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Investment Disputes: Causes, Consequences, Conclusions
Overview No. 1: Arbitration Case –
AES Corp v. Republic of KazakhstanOver the past 27 years, the Republic of Kazakhstan ("RK") has been involved in more than 19 arbitration proceedings related to the breach of its obligations to protect investments ("Investment Disputes"). In total, the amount of claims from foreign investors seeking compensation from the RK for losses have exceeded 12 billion US dollars, which represents over 28% of the revenue portion of the country's national budget for 2023. This amount does not include the expenses incurred by the RK on legal services related to these disputes, where the legal fees alone (excluding other expenses) charged by foreign law firms for each case of this nature range from 5 to 14 million US dollars, impacting the state budget.
By logic, it is necessary for all of us, and especially for the government authorities, to analyse the causes of Investment Disputes, study the negative consequences they entail for the state, and draw appropriate conclusions to prevent the recurrence of such events and actions in the future. Therefore, the purpose of the present and future overviews is to demonstrate, through specific examples, the actions and/or inactions of the state bodies of the Republic of Kazakhstan (RK) that have been recognized by international arbitral tribunals as a breach of the state's obligations to protect investments. It should be noted that in compiling this overview, we rely on information from publicly available sources. Arbitral decisions can be reasoned or otherwise, but in this case, we proceed on the fact that an arbitral decision exists, and other investors may potentially refer to it in the event of initiating new Investment Disputes.
In this overview No.1, the leading national law firms Unicase (Republic of Kazakhstan) and Kalikova & Associates (Kyrgyz Republic) provide a brief summary of the case AES Corp, Tau Power ("AES/Claimants") v. Republic of Kazakhstan ("AES Case"). In the AES Case, the tribunal concluded that the RK breached its obligation to provide fair and equitable treatment, but rejected the claimants' claims for damages and other reliefs. The AES Case can be considered successful as nothing was awarded against the RK. However, it is worthwhile to examine the nature of the RK's breach of its obligations in order to take this aspect into account in the future activities of the state authorities of the RK.
By logic, it is necessary for all of us, and especially for the government authorities, to analyse the causes of Investment Disputes, study the negative consequences they entail for the state, and draw appropriate conclusions to prevent the recurrence of such events and actions in the future. Therefore, the purpose of the present and future overviews is to demonstrate, through specific examples, the actions and/or inactions of the state bodies of the Republic of Kazakhstan (RK) that have been recognized by international arbitral tribunals as a breach of the state's obligations to protect investments. It should be noted that in compiling this overview, we rely on information from publicly available sources. Arbitral decisions can be reasoned or otherwise, but in this case, we proceed on the fact that an arbitral decision exists, and other investors may potentially refer to it in the event of initiating new Investment Disputes.
In this overview No.1, the leading national law firms Unicase (Republic of Kazakhstan) and Kalikova & Associates (Kyrgyz Republic) provide a brief summary of the case AES Corp, Tau Power ("AES/Claimants") v. Republic of Kazakhstan ("AES Case"). In the AES Case, the tribunal concluded that the RK breached its obligation to provide fair and equitable treatment, but rejected the claimants' claims for damages and other reliefs. The AES Case can be considered successful as nothing was awarded against the RK. However, it is worthwhile to examine the nature of the RK's breach of its obligations in order to take this aspect into account in the future activities of the state authorities of the RK.
To enhance the reader's understanding of the provided information, we have structured the overview into three sections:
I. Case Background, which outlines the circumstances that led to the emergence of the Investment Dispute
II. Actions and/or inactions of the state authorities of the Republic of Kazakhstan (RK) recognised by international arbitral tribunals as a breach of the RK's obligations to protect investments
III. Conclusions
I. Case Background, which outlines the circumstances that led to the emergence of the Investment Dispute
II. Actions and/or inactions of the state authorities of the Republic of Kazakhstan (RK) recognised by international arbitral tribunals as a breach of the RK's obligations to protect investments
III. Conclusions
i
CASE BACKGROUND
The AES Case arose due to the following circumstances:
- In 1996-1997, AES acquired a number of assets in the power sector (Ekibastuz Thermal Power Plant, hydroelectric power plant concession, and shares in four thermal power plants) through affiliated entities.
- As a result of changes in Kazakhstan's legislation, from 2001 to 2008, AES companies were included in the list of monopolists. Additionally, sanctions were imposed on AES companies for violations of competition laws and abuse of market dominance. These sanctions were appealed in the courts of Kazakhstan, some of which were overturned or modified, but the majority of sanctions were upheld.
- From 2009 to 2012, changes in Kazakhstan's electricity legislation led to the application of special tariff regulations for electricity generation companies, including AES. It also required the conclusion of agreements on investment obligations (the "Tariff-for-Investment" system).
- Under the Tariff-for-Investment system, all profits, defined as net income, had to be reinvested in the infrastructure of the generating companies. Consequently, generating companies benefiting from the Tariff-for-Investment system had to reinvest all their operating cash flows. Companies without an agreement under the Tariff-for-Investment system were not allowed to account for depreciation, resulting in de facto operating losses.
