Awards and decisions: Mohamed Abdulmohsen Al-Kharafi & Sons Co. v. Libya and others, Final Arbitral Award

IISD | 19 January 2014

Awards and decisions: Mohamed Abdulmohsen Al-Kharafi & Sons Co. v. Libya and others, Final Arbitral Award

by Diana Rosert

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A tribunal has ordered Libya to pay US$935 million in a dispute over a land-leasing contract for a tourism project—marking the second-largest known investment treaty award to date.

The March 22, 2013, award upheld the tribunal’s jurisdiction and ruled Libya responsible for breaches of contract, national law and the Unified Agreement for the Investment of Arab Capital in the Arab States (Unified Agreement). Libya’s nominee to the tribunal, Justice Mohamed El-Kamoudi El-Hafi, refused to sign the award.

Background

In 2006, the Libyan Ministry of Tourism approved an investment project proposed by Al-Kharafi & Sons Co. for the construction and operation of a tourism complex. Shortly after, the Kuwaiti company signed a 90-year land-leasing contract with the Tourism Development Authority, comprised of 24 hectares of state-owned land in Tajura, a city in the Tripoli district. The project was to start in 2007, but construction work never commenced. The Ministry of Economy annulled the project approval in 2010; as a result, the land-leasing contract was also invalidated.

Al-Kharafi & Sons Co. launched its claim against Libya and several authorities in 2011, with two main complaints. Firstly, the claimant asserted that the Tourism Development Authority did not hand over the property “free of occupancies and persons” as required by the contract, and that the Libyan State, through various authorities, was responsible for delaying construction. Secondly, the claimant alleged that annulment of the approval and the cancellation of the land-lease contract were both illegal. Considering that these acts and omissions constituted breaches and caused damages, the claimant demanded compensation from the Libya state.

A tribunal was instituted under the Unified Agreement under consideration of the arbitration clause contained in the land-leasing contract.

Background on the Unified Agreement

Libya and Kuwait ratified the Unified Agreement, to which many other Arab League members have acceded, in 1982. Besides capital liberalisation and protection provisions, the Agreement provides that disputes, including those between state parties and Arab investors, shall be settled through conciliation, arbitration or by the Arab Investment Court established for that purpose. The Agreement also states that the two disputing parties “may agree to resort to arbitration” if they cannot agree on conciliation; if the decision of a conciliation is not rendered within the required time or is not unanimously accepted by the parties. Notably, this is commonly considered not to provide the signatory states’ advance consent to arbitration.[1]

Tribunal assumes jurisdiction on basis of land-leasing contract and the Unified Agreement

The claimant argued that it had access to arbitration under the Unified Agreement by virtue of the arbitration clause contained in the land-leasing contract which referred to the Unified Agreement. The contract determined that disputes between the parties “arising from the interpretation or performance of the present contract during its validity period … shall be settled amicably” and, if this failed, “the dispute shall be referred to arbitration pursuant to the provisions of the Unified Agreement.”

The tribunal deemed that the wording of the contract clause established consent to arbitration under the Unified Agreement. “A fortiori, the two parties explicitly chose to resort to arbitration as provided for in Article (29) of the contract,” the tribunal reasoned.

Challenging jurisdiction under the Unified Agreement, Libya maintained that the project did not involve the transfer of Arab capital from Kuwait to Libya and therefore the “substantive scope for the application of this Agreement is not fulfilled ipso facto.” Aside from the undisputed fact that the construction works on the tourist complex never began, Libya pointed out that the claimant failed to deposit 10% of the established value of the investment project in a Libyan bank account as requested by the General Authority. While the claimant was able to show that it had paid 0.1% of the value to the Authority, Libya contended that was not a proof for the existence of an Arab investment.

Nonetheless, the tribunal determined that the Kuwaiti company’s payment of 0.1% of the investment value constituted a transfer of Arab capital, and the tribunal saw no legal obligation for the claimant to pay 10% at a minimum.

Libya also objected to the tribunal’s jurisdiction arguing that the case fell outside of the limited scope of the arbitration clause contained in the contract. In its view, the clause excluded disputes relating to non-performance, cancellation of the contract and “anything arising after its expiry and any disputes related to compensation claims for any damages.” It stated that “arbitration is a special judicial system arising from the will of the parties to resort thereto … this leads to conclude that the present claim does not fall within the jurisdiction of the arbitration Tribunal.”

