Following expropriation of Dornod uranium investment, Khan Resources announces conclusion of arbitration with Mongolian government
Khan, a mining company listed on the Toronto Stock Exchange’s venture board, its holding company, and its erstwhile joint-venture partner, recently announced victory in arbitration with Mongolia. Khan has apparently been awarded a base amount of US$80 million plus interest as compensation for Mongolia’s expropriation of its investment in the Dornod uranium deposit.
There is still a great deal about the arbitration that remains unknown: the information in Khan’s press release provides an outline while leaving the details blank, and the award itself has not yet been made public. Non-lawyer colleagues likely have questions about Khan’s apparent victory. Some of these questions – for instance, how was the expropriated investment valued, we do not know whether the tribunal used a discount cash flow analysis or some other method to value the Dornod deposit – will only be answered once the award is made public. Other questions though, about for instance the basis for arbitration between Khan and Mongolia as well as the arbitration’s procedure, can be answered based on past experience with investor-state arbitration.
Readers of this blog may be aware that Khan began investing in the Dornod project in the mid 1990s as Ulaanbaatar was undergoing post-Soviet reforms. And that, after some years Khan released a feasibility study in 2009 showing commercial viability, which prompted a takeover bid from China National Nuclear Corporation in February 2010. Subsequently, to simplify a complicated chain of events, the Mongolian government expropriated a majority interest in Dornod without compensation, suspending and then cancelling Khan’s mining licenses.
Readers may also be aware that Canada and Mongolia have started negotiating a Foreign Investment Promotion and Protection Agreement (FIPA). FIPAs like other International Investment Agreements (IIAs) contain both substantive obligations – standards of treatment – and dispute settlement provisions that aim to protect foreign investors from discriminatory or otherwise expropriatory conduct by the host state. In the case of Khan, this would have potentially meant an obligation for Mongolia to pay compensation and access to international tribunal with Mongolia whereby Khan could enforce the compensation obligation judicially. However, while negotiations towards a FIPA started in 2009, progress appears to have stalled and there is to date no treaty.
Given the lack of a FIPA between Canada and Mongolia, it only makes sense to question the basis on which Khan filed for arbitration. A complete answer will have to wait for the award, but some details emerge from Khan’s 10 January 2011 Notice of Arbitration (Notice). In the Notice, Khan cites a series of legal instruments as the basis for arbitration with Mongolia, i.e.: the Energy Charter Treaty, the Mongolian Foreign Investment Law, the CAUC Founding Agreement, and the UNCITRAL Arbitration Rules.
The key point to understand here is that each part of Khan’s ‘corporate family’ or ‘corporate structure’ relied on different instruments to bring arbitration against Mongolia. For example, Khan’s offshore holding company – Khan Resources BV – was able to rely on the Energy Charter Treaty. (The Energy Charter Treaty, or ECT, was one of the most ambitious agreements arising from the collapse of European communism. Among other objectives, it aimed to bring western European capital to oil-rich former-Soviet spaces through the inclusion of an IIA. Mongolia is a signatory to the ECT as is the Netherlands.) Khan Resources BV as a company incorporated in the Netherlands is an investor for the purposes of the ECT and was thus able to claim its protections, including arbitration, against Mongolia.
Dutch holding companies such as Khan Resources BV are routinely used for tax planning but sophisticated solicitors are recognizing that the ECT – not to mention the Netherlands extensive network of bilateral IIAs – provides for investment protection advantages as well. The result is referred to as ‘treaty structuring’ by sympathetic observers and as ‘treaty shopping’ by critics.
The Mongolian Foreign Investment Law is also noteworthy. Khan’s Notice refers to Article 25 as providing that “the settlement of disputes may be resolved pursuant to the provisions of ‘international treaties to which Mongolia is a party or by any contract between the parties’”. The Notice concludes that this provides an “additional basis of consent” beyond the ECT. Mongolia undertook major revisions to this statute, which also dates to the post-Soviet period, in 2013.
I have been asked whether the arbitration’s procedure was impacted by the fact that the Canada – Mongolia FIPA has not been concluded. One useful way of approaching this question is to note the fourth legal instrument relied on in Khan’s Notice, i.e. the UNCITRAL Arbitration Rules. The United Nations Commission on International Trade Law (commonly referred to as UNCITRAL) first adopted arbitration rules in 1976. A major revision exercise was completed in 2010. Canada’s FIPAs always include the option of using the UNCITRAL Arbitration Rules.
The UNCITRAL Arbitration Rules are today one of the two leading sets of procedural rules for investor-state arbitrations. The other being the arbitration rules of the International Centre for the Settlement of Investment Disputes (ICSID), which is a branch of the World Bank. There are a range of differences between ICSID and UNCITRAL procedure, but it cannot be said that one or other systematically advantages claimants as opposed to defendants, or investors as opposed to governments.
I hope that this albeit short blog post helps non-specialists to better understand Khan’s investor-state arbitration claim against Mongolia. As we have seen, Khan relied on multiple arbitration agreements and each member of Khan’s corporate family was involved in ‘treaty structuring’. Also, the procedure of the arbitration took place according to the UNCITRAL Arbitration Rules rather than the arbitration rules of ICSID. These developments fit the pattern found in many other cases where a developing country government expropriates a lucrative natural resource investment. According to the World Bank, for instance, more than one third of ICSID arbitrations initiated in 2014 involved oil, gas, or mining investments.
Exxon-Mobil’s claim against Venezuela for expropriation of two major assets is a relatively well known case featuring facts not dissimilar to the Dornod expropriation. First off, Exxon-Mobil’s claim was brought by five parts of Exxon’s corporate structure including an offshore holding company and various local operating companies. Although the arbitration was not brought under the Energy Charter Treaty, it again involved the Netherlands and took place under an IIA between the Netherlands & Venezuela. The arbitration used the ICSID Arbitration Rules. As it happens, I have prepared a somewhat more detailed summary that can be accessed here, http://www.iisd.org/itn/2015/02/19/awards-and-decisions-18/.
In addition to treaty shopping and the choice of ICSID over UNCITRAL procedure, the Exxon-Mobil award sheds light on how arbitration tribunals approach the valuation of expropriated assets. On the one hand, the tribunal used a discounted cash flow analysis (DCF) for one of the two assets on the basis that it was already at the production stage. On the other hand, the second asset was not yet at the production stage and the tribunal found it more appropriate to consider the claimants’ sunk investment, rather than DCF. As mentioned in the intro to this blog post, we do not know how the Khan tribunal approached valuation: certainly the Dornod project had not advanced to production; but investor-state tribunals are not bound by precedent instead interpreting the specific treaty being invoked, i.e. the ECT in this case.
About Matthew Levine
Matthew Levine is a Canadian lawyer and a fellow at the University of Toronto, Faculty of Law. Matthew began his legal career as an articled student and associate with the International Trade and Arbitration group of a national firm. His practice with mining companies and entrepreneurs includes corporate, securities, and tax law advice as well as arbitration-related work. His international experience includes stints in Geneva and Singapore. Matthew is a graduate of the University of British Columbia (JD, MA) and McGill University (BA).