Paris Court of Appeal, No. 16/24358

Paris Court of Appeal, Pole 1 - First Chamber, 2 April 2019, No. 16/24358

ATLANTIC INVESTMENT PARTNERS LLC , SCHOONER CAPITAL LLC
vs.
THE REPUBLIC OF POLAND

In the 1990’s, Mr. Y X, a U.S. citizen, and the companies Schooner Capital LLC and Atlantic Investment Partners LLC, registered in the State of Delaware (USA) (the “Investors”) have undertaken to invest in the former communist states of Central and Eastern Europe. Through a special purpose vehicle called White Eagle Industries (WEI), incorporated in the United States, at the end of 1994 they acquired stakes in three Polish companies: 55% of Nadodrzanskie Zaklady Przemyslu Thuszczowego w Brzegu S.A. (Kama), a state-owned company specialising in the production and processing of vegetable fat, 51% of Bolmar S.A., active in the same sector, and 49% of Wielkopolskie Fabrykii Mebli S.A. (WFM), which specialises in the production of furniture.

On 12 January 1995, the investors set up a Polish company called White Eagle Industries Poland (WEIP), which received on behalf of WEI the commissions paid by the three Polish companies for management services.

Kama, WFM and Bolmar declared these management fees as deductible expenses for corporate tax and value added tax purposes for the tax years 1994 to 1997.

From 1996 onwards, audits of management services were initiated in respect of Kama by the administration of the county of Opole where the company’s head office was located. As the administration considered that there was no evidence of the effectiveness of the services in question, it imposed an adjustment of PLN 55,371,330. On 16 December 2002 the Supreme Administrative Court in Wroclaw found that Kama withdrew its appeal. On 5 June 2003 the Warsaw Regional Court declared Kama bankrupt.

Audits and a tax adjustment procedure concerning the management fees paid to WEIP were also initiated in respect of WFM by the authorities of the county of Poznan in which the company was headquartered. In 1999, the Tax Chamber in Poznan reversed the conviction judgment issued at first instance, considering that the reality of the services had been sufficiently demonstrated.

On 31 March 2011, the investors filed a request for arbitration with the Secretariat of the International Centre for Settlement of Investment Disputes (ICSID) under the ICSID Rules (Additional Facility) on the basis of the Treaty on Trade and Economic Relations between the United States and Poland, signed on 21 March 1990 and entered into force on 6 August 1994 (the Bilateral Investment Treaty or BIT). They claimed that the Republic of Poland unlawfully expropriated their investment in Kama, violated its commitment to provide fair and equitable treatment and full security for their investment, subjected it to arbitrary and discriminatory measures, and restricted the investor’s freedom to dispose of its investment.

By an award issued in Paris on 17 November 2015, the arbitral tribunal composed of Messrs. Z A B and C W, arbitrators, as well as M. G H I, Chairman, decided by a majority that the dispute concerned tax issues within the meaning of Article VI (2) of the BIT and not an obligation relating to the respect and performance of an investment contract within the meaning of Article VI (2) c), that it had jurisdiction only over claims based on expropriation (Article VII) and transfer of funds (Article V) by virtue of the exceptions provided for in a) and b) of Article VI (2), and it unanimously decided that the claims made on these two grounds were not justified, so that the investors' claim for damages had to be dismissed.

On 2 December 2016, the investors filed an action for setting aside the award.

By submissions notified on 30 October 2018, they requested the court to dismiss the application of the Republic of Poland for a declaration of inadmissibility of two of their arguments, to set aside the disputed award and order Poland to pay them the sum of 50,000 euros pursuant to Article 700 of the Code of Civil Procedure.

They claim that the arbitral tribunal wrongly declared itself incompetent (Article 1520-1 of the Code of Civil Procedure), that it disregarded the scope of its mission (Article 1520-3), that it did neither respect the due process (in French: Principe de contradiction) nor the rights of the defence (Articles 1520-4 and Article 1520-5), and, finally, that the recognition or enforcement of the award would violate international public policy (Article 1520-5).

By submissions notified on 30 November 2018, the Republic of Poland requests the court to dismiss the claims of the opposing parties and order them to pay a civil fine of EUR 10,000, in addition to EUR 200,000 pursuant to Article 700 of the Code of Civil Procedure.

The Republic of Poland alleges that, failing to have presented these grounds to the arbitrators, the investors are not admissible to claim before this court, on the one hand, that the arbitral tribunal should have rejected the provision on exclusion of taxation in a case where the host State had, according to them, acted in bad faith, and, on the other hand, that the tribunal should have declared that it had jurisdiction on the basis of the most-favoured-nation clause. In addition, the defendant concludes that the opposing grounds are inadmissible.

