A BIT of bother for Cyprus

Russians with interests in Cyprus could launch legal claims over the country’s proposed bailout.

As the conditions of the eurozone’s Cyprus bailout emerged over last weekend, the news that bank depositors would face a “hair-cut” of between 6.5 per cent and 10 per cent was met by anger – not only on the streets of Nicosia, but also in the corridors of power in Moscow.

Speaking on behalf of the Russians who are estimated to account for around half of all deposits in Cypriot banks, Russian president Vladimir Putin wasted no time in branding the plan “unfair, unprofessional and dangerous”, while prime minister Dmitry Medvedev described it as “confiscation”. Kremlin sources have hinted that, if Russian depositors ultimately face such expropriation, the €2.5bn loans made by Russia to Cyprus in 2011 might be called in.

Such rhetoric, while not exactly gun boat diplomacy, is certainly redolent of a previous era of “diplomatic protection” by the home states of investors falling foul of unfair treatment abroad. However, with recent reports suggesting that, despite this intervention, the final bail-out package may impose an even greater levy on large (and disproportionately Russian) depositors to limit the sacrifices of local small account holders, injured Russian investors may need to consider alternative means of redress.

Although the double-tax treaty between Russia and Cyprus has probably been more influential in making the island home to so much Russian capital, the two states are also party to a bilateral investment treaty (BIT), entered into in 1997. This is one of approximately 3,000 BITs between states around the world, providing an increasingly popular basis for investment protection based on enforceable legal rights as an alternative to the hit and miss medium of state to state sparring.

Like many BITs, the Cyprus-Russia treaty provides for certain substantive rights of protection for investment and also constitutes a binding offer by each state to submit to arbitration with investors of the other state who claim those rights have been infringed. Under Article 1 of the BIT, “investment” includes “financial assets, as well as shares, deposits and other forms of participation”.

Among the protections afforded to such investments is the guarantee, under Article 4, that they will not be expropriated “or subjected to measures equal in terms of their consequences with expropriation” unless this is “in the public interest and in accordance with the procedure provided for in law, not discriminatory and accompanied by prompt, adequate and effective compensation”.

The treaty goes on to provide explicitly that compensation should be an amount equal to the value of the investment prior to the announcement of the expropriating measure. Therefore, while it is arguable that the proposed measures are indeed for a public purpose and may not be discriminatory, the right to compensation, even for such otherwise justified appropriation, could provide Russian investors with an effective means of undoing the loss of their deposits.

Russians are at an advantage here – while EU citizens with Cypriot bank accounts are unlikely to be able to claim even where their home nations also have BITs with Cyprus, as EU law would prevail over BITs between member states (at least this was the view expressed by the tribunal in the recent case Electrabel S.A. v the Republic of Hungary), Russians do not face the same barrier.

Given the centrality of Cyprus in many Russian corporate structures, potential claimants under the Cyprus-Russia BIT could extend far beyond individuals stashing away funds of possibly dubious origin, who may be assumed to be cautious about the expense and publicity of a legal claim. The many Russian corporate groups with treasury operations in Cyprus will also face a significant hit, and are likely to wish to pursue all available means of legal redress.

Under Article 1 of the BIT, its protections extend only to Russian citizens or Russian incorporated and domiciled entities, so Russian parties which have invested in Cyprus through a chain of companies incorporated in other jurisdictions will need to analyse their situation carefully to identify the appropriate basis for a claim.

However, numerous other successful investment claims by indirect investors suggest such circumstances need not be a barrier to recovery. In view of the choice of forum for claims contemplated by the BIT under Article 7 (Cypriot courts, Stockholm arbitration or ad hoc arbitration) potential claimants will also need to develop a clear strategy at the outset to avoid waiving their rights to a more appropriate forum by commencing litigation prematurely in the local courts.

At the time of writing it is still not clear when the Cyprus Parliament will vote on the bail-out package and full details of the implications – if it is approved at all – will not be known until then.

During the wrangling in the meantime, the position of Russian investors may be given less attention by Cypriot politicians than the outrage of their own compatriots and the pressure from Brussels. However, they would be well advised not to overlook them or they could face a long drawn out and messy legal conflict with the main foreign investor community on the island – the worst possible backdrop to any plan to get Cyprus back on its feet.

Uliana Cooke is a Russian legal consultant in London