working Group (IWG), created by the MoJ to consider an investment dispute, may issue a non-binding decision to recommend to a state agency (which measures violate investor’s BIT rights), to revoke those measures, or, if their validity was challenged in courts, to admit investor’s claims in domestic court proceedings. If the IWG’s decision is implemented, it may resolve the investment dispute.
  • If investor’s rights and interests are not restored based on IWG’s recommendations, an investor and the Government may resolve an investment dispute by entering into a binding settlement agreement.
  • Other solutions may be reached by an investor and the government.

Foreign investors should be prepared, on the one hand, to be assertive and often even aggressive in negotiations with the MoJ and the government of Ukraine. On the other hand, investors should be proactive, practical and flexible and should be prepared to adjust their demands down the road, give up on some of their less essential demands, address reasonable concerns of the government and accept reasonable obligations to reach an amicable settlement.

Negotiations process

After a notice of investment dispute is submitted, an investor may engage in negotiations primarily with the MoJ, an agency acting for Ukraine in investment disputes.

The MoJ under Ukrainian regulations11 creates an IWG to consider an investment dispute, proposals for an amicable settlement and related matters.

If an investor wants to reach an amicable settlement, it is very important for the investor and its legal counsel to be proactive in negotiations with the MoJ and the government of Ukraine and to be able to propose realistic settlement options to the government. For example, an investor is not in any way precluded by the Presidential Decree or other regulations from proposing:

  • IWG’s composition, which normally includes state officials from the MoJ, the Ministry of Foreign Affairs and a state agency which measures gave rise to an investment dispute, but an IWG may also include other state officials willing to support an amicable settlement;
  • to conduct IWG’s meetings, when necessary;
  • specific agenda for IWG’s meetings, such as consideration of investor’s proposals for settlement of an investment dispute; and
  • that an investor, its legal counsel and diplomatic officers of its home government (its Embassy in Ukraine) participate in IWG’s meetings. Although IWG’s meetings often involve discussion of sensitive matters and are generally confidential, the investor may propose to the MoJ that such meetings start with a confidential discussion followed by a non-confidential part, in which the investor, its counsel and diplomatic officers of the investor’s home government may participate.

An investor may also engage in consultations with a responsible agency and other state authorities willing to support or facilitate an amicable settlement.

Settlement Agreement

If, for any reason, investor’s rights are not restored based on IWG’s recommendations, an investor and the government may settle an investment dispute amicably by entering into a pre-arbitration Settlement agreement.

Settlement agreements shall first be approved by an IWG and then submitted by the MoJ for approval by the Cabinet of Ministers of Ukraine. Pursuant to Article 6.2 of the Presidential Decree, the Cabinet of Ministers of Ukraine has the power to approve a draft Settlement Agreement and authorise an appropriate official, normally, a minister, to sign a settlement Agreement with a foreign investor on behalf of the government of Ukraine.

A settlement agreement between an investor and Ukraine has a binding force for Ukraine because the government of Ukraine assumes contractual obligations. Moreover, under some BITs, Ukraine has a treaty obligation to observe its contractual obligations under settlement agreements in accordance with umbrella clauses included in such BITs. If there is no umbrella clause in a specific BIT, it may usually be borrowed from other BITs containing umbrella clauses through most- favored-nation provisions.

For example, the umbrella clause of article II.3(c) of US-Ukraine BIT requires that Ukraine shall ‘observe any obligation with regard to investments’ made by US investors in Ukraine. The umbrella clause operates to transform contractual obligations of Ukraine, with regard to US investments in Ukraine, into treaty obligations of Ukraine under US-Ukraine BIT. The umbrella clause, in other words, puts contractual obligations of Ukraine under the protection, or ‘umbrella’, of US-Ukraine BIT.

Umbrella clauses and their protection may be important for enforcement of settlement agreements, including their enforcement in Ukrainian courts, especially, if such obligations are contrary to some mandatory rules of domestic law.

BITs ratified by the Parliament of Ukraine constitute a part of the domestic law of Ukraine and their provisions should be applied by Ukrainian courts in the same way as provisions of the domestic laws of Ukraine. Moreover, if a domestic law provision is not in line with an applicable provision of a BIT, the treaty provision shall prevail over the contrary provision of the domestic law.

The Supreme Court of Ukraine, Ukraine’s highest court, which decisions are binding for all lower courts in Ukraine, in its judgement in a tax dispute between Zaporizhia Automobile Building Plant (ZAZ), a company with Swiss investments, and the Tax Authority of Ukraine, applied the fair and equitable treatment (FET) provisions of Switzerland-Ukraine BIT to override a contrary provisions of the domestic tax law. That tax dispute involved the claims of ZAZ to invalidate tax charges imposed by the Tax Authority under express provisions of Ukrainian tax law, which cancelled previously existing tax exemptions enjoyed by ZAZ. The Supreme Court revoked the cassation judgement in favor of the Tax Authority and remanded the case for a new consideration to the cassation court. The Supreme Court revoked the cassation judgement in that case by applying the FET standard over the contrary provisions of the domestic tax law.12

Parallel domestic proceedings and interaction with Ukrainian courts

Why important?

