Hulley v. Russia 2014

(e)Summary of Results of Claimants’ Calculations

1729. The valuation by Mr. Kaczmarek of each of the scenarios described above (including pre-award interest through 15 March 2012) is summarized in the following table (amounts in USD billion):

4.Failure of Claimants to Mitigate

1730. In response to Respondent’s contention that Claimants should promptly have paid the original taxes assessed against Yukos (as well as those Yukos should have anticipated would be imposed for succeeding years on the same grounds) to avoid massive damages, Claimants aver that there is no “duty to appease” and that “a victim of extortion is not to blame if the threats against it are carried out after it refuses to pay.”2282

1731. Claimants also argue that Yukos had no reason to concede the validity of the Russian authorities’ position with regard to the initial tax assessments “in circumstances where its objections to the December 29, 2003 Audit Report were still under consideration” and where it

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had received advice from its lawyers that the Audit Report was “totally inconsistent with the Russian tax law.”2283 In any event, Claimants say that Yukos did not have enough cash to settle an alleged tax debt of USD 9 billion in the first quarter of 2004.2284

1732. In addition, Claimants assert that, to apply Respondent’s argument, “the Tribunal would need to ignore the most salient facts―the Respondent’s breaches―and assume . . . that the very same Russian authorities who committed those breaches would have acted differently if only Yukos had taken the actions specified by the Respondent.”2285 In particular, with regard to Respondent’s argument that Yukos could have significantly reduced its tax burden by filing corrected VAT returns during the first quarter of 2004, Claimants contend that the actual conduct of the Russian authorities demonstrates that any amended returns that Yukos might have submitted would, in any event, have been either ignored or rejected.2286

5.Windfall and Double-Recovery

1733. Finally, Claimants also reject Respondent’s arguments that any award of damages should avoid presenting Claimants with a windfall and take into account the risk of double-recovery. According to Claimants, these arguments of Respondent merely seek to “repackage its so-called ‘unclean hands’ theory in the context of damages” and Respondent, they say, “has failed to articulate any basis on which alleged collateral illegalities could . . . be relevant to an assessment of damages.”2287 In any event, conclude Claimants, any benefits they may have received through their investments prior to Respondent’s breaches of the ECT are irrelevant for the calculation of the damages in the present arbitration and, furthermore, any assets located outside Russia have been excluded from Mr. Kaczmarek’s valuations.2288

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B.RESPONDENT’S POSITION

1734. Respondent argues that, even if it were held to be liable for a breach of the ECT, Claimants should not be awarded any damages in this case.2289 Respondent has submitted two expert reports on damages by Professor James Dow, one dated 1 April 2011 and the other 15 August 2012, with their Counter-Memorial and their Rejoinder, respectively. These reports and Respondent’s arguments with regard to Claimants’ damages calculations can be summarized as follows.

1.Valuation Date

1735. Respondent disagrees with both valuation dates proposed by Claimants.

1736. With regard to Claimants’ valuation as of the date of expropriation, Respondent invokes the principle that “the valuation date should be when the purported substantial deprivation of the investor’s investment has occurred.”2290 Respondent objects, however, to Claimants’ assessment that in this case a substantial deprivation of their investment occurred on 21 November 2007, a date which Respondent considers “arbitrary.”2291 Respondent argues that “the hallmark of an appropriate valuation date is the loss of effective control over the investor’s investment”2292 and concludes that “Claimants have repeatedly averred that they lost control of their investment and that it lost all value long before November 21, 2007.”2293

1737. As a result, Respondent disputes that the date of 21 November 2007 chosen by Claimants has any relevance. As Professor Dow explained at the Hearing:

I am very clear in stating that the 2007 date has no economic relevance, in my view. And I say that because at the end of 2004 Yukos shares had lost essentially all of their value. Yukos was a penny stock. It wasn’t expected to recover, the market did not expect it to recover; that was reflected in the share price. . . . So from an economic point of view, the date of delisting in 2007 is a bureaucratic event, not an event at which value was lost.2294

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1738. While Respondent does not propose any specific alternative date when Claimants lost control of their investments, Professor Dow suggested at the Hearing that such a date would, in any event, have to be before the end of 2004.2295

1739. Respondent also rejects Claimants’ submission that the date of an award can be used as an alternative valuation date. In this regard, Respondent argues that the “standard theoretical framework economists typically use to calculate damages is an ‘ex ante’ one” where damages are assessed at the moment of the relevant breaches and then brought to present value with prejudgment interest.2296 By contrast, an “ex post” approach would, according to Respondent, use information based on hindsight, provide no principled basis for choosing a date and therefore be vulnerable to error.2297 In addition, Respondent claims that, “with each passing day after the alleged takings date, it becomes increasingly speculative to value the asset taken as of some later date.”2298

