Table of Contents
“Occidental Exploration and Production Company v. The Republic of Ecuador” is a 2002 Investor-State case decided by the “London Court of International Arbitration” (LCIA) in 2004. It is based on International Treaty Law under Public International Law concerning the application of Bilateral Investment Treaty signed between the two parties as well as tax policies regarding exports. Treaties are agreements between sovereign nations. Article 2 of the “Vienna Convention on the Law of Treaties” (VCLT) states that: “a treaty is an international agreement (in one or more instruments, whatever called) concluded between States and governed by international law” and it applies to all treaties. The case forays into aspects of breach of contract between parties belonging to different states, international arbitration proceedings, issuance of arbitral awards and application of municipal tax laws in inter-state disputes.
The case specifically deals with the issue of “Value Added Tax” (VAT) reimbursement by countries to exporters. VAT is an indirect tax that is imposed on products and services for value added at each stage of the production or supply chain, from the procurement of raw materials through the final retail sale. It is evaluated at every step of the supply chain. From the point of production to the point of sale, a certain value (a small portion of the overall tax) is added at each step. Likewise, VAT is imposed by several countries when goods and services are exported from one country to another. This is relevant in light of this case analysis as there is a dispute regarding the reimbursement of VAT amounts paid by the exporter, by the country that requires the exported goods and services. The exporter here is the “Occidental Exploration and Production Company” and the concerned country is The Republic of Ecuador.
In this paper, I will first present a briefly summarise the case and the ratio of the judgement given by LCIA. Based on my understanding of the same, I then proceed to critically analyse the relevance of the laws relied upon in the case while arriving at the decision. This includes treaties signed between the particles, rules of arbitration institutions being subject to consensually, municipal tax legislations and Andean community laws. Before concluding the paper, I also briefly examine some existing and emerging jurisprudence on the issue of bilateral investment treaties and international tax law that have been dealt with in the case at hand.
Brief Summary of the Case
The “Occidental Exploration and Production Company” (OEPC), a company based in US and registered under Californian laws, entered into a participation contract with State-owned corporation of Ecuador, called Petroecuador in 1999. The contract required the inspection and production of oil by OEPC for Ecuador. OEPC applied regularly to an Ecuadorian tax authority called “Servicio de Rentas Internas” (SRI) for reimbursement of the amounts of VAT incurred in the process of production, exploration and exploitation of the oil by OEPC, as a part of the contract. This reimbursement policy was consistently adhered to until mid-2001 when SRI adopted resolutions to deny all future applications for VAT refunds by OEPC. Moreover, it also demanded back the amounts reimbursed earlier on the grounds that VAT reimbursement was already accounted for in the ‘participation’ nature of the Contract.
Aggrieved by this, OEPC filed four lawsuits in Ecuador’s tax courts claiming incompatibility of SRI’s resolutions with the laws of the country. Additionally, it also initiated arbitration proceedings against Ecuador for contravention of the obligations under Bilateral Investment Treaty (BIT) between Ecuador and US, in force since 1997. OEPC claimed refunds for all the VAT amounts already paid by it in addition to future VAT refunds by SRI.
Issues of the Case
The issues that can be identified from the facts include:
- Whether VAT refunds was a part of the contract for production and exploration of oil, between OEPC and Ecuador?
- Whether there has been violation of obligations by SRI under the US-Ecuador BIT?
The two issues were indisputably interconnected.
Applicability of Laws
According to “Article VI (4)” of the BIT, Ecuador gave its consent to the application of the “Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL Arbitration Rules)”, in case any investment dispute arose. Article VI (3)(a)(iii) of the same mentions OEPC’s consent to the “UNCITRAL Arbitration Rules” as well.
The LCIA concluded that the laws applicable to the dispute should include the Contract between OEPC and Petroecuador, Ecuadorian tax legislations as well as decisions adopted by Andean Community in addition to the laws of the “World Trade Organisation” (WTO).
