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Views/ Damage Compensation in Investment Arbitration
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Milan LazićAdvokat / Senior Partnermilan.lazic@karanovic-nikolic.com
11/01/2015
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This article was originally published in the Young Arbitration Review - Year 4, Ed. 16. 

Introduction

This article aims to point out different approaches to interpretation of the damage in investment arbitration practise touching upon a comparison between damage compensation concepts in court proceedings in civil law systems (with a focus on the Serbian court system) and the ones in investment arbitrations. This has been illustrated through an analysis of basic elements identified as necessary for damages to be awarded as established by court practise in civil law systems and theory, and the application of these elements to international investment cases. 

Basic elements of damages are: (i) existence of damage, (ii) damaging action, (iii) unlawfulness and (iv) causal link between the damaging action and the damage suffered. It should be noted that these elements are not explicitly stipulated by e.g. Serbian law, but rather created through court practise in the Serbian court system and elaborated on by legal literature. Also, many international scholars recognise these elements as elements of damage. The first two elements are not disputable, since they evidently need to exist for damages to be awarded. Therefore, we will focus on elements of unlawfulness and causal link. 

Causal link

The element of causal link can be portrayed through analysing two pioneering investment cases – Ronald S. Lauder vs. The Czech Republic1 and CME Czech Republic vs. The Czech Republic.2 These two cases were based on the same factual background, but have two competently different outcomes. For the purpose of this article, we will present the factual background of these two cases in a simplified manner, without going into detailed facts that may have influenced the tribunals to decide the way they did. 

The cases were brought before ad hoc tribunals under the Arbitration Rules of UNCITRAL. The subject of these cases were damages that were allegedly caused by actions of the Media Council of the Czech Republic (authority issuing broadcasting licenses and supervising the activity of broadcasters) towards a foreign investor, that allegedly led to a breach of the Treaty between the United States of America and the Czech and Slovak Federal Republic Concerning the Reciprocal Encouragement and Protection of Investment (Lauder case) and the Agreement on Encouragement and Reciprocal Protection of Investments between the Kingdom of the Netherlands and the Czech and Slovak Federal Republic (CME case). 

American citizen Mr. Ronald S. Lauder (claimant in the case Lauder vs. the Czech Republic) was the owner of the company CME (claimant in the case CME vs. the Czech Republic), which owned 99% of the Czech company CNTS. In 1993, the Media Council issued a broadcasting license to the local company CET 21. CNTS entered into cooperation with CET 21, whereby CET 21 contributed the License while CNTS was the operator of the broadcasting station TV Nova (which soon became a very successful TV station in the Czech Republic). Dr. Vladimír Železný served as both general director and chief executive of CNTS and as general director of CET 21. Part of the arrangement before the Media Council was the contractual relationship between CET 21 and CNTS. In fact, the Memorandum of Association ("MOA") concluded between CME and CET 21 (which defined the above mentioned contributions) was approved by the Council and the conditions attached to the License acknowledged CEDC's partnership with the holder of the License, CET 21. 

After the change of the Czech Media Law in 1996, the climate also changed in the Media Council, which initiated the issues such as whether CNTS can be entitled to broadcast and in fact manage TV Nova, since CET 21 was the actual License holder. Several administrative proceedings were initiated against CNTS in that respect and numerous meetings with the Media Council were held. As a consequence, in 1996, shareholders of CNTS agreed to change MOA and replace CET 21's contribution "Use of the License" by "Use of the Know-how of the Licence." In conjunction with the change of the contribution of the use of the License, CET 21 and CNTS entered into a Service Agreement, which was thereafter the basis for the broadcasting services provided by CNTS to CET 21 for operating TV Nova. In 1999, after communication between the Media Council and Dr. Železný, CET 21 terminated the Service Agreement. The formal reason given for this termination was the non-delivery of the day-log for broadcasting by CNTS to CET 21. CET 21 thereafter replaced CNTS as service provider and operator of broadcasting services by other service providers, with the consequence that CNTS broadcasting services became idle and, according to CME, CNTS's business was totally destroyed. Prior to the termination, the Media Council sent Dr. Železný a letter stating that the business relations between the operator of broadcasting and service organisations are built on a non-exclusive basis. The claimants alleged that this letter gave Dr. Železný the wind beneath his wings that he needed to terminate the contract with CME. 