Negotiations and pre-arbitration settlement in investment disputes with the government of Ukraine normally require significant interaction with parallel proceedings in the national courts, which may be pursued to invalidate harmful state measures or, at least, delay their enforcement.

For example, interactions with national courts are normally essential for an amicable settlement of tax-related investment disputes with Ukraine. In tax cases, validity of arbitrary, ungrounded or discriminatory tax charges is normally challenged by an investor or its local subsidiary in Ukrainian courts. If they are not challenged in the national courts, tax charges become immediately due and payable and, after tax dues are paid, it will be hard to reach an amicable settlement with Ukraine in a tax-related investment dispute. The government will consider paid taxes as its own and it will difficult to convince public officials to return taxes, especially, if large amounts are involved, even under threat of an investment arbitration.

Suspending domestic court proceedings

Foreign investors may consider the following actions in national courts, in parallel to investor-state negotiations with the MoJ and the government of Ukraine:

  • to inform the courts about the existence of an investment dispute and investor-state negotiations between an investor and Ukraine’s Government to seek an amicable settlement of the BIT dispute;
  • to submit to the courts, as evidence of an investment dispute, a copy of a notice of investment dispute (in English) and its translation into Ukrainian; and
  • to request the courts to suspend domestic court proceedings while a foreign investor and the government of Ukraine are negotiating in good faith to seek an amicable settlement in a parallel investment dispute, especially, if one of the settlement options considered in negotiations involves admittance of claims in domestic court proceedings.

In the tax-related BIT dispute mentioned earlier, the Ukrainian subsidiary of the US and French investors challenged validity of arbitrary fines in two domestic court cases. In both court cases Ukrainian courts agreed to suspend proceedings to allow the investors and the government of Ukraine to negotiate the investment dispute. In one case the appeal court suspended proceedings despite strong objections by the tax inspection.13 In the other case the lower court suspended proceedings pursuant to a motion of the local subsidiary (claimant), which was supported by the tax inspection (respondent) and by the MoJ (third party acting in the interests of Ukraine).14

The MoJ, acting in the interest of Ukraine, joined that court case as a third party in connection with the investment dispute between the US and French investors and Ukraine pursuant to US-Ukraine BIT and France-Ukraine BIT.15

It was the first time the MoJ, acting in the interests of Ukraine, had joined a domestic court case as a third party in connection with an investment dispute.

Engaging Ukraine as third-party in domestic court proceedings

An investor may consider engaging Ukraine, represented by the MoJ, as a third-party into court proceedings, for example, to explain the background of an investment dispute and its connection to the domestic proceedings, to support investor’s motion to suspend court proceedings or for other reasons.

Conclusion

Negotiations and pre-arbitration settlement may be an efficient, cost-effective and expedient option for resolution of investment disputes, allowing foreign investors and a host state’s government to reconcile their differences and retain good relations beneficial to interests of both parties.

Notes

  1. Ukraine has more than 50 BITs currently in force with its major trading partners, including Austria, Canada, China, Denmark, Finland, France, Georgia, Germany, India, Italy, Israel, Japan, Kazakhstan, Netherlands, Poland, Portugal, the Russian Federation, Spain, Sweden, Switzerland, Turkey, the UK and the US. Ukraine has signed 15 additional BITs, which are not yet in force: http://investmentpolicyhub.unctad.org/IIA/CountryBits/219.
  2. http://zakon5.rada.gov.ua/laws/show/45-2017-%D1%80; https:// www.italaw.com/cases/5401; https://twitter.com/IAReporter/status/842797466818756608.
  3. https://icsid.worldbank.org/en/Pages/cases/casedetail. aspx?CaseNo=ARB%28AF%29/98/1.
  4. https://icsid.worldbank.org/en/Pages/cases/casedetail. aspx?CaseNo=ARB/04/2.
  5. https://www.italaw.com/cases/1547; After UNCITRAL BIT Arbitration Clears Jurisdictional Hurdle, Ukraine Agrees to Settlement of an Investment Treaty Claim (Laskaridis v. Ukraine) https://www. iareporter.com/articles/after-uncitral-bit-arbitration-clears- jurisdictional-hurdle-ukraine-agrees-to-settlement-of-an-investment- treaty-claim-laskaridis-v-ukraine/.
  6. Regulatory, taxation and other illegal state measures harmful to a foreign investor and its investments in Ukraine may be challenged by the investor or its local subsidiary in national courts. However, domestic remedies should be pursued with care because some Ukrainian BITs (for example, US-Ukraine BIT) contain fork-in-the-road provisions.
  7. Ukrainian BITs may provide protection against a wide range of measures, including taxation or regulatory measures, if they
are arbitrary, unreasonable or discriminatory in respect of
foreign investments. Such measures may include arbitrary or unreasonable tax charges; discriminatory or unreasonable antitrust fines; unreasonable restrictions on export-import transactions; unreasonable or discriminatory price regulations; failure to take reasonable and proper measures to counteract violations of IP rights;
failure of the competition authority to take proper measures against unfair competition practices, anticompetitive behavior or abuse of dominance, which have led to a violation of investor’s rights and interests in its investments.
  8. Arbitrary, unreasonable, discriminatory or expropriatory taxation measures, such as tax charges or denial to refund VAT by tax authorities, may provide grounds for investment claims under Ukrainian BITs. For example, tax-related measures have been or are currently considered by arbitral tribunals in over 40 publicly-known investment arbitrations, including such well-known tax-related arbitration cases as EnCana v Ecuador, Occidental v Ecuador, Feldman v Mexico and Biwater v Tanzania. However, some Ukrainian BITs
limit the jurisdiction of arbitral tribunals to consider taxation measures.
For example, Article X.2 of US-Ukraine BIT explicitly limits the jurisdiction
of tribunals under US-Ukraine BIT in matters of taxation only to expropriatory claims:
    ‘ARTICLE X
    2.    Nevertheless, the provisions of this Treaty, and in particular Articles VI [Article VI of US-Ukraine BIT establishes the jurisdiction of arbitral tribunals to consider investment disputes under US-Ukraine BIT] and VII, shall apply to matters of taxation only with respect to the following:

    (a) expropriation, pursuant to Article III;
    (b) transfers, pursuant to Article IV; ...’
  9. Pursuant to the Decree of the President of Ukraine On Procedure for Protection of Rights and Interests of Ukraine in Proceedings
in Disputes between Foreign Persons and Ukraine in Foreign Jurisdictions and Settlement of Such Disputes dated June 25, 2002 No. 581/2002 (‘Presidential Decree’).
  10. Eg, Article VI of US-Ukraine BIT establishes the jurisdiction of arbitral tribunals to consider investment disputes between US investors and Ukraine under the ICSID or UNCITRAL arbitration rules:
    ‘ARTICLE VI
    1.    For purposes of this Article, an investment dispute is a dispute between a Party [eg, Ukraine] and a national or company of the other Party [eg, US company] arising out of or relating to (a) an investment agreement between that Party [Ukraine] and such national or company [US company]; (b) an investment authorization granted by that Party [Ukraine] to such national or company [US company]; or (c) an alleged breach of any right conferred or created by this Treaty with respect to an investment.’

    2.    In the event of an investment dispute, the parties to the dispute [eg, US company, on the one side, and Ukraine,
on the other side] should initially seek a resolution through consultation and negotiation. If the [investment] dispute cannot be settled amicably [during a cooling-off period], [.. .] the company concerned [US company] may choose to submit the [investment] dispute for resolution: 
    (a) to the courts or administrative tribunals of the Party that is a party to the dispute [in case of US company – to Ukrainian courts, which is an unlikely scenario]; or [.. .]

    (c) in accordance with the terms of paragraph 3 [which establishes the jurisdiction of arbitral tribunals to consider investment disputes under the ICSID or UNCITRAL arbitration rules].
    3.    (a) Provided that the [.. .] company concerned [US company] has not submitted the [investment] dispute for resolution under paragraph 2 (a) [to the courts of Ukraine] [.. .] and that six months have elapsed from the date on which the [investment] dispute arose, [.. .] the company concerned [US company] may choose to consent in writing to the submission of the [investment] dispute for settlement by binding arbitration:

    (i)    to the International Centre for the Settlement of Investment Disputes (‘Centre’) established by the Convention on the Settlement of Investment Disputes between States and Nationals of other States, done at Washington, March 18, 1965 (‘ICSID Convention’) ...; or ...
    (iii)   in accordance with the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL) [ad hoc arbitration administered by default by the Permanent Court of Arbitration (PCA) with the seat of arbitration in the Netherlands].’
  11. Under Article 5.4) of the Presidential Decree, the MoJ shall create an IWG within five calendar days after the MoJ has received
a notice of investment dispute and all related information and documents. The MoJ normally requests various government authorities to provide their comments and documents in respect
of the measures giving rise to investment claims. As a matter
of practice, it may take at least one month or even longer for the MoJ to create an IWG and to hold its first meeting to discuss an investment dispute and the prospects of its amicable settlement.
  12. http://www.reyestr.court.gov.ua/Review/5363721.
  13. Ruling of Zhytomyr Appeal Administrative Court dated 11 May 2016 in court case # 817/3117/15 [to suspend proceedings] http://www.reyestr.court.gov.ua/Review/57728710.
  14. Ruling of Rivne Regional Administrative Court dated September
01, 2016 in court case # 817/1200/15 [to suspend proceedings] http://www.reyestr.court.gov.ua/Review/61384885.
  15. Ruling of Rivne Regional Administrative Court dated August 12, 2016 in court case # 817/1200/15 [to engage the MoJ, acting in the interests of Ukraine, as a third party]( http://www.reyestr.court.gov.ua/Review/59757238).