Hulley v. Russia 2014

1168. By contrast, Respondent points out that the insolvency test applicable to the initiation of bankruptcy proceedings against Yukos was an “illiquidity test,” based on the debtor’s inability to discharge a certain debt “within three months of its due date.”1480 According to Respondent, this “illiquidity test” was satisfied when the Western Banks filed a petition for Yukos’ bankruptcy.1481 Further, the question of whether the bankruptcy proceedings will result in the adoption of a financial rehabilitation plan and the company’s survival or in the company’s liquidation depends on whether the financial rehabilitation plan provides for the discharge of all the creditors’ claims within certain applicable time limits.1482 Respondent points out that the debt repayment schedule in the Rehabilitation Plan did not do so.1483

1169. Respondent denies all allegations of impropriety or bias relating to the way the Russian courts conducted the bankruptcy proceedings:

As confirmed by the Moscow Arbitrazh Court, the syndicate’s petition satisfied the insolvency test under Russian bankruptcy law applicable at the time, which was based on the debtor’s inability to discharge a debt exceeding US$ 3,500 within three months of its due date.

Nothing in Russian law in this regard concerning the initiation of bankruptcy proceedings is at odds with international practice. In a number of other jurisdictions, the so-called “illiquidity test: (i.e., the debtor’s inability to pay its debts as they become due) is sufficient to initiate bankruptcy proceedings.1484

1170. In any event, Respondent claims that Yukos’ liabilities did exceed its assets, a position Respondent seeks to support by stressing that, after the sale of Yukos’ assets, liabilities of Yukos in an amount of USD 9.2 billion remained unsatisfied.1485

(iv)The Liquidation of Yukos’ Remaining Assets

1171. According to Claimants, the last stage in the “confiscation of Yukos”1486 was the bankruptcy auctions of Yukos’ remaining assets.1487

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1172. Claimants’ argument regarding the auctions does not point to specific acts. While Claimants fault Rosneft for the initiation of the bankruptcy, the courts for the discriminatory rejection and allowance of claims, the Federal Taxation Service and Rosneft for the rejection of the Rehabilitation Plan, they fault “the Russian Federation” for the auctions.1488 Claimants state “[t]he results of the auctions speak for themselves.”1489 Claimants argue that the small number of bidders, the speed of the auctions, the below-market-value resulting prices, and the overall benefits to Respondent leave no doubt about Respondent’s “monopolization” of the auctions.1490

1173. Claimants note that Respondent as creditor in the bankruptcy was involved in the auctions in four ways. Firstly, it approved the procedure for the auctions1491 and Mr. Rebgun’s allotment of Yukos’ assets into twenty lots.1492 Secondly, it selected the Russian Federal Property Fund to organize and conduct the auctions.1493 Thirdly, it set the starting price for the auctioned

Fourthly, it “actively communicated with [Mr. Rebgun] on other issues as well.”1495

1174. Respondent underlines that this involvement was in accordance with Russian law and emphasizes that Respondent as creditor in the bankruptcy did not have the power to control the identity of the bidders, and that in each instance the starting price for the auctioned assets was at least equal to the appraised market value.1496

1175. Claimants assert that “[a]s creditor, the Russian Federation received, either directly or through Rosneft, approximately 99.71% of the bankruptcy proceeds.”1497 This occurred through

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“Rosneft [having] won 11 out of the 17 bankruptcy auctions, including acquiring Samaraneftegaz (Lot No. 11) and Tomskeneft (Lot No. 10).”1498

1176. In their Skeleton Argument, Claimants summarize the eleven auctions that completed the bankruptcy proceedings as follows:

Yukos’ remaining assets were transferred to the Russian State at well below their fair market value through a series of 17 auctions held between March 2006 and August 2007. Rosneft thereby directly or indirectly acquired Yukos’ key remaining assets, including Samaraneftegaz (Lot No. 11) and Tomskneft (Lot No. 10), which were sold at a gross discount of approximately 37% and 33%, respectively, of their fair market value. For its part, Gazprom acquired through Eni/Enel the 20% minus 1 share stake in Sibneft that the Russian Federation had persistently refused to let Yukos sell to pay off alleged tax debts. As with the sham auction of Yuganskneftegaz, there was no genuine competition in the bankruptcy auctions and, in many instances, including those for Samaraneftegaz and Tomskneft, the only participants were Rosneft and a previously unknown entity whose sole role was to satisfy the formal requirement that there be a minimum of 2 bidders.

Finally, when, by the end of July 2007, it became clear that despite the low auction prices, the bankruptcy might still generate some surplus, further claims were admitted in the bankruptcy proceedings on behalf of the Russian State, through the Federal Taxation Service and Rosneft. This ensured the completeness of Yukos’ destruction and the transfer of its value and assets to the Russian State. Thus, the Russian Federation received, either directly or through State-owned Rosneft or Gazprom, approximately 99.71% of the bankruptcy proceeds and over 95% of Yukos’ remaining assets, including all of Yukos’ main production assets.