UPON WHICH

On the first ground for annulment based on the fact that the arbitral tribunal wrongly declared that it had no jurisdiction (Article 1520-1 of the Code of Civil Procedure):

1. The claimants argue, principally, that the exclusion by Article VI (2) of the BIT of ‘matters of taxation’ refers only to substantive tax provisions and cannot have the effect of protecting a Contracting State when, in the course of tax proceedings, its representatives act in an arbitrary, unfair or discriminatory manner. They argue, in this respect, that the exclusion clause is intended to avoid conflicts with conventions dealing specifically with taxation, and that the existing tax treaty between the United States and Poland contains only substantive tax provisions, so that an extension of the BIT’s exclusion clause to tax proceedings, not covered by the tax treaty, would have the effect of depriving them of any remedy for breach of the standards protected by the treaty. Moreover, according to the claimants, similar clauses contained in other treaties, such as the Energy Charter Treaty, limit the scope of the exclusion to material tax provisions only. The investors add that the exclusion clause must be interpreted in the light of the right to fair and equitable treatment - which implies the principle of non-retroactivity of stricter criminal laws - which is major in the BIT,

2. In the alternative, the claimants argue that some of their claims related to issues of ‘tax policies’ within the meaning of Article VI (1) which provides that in such matters ‘each Party should strive to accord fairness and equity in the treatment of investment of, and commercial activity conducted by, nationals and companies of the other Party’.

3. In the further alternative, the claimants argue that the arbitral tribunal could not apply a tax exclusion clause in a case where the actions of the State were not carried out in good faith.

4. In the further alternative, they claim that the arbitrators should have declared that they had jurisdiction on the basis of the most-favoured-nation clause (Articles I and II of the BIT), which allows additional guarantees applicable in tax matters to be imported into the treaty and correspondingly extends the arbitrators’ jurisdiction under the right to fair and equitable treatment.

The annulment judge reviews the decision of the arbitral tribunal on its jurisdiction, whether it has jurisdiction or not, by examining all the legal and factual elements that determine the existence and scope of the arbitration agreement. This is no different when arbitrators are seized on the basis of a treaty.
In this case, the arbitration proceedings were initiated by the investors under the Treaty on Trade and Economic Relations between the United States and Poland, signed on 21 March 1990 and entered into force on 6 August 1994 (BIT), Articles IX and X of which provide for the settlement of investment disputes by arbitration.

On the first part of the ground:

Article VI of the BIT states:
‘1. With respect to its tax policies, each Party should strive to accord fairness and equity in the treatment of investment of, and commercial activity conducted by, nationals and companies of the other Party.
2. Nevertheless, the provisions of this Treaty, and in particular Articles IX and X, shall apply to matters of taxation only with respect to the following:
(a) expropriation, pursuant to Article VII;
(b) transfers, pursuant to Article V; or
(c) the observance and enforcement of terms of an investment agreement or authorisation as referred to in Article IX(l) (a) or (b), to the extent they are not subject to the dispute settlement provisions of a convention for the avoidance of double taxation between the two Parties, or have been raised under such settlement provisions and are not resolved within a reasonable period of time.’

The majority of the arbitral tribunal held that the dispute concerned ‘matters of taxation’ within the meaning of that text and that its jurisdiction was therefore limited to the exceptions listed in Article VI (2) (a), (b) and (c), which the claimants contested.

In accordance with international custom as expressed by the Vienna Convention on the Law of Treaties of 23 May 1969:
1.A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.
2.The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:
(a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;
(b) any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.
3.There shall be taken into account, together with the context:
(a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;
(b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;
(c) any relevant rules of international law applicable in the relations between the parties.
4.A special meaning shall be given to a term if it is established that the parties so intended.

First and foremost, it does not follow from this rule, nor from any principle of interpretation, that a distinction should be made where a text does not make a distinction.

In the present case, the BIT does not contain a definition of the concept of ‘matters of taxation’. The terms of Article VI (2) do not distinguish between substantive tax provisions and procedures in tax matters. It states that ‘matters of taxation’ of any kind are not covered by the Treaty except in three precisely circumscribed cases, namely where such matters relate either to an expropriation (a) or to the transfer of income from an investment governed by Article V (b), the observance and enforcement of terms of an investment agreement or authorisation as referred to in Article IX(l) (a) or (b) of the Treaty (c), to the extent they are not subject to the dispute settlement provisions of a convention for the avoidance of double taxation between the two Parties, or have been raised under such settlement provisions and are not resolved within a reasonable period of time.

