Burlington v. Ecuador

Burlington Resources Inc. v. Republic of Ecuador, ICSID Case No. ARB/08/5

(Published in 2018 in International Investment Law and Sustainable Development: Key cases from the 2010s and on this website on October 18, 2018. Read more here.)

Decisions and Award are available at https://www.italaw.com/cases/181

Keywords

Taxation, investor obligations, environmental counterclaim

Key Dates

Request for Arbitration: April 21, 2008

Constitution of Tribunal: February 18, 2009

Decision on Jurisdiction: June 2, 2010

Decision on Liability: December 14, 2012

Decision on the Proposal for Disqualification of Francisco Orrego Vicuña: December 13, 2013

Decision on Ecuador’s Counterclaims: February 7, 2017

Decision on Reconsideration and Award: February 7, 2017

Decision on Stay of Enforcement of the Award: August 31, 2017

Decision on Annulment: pending

Arbitrators

Gabrielle Kaufmann-Kohler (president)

Brigitte Stern (respondent appointee)

Francisco Orrego Vicuña replaced by Stephen L. Drymer (claimant appointee)

Ad hoc Annulment Committee

Andrés Rigo Sureda (president)

Piero Bernardini

Vera van Houtte

Forum and Applicable Procedural Rules

International Centre for Settlement of Investment Disputes (ICSID)

ICSID Rules of Procedure for Arbitration Proceedings

Applicable Treaty

United States–Ecuador Bilateral Investment Treaty (BIT)

Alleged Treaty Violations

• Expropriation
• Umbrella clause

Other Legal Issues Raised

• Jurisdiction
• Jurisdiction/merits—environmental counterclaim

1.0 Importance for Sustainable Development

The Burlington v. Ecuador case is factually linked to the case of Perenco v. Ecuador,[1] as both companies were part of the same consortium. Also, with respect to their importance for sustainable development, the cases highlight two interesting aspects. Both relate to the same Ecuadorean taxation measure, i.e., the “windfall tax” that was imposed on excess profits resulting from oil exploitation. Moreover, in both cases Ecuador filed a counterclaim against the investor.

First, with respect to the Ecuadorian windfall tax (known as Law 42) the tribunals of Burlington and Perenco came to the same conclusion as to find that the disputed measure did not constitute an expropriation. A majority of the Burlington tribunal added an interesting statement according to which it would be unlikely that a windfall tax would qualify as an expropriation because by definition, such a tax would appear not to have an impact upon the investment as a whole, but only a portion of the profits (decision on liability, para. 404). However, in the case of Occidental v. Ecuador,[2] where the investor also challenged the same tax measure (Law 42), the tribunal inOccidental arrived at a different conclusion. In a 2012 award, the same measure was found to amount to an unlawful expropriation. These cases demonstrate that there are uncertainties around the manner in which tribunals will address taxation issues, making it difficult for governments to predict the legality of taxation reform under investment treaties, and possibly causing governments to back away from reform. This is especially significant today as discussions around tax justice are at their height, and governments and international institutions have committed to fight tax avoidance and tax evasion.[3]

Second, discussions on counterclaims against investors are a prominent feature in the current discussion on reform of international investment law. The reason is that counterclaims can mitigate to some extent the asymmetry in investment arbitration since a state can, in the same proceedings, enforce social and environmental obligations against an investor. In both Burlington and Perenco, Ecuador filed counterclaims alleging that the companies’ activities resulted in significant environmental harm. While the decision on the counterclaim in the Perenco case is still pending, the Burlington tribunal has rendered a decision holding the investor liable. The Burlington case is thus also important because the tribunal considered the investor’s behaviour through the respondent’s counterclaim. Even though the investor’s obligations were mainly found in domestic law, the Burlington case may be relevant in future for the enforcement of investor obligations through international proceedings. The case demonstrates tribunals’ willingness to engage in a substantive manner in national environmental law remediation obligations.