On November 12, 2007, the Moscow Arbitrazh Court formally endorsed all the activities of Yukos’ receiver Mr. Rebgun, closed the Company’s receivership and ordered that

Yukos be struck off the register of legal entities. The latter happened on November 21, 2007.1499

1177. Respondent contends that Yukos’ bankruptcy auctions were held in full compliance with Russian law, and that Mr. Rebgun had secured appraisals for the fair value of the assets:

Once Yukos’ liquidation was properly approved, the company’s assets were sold at auction in accordance with Russian law and international practice. Yukos’ receiver obtained appraisals for the fair value of the assets, and used those appraisals to set minimum bids in the auctions, all of which were exceeded, some by very large margins. The auctions were open to domestic and foreign bidders, adequately noticed and advertised, and competitive. To the extent that any bidders may have been discouraged from participating, this was again the result of Claimants and Yukos having threatened potential bidders with legal action. While the aggregate results exceeded Yukos’ own (and other) contemporaneous fair market value estimates, more than US$ 9 billion in creditor claims nonetheless remained unsatisfied.1500

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(v)Tribunal’s Observations

1178. The Tribunal notes Respondent’s insistence that all aspects of the bankruptcy were conducted in accordance with Russian bankruptcy law. However, the Tribunal’s inquiry is not limited to a mere review of the formalities of the bankruptcy. It must address and review all the substantial features of the proceedings.

1179. Thus, the Tribunal views as improper and unfair that, for example:

All claims filed by Rosneft and the Federal Taxation Service, valued in the billions, were peremptorily accepted by the Court, while the many claims filed by Yukos’ affiliated companies were rejected by the Court in a very summary way; and

Yukos was saddled with a claim of some USD 6 billion that related only to the profit tax to be collected by the Federal Taxation Service as a result of the liquidation of Yukos’ assets in the bankruptcy.1501

The Tribunal is also troubled by the fact that Rosneft’s acquisition of YNG (discussed in Chapter VIII.F of this Award) generated a claim of almost USD 10 billion against Yukos in the bankruptcy, including a claim based on the attribution to Yukos of debts owed to YNG by Yukos’ trading companies. Since the Tribunal has already found that Rosneft’s acquisition of YNG was, to say the least, questionable, in its view, this claim is equally questionable.

1180. In light of the above conclusions, the Tribunal cannot accept that it was in any sense proper or fair for the creditors’ committee to reject the Rehabilitation Plan, for the court to declare Yukos bankrupt, or for Yukos to have been deprived of all of its remaining assets through a hasty and questionable liquidation process. On the contrary, it is evident to the Tribunal that the totality of the bankruptcy proceedings reviewed in this chapter were not part of a process for the collection of taxes but rather, as submitted by Claimants, indeed the “final act of the destruction of the Company by the Russian Federation and the expropriation of its assets for the sole benefit of the Russian State and State-owned companies Rosneft and Gazprom.”

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1181. The Tribunal notes that its conclusions are consistent with those of the RosInvestCo tribunal and the Quasar tribunal.

1182. With respect to the bankruptcy proceedings, the RosInvestCo tribunal concluded as follows:

Though the Tribunal did not find the bankruptcy auctions to be conducted contrary to Russian law, this does not change the general impression from the evidence on file for the Tribunal, since the application for bankruptcy by the SocGen Group was also conducted by association with the State-controlled company, Rosneft, and that they fitted into the

obvious general pattern and obvious intention of the totality of the scheme to deprive Yukos of its assets.1502

1183. The Quasar tribunal concluded:

141. The Tribunal has carefully considered each of the Respondent’s defences, but is ultimately unpersuaded by them. The issue here is not one of the legality of the bankruptcy proceedings, nor their conformity with Russian bankruptcy regulations. Rather, it is whether the steps that were taken can properly and fairly be characterised as part of an ordinary process of collecting taxes. In the Tribunal’s view, they cannot fairly be so characterised, particularly when viewed against the broader chronology of which they form part (as summarised later in this section). This conclusion is not overcome by the Respondent’s various technical analyses of the consortium agreement.

. . .

157.But the Tribunal also notes that, as a result of these auctions, “at the end of the day”

. . . the Russian Federation has ended up with 93% of Yukos Oil Company.” . . .