Secondly, the interpretation that the Contracting Parties accept the use of arbitration in tax matters only in the cases provided for in (a), (b) and (c) of Article VI (2) is in line with the object and purpose of the treaty, which is to promote economic cooperation and to develop cross-investment by ensuring fair and equitable treatment of such investments while respecting the sovereignty of the Contracting States (preamble of the BIT). The “overriding” objective of fair and equitable treatment, according to the claimants, cannot have the effect of distorting the interpretation of the special provisions by which States, in the exercise of their sovereignty, have limited the scope of their consent to arbitration.

Thirdly, the Energy Charter Treaty, to which the United States is not a party, is entirely unrelated to the treaty at issue in the present case, so that, assuming that its provisions have the meaning attributed by the claimants, they are irrelevant to the interpretation of Article VI (2) of the BIT, which must be made in the light of the common intention of the contracting parties in concluding that treaty.

Fourthly, in accordance with the customary rules expressed in Article 32 of the Vienna Convention referred to above:

Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:

a) leaves the meaning ambiguous or obscure; or
b) leads to a result which is manifestly absurd or unreasonable.

In the present case, the interpretation of Article VI (2) according to the ordinary meaning of the terms leads to a perfectly clear and reasonable result. There is therefore no need to refer to the preparatory work.
Moreover, the claimants argue, against the letter of the text, that the intention of the Contracting States was to exclude only substantive tax law from the arbitration offer of the States, rely on arguments which are not relevant. Indeed, they rely on extracts from a report on the BIT sent by the U.S. State Department in the Senate which states:

In the course of negotiations, the United States pursued four main objectives:

Foreign investors are to be accorded treatment in accordance with international law and are to be treated no less favourably than investors of the host country or of third countries, whichever is the most favourable treatment (“national” or “most-favoured-nation” (MFN) treatment), subject to certain specified exceptions;
International law standards shall apply to the expropriation of investments and to the payment of compensation for expropriation;
Funds associated with an investment may be freely transferred into and out of the host country; and
An investor may take a dispute with a Party directly to binding third-party arbitration without first resorting to domestic courts.

The U.S.-Poland treaty urges Parties to apply their tax policies fairly and equitably. Because the United States specifically addresses tax matters in tax treaties, this treaty generally excludes such matters, addressing them only to the extent that they relate to expropriation, transfers, or investment authorisations, and are not covered by the bilateral tax treaty.

However, on the one hand, this document is internal to the American institutions, so that it cannot be presumed to reflect the common intention of the parties. On the other hand, contrary to what the claimants argue, this document expresses the intention to ‘generally’ exclude tax matters, with the exceptions set out in Article VI (2), and, not covered by a bilateral tax treaty. This means that the intention of the United States, when concluding the treaty, was indeed to give Article VI (2) the scope that can be deduced from a literal reading of this text.

Finally, on the possibility of a denial of justice that would result from the application of the exclusion clause of the BIT to tax proceedings, when these would not be covered by the bilateral tax treaty, it is necessary to remind that the offer of arbitration resulting from a BIT derives its effectiveness from the consent of the States, and that the conditions attached to it delimit the arbitrators' power to judge. The allegation of a denial of justice cannot allow these limits to be overstepped.

It follows from the foregoing that the ground, in its first limb, is unfounded.

On the second part of the ground:

Article VI (1) of the BIT states:

1. With respect to its tax policies, each Party should strive to accord fairness and equity in the treatment of investment of, and commercial activity conducted by, nationals and companies of the other Party.

It follows from these terms that, while Article VI (1) may have effect between Contracting States, it does not create a right for investors to bring an action before an arbitral tribunal.

This interpretation is confirmed by Article VI (2) which opposes (1) as follows: Nevertheless, the provisions of this Treaty, and in particular Articles IX and X, shall apply to matters of taxation only with respect to the following:

The second part of the ground is therefore unfounded.

On the third and fourth parts of the ground:

According to Article 1466 of the Code of Civil Procedure, applicable in international cases by reference to Article 1506 of the same Code: ‘A party which, knowingly and without a legitimate reason, fails to object to an irregularity before the arbitral tribunal in a timely manner shall be deemed to have waived its right to avail itself of such irregularity’.

