Analysis of arbitration practice in matters of reimbursement of expenses incurred by the investor prior to the conclusion of production sharing agreements

Due to the systematic emergence of controversial issues related to the state's reimbursement of costs to the investor before they conclude a production sharing agreement, there is a need to analyze arbitration practice.

Production sharing agreements are a type of investment agreement, and therefore any conclusions from arbitration awards on investment agreements have practical implications for the application of production sharing agreements.

To prepare this analysis, we referred to a number of the following tribunal decisions: «Tethyan Copper Company Pty Limited v. Islamic Republic of Pakistan», «The Patel Engineering Limited v. Republic of Mozambique», «Mihaly International Corporation v. Democratic Socialist Republic of Sri Lanka», «Zhinvali v George», «Mytilineos v. Serbia and Montenegro», «Duke Energy v. Peru», «Union Fenosa Gas v. Egypt», «PSEG v. Turkey», «Bear Greek Mining v. Peru», «ADS v Hungary».

From the content of the arbitration decisions, it is apparent that the main factor influencing the amount of compensation to the investor is based on the universal principle that the investor's income from the transaction must be protected throughout the entire life cycle of the investment agreement.

The most common assessment of the above cycle is using a method such as Discount Cash Flow (DCF).

However, the application of this method causes discrepancies between the assessment of the value of the investor's investment and the value of the costs incurred by investors, especially when investment agreements are concluded for long terms and are valid for up to 50 years or more.

Mmaintaining a balance between the cost of investments and the cost of expenses incurred by the investor, and to protect the national economies of states from monetary collapse, arbitration practice has developed 3 postulates in its work:

1) enhanced public interest of the state is a rational argument in disputes with the investor.

2) investor misconduct is subject to a limited exception (for example, signs of corruption in the case of «Union Fenosa Gas v. Egypt», the investor received gas supplies under the influence of the decision of the director of the Egyptian Petroleum Group company. The gas supply was not included in the list of compensating costs to the investor).

3) the state-receiver of the investment can pay the costs.

As a rule, investors incur expenses before the stage of signing investment agreements.

World arbitration practice is consistent in that the following are always subject to compensation to the investor without any conditions:

a) the investor's expenses for environmental impact assessment.

b) scientific research and development.

c) payment for financial advice.

Arbitration tribunals (arbitration courts/commercial arbitration panels) in disputes regarding reimbursement of costs to the investor incurred by him before the conclusion of the investment agreement are resolved based on an individual understanding of the concept of «investment».

Arbitral tribunals/courts agree that costs incurred before the signing of an investment agreement may not have an economic effect, but they are subject to protection.

The source of this conclusion was the inaccuracy of Article 25 of the Convention on the Settlement of Investment Disputes between States (hereinafter referred to as the Convention), which reserves flexibility in determining the essence of an «investment agreement» and «pre-investment preparations» for it.

The commentary to the Convention does not specify a list of «pre-investment preparations, nor their start dates, nor their end dates.

The answer to what exactly should be considered «pre-investment preparations» lies in the content of the investment agreement, which has been analyzed by international commercial arbitrations/tribunals.

Article 10(2) of the Energy Charter Treaty obliges the parties to the agreements to facilitate the pursuit of investment. Such investment shall be provided with the greatest possible permanent protection and security for the investor.

Similar concepts are also found in interparliamentary agreements on mutual investment protection and intergovernmental free trade agreements, which are also arbitration instruments in settling disputes with investors. For reference, as of today, Ukraine has concluded over 3,000 agreements on mutual investment protection and 19 free trade agreements.

The investment theory remains unchanged and conservative today.

The conclusions in the decisions in the cases of «PSEG v. Turkey», «Bear Greek Mining v. Peru» are formulated on the unity of the investment theory, which means that the investor's expenses are included in the limits of the investment that he made.

For example, in the case of Mytilineos v. Serbia and Montenegro, the tribunal held: «where there is doubt that the agreements prior to the investment agreement are taken separately and in isolation, it becomes clear that the combined cumulative nature of such agreements affects the investment agreement».

Despite the unitary nature of the perceived fact of the advantage of the «investor» over nation-states, there are arbitration precedents in arbitration practice in which investors were denied compensation (cases «Mihaly International Corporation v. Democratic Socialist Republic of Sri Lanka», «Zhinvali v George») under concession agreements, commercial transaction agreements and contracts for the construction of energy facilities.