158.As summarised below, the overall chronology of which the liquidation auctions form part, casts them and their outcome in a particular light. After careful consideration of the entire record, the Tribunal concludes that, as with the preceding events, the liquidation auctions were part of the same overall scheme of confiscation. In this regard, the Tribunal’s findings are consistent with those of the RosInvest Tribunal. . . . The ECHR’s finding to the contrary—i.e., that Yukos failed to prove that the Russian Federation “had misused those [enforcement] proceedings with a view to destroying the company and taking control of its assets”—must be understood as based on a heightened requirement of “incontrovertible and direct proof,” given the “wide margin of appreciation” a State enjoys

under Protocol No. 1 to the European Convention on Human Rights. . . .1503

H.THE WITHDRAWAL OF PWC’S AUDIT OPINIONS

1.Introduction

1184. As noted earlier in this Award,1504 Yukos’ auditor, PwC, withdrew its audit reports for Yukos in June 2007. This withdrawal was often mentioned, mostly by Respondent’s counsel, during

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these proceedings. Although neither Party called as a witness anyone from PwC, the Tribunal has formed the view that it is essential for it to review PwC’s role in the present Awards.

1185. PwC was Yukos’ auditor from 1997 to 2004. It also played an advisory role to Yukos, consulting on the company’s domestic and international structures. On 15 June 2007, PwC formally withdrew all its prior audit reports for Yukos for the period from 31 December 1995 until 31 December 2004, stating that “new information” had led it to conclude that such reports could no longer be relied upon as trustworthy.1505

1186. Claimants say that the Russian Government exerted pressure on PwC to withdraw the audits in order to bolster the legitimacy of the destruction of Yukos. The harassment of PwC, say Claimants, took the form of searches, seizures, interrogations, criminal charges, two tax lawsuits, and the potential loss of clients and its license to do business in Russia. Rather than risk its business and employees for the sake of a client that was “no longer a going concern,” PwC chose the “only viable option,” namely to cooperate with the Russian authorities by finding pretexts to withdraw its Yukos audits.1506

1187. In contrast, Respondent says that PwC and Yukos had had a troubled relationship for a long time, noting that PwC refused to audit the company after 2004. During interrogations of PwC auditor Douglas Miller in May and June 2007, PwC received credible “new” information showing that Yukos’ senior management had repeatedly lied to its auditors, confirming PwC’s prior suspicions on four particular issues, and causing PwC to lose confidence in the content of its audit reports. At the time, Yukos was in bankruptcy and former executives and company records were no longer accessible. PwC thus could not conduct satisfactory inquiries to determine how the new information affected the audited financial statements. In the circumstances, the “only viable option” for PwC was to withdraw the audits, a move endorsed and approved by Respondent’s audit expert, Mr. Ellison.1507

1188. No witnesses from PwC were presented by the Parties.1508 PwC is not on trial before this Tribunal. The Tribunal draws no conclusions in this Award on PwC’s professional conduct.

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Nevertheless, the events surrounding PwC’s withdrawal of the Yukos audits help to inform the Tribunal’s view as to whether Yukos was the object of a series of politically-motivated attacks, or is now simply “blaming the Russian Federation for the consequences of its own misconduct.”1509

2.Chronology

1189. Absent direct testimony from PwC, the Tribunal must draw its conclusions from the testimony of Claimants’ witnesses; correspondence amongst Yukos, PwC, external advisors and the Russian authorities; and the testimony of PwC personnel before other fora. There are also contemporaneous U.S. State Department cables, which emerged via “Wikileaks” and reveal the “candid”1510 and “unguarded”1511 views of PwC’s senior management.

(a)PwC Serves as Both Auditor and Consultant to Yukos

1190. From 1997, Yukos was one of PwC’s major clients in Russia. At the Hearing, Claimants’ witnesses described a “perfectly normal”, “cordial and close” business relationship in which PwC was a “permanent partner of Yukos and its subsidiaries for a long time.”1512 PwC conducted Yukos’ external audits and assisted with training Yukos’ in-house accountants. PwC played an “integral role”1513 in developing Yukos’ financial reporting system, and, according to Mr. Theede, “PwC’s consulting arm was actually the architect of [the trading company] structures.”1514

1191. Mr. Kosciusko-Morizet testified that “from 1997 to 2004, PwC was given access to the entire documentation of the whole of the Yukos group without restriction and had a very detailed and global view of the financial situation and the procedures of Yukos and its subsidiaries.”1515 It was a consistent theme among Claimants’ witnesses that PwC enjoyed full access to Yukos’

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accounts, employees and information, “including related-party transactions, shareholders, costs [and] taxation.”1516 PwC also maintained a permanent staff presence within Yukos and performed site visits to Yukos entities.1517

1192. Claimants’ witnesses pointed out that PwC never voiced complaints about access to the company or any of its staff. Mr. Kosciusko-Morizet affirmed that PwC was “perfectly able to check for themselves any documentation, ask for any documentation anywhere in the group at any level.”1518 Mr. Misamore observed that if PwC “did not have sufficient information, they should have asked for more.”1519 It is interesting to note that in 1998 PwC initially refused to sign the Yukos financials, as it was unable to resolve which trading companies should be consolidated as “controlled by Yukos and used for tax optimization.” However, the next year, PwC did sign, as by then it had apparently been shown information sufficient to enable it to understand the control relationships.1520

1193. Similarly, as detailed in the next section, PwC occasionally requested additional information about certain aspects of Yukos’ activities, and was provided each time with sufficient answers to enable it to certify the financial statements according to U.S. GAAP standards.