With regard to the first issue, the Tribunal decided that VAT refunds were not a part of the participation formula of the Contract as contended by the SRI. Additionally, it was found that the Participation contract qualified as an “investment agreement” under Article VI(I)(a) of the 1993 BIT. The case of the OEPC was strengthened by the tax laws of Ecuador as well as the laws of the Andean Community, that were relied upon by the Tribunal. Tax legislations in Ecuador accorded the right to reimbursement of VAT to all exporters, including those involved in the oil sector. The Tribunal thus came to the conclusion that OEPC was in fact entitled to the VAT refunds that had been incurred by it as well as those in the future, as long as the contract between OEPC and Ecuador holds validity.
The second issue regarding the violation of national treatment of obligations was also decided in favour of the OEPC. The claims of the OEPC that the obligations under the BIT had been breached by the SRI was accepted by the Tribunal. This was more so because companies engaged in export of goods other than oil were still receiving their VAT refunds. The Tribunal found that “the result of the policy enacted and the interpretation followed by the SRI in fact has been less favourable treatment” of OEPC.
Additionally, the Tribunal examined the “Fair and Equitable Treatment” (FET) standard with regard to the second issue. The Tribunal’s interpretation of the FET underscored that the test for whether a legal or commercial framework satisfies the prerequisites of predictability and stability was more important than whether a VAT refund obligation existed under international law. The Tribunal further emphasised that the standard was objective and independent of whether or not the respondents operated in good faith. There are a lot of tribunals, that have, in their interpretation of FET as an autonomous standard, opined that it should be considered as a part of customary international law.
Further, the aspect of the relevance of WTO law in the light of this case was undermined as the mere existence of an international practice accepted by both parties does not make it binding on the parties as no such things is followed in accordance to any customary or treaty international law obligation.
The Tribunal concluded after considering the facts and circumstances of the case that the parties have both won and lost vis-à-vis pertinent issues of the dispute. It accorded 55 percent of the costs of the arbitration to the Respondent and 45 percent to the claimant. It also said that each party was to fend for its own legal expenses. The claimant, OEPC was held entitled to the refund of all the VAT paid as a result of the local procurement of goods and services for the production of oil for export and de minimis expenses linked with production activities, specifically related to native communities. All requests for refunds to SRI would follow the general administrative procedures of Ecuador’s tax laws apart from the amount of compensation and interest estimated in the Award. The Resolutions of the SRI were invalidated. Additionally, in order to prevent double recovery by OEPC, the Tribunal directed against institution of any civil or administrative suits against Ecuador seeking refund for any payment of VAT and that “any and all such actions and proceedings shall have no legal effect.” SRI was held liable to pay compensation amounting to a total of about 75 million USD, (inclusive of interest for delay in payment of tax obligations) for breaching obligations of FET and standard of national treatment, guaranteed to the claimant under the BIT.
The Tribunal also offered rebalancing of the contract to reach a mutually satisfactory solution. In addition to refund, they could also explore other methods of compensation like payment in kind or any other mutually agreeable form of compensation, as deemed appropriate by the parties.
Sources of Laws relied upon
Apart from the contract entered into by the OEPC and the Republic of Ecuador, there are mainly four sources of law that the LCIA relied upon before coming to a decision:
- The US-Ecuador BIT
- “The UNCITRAL Arbitration Rules”
- Decisions of the Andean Community
- Ecuador Tax legislations
The US-Ecuador BIT
Article 38 (1) of “the International Court of Justice” (ICJ) statute makes treaties a source of international law. Bilateral investment treaties are those in which parties agree to certain terms and conditions for private investments by nationals and companies in each other’s states respectively. These private investments are formally known as foreign direct investment (FDI). A similar treaty was signed between US and Ecuador in 1993, called as the “Treaty between the United States of America and the Republic of Ecuador Concerning the Encouragement and Reciprocal Protection of Investment” for bilateral flow of capital from private investors of both the countries and to promote economic cooperation among them. The dispute in the case concerns Article VI (4) of the treaty in which the parties have assented to submit to binding arbitration if any settlement dispute arose. Such submission to binding arbitration, as per Article VI (3) of the same treaty could be to “International Centre for the Settlement of Investment Disputes” (ICSID), provided both countries are party to the Convention, or “UNCITRAL Arbitration Rules” or any other arbitration institution. The “UNCITRAL Arbitration Rules” have been applied by virtue of Article VI (3)(a)(iii).