2.0 Case Summary

2.1 Factual Background

Burlington Resources Inc. (Burlington) is a U.S. investor investing in several oil production facilities in Ecuador together with its consortium partner Perenco Ecuador Ltd. (Perenco).[4] Burlington was assigned production-sharing contracts (PSCs) in 2001 for Blocks 7 and 21. The PSCs put the entire cost and operational risk on Burlington and Perenco. In return, they were to receive a share in the oil produced. The PSCs defined the tax regime applicable to Burlington. They also set out an obligation for the state-owned oil company PetroEcuador to absorb any future tax increases by including a correction factor in the production-sharing formula (para. 21, decision on liability).

After a substantial rise in oil prices, Ecuador adopted Law 42 in April 2006. According to the law, a 50 per cent tax was imposed on “extraordinary profits,” also called “windfall profits,” made by oil companies (para. 32, decision on liability). In October 2007 Ecuador raised the tax rate on windfall profits to 99 per cent (para. 35, decision on liability). Windfall profits were defined as the profits resulting from an “unforeseen” rise of oil prices in excess of the price level at the time of conclusion of the PSCs. Burlington paid the tax while at the same time making a request for “absorption” of the additional taxes. Ecuador and PetroEcuador ignored the request, and any attempt to renegotiate the PSCs failed. Burlington paid the tax imposed by Law 42 from 2006 to 2008, but decided to stop paying in 2009. In order to enforce its tax claims, Ecuador seized and auctioned off Burlington’s shares of the oil production. In addition, PetroEcuador acquired oil at below-market prices (paras. 56–62, decision on liability). After Burlington threatened to stop the production, Ecuador took possession of the production facilities in July 2009. Ecuador ultimately annulled the PSCs with Burlington by ministerial decree (paras. 63–66, decision on liability).

2.2 Summary of Legal Issues and Decisions

Burlington made a Request for ICSID Arbitration on April 21, 2008. In its principal claim, Burlington argued that four measures taken by Ecuador—Law 42, the seizure of shares, the physical takeover of the production facilities and the termination of the PSCs—constituted an expropriation. According to Ecuador, its measures were not expropriatory mainly because Burlington had no right to revenues stemming from oil prices in excess of the price assumption made by the parties. In addition, Ecuador filed counterclaims for violations of Ecuadorian environmental laws and breaches of contractual obligations by Burlington.

In its decision on liability, by analyzing each measure individually, the tribunal found that Law 42 was not expropriatory as such, because it did not substantially deprive Burlington of the investment as a whole. The seizure of certain fractions of the investment was also not tantamount to expropriation mainly because the investment remained profitable. However, the tribunal found that Ecuador expropriated Burlington’s investment when it took possession of the production facilities in 2009.

On February 7, 2017 the tribunal issued a decision on the counterclaims of Ecuador, ordering Burlington to pay USD 41.7 million to Ecuador for breach of Ecuadorian environmental law and contractual obligations.

Lastly, a decision on “Reconsideration and Award” was also released on February 7, 2017 in which the tribunal dismissed the request made by Ecuador to reconsider the question of liability. It also set the quantum of the award: the Tribunal awarded damages of USD 379.8 million to Burlington for the expropriation of its investment.

3.0 Select Legal Issues

3.1 The Issue of Taxation and Expropriation

The approach taken by the tribunal gives some insight into how issues of state liability for expropriation can or cannot arise from tax measures. The tribunal adopted an approach in which the effect of the expropriation is more relevant than the intent of the host state.

First, Burlington argued that Law 42 imposing a 50 per cent tax, which applied between April 2006 and October 2007, had a devastating impact on its investment (para. 420, decision on liability). In 2006, its profits diminished by 40 per cent and in 2007 by 62.9 per cent (para. 426, decision on liability). On these figures, the majority of the tribunal held that Burlington did not suffer a substantial deprivation of its investment. It found so based on three elements. First, the consortium submitted plans for further investments in Block 7, thereby implicitly conceding that Block 7 was economically viable with Law 42 at 50 per cent in force. Second, Burlington’s financial statement for Block 21 showed positive figures, not losses. Third, there were bidders willing to acquire Burlington’s interests in Blocks 7 and 21 despite Law 42 being in force. Furthermore, according to the tribunal, the intent of Ecuador in adopting Law 42 was not to force Burlington to abdicate its rights under the PSCs; rather, the intent was to share the windfall profits resulting from higher oil prices on a 50/50 basis between the state and the oil company (para. 432, decision on liability).

