WNC v. Czechia: tribunal dismisses expropriation claim and determines that it has no jurisdiction over all other claims

WNC Factoring Limited v. The Czech Republic, PCA Case No. 2014-34

On February 22, 2017, a Permanent Court of Arbitration (PCA) tribunal dismissed all claims by WNC Factoring Ltd. (WNC) against the Czech Republic (Czechia). The tribunal decided that it lacked jurisdiction to hear claims regarding the fair and equitable treatment (FET) and most-favoured-nation (MFN) obligations of the United Kingdom–Czechia bilateral investment treaty (BIT). On the remaining expropriation claim, it declared that Czechia did not breach the relevant provisions. Consequently, it ordered the British company to pay Czechia’s legal costs (CZK35,940,599.34) and Czechia’s share of the arbitration costs (USD425,500).

Background

Between 2007 and 2008, WNC successfully partook in a public tender to acquire a Czech state-owned enterprise, Škoda Export, for approximately CZK210 million (about USD9.5 million). WNC participated in the tender through its subsidiary ČEX, a.s., later renamed FITE Export, a.s.

WNC claimed that, following the acquisition, it found Škoda Export to be in substantially worse shape than presented during the due diligence phase of the tender: its books were CZK860 million shorter vis-à-vis the data communicated by the former management (para. 3.44).

Škoda Export informed the then Czech finance minister Kalousek that there was a risk of serious economic difficulties. The company sought state guarantees as to the acquisition of operational financing from an export bank, but the minister refused. It also applied for credit between CZK1 and 1.3 billion with the bank, and filed a petition for the payment of more than CZK1 billion with the municipal court in Prague against the finance ministry a couple of weeks later.

In 2009 Škoda Export’s board of directors resigned en masse, and the Czech police’s money-laundering unit froze the company’s accounts. Although in summer 2009 they were unfrozen, in November 2009 Škoda Export was declared bankrupt. Two years later, the municipal court approved its sale to another company.

Two-prong objection to the tribunal’s jurisdiction to hear any of the investor’s claims.

Czechia argued that the tribunal did not have jurisdiction to hear the claims because the BIT’s arbitration clause had been superseded by European Union (EU) law; and alternatively, that it lacked jurisdiction with respect to all save one (expropriation) of the BIT claims (para. 5.64).

EU law vs. intra-EU BITs

The intra-EU jurisdictional objection itself comprised two limbs. One was that since the signing of the BIT, another treaty—the Treaty on the Functioning of the European Union (TFEU)—had been signed, “relating to the same subject-matter,” as per Art. 59(1) of the Vienna Convention on the Law of Treaties (VCLT). Czechia argued that because EU law provides for investor protections of the type embodied by the treaty, the TFEU superseded the BIT’s arbitration clause. Another limb stemmed from VCLT Arts 59(1)(b) and 30(3), stipulating that where this earlier treaty has not been terminated under Art. 59, it applies “only to the extent that its provisions are compatible with those of the later treaty.” According to Czechia, Art. 59 then nipped the BIT’s applicability in the bud: should the two treaties’ incompatibility be so great as to render them impossible to be simultaneously applied, the earlier treaty “shall be considered as terminated,” resulting in the sole application of the TFEU, to the exclusion of the BIT. Essentially, Czechia was trying to present the case that EU law and the BIT were incompatible, as opposed to “the same” as per the former limb. The tribunal rejected the objection regarding both limbs.

Although acknowledging that EU law was being developed, and that the European Court of Justice would “define its position more precisely in due course” with respect to intra-EU investment treaties and their compatibility with EU law (para. 6.311), the tribunal concluded that the substantive protections afforded to investors in investment treaties were not available under EU law. Specifically, it relied on the decision of the tribunal in Eastern Sugar B.V. v. Czechia, which had resolved that EU rights with respect to capital flows hardly “co-ordinate[d] with the right to FET and the prohibition on expropriation” (para. 6.301).