Addressing this objection, the tribunal deemed that it was competent to rule on the “scope of extension of the arbitration clause” so as to cover the annulment of the contract and compensation for damages. Since it had already determined that the Unified Agreement applied to the dispute, the tribunal considered that the arbitration rules stated therein applied to the case, including Article 2.6 of the Unified Agreement’s Annex, which states that the “arbitral panel shall decide all matters related to its jurisdiction and shall determine its own procedure.” The tribunal interpreted this as giving it competence to rule on its own competence as well as the extension of scope of the contract clause.

Another jurisdictional objection related to the contract’s requirement of amicable settlement prior to arbitration. Libya contended that the claimant did not make serious efforts to fulfill it and asserted that the arbitration was therefore filed prematurely, while the claimant argued that it had attempted to settle the dispute amicably. The tribunal found that both parties “made amicable endeavors,” and since all endeavors failed, the claimant was permitted to file the arbitration.

Given that only the Tourism Development Authority was a signatory of the contract, Libya argued that the contract provisions could not be invoked against the Libyan government and the other authorities. Granting the claimant’s request to extend the arbitration clause to non-signatories of the contract, the tribunal determined that “the intervention of multiple government bodies and public institutions as well as ministries in the contract performance or termination” gave the contract a “governmental character.” However, it declined to include the Libyan Investment Authority as a disputing party, considering that, unlike the others, this institution was not involved in the dispute.

The tribunal further established that the land-leasing contract was a private law contract governed by the Libyan Civil Code, national laws on the Promotion of Foreign Capital Investment (Libyan Investment Law) and the Unified Agreement.

Libyan defendants found to have frustrated claimant’s project execution

With respect to the merits, the first contentious issue was whether the Tourism Development Authority had handed over the land to the claimant according to the terms of the contract. The contract signed by both parties stipulated that the tourism authority “undertakes to hand over … the plot of land free of any occupancies and persons, guarantees that there are no physical or legal impediments preventing the initiation of the project execution or operation during the usufruct period immediately upon the signature of this contract, and permit it to take physical possession thereof for the purpose of establishing the project.”

According to the claimant, the tourism authority failed to fulfill this contractual obligation, because other persons and businesses occupied the land and impeded the execution of the project from the outset. The claimant asserted that during several attempts to take over the land and build a fence, it was assaulted by municipal guards and other occupants. It alleged that the tourism authority was aware of these obstacles, but refrained from evacuating the land. Instead the authority demanded that the claimant stall the project until the issues were resolved and offered an alternative plot of land.

However, according to Libya, the claimant took over the site in 2007 “free of any occupancies or impediments.” It maintained that Al-Kharafi & Sons Co. was responsible for the delays due to its failure, among other things, to provide the authorities with final project designs, deposit 10% of the project value on a Libyan bank account, and apply for permits.

The tribunal found that “all the data and facts established” confirmed the claimant’s allegations that the land was not “free of occupancies,” and that Libyan authorities prevented it from starting the project. The tribunal also concluded that the claimant did not cause any “self-inflicted obstacles.” Indeed, it held that Libya’s offer to provide the Kuwaiti company with alternative land was “further proof of the Defendants’ failure.” The tribunal therefore ruled that Libya breached a primary obligation of the leasing contract, as well as the Libyan Civil Code that required it to adhere to such obligations. Furthermore, the tribunal noted that the case involved “administrative corruption.” Even if not “organized or deliberated” by the Libyan state, Libya had committed “gross negligence and disregard of investment rules.”

Decision to annul project considered to have led to “confiscation, liquidation, freezing and control of the investment”

The tribunal went on to consider the claimant’s assertion that the annulment of the project approval by the Ministry of Economy was an “illegal act” in violation of various Libyan laws and provisions of the Unified Agreement.

Libya argued that the ministry cancelled the approval due to a four-year delay in construction. It maintained that the step was taken in accordance with national laws as well as the contract, which in Article 24 expressly stated the authority’s right to terminate the contract if the project was not executed in time.

Meanwhile, the claimant argued that the “real reason” behind the annulment was that Libya neglected its obligation to hand over the land free of occupants.

The tribunal ruled that the annulment constituted a second serious violation of Libya’s obligations. While recalling that all evidence confirmed that Libya was responsible for the delay, it disproved Libya’s factual allegations concerning the claimant’s faults one by one. Examining liability under different law, it found that the annulment was “an arbitrary decision” that led to confiscation, liquidation and freezing of project which was prohibited by Libyan Investment Law and Article 9(1) of the Unified Agreement. The tribunal decided that the Libyan authorities were liable for those breaches and obliged to pay compensation according to the Libyan Civil Code.

