Michael Broeders September 15 2017 Amsterdam Court of Appeals denies recognition of Yukos bankruptcy based on public order exemption Freshfields Bruckhaus Deringer | Insolvency & Restructuring - Netherlands Michael Broeders Insolvency & Restructuring BackgroundPowers of non-EU bankruptcy trustee in the NetherlandsAmsterdam Court of Appeals decisionUNCITRAL arbitration proceedings and setting-aside proceedingsPossible impact on setting-aside proceedings in appealOn May 9 2017 the Amsterdam Court of Appeals ruled that the Russian liquidation order of August 1 2006 regarding OAO Yukos Oil Company is contrary to Dutch public order and therefore null and void.(1) An interesting question is whether the judgment will have a bearing in the appeal of the annulment proceedings concerning the $50 billion Energy Charter Treaty (ECT) arbitration case between former Yukos shareholders and Russia, which is pending before The Hague Court of Appeal.Background Yukos, established by Mikhail Khodorkovsky and at the time Russia's largest oil company, was declared bankrupt on August 1 2006 by the Moscow City Arbitrazh Court. Rebgun was appointed as Yukos's bankruptcy trustee. Important Yukos assets, such as a refinery in Lithuania and a pipeline operation in Slovakia, were held by a 100% Dutch subsidiary, Yukos Finance BV. Rebgun, in its role as representative of Yukos Finance's 100% shareholder, Yukos, dismissed Yukos Finance directors David Godfrey and Bruce Misamore and appointed new directors. On September 10 2007 Rebgun sold the shares in Yukos Finance in an auction to Russian investment company Promneftstroy for $307 million. Godfrey and Misamore sued Rebgun before the Amsterdam District Court, with the main purpose of obtaining declaratory decisions that all resolutions adopted by or on behalf of Rebgun and the new directors were null and void. In the annulment proceedings, Godfrey and Misamore created landmark case law in advancing two sets of defences relating to:the powers of a non-EU bankruptcy trustee in the Netherlands; andthe recognition of a foreign bankruptcy order in the Netherlands.Powers of non-EU bankruptcy trustee in the Netherlands In two prior rulings in the annulment proceedings, the Supreme Court held that the Russian bankruptcy trustee Rebgun could exercise its powers as a bankruptcy trustee in the Netherlands on the basis of the lex concursus (ie, the law of the state in which the insolvency proceedings were commenced – in this case, Russia). These landmark rulings brought clarity regarding the scope and application of the principle of territoriality and the powers of a foreign, non-EU bankruptcy trustee in the Netherlands. Rebgun was, in principle, entitled to exercise the voting rights attached to the Dutch Yukos Finance shares and manage and dispose of the Dutch assets of the Yukos estate unless, as a result, the unpaid creditors would no longer have any recourse on the assets. Hence, despite the fact that the principle of territoriality formally implies that the Netherlands does not recognise a non-EU bankruptcy, in practice, it does so to a large extent.Amsterdam Court of Appeals decisionAfter the Supreme Court had dealt with the principle of territoriality, the Amsterdam Court of Appeals still had to decide on the argument put forward by Godfrey and Misamore that the 2006 Russian judgment declaring Yukos bankrupt should continue to have no legal effect in the Netherlands because it was contrary to Dutch public order and, as such, could not be recognised in the Netherlands.Foreign constitutive judgments, such as a Russian judgment opening insolvency proceedings, are recognised in the Netherlands if the following minimum requirements are met:the foreign court was competent to rule on the matter on the basis of an international generally accepted ground.(2) Given the far-reaching consequences of the public order exception (ie, that a foreign court judgment has no effect in the Netherlands), it is generally accepted that it can be used against the recognition of foreign judgments only in exceptional circumstances;the judgment was rendered after a proper judicial procedure; andthe judgment is not contrary to Dutch public order.Case law on the application of the public order exception is sparse. In Eurofood, the European Court of Justice ruled that a member state may deny recognition of a judgment opening insolvency proceedings if the fundamental right to be heard has been violated.