International arbitration

Quantum matters – Venezuela manufacturing expropriation

Sandy Cowan Sandy Cowan

On 30 December 2016, an ICSID Arbitral Tribunal found Venezuela liable to pay damages to Saint-Gobain for the expropriation of its investments in a ceramic proppants production plant. The Tribunal considered that the country risk premium must reflect all political risks associated with investing in Venezuela. This included the general risk of being expropriated without payment of sufficient compensation.

Background

The Tribunal laid out principles for calculating damages and would fix quantum at a later date. The Claimant alleged that the Respondent breached the Bilateral Investment Treaty between France and Venezuela (the Treaty) which entered into force on 15 April 2004. This was done so by refusing to offer compensation for the expropriation of Norpro’s proppants plant.

Position of the parties

The parties agreed on the use of the Discounted Cash Flow (DCF) method to value Norpro, and considered the fair market value of the plant as a going concern on the date of the expropriation (determined to be 15 May 2010). The Claimant’s expert calculated this value at USD115.1 million vs USD9.5 million as calculated by the Respondent's experts.

The main areas of disagreement between the experts related to the level of country risk premium (CRP) to be included in the discount rate. And, whether the CRP should incorporate an element of risk for expropriation without sufficient compensation (something for which the Treaty expressly provides).

Claimant’s approach

The Claimant calculated the fair market value of USD115.1 million on the date of expropriation using a weighted average cost of capital (WACC) of Norpro of 13.5%, which incorporated a CRP of 4.5%.

The Claimant claimed the fair market value of Norpro on the date of the expropriation, plus pre-award interest at a rate of 13.04% until the date of the Tribunal’s award (compounded annually). Post award, it was 9.08% per annum from the date of the Tribunal’s award (compounded annually).

Respondent’s approach

The Respondent’s experts calculated compensation due as the fair market value of the plant on 15 May 2010, amounting to USD9.5 million. Additionally there was a pre-award simple interest equal to a three-month US Treasury Bill plus 1.1 percentage points.

The Respondent’s experts used a discount rate of 26.4% which reflected a CRP of 14.3%.

Approach taken by the Tribunal

The Tribunal noted that there are several points of disagreement between the parties' experts in relation to the determination of an appropriate CRP.

After consideration, the Tribunal adopted a CRP of 10.26% proposed by the Respondent’s experts (excluding any further equity risk multiplier that the Respondent had incorporated).

As a result of all of the component calculations, the Tribunal applied a 21.86% cost of equity (i.e. 11.6% cost of equity for a company operating in the US and a CRP for Venezuela of 10.26%) and a 10.14% cost of debt. This resulted in a nominal WACC of 19.88%.

The Tribunal noted that there was no reason to apply differing rates for pre, and post-award interest. Thus, interest of 2% over the average six-month US Treasury bill rate, (compounded annually) accrued both prior to and following the award in order to reflect the balance between risk and reinvestment opportunity. Post-award interest was to be paid only on the principal amount of compensation, and not on the pre-award interest awarded.

Conclusion

As is increasingly frequent, the Tribunal considered each separate element of the Claimant’s and Respondent’s experts models to calculate its own valuation by adjusting the underlying assumptions and inputs it considered most appropriate. This included complex components of the discount rate.

The fundamental issue, which created the greatest divergence between the parties’ experts, concerned whether the risk of being expropriated without the payment of (sufficient) compensation as required by the Treaty, should be excluded from the CRP.

In this case the majority of the Tribunal agreed with the Respondent and considered that the CRP must reflect all political risks associated with investing in Venezuela, including the general risk of being expropriated without payment of sufficient compensation.

Case information

Claimant: Saint-Gobain Performance Plastics Europe 

Respondent: Bolivarian Republic of Venezuela

Case ref: ICSID Case No. ARB/12/13

Tribunal: Professor Dr Klaus M Sachs, President

The Honourable Charles N Brower, Arbitrator

Mr Gabriel Bottini, Arbitrator

Ms Natali Sequeira, Secretary of the Tribunal

For further information, please contact Sandy Cowan or Rob Soady