(b)PwC Responds to the Massive Tax Reassessments against Yukos

1194. When Mr. Lebedev was arrested in 2003 on tax-related charges, Yukos turned to PwC. Mr. Michael Kubena, a PwC partner, assured the specially-formed ad hoc Yukos Board committee chaired by Mr. Kosciusko-Morizet that Yukos had always complied with Russian law, including in the operation of its tax optimization structure, and that PwC did not believe that there was any possibility that the Russian authorities would attack Yukos on these issues.1521

1195. In December 2003, after Yukos received the 2000 Audit Report, Yukos again asked PwC for its

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comments. In a letter dated 15 January 2004, Mr. Kubena advised that, under the relevant Russian tax legislation, Yukos was not required to discharge the tax obligations of other taxpayers, regardless of whether they were affiliated parties.1522

1196. PwC’s advice to Yukos was to set up a Board committee with independent legal counsel to carry out an investigation.1523 Mr. Kosciusko-Morizet thus resurrected the special ad hoc Board committee and Yukos engaged the law firm Akin Gump to examine the tax reassessments. PwC explained in a letter to Yukos of 29 January 2004 that an independent investigation of the pending charges and allegations against key Yukos personnel would enable PwC to obtain an understanding of possible illegal acts for purposes of its own auditing standards.1524 Mr. Kosciusko-Morizet said that “to understand this letter, you have to remember the events . . .

if you know that the problem was political, as everybody did . . . . The answer is you get cold feet and you start hedging, and this letter in technical language is about hedging.”1525 PwC’s persistence about the investigation led Mr. Kosciusko-Morizet to suggest at the time that PwC was “trying to evade its responsibilities.”1526 At the Hearing, he explained what he meant by this comment:

You’re an auditor, you’re in Russia, you know it’s political; you get cold feet. What do you do? You don’t want to be involved in the matter, so you find reasons to technically withdraw from the issue. What happened here is that we made every effort to satisfy the PwC requirements. The effort continued. Akin Gump was hired. A couple of memos, interviews and so on. And in the midst of April . . . assets of Yukos . . . were frozen. So that was that. At that point, any realistic hope of having PwC approving the 2003 GAAP accounts disappeared, for it was practically impossible. Even though we had satisfied all their requirements, they would not have approved the accounts because they knew―they thought, “It’s a political struggle. What about our office?” And they were right, because two years later they got into a problem that we all know about . . . . They know it’s political; they don’t want to be in the middle of the battle, they don’t want to be touched.

So they will keep raising arguments, technical arguments, in order not to be dragged into the fight.1527

1197. In April 2004, PwC decided they would no longer audit Yukos. Mr. Doug Miller, a PwC Moscow partner, explained several years later, in an interrogation before the Prosecutor

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General of the Russian Federation, that the results of the Yukos/Akin Gump investigation “were not final for us, they did not help us, i.e. we did not obtain the confirmation or comfort that would satisfy us as auditors. This was one of the factors which led to our refusal to audit the company in the future.”1528

1198. The timing of PwC’s April 2004 decision to cease auditing Yukos coincides with the period when, according to Mr. Rieger, harassment of PwC at the hands of the Russian authorities commenced. PwC employees involved in Yukos’ Russian accounts were interrogated.1529 In the spring of 2005, Mr. Miller told Mr. Rieger that he could not even meet with Yukos employees or management anymore, which Mr. Rieger understood to be a “direct result of the permanent pressure put by the Russian authorities on PwC.”1530

(c)PwC Faces Mounting Pressure from the Russian Federation around the Same Time as Mr. Khodorkovsky’s Second Trial Starts

1199. Pressure on PwC from the Russian authorities was sustained. In March 2006, a court case was brought against PwC for tax violations relating to expatriate salaries. There was speculation that the lawsuit was indirectly connected with investigations against Yukos.1531

1200. In December 2006, a second court case was filed against PwC by the Tax Inspectorate. The Tax Inspectorate accused PwC of colluding with Yukos on tax evasion. PwC categorically rejected the claims that the Yukos audit reports were defective in any professional, legal or regulatory way.1532 While PwC acknowledged that it had raised certain matters with Yukos, it insisted that these matters did not materially affect the company’s financial statements or alter PwC’s opinion in respect of the financial statements.1533

1201. In March 2007, PwC’s Moscow offices were raided by 50 officers from the Prosecutor General’s Office and the Interior Ministry. Documents were seized and PwC was eventually

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