(3)In the first instance, the Amsterdam District Court ruled that the process leading up to the 2006 Russian liquidation contravened the Dutch principles of due process and public order. The Amsterdam Court of Appeals upheld this decision. Its reasoning was largely based on a 2014 European Court of Human Rights (ECHR) judgment following a complaint lodged against Russia by the former Yukos shareholders with regard to Yukos's liquidation. The ECHR had ruled that Article 6 of the European Convention for the Protection of Human Rights and Fundamental Freedoms was breached and awarded compensation to the former shareholders in the amount of €1.8 billion. This ruling has since become irrevocable. Pursuant to Section 93 of the Dutch Constitutional Act, ECHR rulings give substance to Dutch public order. In this case, the Amsterdam Court of Appeals considered that:"great weight is attached to decisions from the ECHR with regard to the fiscal proceedings and collection measures in the context of the public order test to be carried out in these proceedings if and to the extent such decisions are based on the same material facts as in this case."In addition, the court considered that, further to the breaches established by the ECHR, additional breaches of tax proceedings with a larger impact than that assumed by the ECHR in its ruling had occurred.According to the Amsterdam Court of Appeals, the Russian authorities' breach of Russian tax rules should effect the annulment proceedings only if the breach occurred in order to bring about Yukos's inability to pay and ultimately its bankruptcy. The court held that this was the case for numerous reasons, the most important being as follows:The Russian authorities treated Yukos in its attempts to remedy its earlier fraudulent value added tax constructions differently to other Russian companies in similar cases.The Russian tax authorities, in their auction of Yukos's production facility (its main source of income), did not, in good faith, strive for the highest possible proceeds to pay off Yukos's outstanding tax debt. The main reasons for this conclusion were:the Russian tax authorities' refusal to consider Yukos Oil's proposal to repay part of the tax debt in order to prevent an auction;the unusually high speed in which the auction was completed;the small number of bidders; andthe initial bid price, which was set at a lower price than the market price, which was contrary to the standard bidding rules.Facts and circumstances that took place after Yukos's bankruptcy also indicate that the tax authorities' breaches were aimed at bringing about Yukos's insolvency. Almost all important assets ended up with Russian state-owned companies, which were given the opportunity to pay Yukos's tax debt in arrears.The court concluded that the breaches of the Russian tax proceedings had resulted in Yukos's bankruptcy and that:"the approach chosen by the authorities leaves no room for another conclusion than that they chose not to come to an orderly and legitimate levy and collection of the taxes that were due and payable, but instead chose to put Yukos in a situation where it could no longer pay its debt and would ultimately end up bankrupt… As result, given the way the bankruptcy order has come into existence, recognition of such order whereby legal effects would be attributed to it in The Netherlands, is contrary to Dutch public order."Consequently and necessarily, Rebgun was not entitled to represent Yukos Finance in the Netherlands. Such power is derived from the recognition of the legal effects of Yukos's bankruptcy in the Netherlands. As a result, the shareholders' resolutions adopted by Rebgun on behalf of Yukos to sell the shares in Yukos Finance and dismiss Godfrey and Misamore were null and void.UNCITRAL arbitration proceedings and setting aside proceedingsOn July 18 2014 the arbitrators in the United Nations Commission on International Trade Law (UNCITRAL) arbitration proceedings administered by the Permanent Court of Arbitration between Russia and the former Yukos shareholders on the basis of the ECT ruled that Russia must pay a record-breaking $50 billion in damages to the shareholders.