The UNCITRAL Arbitration Rules
“The UNCITRAL Arbitration Rules”, which are frequently used in both administered arbitrations and ad hoc arbitrations, provide a thorough set of policy guidelines upon which parties may agree for managing the arbitral proceedings emanating from their business relationship. The Rules set forth procedures for the appointment of arbitrators, the conduct of arbitration proceedings, and the form, effect, and interpretation of the award, and they encompass all areas of the arbitral process. They also provide a prototype arbitration clause. The rules were initially ratified in 1976 and have aided in resolving a wide array of issues relating to arbitral awards, investor-State disputes, commercial conflicts involving private parties etc.
Decisions of Andean Community
The Andean Community is a customs union comprising of 4 South American nations, namely, Bolivia, Colombia, Ecuador and Peru and headquartered at Lima, Peru. It came into existence in 1969 by the signing of the Cartagena Protocol. It is a trading bloc that promotes Free Trade Agreements among its members as well as members and other states and members and organisations. Within the Cartagena Protocol, two key decisions with respect to VAT policies were adopted- Commission Decision 388 of 1996 provided that the indirect taxes paid by the countries in the process of procurement and export of goods are to be reimbursed to the exporters. The Tribunal found that the rules governing the Andean Community are binding on the parties and they are obligated to follow them. The Decision 388 was based on the “Report of the Andean Council on Harmonization” that explained that the harmonization concerned indirect taxes both “internally and with respect to third parties”.
Ecuadorian Tax Legislations
Even though tax laws of Ecuador would essentially be considered as municipal law, they become relevant here as Petroecuador is a completely State-owned entity and in case of any dispute with Petroecuador, the Republic of Ecuador is sued, as in this case besides the fact that the case involved the breach of an inter-State investment treaty. The ‘participatory contract’ between OEPC and Ecuador, as contended by Ecuador was drafted in a way that OEPC’s tax amounts are included in the participation percentage that is received by OEPC under the contract. On close examination of the contract, it was found. However, that VAT amounts were never exclusively included under OEPC’s participation percentage. Ecuador’s tax laws protect exporters from VAT liability and the same was applied here. The contract was governed by the “Internal Tax Regime Law of Ecuador” (ITRLA) and OEPC alleged the violation of Article 65 particularly, which grants “a right to a tax credit for all the VAT paid in local acquisitions or the importation of goods”. Article 69A, which was added to ITRLA on 30th April, 1999, was also induced as it provided for an entitlement to a “refund” of VAT paid “in local acquisitions or importation of goods employed in the manufacture of exported products”. According to the Ecuadorian law, therefore, all exporters must be reimbursed their VAT amounts and since the contract failed to mandate otherwise, OEPC was found to be entitled to VAT reimbursements by Ecuador.
After the verdict given by the LCIA, in 2006, the government of Ecuador terminated its Participation contract with OEPC with immediate effect by issuing a decree (the “Caducidad Decree”). This was due to a Farmout Agreement between OEPC and Alberta Energy Corporation Ltd. that contravened both the Participation contract as well as Ecuadorian law. Subsequently, Ecuadorian government officials confiscated all of OEPC’s property including offices and oil fields in Quito. OEPC filed a request for arbitration that was taken up by the ICSID. In a split verdict, ICSID went on to issue its largest award in history- damages worth USD 2.3 billion- to OEPC citing breach of the US-Ecuador BIT.