1740. In his first report, Professor Dow writes that there is a “general preference among economists for the ex ante approach when evaluating damages in commercial matters” and refers, in this connection, to an article published in the 1990 Journal of Accounting, Auditing and Finance.2299 Relying on this article, Respondent submits that “an expropriation relieves the owner not only of the value of the asset on the date of expropriation, but also of the risk associated with owning it” and that, as a consequence, “[t]he only way to recognize both aspects is to assess the value of the asset on the date of expropriation, when neither its owner nor the State knows whether the asset will increase or decrease in value.”2300

2.Causation

1741. Respondent also disagrees with Claimants with respect to causation. In particular, Respondent emphasizes the need to establish “a sufficient causal link” between breach and damage, where

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the latter is the “proximate result” of the former.2301 Respondent advocates the following methodology:

[I]f the damages are caused by a series of harmful actions . . . each violation can be treated as a new action and the corresponding incremental change can be estimated at the time of the action, . . . [t]he incremental damage figures for each violation can then be added together to obtain a total damage figure.2302

1742. According to Respondent, Claimants’ approach to damages fails “to connect any of the alleged treaty violations to a specific amount of damages” and provides “no mechanism for determining the incremental damages allegedly caused by any specific alleged violation.”2303 As a consequence, Respondent alleges that Claimants’ valuations “do not accommodate the situation where the Tribunal finds that fewer than all of the scores of alleged ‘bad acts’ were violations.”2304

3.Specific Aspects of the Calculations Performed by Claimants Criticized by Respondent

1743. Principally, Respondent criticizes Claimants’ damages claims as being “based on inherently incorrect or speculative assumptions.”2305 According to Professor Dow, Mr. Kaczmarek’s various calculations are “riddled with errors” and the obvious result of “reverse engineering to a desired result.”2306 Respondent and its expert raise numerous arguments in support of their criticism, the most important of which are summarized below.

(a)Credibility of Claimants’ DCF Analysis

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these errors in his second expert report, the valuation of YNG remained virtually unchanged.2308 As a consequence, Respondent claims that Mr. Kaczmarek’s “main task” in his second report must have been to “find a way to make up for gaping holes in his initial valuation that he concedes were the result of readily identifiable errors that he realized had to be corrected, after Professor Dow had identified them.”2309 Respondent points out that, while the necessary corrections identified by Professor Dow caused Claimants’ expert to make adjustments of over USD 10 billion to his valuation of YNG, Mr. Kaczmarek still ended up with virtually the same figure as in his first report as a consequence of a series of simultaneous “discretionary” upward adjustments.2310

1745. Respondent also claims that Claimants’ expert “did the same thing in his other two DCF models, correcting mistakes that reduce his valuation of Yukos and YukosSibneft by USD 40 billion and USD 90 billion, respectively, and then adjusting other elements to bring his conclusions back up to where he started.”2311 According to Respondent, “Mr. Kaczmarek confirmed . . . that his DCF model is simply a device for justifying an a priori conclusion, conceding repeatedly that his focus was not on critically analyzing the inputs to his model, but rather on whether the output met pre-conceived notions that were never disclosed in his

As a result, Respondent concludes that Claimants’ results have been “reverse engineered”2313 and are “made-up numbers around which models were built.”2314

(b)Claimants’ Selection of Comparable Companies for Purposes of the Comparable Companies Analysis

1746. With regard to Claimants’ use of the comparable companies method, Respondent criticizes Claimants’ valuation as being based on an “unsupportable decision to weigh Rosneft as 70% of the analysis, when Rosneft’s market metrics never resembled Yukos’ or those of other private

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Russian oil companies.”2315 Professor Dow, provides a “corrected” comparable companies analysis that excludes the data with regard to Rosneft, Gazprom Neft and the international major oil companies from the analysis,2316 and leads to an enterprise value for Yukos in 2007 that is approximately USD 32 billion lower than the enterprise value calculated by Mr. Kaczmarek based on the comparable companies method.2317

(c)Claimants’ Reliance on Comparable Transactions

1747. With regard to Claimants’ calculations based on comparable transactions, Respondent asserts that Claimants’ expert, Mr. Kaczmarek, admits that no truly comparable transactions exist.2318 In addition, Professor Dow criticizes Mr. Kaczmarek’s selection criteria for identifying comparable upstream and downstream transactions as “indefensible from an economic perspective.”2319

(d)Claimants’ Calculations of Hypothetical Cash Flows from Dividends

1748. Respondent does not explicitly address Claimants’ calculations of hypothetical dividends that would have been paid by Yukos to its shareholders if there had been no breach of the ECT as alleged by Claimants. However, when criticizing Mr. Kaczmarek’s calculations with regard to scenario 3, Professor Dow does comment on the free cash flows of Yukos that, according to Claimants, would have been the basis for the payment of dividends. Thus, according to Professor Dow, the free cash flows identified by Mr. Kaczmarek in this context are “inflated because they are based on his . . . grossly erroneous[] Yukos DCF model that overstates Yukos cash flows.”2320 Professor Dow provides an alternative set of figures that he refers to as the “corrected” cash flows from Mr. Kaczmarek’s model.2321