(4) The tribunal held that Russia had breached Articles 10 (fair and equitable treatment of investors) and 13 (wrongful expropriation) of the ECT. Subsequently, Russian assets were seized in various countries, including the United Kingdom, France, Belgium, Germany, the United States and India.Russia initiated annulment proceedings before The Hague District Court and succeeded in setting the awards aside. The district court agreed with Russia that the tribunal was incompetent because Russia was not bound by the ECT. Russia had signed the ECT, but never ratified it. In such case, Article 45 of the ECT provides that the treaty will apply provisionally, pending its entry into force, "to the extent that such provisional application is not inconsistent with its constitution, laws or regulations." The Hague District Court held that Article 45 required the tribunal to verify the consistency with each and every section of the treaty (the so-called 'piecemeal' approach), dismissing the so-called 'all or nothing' approach defended by the former Yukos shareholders which has been applied by various tribunals in investment treaty cases, whereby the provisional application of the treaty as a whole is tested against Russia's constitution, laws or regulations. On the basis of the piecemeal approach, The Hague District Court held that Article 26 of the ECT – the arbitration clause – was incompatible with Russian law, leaving the tribunal incompetent to rule on the matter.Possible impact of decision on setting-aside proceedings in appealThe Amsterdam Court of Appeals recently denied recognition of the Russian bankruptcy proceedings because the Russian liquidation order is contrary to Dutch public order. This decision could affect the proceedings regarding the setting aside of the UNCITRAL arbitral award, which are currently in the appeal phase before The Hague Court of Appeal. The Amsterdam Court of Appeals' decision that the Russian bankruptcy trustee was not competent to sell the Dutch Yukos assets and replace the directors of the Dutch Yukos subsidiary could play a role in this regard.In setting aside the awards, The Hague District Court attached great importance to the fact that the disputes before the arbitral tribunal had dealt with reviewing government acts pertaining to public law. Russian law provides that such disputes can be brought only before a Russian court (and not before an arbitral tribunal), making part of the ECT incompatible with Russian law. As the Amsterdam Court of Appeals established that the acts of the Russian tax authorities had been performed in order to deliberately cause Yukos's insolvency, the limit of legitimately exercising Russia's authority under public law may have been exceeded. This raises the question of whether it can be maintained that the disputes before the arbitral tribunal had in fact dealt with acts of Russia pertaining to public law, which shall be dealt with exclusively in the Russian courts.If The Hague Court of Appeal disagrees with Russia and holds that the arbitral tribunal was competent to rule on the matter, the court will need to decide on the other grounds for overturning the arguments raised by Russia. In the first instance, these included that:the arbitral tribunal exceeded its assignment;the arbitral tribunal was composed irregularly because its secretary played too big a role;the arbitral awards were insufficiently reasoned; andthe arbitral awards are contrary to Dutch public order – in particular, Russia's fundamental right to a fair trial – because they show that the arbitral tribunal failed to act impartially and without prejudice.It remains to be seen whether the third and fourth grounds may be more difficult for Russia to prove after the Amsterdam Court of Appeals' ruling that the Russian bankruptcy proceedings were contrary to Dutch public order.Further, the former Yukos shareholders could, on the basis of the Amsterdam Court of Appeals decision, file claims against Rebgun and Russia to be compensated for any damages caused by Rebgun's annulled actions to sell the Dutch assets and replace the directors of the Dutch Yukos subsidiary, to the extent these were not compensated in the European Court of Human Rights case. The Dutch courts may assume competence now that the sale has taken place in the Netherlands before a Dutch notary and the directors were dismissed and replaced in the Netherlands.For further information on this topic please contact Michael Broeders or Ulrike Verboom at Freshfields Bruckhaus Deringer LLP by telephone (+31 20 485 7000) or email ([email protected] or [email protected]). The Freshfields Bruckhaus Deringer LLP website can be accessed at www.freshfields.com.Endnotes(1) Amsterdam Court of Appeals, May 9 2017, ECLI:NL:GHAMS:2017:1495.(2) See L Strikwerda, Inleiding tot het Nederlandse Internationaal Privaatrecht, 2015, p 293.(3) European Court of Justice, May 2 2006 (C—341/04). This ruling was based on the public order exception provided for by the EU Insolvency Regulation (1346/2000/EC), which seems to be similar to the Dutch public order exception.(4) Yukos Universal Limited (Isle of Man) v The Russian Federation, PCA Case AA 227, UNCITRAL; Hulley Enterprises Ltd v The Russian Federation, PCA Case AA 226, UNCITRAL; and Veteran Petroleum Ltd v The Russian Federation, PCA Case AA 228, UNCITRAL.