- The claimants requested, among other things, that the tribunal recognises that Kazakhstan, through the adoption and application of new legislation affecting AES companies, breached its obligations to provide a fair and equitable treatment (including stabilisation), prohibit arbitrary and unjustified measures, ensure full protection and security, and sought compensation for the losses incurred.
ii
ACTIONS/INACTIONS OF THE GOVERNMENTAL AUTHORITIES OF THE REPUBLIC OF KAZAKHSTAN RECOGNIZED AS VIOLATION OF OBLIGATIONS TO PROTECT INVESTMENTS
In relation to the amendments to the legislation of the Republic of Kazakhstan during the period from 2004 to 2008, the tribunal concluded that as a result of changes in competition legislation and its application to AES companies during the period from 2004 to 2008, the Republic of Kazakhstan did not violate its obligations regarding stabilization regime, ensuring equal and fair treatment, prohibiting arbitrary and unjustified measures, and providing full protection and security.
However, with regard to the period from 2009 to 2015, AES claimed that the implementation of tariff amendments for generating companies in 2009 led to a return to a heavily regulated market model. The situation was further exacerbated by the adoption and application of the 2012 Law on Electric Power, which the Claimants consider to be an arbitrary and irrational legislative act that did not pursue any legitimate policy objectives and was explicitly aimed at preventing the Claimants from deriving income from their investments in electricity production activities. In this part of the tribunal's findings, it concluded that
However, with regard to the period from 2009 to 2015, AES claimed that the implementation of tariff amendments for generating companies in 2009 led to a return to a heavily regulated market model. The situation was further exacerbated by the adoption and application of the 2012 Law on Electric Power, which the Claimants consider to be an arbitrary and irrational legislative act that did not pursue any legitimate policy objectives and was explicitly aimed at preventing the Claimants from deriving income from their investments in electricity production activities. In this part of the tribunal's findings, it concluded that
1) The Claimants had legitimate expectations based on the Law of the Republic of Kazakhstan dated 27 December 1994 No. 266-XIII "On Foreign Investments" that they could obtain a reasonable return on their investments. The fact that the aforementioned law ceased to be in force in 2003 does not affect the existence of the aforementioned legitimate expectations that arose at the time when the principal investments were made (in 1997). In turn, such legitimate expectations imply the investors' right to a certain discretion regarding how to use such income. This right, in principle, includes the right of foreign investors to repatriate such income.
2) The protection of the aforementioned legitimate expectations/rights is not absolute, and in order to claim that a particular legislative restriction on the aforementioned rights (the right to repatriate income, the right to use income at their discretion) constitutes a violation of the standard of ensuring fair and equitable treatment, it is necessary to demonstrate that such restrictions are inherently discriminatory or unfair.
3) In turn, legislative restrictions do not violate the standards for protecting investors' rights if they pursue legitimate policy objectives and the measures taken to achieve such objectives are proportionate and reasonable.
4) The "tariff-for-investment" system pursued legitimate policy objectives (increasing investments in the production and transmission of electricity). However, the tribunal disagreed that the restrictions imposed for the implementation of the "tariff-for-investment" system were proportionate and reasonable.
5) The restriction within the "tariff-for-investment" system obligated generating companies to reinvest their operational cash flows until 31 December 2015, thereby prohibiting them from using the income for other purposes. Such restriction was rigid and radical.
6) The restrictions imposed by the Republic of Kazakhstan within the "tariff-for-investment" system could only be justified if the threat of a collapse was real and imminent, and the measures necessary to prevent the collapse could not be implemented through means that would involve less interference with the Claimants' rights.
7) The tribunal agreed that the threat of a collapse was real and imminent in 2008-2009. However, the tribunal noted that Kazakhstan failed to demonstrate that it could not have prevented the collapse by adopting less intrusive measures. Even if the measures taken were the only way to avoid the collapse, once it became evident that the anticipated collapse would not occur, the principle of proportionality required Kazakhstan to adjust the restrictions accordingly.
8) Considering that the prohibition on profit distribution was complete, the restrictions within the "tariff-for-investment" system intended to remain in effect for seven years and therefore served not only to prevent an imminent danger but also appeared to be part of a long-term plan for the modernization of the national electricity distribution system. As such, they cannot be considered proportionate or reasonable, and therefore, they constitute a violation of the standard of providing equal and fair treatment.
2) The protection of the aforementioned legitimate expectations/rights is not absolute, and in order to claim that a particular legislative restriction on the aforementioned rights (the right to repatriate income, the right to use income at their discretion) constitutes a violation of the standard of ensuring fair and equitable treatment, it is necessary to demonstrate that such restrictions are inherently discriminatory or unfair.
3) In turn, legislative restrictions do not violate the standards for protecting investors' rights if they pursue legitimate policy objectives and the measures taken to achieve such objectives are proportionate and reasonable.