It is a well-known fact that international law seeks to provide maximum autonomy to States. BITs have gained widespread popularity over the past few years and simultaneously the arbitration proceedings under BITs have increased in number too. Arbitration tribunals across the world have decided numerous disputes in this field in recent times. This evolution, however, has come with costs. States with higher capital and economically benefitted private investors who dominate the markets, like the USA, for example, have higher chances of escaping the kind of verdict that was given in the above case, if sides are switched. This also poses a question to the states that attempt to alter their laws or enact a regulatory legislation with the motive of improving their framework. Consequently, states may have a financial incentive to forego enhancing their regulatory framework due to the possible risk and expense of defending allegations like those arising in the aforementioned case. Strangely, the states that are most in need of reform may be ones that are sensitive to these issues. This shows that requirements of foreign investors might be better met by letting go of economic incentives to perpetuate a static regulatory regime.
The verdicts given by both LCIA and ICSID in the above cases have been criticised as far-reaching and over-analysing the scope of the issue. The volume of the damages awarded, led to Ecuador ending BITs with all countries in 2018, considering the amount representing 59 percent of the annual budget of the country in 2012. Instances like these have led to states been cautious about BITs in general. Nevertheless, arbitration as a part of BITs has continued to evolve. Measures have been taken to impose greater scrutiny on the transparency and legitimacy of the arbitral tribunals. Principles of treaty investment have also developed along with the remedies available in investment arbitration. While there is no breakthrough law that has come into being, the interpretations of countries with regard to arbitration proceedings in BITs is definitely transforming day by day. Simultaneously, the way in which tribunals are enforcing these treaty laws have also shown diverse trends. The jurisprudence in the field of arbitration and investment treaties is essentially shaped by the agreements enforced by countries and international tribunals interpreting the same along with accepted State practices in case of disputes.
In the course of the paper, I have looked at and attempted to analyse the various aspects of arbitration proceedings in the light of BITs as a part of the case of “Occidental Exploration and Production Company v. The Republic of Ecuador”. Issues like VAT refunds by states to exporters and principles essential to BITs have been discussed. The critical analysis of the facts, judgement and laws involved seek to provide a better understanding of the case and its impacts. Sources like journal articles, online blogs and case readings have been used to research and furnish information, which is mostly analytic. In conclusion, this paper examines a small portion of the wide-ranging world of international arbitration.
This article is authored by Anushka Guha, second year law student pursuing BA.LL.B (Hons.) from National Law university Odisha.
 (LCIA Case No. UN3467).
 Convention on the Law of Treaties, Vienna, 23 May 1969.
 Mrs. Knoll-Tudor loana, ‘Fair and Equitable Treatment’(JUS MUNDI, 7 November 2022) <https://jusmundi.com/en/document/publication/en-fair-and-equitable-treatment> accessed 15 March, 2023
 Bilateral Investment Treaty (United States of America-Republic of Ecuador) (Signed 27 August 1993, entered into force 11 May 1995, terminated 18 May 2018).
 UNCITRAL Arbitration Rules (United Nations Commission on International Trade Law) <https://uncitral.un.org/en/texts/arbitration/contractualtexts/arbitration> accessed 12 March 2023.
 Tai-Heng Cheng & Lucas Bento, ‘ICSID’s Largest Award in History: An Overview of Occidental Petroleum Corporation v the Republic of Ecuador’ (Kluwer Arbitration Blog, 19 December 2012) <https://arbitrationblog.kluwerarbitration.com/2012/12/19/icsids-largest-award-in-history-an-overview-of-occidental-petroleum-corporation-v-the-republic-of-ecuador/> accessed 15 March, 2023.
 Susan D. Franck, ‘Occidental Exploration & Production Co. v. Republic of Ecuador. Final Award. London Court of International Arbitration Administered Case No. UN 3467’ (2005) 99 (3) TAJIL <https://www.jstor.org/stable/1602299 >accessed 15 March, 2023.
 Cecelia Olivet, ‘Why did Ecuador terminate all its Bilateral Investment Treaties?’(tni, 25 May 2017) <https://www.tni.org/en/article/why-did-ecuador-terminate-all-its-bilateral-investment-treaties> accessed 15 March 2023.
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