As it can be concluded from the above described facts, the direct cause of the damage on the side of the foreign investors was the decision of Mr. Železný (i.e. CET 21) to terminate the contractual relationship with CNTS and to eliminate CNTS from the business. The Tribunals in two cases took two completely divergent stands: 

  • In the Lauder case, the Tribunal found that there were certain discriminatory and arbitrary measures on the side of the Media Council (i.e. Czech Republic) towards the claimant, which constituted a violation of the Treaty. However, the actual cause of damage was the termination of the agreement by CET 21, i.e. this was a direct act, and the immediate cause of damage. Therefore, the Tribunal concluded that the alleged harm was caused by the acts of CET 21, controlled by Mr. Železný and that the breach of the Treaty was too remote to qualify as a relevant cause for the harm caused. In other words, the Tribunal concluded there is no causal link between the actions of the Media Council and the alleged damage on the side of Mr. Lauder.
  • In the CME case, the Tribunal took a completely opposite stand. The Tribunal found that the collapse of CME's investment was caused by the Media Council's coercion against CME, by requiring the amendment of the legal structure of the partners and by Media Council's interference with the legal relationship between CET 21 and CNTS. According to the Tribunal, Media Council made an impact by issuing an official regulator's letter which eliminated the exclusivity of the Service Agreement, an exclusivity that was the cornerstone of CME's legal protection for its investment. The Tribunal concluded that the destruction of CME's investment after the termination of the Service Agreement was the consequence of the Media Council's actions and inactions, hence there was a causal link between the actions of the Media Council and the damage on the side of CME. 

By observing these two cases, we notice two completely different approaches to the concept of damage compensation, in particular in regard to the element of causal link. The first approach in the Lauder case is closer to the interpretation applied by judges in state courts and that is the strict, formalistic approach of presence of the causal link element. The second approach is more flexible and wide in terms of interpretation of connection between the damaging action and the damage suffered. The second approach is more alike to damage compensation concepts in common law systems. Being amongst the first investment arbitration cases in Europe, it could be even said that the CME case represents the turning point in interpretation of the causal link element of damage in investment arbitrations in Europe. 

The element of "unlawfulness"

The second controversial element of damage is "unlawfulness". Some scholars do not consider this element to be decisive in interpretation of damage. Others regard unlawfulness as an element attributable to damage in tort (contractual damage obviously does not require unlawfulness as a precondition). The investment arbitrations usually refer to actions of the states which represent the tort and which led to the breach of the bilateral investment treaties. The question therefore is whether "unlawfulness" is the element that tribunals regard as necessary in order for damage to exist in investment arbitrations. 

In respect to this question, we would refer to two investment arbitration cases which dealt with the issue where the EU member states were acting in compliance with EU law (or by the order or instruction of EU authorities), but in contravention with obligations from the investment treaties. 

For example, in Electrabel S.A. vs. the Republic of Hungary, the Tribunal took the following stand: "Where Hungary is required to act in compliance with a legally binding decision of an EU institution, recognised as such under the ECT (Energy Charter Treaty), it cannot (by itself) entail international responsibility for Hungary. Under international law, Hungary can be responsible only for its own wrongful acts. The Tribunal considers that it would be absurd if Hungary could be liable under the ECT for doing precisely that which it was ordered to do by a supranational authority whose decisions the ECT itself recognises as legally binding for Hungary. For these reasons, the Tribunal decided that if and to the extent that the European Commission's Final Decision required Hungary, under EU law, to prematurely terminate Dunamenti's PPA, that act by the Commission cannot give rise to liability".3 Clearly, this award goes in line with the stream that considers "unlawfulness" as a constitutive element of damage.

On the other hand, we have the case Achmea B.V. vs. the Slovak Republic, in which the tribunal took the stand that the mere breach of obligations from the investment treaty is sufficient to establish the state's liability for damage, regardless of the fact that the state acted in compliance with EU law or upon EU institutional instruction: "This Award has no bearing upon any question of EU law. This Award relates only to the compliance by Respondent with the terms of the obligations it has assumed under the agreement it made in the Treaty."4 

It is indeed in the vast majority of investment cases that the states were actually acting in compliance with their local laws and at the same time committed a breach of their treaty obligations. The Tribunals have typically supported the position that acting in compliance with local law does not have a bearing upon the conclusion that the treaty was breached. 

The real controversy actually lies in the application of international law and supranational law such as EU law. Do the damaging actions of a state that are in conformity with international or EU law represent a treaty breach? Is unlawfulness a pre-condition for the existence of damage in investment arbitrations? As we see from the two above mentioned examples, there is no unified practise in this respect. 

Conclusion

State courts still tend to be very strict and formal when deciding on damage compensation cases. They still hold firmly to unlawfulness as an element of damage and require the causal link to be strict and evident. 

On the other hand, although different awards were rendered in respect to damage compensation cases, we may notice that arbitral tribunals in investment arbitrations have opened the window for a more flexible and extensive approach to the interpretation of damage compensation. By analysing the elements of damage in the practise of investment tribunals, we see that not all the elements of damage should necessarily be present. It appears that the arbitration practise is evolving through time towards the understanding of damage which is closer to the common law approach. Concepts of damage that have been (and still are) hard to imagine in civil law systems, have now become regular practise of the arbitral tribunals in investment arbitrations.

 

1. Ronald S. Lauder vs. the Czech Republic, Final award

2. CME vs. the Czech Republic, Final award no. 1303

3. Electrabel S.A. vs. the Republic of Hungary, ICSID Case no. ARB/07/19, Decision on jurisdiction, applicable law and liability, part VI, p. 22

4. Achmea B.V. vs. the Slovak Republic, PCA Case No. 2008-13, Final award, p. 93

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