Second, Burlington argued that Law 42 imposing a 99 per cent tax destroyed the value of its investment (para. 434, decision on liability). Law 42 at 99 per cent applied from November 2007 to March 2009—thus, it applied throughout 2008. Burlington proved that it did not make profits in 2008. On a diminishment of revenue basis, the impact of Law 42 at 99 per cent meant that Burlington saw its share of oil revenues reduced, 58 per cent regarding Block 7 and 70.2 per cent regarding Block 21 (para. 450, decision on liability). With respect to Law 42 imposing a 99 per cent tax, the tribunal accepted Burlington’s argument that the law was intended to make Burlington abdicate its rights under the PSCs. However, the tribunal held that the intent was less important since “the State’s intent alone cannot make up for the lack of effects amounting to a substantial deprivation” (para. 455, decision on liability).

The dissenting arbitrator, Francisco Orrego Vicuña who was subsequently disqualified on December 13, 2013, did not agree with the majority of the tribunal on the analysis of Law 42. For him, Law 42—whether at 50 per cent or at 99 per cent—was expropriatory. He underlined that the tax prevented Burlington from recovering from past investments, forced it to scale back its development plans and diminished the value of its overall investment. In his opinion, the impact of Law 42 at 50 per cent was “very substantial” and the impact of Law 42 at 99 per cent was “confiscatory” (para. 27, dissent). He pleaded for the adoption of a more flexible approach based on reasonableness, where the reasonableness is measured by asking what a “reasonable businessman” would be likely to conclude after the imposition of Law 42 (paras. 25–26, dissent).

In sum, the majority of the tribunal set a high threshold with respect to expropriation claims based on tax measures, requiring substantial deprivation. However, the tribunal did find that the physical taking of the blocks constituted an unlawful expropriation of Burlington’s investment (para. 545, decision on liability).

It is interesting to note that the Perenco tribunal’s analysis was similar. It held that at 50 per cent, the disputed tax measure reduced the investor’s profitability but it did not deprive Perenco of its rights of management and control over the investment in Ecuador, nor did it reach the requisite level of a substantial diminution in the value of that investment. In addition, it found that although the tax at 99 per cent rendered the investment operation suboptimal, the tax did not amount to an expropriation because Perenco‘s business was not effectively taken away from it.[5]

3.2 Successful Counterclaims of Ecuador

In the past years, many counterclaims made by the host state have been rejected because tribunals did not accept having jurisdiction over them. In the case of Ecuador’s counterclaims, the tribunal’s jurisdiction was not disputed. In fact, Burlington and Ecuador entered into an agreement in May 2011 in which they explicitly stated their consent to jurisdiction over the counterclaims of Ecuador (paras. 60–62, decision on counterclaims). Thus, the Burlington case did not break new ground with respect to jurisdiction over counterclaims due to the very specific agreement in place. The approach taken by the Burlington tribunal, however, does break new ground, insofar as it included a detailed analysis of national environmental law as it related to the investment at issue.

Ecuador argued that Burlington’s activities had resulted in significant environmental damage (environmental counterclaim) and amounted to a failure to properly maintain the blocks’ infrastructure in good working condition (infrastructure counterclaim). The environmental counterclaim was divided into four factual settings: soil contamination, mud pits, groundwater and well site abandonment. The counterclaim on infrastructure was divided into five different aspects of the oil exploration and exploitation: tanks, fluid lines and pipelines, generator engines, crude-diesel fuel blend and finally, pumps, electrical system, IT and roads.

3.3 Applicable Law

The ICSID Convention, the ICSID Arbitral Rules and the tribunal’s procedural orders governed the procedure of the counterclaims. With respect to the substance of the counterclaims, a distinction needs to be made between the environmental and the infrastructure counterclaim (paras. 71–75, decision on counterclaims). First, according to Ecuador its environmental counterclaim was based solely on its national tort law and not contract law. Moreover, neither party argued that the choice of Ecuadorian law in the contract between them also encompasses Ecuadorian tort law. Therefore, the tribunal applied Ecuadorian tort law, not as the law chosen by the parties (Article 42(1) of the ICSID Convention) but as the law of the host state (Article 42(2) of the ICSID Convention). Applying the second leg of Article 42 is of relevance because, with respect to the environmental counterclaim, international law may also be applicable. More precisely, it is within the tribunal’s discretion to apply either domestic or international law depending on the type of issue to be resolved.Second, as far as the infrastructure counterclaim is concerned, the tribunal decided to apply Ecuadorian law as the law chosen by the parties (Article 42(1) of the ICSID Convention).