Firstly, contrary to what the claimants argue, this provision does not refer only to procedural irregularities but to all the complaints which constitute grounds for setting aside the award, with the exception of grounds based on Article 1520-5 of the Code of Civil Procedure and alleging that the recognition or enforcement of the award manifestly, effectively and concretely violates international public policy on the merits, may be raised ex officio by the annulment judge and raised for the first time before it.

Secondly, the waiver presupposed by the aforementioned Article 1466 of the Code of Civil Procedure concerns specifically articulated complaints and not categories of grounds. Indeed, the aim pursued by this provision - which is to prevent a party from withholding arguments in case the award is unfavourable to it - would not be achieved if, under the guise of a single ground, the claimant were allowed to develop before the court arguments which differed in law and in fact from those which he had submitted to the arbitrators. This scope attributed to Article 1466 of the Code of Civil Procedure is not incompatible with the annulment judge’s full review of the grounds raised in an action for annulment. The annulment judge is not bound by the interpretation of arbitrators concerning the texts or by their assessment of the facts, even on grounds identical to those submitted to the arbitrators.

In the present case, it is common ground that in claiming that the arbitral tribunal had jurisdiction, notwithstanding the exclusion of tax issues from the scope of application of the BIT, the investors did not plead in the arbitration proceedings the improper use of this exclusion or the benefit of the most-favoured-nation clause.

The third and fourth parts of the ground is therefore inadmissible.
It follows from all the foregoing that the first ground must be dismissed.

On the second ground for annulment, alleging that the arbitrators failed to comply with their mission (Article 1520-3 of the Code of Civil Procedure):

The claimants argue that the arbitral tribunal limited itself to asserting that the procedure followed was lawful without responding to the claim that the retroactive application of tax law was contrary to the right to a fair trial and that it was likely to constitute indirect expropriation. Thus, the claimants argue that the arbitral tribunal failed to comply with the obligation to state reasons for its award imposed by the ICSID Rules (Additional Facility), and therefore failed to comply with its mission.

The requirement to give reasons for judicial decisions is an element of the right to a fair trial. Arbitrators who fail to give reasons for their decisions disregard the scope of their mission, and the recognition of an award without reasons is contrary to the French concept of international public policy.

However, the annulment judge’s review can only relate to the existence and not the relevance of the reasons, and it is of little importance in this respect that the obligation to give reasons for the award is included in the arbitration rules.

In the present case, the arbitral tribunal responded to paragraphs 478 and 479 of the award that, contrary to what the investors claimed, they lost their case not because of the conduct of the tax authorities, and in particular not because of an alleged application of non-mandatory guidelines before they were incorporated into law. The arbitrators mention that the investors lost the case because that, in accordance with a quite general principle, in tax proceedings the burden of proof of a fact lies on the person who derives legal effect from that fact, that it was therefore incumbent on the taxpayer to document the costs he claimed to have incurred and that in the present case Kama had not fulfilled that obligation.

It appears, therefore, that the award is reasoned on this point.

The second ground will be dismissed.

The third ground for annulment alleges a violation of due process (in French: Principe de contradiction), equality of arms and the right to a fair trial (Articles 1520-4 and 1520-5 of the Code of Civil Procedure):

The claimants state that they argued before the arbitral tribunal that Kama was discriminated against in relation to WFM, that they provided extensive evidence illustrating the identity of the facts and issues between the two tax proceedings, the identity of the applicable standards and the diametrically opposed results that these proceedings had produced. Moreover, the claimants state that no obligation to produce more evidence was mentioned. Nonetheless, the arbitral tribunal ‘unexpectedly’ decided, after the conclusion of the proceedings, that in the absence of the evidentiary file held by the Polish tax authorities, it did not intend to examine the evidence submitted by the claimants. Discrimination is composed of three elements: the similarity of the situations, the difference in treatment and the lack of justification, and that the proof of the first two lies with the claimant. The defendant shall establish that the difference is justified and that the arbitral tribunal could not impose on them the consequences of the fact that the Republic of Poland claimed that the records of the tax proceedings had been destroyed.

Due process (in French: Principe de contradiction) ensures fair proceedings and a fair trial. It prohibits a decision being issued if each party was not able to assert its claims in fact and in law, to gain knowledge of the claims of its opponent, and to discuss them. It also prohibits the disclosure of documents or written materials to the arbitral tribunal without such information also being communicated to the other party, and further prevents the arbitral tribunal from raising of grounds of fact or law ex officio if the parties were not given the opportunity to comment on them.

