Deutsche Bank ("DB"), a global financial institution with a prominent energy trading arm, created a specific derivative instrument allowing Sri Lanka's state-owned Ceylon Petroleum Company ("CPC") to limit (or "hedge") its exposure to oil price increases and variations over one year. In late 2008, a few months after the hedging agreement's entry into force, worldwide oil prices marked a considerable drop. Under the hedging agreement, CPC had to make significant monthly payments to DB in order to cover these price variations. CPC subsequently defaulted, prompting DB to terminate the agreement and initiate ICSID arbitration proceedings, claiming that Sri Lanka breached the Germany-Sri Lanka BIT. Sri Lanka objected to the tribunal's jurisdiction, arguing that the hedging agreement did not constitute a protected investment under the applicable BIT. Amongst other arguments, Sri Lanka claimed (i) that DB had not made any contribution to the hedging agreement, (ii) that the agreement only constituted an ordinary commercial transaction, and (iii) that the agreement presented no territorial nexus with Sri Lanka. The arbitral tribunal rejected Sri Lanka's arguments, concluding instead that it had jurisdiction over the dispute and that Sri Lanka had violated its obligations under the applicable BIT. It subsequently awarded DB its entire US $60 million damages claim.
In pursuing its claim, Sri Lanka argued that DB had no protected investment because it did not contribute any amount when entering into the hedging agreement, and because its subsequent payments were nominal (approximately US$50,000) when compared to its damages claim. After noting that a contribution can take any form and is not limited to financial terms, the tribunal concluded that initial contribution took the form of DB's irrevocable obligation to pay up to US $2.5 million if CPC's costs of importing oil remained above US$112.50 per barrel. That the actual performance of this obligation would require a pre-determined condition to occur (the price of oil exceeding a certain level) did not change the contributory nature of DB's obligation. Sri Lanka also argued that the hedging agreement was a commercial transaction and could therefore not constitute a protected investment for the purpose of Article 25(1) of the ICSID Convention. Relying on the Pantechniki v. Albania award, the tribunal found that where a sales agreement includes special features such as a bespoke product, it will usually be considered an investment. The tribunal concluded that the hedging agreement was in no sense an ordinary commercial transaction because it had been negotiated over a period of two years and was instigated and approved by the highest authorities in Sri Lanka to further the national interest.
The tribunal relied on the test identified by the Abaclat v. Argentina tribunal in order to determine whether a territorial nexus exists in case of a financial investment. Under the Abaclat test, the relevant criteria for financial investments are necessarily different from those applying to business operations. The issue becomes where and/or for the benefit of whom the funds are ultimately used, and not the place where the funds are paid out or transferred. Applying these criteria, the Deutsche Bank tribunal concluded that the hedging agreement presented a territorial nexus with Sri Lanka because the funds to be paid by DB in execution of the hedging agreement were made available to Sri Lanka, were linked to an activity taking place in Sri Lanka, and served to finance its economy, which is oil dependent. The Deutsche Bank award consecrates the idea that assets and rights do not have to be connected to a physical business operation in order to be considered a protected investment. This allows financial energy trading operations to be afforded the same guarantees as if they were directly connected to the ownership or use of energy assets, reflecting the changing nature of energy trading worldwide.
Source:
Energy Trading Disputes: Investment Treaty Protection for Hedging Agreements and Charter-party Operations,
Louis-Alexis Bret
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