Yukos v Russia: Be careful with the big stick

On 20th September the European Court of Human Rights handed down its judgment in OAO Neftyanaya Kompaniya Yukos v Russia, holding Russia guilty of three violations of the Convention in the conduct of part of its highly publicised battle with the former oil giant Yukos and its former owner, Mikhail Khodorkovsky.

The judgment contains a salutary warning to those charged with recovering assets and enforcing debts.

The application by Yukos made wide-ranging allegations that the tax case brought against the company had been a manufactured attack by the Russian authorities motivated by a desire to destroy the company, seize its assets and put an end to the political activity of Mr. Khodorkovsky. The Court rejected that claim, saying that the assessments of tax, interest and penalties were in accordance with the laws of Russia, reasonably foreseeable, and that Yukos had failed to prove that the application of those laws to Yukos was either discriminatory or motivated by a collateral political purpose. In essence, what was alleged against Yukos was that it created a network of sham companies domiciled in internal tax havens in the Russian Federation, nominally owned by third parties but in reality controlled by Yukos, to which Yukos sold oil at reduced prices. It was said that those companies then sold the oil on, either directly or indirectly, at market rate, and took fraudulent advantage of benevolent tax arrangements in their domestic jurisdictions to avoid substantial taxes on the profits. Those profits were then said to have been “gifted” by those companies back to a fund controlled by Yukos. In this way it was alleged that taxes equivalent to billions of Euros had been evaded, even before interest and penalties were added. The Court held unanimously that the Russian courts had been entitled to find that the arrangements amounted to a fraudulent tax evasion scheme. It further held that Yukos had failed to establish either that the Russian tax authorities had been well aware of the scheme long before they chose to take action, or that other companies had been involved in identical sham arrangements but had not been proceeded against. A claim for a violation of Article 1 of the First Protocol to the Convention, and for violations of Articles 14 and 18, taken together with Article 1 of the First Protocol, therefore failed.

The Court did however find three violations of the Convention in the course of the proceedings against Yukos. First, the Court held that there had been a violation of the right of Yukos to adequate time to prepare its defence guaranteed by Article 6.3(d) of the Convention. The Court approached the case on the basis that the allegations of tax cheat were in effect criminal, and therefore applied the requirements of Article 6.3 – of course even if they had not done so, the Court has repeatedly stated that the requirements of Article 6.3 are exemplars of the minimum requirements of a fair trial guaranteed by Article 6.1. The issue was joined in relation to proceedings concerning Yukos’ tax liability for 2000. A final decision by the Russian tax authorities was delivered on 14th April 2004, and proceedings challenging its legitimacy and deciding on the appropriate penalty began on 21st May 2004. About four days before the hearing began, Yukos’ legal team were given access to some 43,000 pages of documents, and their application for an adjournment to marshal that material was refused. The defence of the Russian government (that Yukos had been aware of the nature of the case it faced in December 2003, when an initial determination was made (and responded to by Yukos), and that the documents concerned almost exclusively emanated from Yukos itself) was rejected by the Court, which held by a majority that the very short time scale allowed to Yukos to prepare its case, notwithstanding that it accepted many of the underlying facts, was so short as to amount to a denial of the opportunity of properly preparing its defence. Accordingly, there was a violation of Article 6.3(d) of the Convention.

The second violation related to the disapplication of a rule which would have rendered the claim of the Russian authorities in relation to the 2000 tax year time-barred. Under Russian law proceedings for a tax violation had to be brought within three years, and the decision of April 2004 appeared to be out of time. Before this case the Russian courts had recognised no exception to this rule, but when faced with the Yukos case the Constitutional Court recognised an exception where the tax payer had acted in bad faith, and had therefore prevented discovery of the tax evasion. The Strasbourg Court held that this change went beyond the margin of appreciation permitted to member states to develop their laws to meet changing circumstances and address ambiguities in their legislation. The Court applied the case law and principles which prohibited a retrospective change in criminal liability set out in Article 7 of the Convention to hold, by a majority that there had been a violation of Article 1 of the First Protocol, guaranteeing the right to the peaceful enjoyment of possessions.

The third violation identified by the Court related to the enforcement of the tax debt. Bailiffs were appointed to get in Yukos’ assets and settle the total liability (which, by the time all of the various claims were aggregated, amounted to an eleven figure sum when calculated in Euros). Almost immediately an “administration charge” or default penalty of 7% was added to the bill. The most valuable and readily realisable asset of Yukos was a subsidiary company, but the sale of that company rendered the rest of the business non-viable. As well as imposing the maximum default penalty, the bailiffs, and indeed the Russian tax authorities, refused to consider alternative proposals by Yukos for the payment of the debt, and pressed ahead with the sale of the subsidiary by auction. The Court held, again by a majority, that the “administration charge” (which itself amounted to a nine figure sum when calculated in Euros) bore no relationship to the actual costs of enforcement, and that the rush to realise the most readily saleable asset of Yukos without consideration of the effect which that sale would have on the ability of the company to survive rendered the enforcement process disproportionate to the legitimate aim of securing the payment by Yukos of its liability. Accordingly, the Court found a further breach of Article 1 of the First Protocol.

No doubt the judgment of the Court will give rise to fierce debate on both sides of the long-running battle between the Russian authorities on the one side and Mr. Khodorkovsky and those who lost money in the collapse of Yukos on the other. However, for anyone engaged in asset recovery and debt enforcement the judgment gives a timely warning; although it is a legitimate aim within the Convention to ensure that those engaged in fraudulent schemes are forced to make good the losses caused by their actions and pay their debts, such individuals and businesses retain the right to due process, and to continue with their financial existence once the debts have been paid, if possible. While the facts of this case may be extreme, the decision shows that a rush to judgment, an over-imaginative approach to legal obstacles along the way, and aggressive enforcement against the most obvious and easily realisable asset of the debtor without thought of the wider consequences for that debtor may well violate the requirements of the Convention – over-enthusiastic use of the “big stick” runs the risk of turning a defendant into a victim.

Andrew Bodnar is a barrister at Matrix