Equality of arms implies the obligation to give each party a reasonable opportunity to present its case - including the evidence - in conditions that do not place it at a substantial disadvantage vis-à-vis the other party.

In the present case, the arbitral tribunal found that it was not established by the investors that the evidence submitted to the Polish courts in the cases concerning Kama and WFM was similar and, therefore, that the two cases were comparable.

In the first place, contrary to what the claimants argue, the award does not indicate that the files held by the Polish authorities would have been the only ground for proving the similarity of the situations and that the content of the evidence submitted to the Polish courts could not have been established by documents which were available to the investors.

Secondly, the arbitrators neither obliged to submit their reasoning in advance to an adversarial discussion between the parties, nor required to warn a party preventively of the insufficiency of its factual file.

The ground, which, under the guise of violation of the due process (in French: Principe de contradiction) and the right to a fair trial, tends towards a review of the merits of the award, can only be dismissed.

On the fourth ground for annulment based on the violation of international public policy (Article 1520-5):

The claimants argue that the recognition or enforcement of an award which upholds an award rendered on the basis of a retroactive tax law in disregard of the principle of nullum crimen, nulla poena sine lege breaches international public policy. They explain that the adjustments which were imposed on Kama were not only aimed at the collection of the tax evaded and compensation for damage, but included a penalty designed to deter similar conduct, and were therefore punitive in nature. They allege that on 29 April 1996 the Minister of Finance enacted directives on the procedure for determining income through retroactive application estimates, which were not incorporated into the Act until 1 January 1997. However, those directives were applied to the audits relating to the financial years 1994 to 1997 and resulted in the challenged validity of the management service agreements and in the request for supporting documents, which were not required up to that point, could not be produced in full, which led to the recovery.

The non-retroactivity of the stricter criminal law, derived from the principle of legality of offences and penalties, is a principle of international public order.

It is a common ground that, under the legislation applicable to the financial years in question, an adjustment entailed the application of a penalty equal to three times the principal sum, in addition to the loss of the tax benefits granted to the investment.

It is not disputed that the amount of the penalty in relation to the principal excludes the classification of interest as late payment or pecuniary compensation and leads to the view that it is a measure intended to punish offences and deter similar conduct. Consequently, the rules modifying the definition or the elements of assessment of failures to fulfil obligations cannot have retroactive effect.

In the present case, the claimants invoke the retroactive application of Ministry of Finance guidelines of 29 April 1996 which provided tax authorities with rules for the estimation of income from transactions between related entities based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘1995 OECD Report’). They argue that these guidelines made compulsory evidence of the material reality of management services that was not previously required.

It follows from the submissions of the investors in the arbitration proceeding (Schooner Reply Brief, Exhibit Claimant 14) that the guidelines at issue provided for four methods of valuation of prices in related party transactions: ‘1) comparable unrelated price method, 2) resale price method, 3) cost plus method and 4) transactional profit method (as a method of last resort)’. (Exhibit No. 14, § 884).

However, the investors did not object to the application of any of these methods before the arbitral tribunal, but rather to the fact that the tax authorities had ‘requested Kama to provide material evidence to show that Management Services had been supplied, even though, as stated by Professor Gwiazdowski in his Opinion, ‘intangible services do not have to be associated with material evidence’. Therefore, Kama was not required by law to prepare and preserve such material evidence’. (Exhibit No 14, § 891) It was therefore the existence of the services themselves that was at issue, not their assessment, and the application of the general principle that the burden of proof is on the person claiming a fact, as stated above, to prove its existence, cannot be regarded as retroactive.

As the arbitral tribunal found, the adjustment was not the result of an improper application of tax law by the authorities but of the gaps in the Kama file, which were occasionally filled with documents forged after the event (award, § 480).

The recognition or enforcement of the award thus does not manifestly, effectively, and concretely breach any principle of international public policy. The ground is unfounded.

It follows from the foregoing that the claimant’s action for annulment must be dismissed.

On the civil fine:

There is no need for a civil fine.

On article 700 of the code of civil procedure:

Successful claimants cannot benefit from the provisions of Article 700 of the Code of Civil Procedure and on this basis will be ordered to pay to the Republic of Poland the sum of EUR 200,000.

FOR THE REASONS:

Dismisses the claimant’s application for annulment of the award issued between the parties on 17 November 2015.

Orders Schooner Capital LLC, E F Partners LLC and Mr. X to pay the costs and the sum of EUR 200,000 to the Republic of Poland pursuant to Article 700 of the Code of Civil Procedure.

Dismisses all other requests.