3.4 Strict Liability for Environmental Harm

The liability regime for hydrocarbons in Ecuador is enshrined in the 2008 Constitution of Ecuador. The Constitution provides for a strict liability for environmental harm (paras. 229–230, decision on counterclaims). However, the 2008 Constitution did not apply in the present case, according to the tribunal, since Burlington started its oil exploitations in Ecuador before 2008 and did not accept that the constitutional regime had retroactive effect (para. 102, decision on counterclaims).

The tribunal held that the regime prior to 2008 was in principle a fault-based liability, which means that operators can escape liability when proving that they acted with due diligence (para. 236, decision on counterclaims). However, as an exception to this general rule, Ecuadorian courts established a strict liability regime for certain activities including oilfield operations. Such a regime based on case law had applied to Burlington at least since 2002 (para. 236, decision on counterclaims). The former strict liability regime under Ecuadorian law foresaw that the plaintiff must prove harm connected to the defendant’s activities, the existence of fault is not required, and causation between the harm and the defendant’s activity is presumed (para. 238, decision on counterclaims). Consequently, once Ecuador proved environmental harm, Burlington could only escape liability by proving that the harm was caused by force majeure or by a third party.

3.5 Reviewing Evidence and the Principle of In Dubio Pro Natura

Reviewing the evidence on the existence of environmental harm was the most comprehensive part of the tribunal’s analysis. The tribunal did a site visit in March 2015 to gain an impression of the environmental degradation (para. 27, decision on counterclaims). The most complex issue was the assessment of the contamination of the oil sites. The tribunal reviewed each site of Burlington’s oil fields and classified them into “industrial,” “agricultural” or “sensitive ecosystem” since for each classification a different standard was applicable. This allowed the tribunal to determine the appropriate remediation costs and consequently the compensation due from Burlington. It is noteworthy that whenever there was doubt on the classification of the sites, the tribunal “adopted the most protective standard in conformity with the principles of precaution and in dubio pro natura” (para. 343, decision on counterclaims).

3.6 Compensation Was Only a Fraction of the Sum Claimed by Ecuador

The damages that the tribunal awarded pursuant to the counterclaims were only a fraction of the USD 2.8 billion initially claimed by Ecuador. In particular, Ecuador sought compensation of USD 2.5 billion for the remediation costs to restore the oilfields to their original condition and USD 300 million for breaches of Burlington’s obligations to maintain the infrastructure of the oilfields. The tribunal ordered Burlington to pay USD 39.2 million for environmental remediation and a further USD 2.5 million for Burlington’s breaches with respect to the maintenance of the infrastructure. Thus, the final compensation was USD 41.7 million, with post-award interest at the LIBOR[6]three-month rate plus 2 per cent (para. 1099, decision on counterclaims). The important difference between the amount claimed and the final compensation lies within the diverging assessments of the remediation costs provided by the disputing parties. For most of the contaminated oil fields, the tribunal was more convinced by the cost assessment made by Burlington.

Notes

[1] Perenco Ecuador Ltd. v. The Republic of Ecuador and Empresa Estatal Petróleos del Ecuador (Petroecuador),ICSID Case No. ARB/08/6, pending.

[2] Occidental Petroleum Corp. v. Ecuador, ICSID No. ARB/06/11, Award, 2012.

[3] See OECD/G20, Inclusive Framework on BEPS: Progress Report July 2017–June 2018, 22 July 2018.

[4] Perenco also filed a claim against Ecuador, see Perenco Ecuador Ltd. v. The Republic of Ecuador and Empresa Estatal Petróleos del Ecuador (Petroecuador),ICSID Case No. ARB/08/6, pending.

[5] Perenco Ecuador Ltd. v. Ecuador, No. ARB/08/6, Decision on Liability (ICSID 2014) (Perenco(Liability)), paras. 672 and 687.

[6] London Interbank Offered Rate.