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(e)Claimants’ Calculations Based on the Loss of a Chance to Obtain a Listing on the New York Stock Exchange

1749. Professor Dow also criticizes Claimants’ assumption that Yukos would have benefited from a listing on the NYSE as “thrice wrong because it assumes an event that did not happen, that was entirely within Yukos’ control, and overstates the economic benefit that would be expected were the event to have come to pass.”2322 In addition, Professor Dow states that there is no basis for the assumption that, without Respondent’s actions, Yukos would have had a 70 percent chance of being listed on the NYSE.2323

(f)Claimants’ Calculations Based on the Assumption of a Completed Yukos– Sibneft Merger

1750. Professor Dow criticizes Claimants’ calculations based on a completed Yukos–Sibneft merger arguing that such a merger was never completed and that the valuation of a combined YukosSibneft entity is therefore utterly speculative.2324 In particular, Professor Dow claims that Mr. Kaczmarek’s calculations largely ignore “the effects of the merger on operational costs, any impact on costs as a result of changed regulatory requirements, and the combined entity’s creditworthiness and cost of borrowing.”2325

(g)Claimants’ Scenarios 3a to 3d

1751. With regard to Claimants’ scenarios 3a to 3d, which assume payment of Yukos’ tax liabilities over a period of one, three or five years, Respondent asserts that Russian law did not allow the Tax Ministry to enter into any such arrangements as postulated by Claimants2326 and that it was, in any event, not obligated to do so.2327 In addition, Respondent claims that, based on the knowledge available regarding the development of oil prices in 2004, Claimants’ calculations in relation to expected cash flows are not realistic.2328 Respondent also disputes that Claimants

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would have been able to negotiate a loan of USD 16 billion, as assumed in Claimants’ scenario 3c.2329

(h)Claimants’ Scenario 3e and the Valuation of YNG

1752. With regard to Claimants’ scenario 3e (which assumes that the auctioning of YNG was necessary, but should have been realized at a fair price) and the valuation of YNG in Mr. Kaczmarek’s first expert report, Respondent claims that Mr. Kaczmarek made three “obvious and significant errors” relating to the application of the inflation rate, the export duty rate and the mineral extraction tax rate.2330 Adjusting for these errors, the valuation of YNG would have been USD 12.5 billion,2331 with the consequence that Yukos would not have been able to pay its taxes by the end of 2005, even if YNG had been sold at a higher price.2332

(i)Claimants’ Calculation of Pre-Award Interest

1753. As described in Part XI above, Respondent submits that Claimants are not entitled to claim preaward interest.

4.Failure of Claimants to Mitigate

1754. Respondent asserts that Claimants had “repeated opportunities to mitigate the damage caused,”2333 and that, in particular, by paying its taxes in early 2004, Yukos could have “halved the total amount to be paid”2334 rather than “subject[ing] itself to . . . US$ 12 billion in additional 2000–2003 Avoidable Taxes and Fees.”2335 If Yukos had paid its taxes and filed appropriate returns during the first quarter of 2004, Respondent says it “would have survived as a going concern and still could have pursued a claim for a refund of any amounts the courts found it did not need to pay.”2336 Accordingly, the “loss of all value of Yukos” would be “the

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consequence of the contributory fault and the failure to mitigate of Yukos, under the control of Claimants.”2337

1755. Respondent claims that, as a consequence, “Claimants’ maximum damage claim is for their proportion of the harm (if any) Yukos would have suffered if the assessment and payment of the 2000–2003 Unavoidable Taxes were deemed to constitute a violation of the ECT.”2338 Respondent calculates this “maximum damage” as amounting to USD 6.27 billion.2339

5.Windfall and Double-Recovery

1756. In addition, Respondent claims that any calculation of damages should take into account any previous benefits obtained by Claimants from their investments in Russia, so as to prevent any “double-recovery.”2340 Respondent contends that granting Claimants the damages sought “would be a massive windfall to Claimants, who have already received far more from their investment in Yukos than they would have received had they invested in a comparable Russian oil company during the same period.”2341 Respondent also suggests that, had the market known of “Yukos’ lack of transparency, its disregard of minority interests, and its failures of corporate governance, not to mention its internal documents acknowledging the civil and criminal exposure it faced from its massive tax fraud, Yukos would not have experienced the share appreciation . . . on which Claimants’ damages claim depends.”2342 As a consequence, Respondent claims that “the market metrics . . . are not fair indicators of value and cannot be relied upon by the Tribunal.”2343

1757. Respondent concludes that “any damages award should provide for no more than a reasonable rate of return.”2344 Since Claimants would “have already gained that return through Yukos’ dividends and share repurchases, . . . hundreds of millions of dollars worth of Russian taxes

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