Likewise, the tribunal considered that while the freedom to move capital in and out of different EU jurisdictions is a TFEU prerogative, “treatment afforded to investments while operating in situ” (para 6.305) under BITs was another matter altogether. For the tribunal, while WNC was falling back on the FET standard both during Škoda Export’s acquisition and its subsequent treatment by the Czech Export Bank, a.s. (CEB), only the former was protected by EU law: “While free movement of capital might complement the FET standard in respect to the acquisition, it is difficult to see how it could be invoked with respect to the treatment of FITE or Škoda Export (as domestically incorporated companies) by a Czech bank” (para. 6.305).

The umbrella clause, MFN and FET

While Czechia’s EU-related jurisdictional objections failed, it fared better with its alternative argument that the tribunal had jurisdiction over claims pertaining to expropriation only.

The tribunal’s jurisdiction derived from BIT Art. 8 (dispute settlement), delimiting the precise contours of obligations susceptible to arbitration. In turn, these had to do with, broadly speaking, compensation, expropriation, repatriation, and—importantly—a clause concerning the promotion and protection of investment (BIT Art. 2(3)).

BIT Art. 2(3) contains an umbrella clause: “Each Contracting Party shall, with regard to investments of investors of the other Contracting Party, observe the provisions of these specific agreements, as well as the provisions of this Agreement.” WNC invoked this clause in an attempt to bring within the tribunal’s jurisdiction the FET claim regarding the purchase of Škoda Export by its subsidiary FITE. Alternatively, it sought to establish jurisdiction pursuant to BIT Art. 3(1) (MFN) by bringing its MFN claim under the umbrella clause. Absent a direct avenue for the tribunal to hear disputes arising under Art. 3, WNC argued that the umbrella clause is activated by the existence of the specific agreement. It further contended that the clause extended jurisdiction “to all substantive obligations in the BIT” (para 6.351).

The tribunal found that the umbrella clause depended on the existence of a “specific agreement” (here, FITE’s Škoda Export acquisition), and that the article did not serve to extend jurisdiction beyond the scope provided for in BIT Art. 8(1). Thus, seeing that FITE had been incorporated in Czechia and was therefore not a British investor, the tribunal determined that the acquisition was not, prima facie, a “specific agreement” within the meaning of the umbrella clause (para. 6.318). Neither was it moved by WNC’s argument that such “restrictive interpretation” could lead to manifestly absurd results should a state condition an acquisition by domestic incorporation, thus circumventing its BIT obligations (para. 6.340).

This determination had the domino effect of quashing both the investor’s FET and MFN claims in one logical succession. Considering that no article can operate to extend its jurisdiction under BIT Art. 8(1), the tribunal concluded that, in the absence of a “specific agreement,” no jurisdiction could arise from the umbrella clause to cover WNC’s FET claim (paras 6.362 and 6.365).

WNC also sought to use the MFN clause under BIT Art. 3(1) to rely on more favourable umbrella clauses contained in other BITs to which Czechia is a party. However, the tribunal considered that its jurisdiction stemmed from BIT Art. 8(1) and noted that Art. 3(1) is manifestly missing (paras 6.349 and 6.358).

Expropriation

WNC’s basic position was three-fold: (i) Czechia coordinated with financial institutions to deliberately offer export financing on conditions that it knew were impossible for Škoda Export to fulfil; (ii) these institutions tried diverting Škoda Export’s projects to another contractor; and (iii) CEB froze Škoda Export’s accounts on fabricated grounds, following which Czechia failed to see the freeze lifted in due course; and (not) doing so permitted its insolvency to eventuate. In other words, that Czechia was directly responsible for the venture’s failure. After inspecting the available evidence, the tribunal determined that there was no evidence of a conspiracy and that the freezes were legitimate. Importantly, the tribunal concluded that no behaviour on the part of Czechia amounted to expropriation under BIT Art. 5.

Notes: The PCA tribunal was composed of Gavan Griffith (presiding arbitrator appointed by the co-arbitrators, Australian national), Robert Volterra (claimant’s appointee, Canadian national) and James Crawford (respondent’s appointee, Australian national). (Crawford was later also elected to be a Judge of the International Court of Justice [ICJ], but continued to serve as arbitrator in the case.) The award is available in English at https://www.italaw.com/sites/default/files/case-documents/italaw8533.pdf.

Andrej Arpas is an analyst specializing in trade policy. A graduate of the University of Manchester’s law school, he joined a Washington-based think-tank after a short period at Slovakia’s labour ministry.