4) The "tariff-for-investment" system pursued legitimate policy objectives (increasing investments in the production and transmission of electricity). However, the tribunal disagreed that the restrictions imposed for the implementation of the "tariff-for-investment" system were proportionate and reasonable.
5) The restriction within the "tariff-for-investment" system obligated generating companies to reinvest their operational cash flows until 31 December 2015, thereby prohibiting them from using the income for other purposes. Such restriction was rigid and radical.
6) The restrictions imposed by the Republic of Kazakhstan within the "tariff-for-investment" system could only be justified if the threat of a collapse was real and imminent, and the measures necessary to prevent the collapse could not be implemented through means that would involve less interference with the Claimants' rights.
7) The tribunal agreed that the threat of a collapse was real and imminent in 2008-2009. However, the tribunal noted that Kazakhstan failed to demonstrate that it could not have prevented the collapse by adopting less intrusive measures. Even if the measures taken were the only way to avoid the collapse, once it became evident that the anticipated collapse would not occur, the principle of proportionality required Kazakhstan to adjust the restrictions accordingly.
8) Considering that the prohibition on profit distribution was complete, the restrictions within the "tariff-for-investment" system intended to remain in effect for seven years and therefore served not only to prevent an imminent danger but also appeared to be part of a long-term plan for the modernization of the national electricity distribution system. As such, they cannot be considered proportionate or reasonable, and therefore, they constitute a violation of the standard of providing equal and fair treatment.
1) The Claimants failed to meet their burden of proof regarding the existence of damages resulting from the Respondent's breach of its obligations. That is to say, there must be a causal link between the damages and the breach committed. The Tribunal concluded that the implementation of amendments to the tariff system for generating companies in 2009, as well as the adoption and application of the Electricity Law of 2012, constituted a violation of the fair and equitable treatment standard.
2) Consequently, the Claimants were required to demonstrate that they suffered damages specifically as a result of the implementation of amendments to the tariff system for generating companies in 2009 and the adoption and application of the Electricity Law of 2012.
3) However, the calculations of the Claimants' damages were based on the assumption that the changes to the competition legislation should not have been applied to their companies (which the Claimants considered to be a violation of investment protection standards). In other words, if the competition legislation had not been applied, their companies could have applied a different tariff and thus obtained different revenues (there would be a difference between the tariff imposed on the Claimants' companies due to legislative restrictions and the competitive market price).
4) The issue for the Claimants was that the Tribunal concluded that the changes to the competition legislation and their application to AES companies did not constitute a violation of investment protection standards. Therefore, the entire basis of the Claimants' damage calculations was unfounded.
5) The Tribunal questioned the Claimants on how they would calculate damages if, for example, the Tribunal were to find that the Energy Law of 2009-2012 violated the Claimants' rights but that tariff regulation based on competition law did not. However, the Claimants did not provide a recalculation of their damages; they only relied on the calculation based on the assumption that the changes to the competition legislation should not have been applied to their companies.
2) Consequently, the Claimants were required to demonstrate that they suffered damages specifically as a result of the implementation of amendments to the tariff system for generating companies in 2009 and the adoption and application of the Electricity Law of 2012.
3) However, the calculations of the Claimants' damages were based on the assumption that the changes to the competition legislation should not have been applied to their companies (which the Claimants considered to be a violation of investment protection standards). In other words, if the competition legislation had not been applied, their companies could have applied a different tariff and thus obtained different revenues (there would be a difference between the tariff imposed on the Claimants' companies due to legislative restrictions and the competitive market price).
4) The issue for the Claimants was that the Tribunal concluded that the changes to the competition legislation and their application to AES companies did not constitute a violation of investment protection standards. Therefore, the entire basis of the Claimants' damage calculations was unfounded.
5) The Tribunal questioned the Claimants on how they would calculate damages if, for example, the Tribunal were to find that the Energy Law of 2009-2012 violated the Claimants' rights but that tariff regulation based on competition law did not. However, the Claimants did not provide a recalculation of their damages; they only relied on the calculation based on the assumption that the changes to the competition legislation should not have been applied to their companies.
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CONCLUSIONS
Any arbitration decision that is not in favour of the Republic of Kazakhstan has a negative impact on the country's investment image. We hope that such reviews can contribute to ensuring that government entities and officials are aware of the possible consequences of their decisions from the perspective of international law. Accordingly, these reviews can serve as a preventive mechanism against the emergence of investment disputes in the future.
The main question is, what conclusions can we draw from the AES Case?
For example, the following conclusions can be made:
The main question is, what conclusions can we draw from the AES Case?
For example, the following conclusions can be made:
- Yes, the Republic of Kazakhstan, like any sovereign state, has the right to change its legal regulations within the country. However, it should be taken into account that Kazakhstan has international legal obligations to protect investments.
- These obligations entail requirements that legislative changes must pursue legitimate policy objectives, and the measures taken to achieve such objectives must be proportional and reasonable.
Authors
Artem Timoshenko
Managing Partner
Unicase
Nurbek Sabirov
Partner
Kalikova& Associates