US$935 awarded for lost profits, moral damages, and material losses and expenses

The tribunal ordered Libya to pay US$5 million for value of losses and expenses suffered by the Kuwaiti company, US$30 million for moral damages and US$900 million for “lost profits resulting from real and certain lost opportunities.”

It is noteworthy that, in the course of the proceeding, the claimant increased the compensation claim to more than US$2 billion covering lost future profits for 83 years, corresponding to the length of the revoked land-leasing contract. Originally, Al-Kharafi & Sons Co. had claimed US$55 million which it amended to US$1,144,930 billion in September 2012. Libya maintained that the company “incurred damages, if any, due to its own faults” and considered the compensation claim to be “characterized by corruption.”

Compensation for moral damages to claimant’s reputation awarded

The claimant demanded US$50 million in moral damages, in addition to US$5 million for material losses and expenses related to the opening of an office in Tripoli. It argued that it should receive this “merely symbolic” amount because the cancellation of the project damaged its high national and international reputation.

The Libyan defendants contested that moral damages had not occurred and pointed out that the claimant had not submitted proofs in this regard.

Ultimately, the tribunal decided that compensation for moral damages was permitted under Libyan law and that the claimant was entitled to it. It considered that the claimant suffered moral damages “to its reputation in the stock market, as well as in the business and construction markets in Kuwait and around the world.”

The tribunal’s decision on moral damages is an outlier in the field of investment arbitration. Moral damages claims have been raised in other investment treaty arbitrations, but tribunals commonly placed strict conditions on the validity of such claims. For instance, in Rompetrol v. Romania, the tribunal considered that moral damages were “subject to the usual rules of proof.” [2] It eventually rejected the claimant’s demand of US$46 million for moral damages “for loss of reputation and creditworthiness.” The tribunal in Arif v. Moldova[3] dismissed a moral damages claim of €5 million, holding that the “different actions did not reach a level of gravity and intensity” sufficient to justify it.

US$2 billion considered “sound and convincing” estimation of future lost profits

The company’s claim of US$2 billion for lost profits was based on four reports that Ernst & Young, Prime Global (Khaled El-Ghannam), Habib Khalil El-Masri and Ahmad Ghatour & Partners prepared on the claimant’s request and based on documents submitted by it.

Libya asserted that the reports lacked credibility because they were based solely on data and information provided by the claimant, which were not independently verified. Libya did not, however, present its own expert estimations.

Firstly, the tribunal determined that the Libyan Civil Code (Article 224), supported by Libyan Supreme Court rulings, covered compensation for lost profits. It deemed that the UNIDROIT Principles of International Commercial Contracts confirmed that it had discretion to decide on such issues. It then interpreted the Libyan law on compensation for damages, concluding that the lost profit claim was valid only if damages resulted from opportunities that were “real and certain.”

Secondly, the tribunal found that the submitted reports on lost profits were “scientific and unbiased reports” by firms with good reputations. The tribunal noted that Libya’s criticism of the reports was not on “the same level of expertise,” since it had not submitted own expert reports disproving any of the findings.

Based on those conclusions, the tribunal decided that the reports with estimations ranging from US$1.7 to 2.6 billion were “sound and convincing.” Two of the experts that had drafted reports, Khaled El-Ghannam and Habib Khalil El-Masri, confirmed during a hearing that the amounts were “certain lost profits” and constituted a “minimum” of what the claimant “would have otherwise certainly realized in the normal conditions currently prevailing in Libya.”

However, instead of awarding the arithmetic average of US$2.1 billion, the tribunal decided to reduce the amount of compensation for lost profits, “by virtue of its discretionary power,” to US$900 million. In light of the Libyan revolution, the tribunal noted that “this arbitration will serve as an incentive to government agencies” and “reassure the Arab investors.”

Lost profit claims are not unusual in treaty or commercial arbitration, yet the amount awarded in under the circumstances of the present case appears to be distinct. For example, in a seminal case, PSEG v. Turkey, the tribunal declined to grant the claimants compensation for future lost profits of US$223.742 million for a power plant project that was not constructed.[4] The PSEG award recalled that other investment tribunals were also hesitant to award lost profits for not established businesses that, consequently, lacked historical evidence for profits.

The tribunal is composed of Dr. Abdel Hamid El-Ahdab (presiding arbitrator), Dr. Ibrahim Fawzi (claimant’s nominee) and Justice Mohamed El-Kamoudi El-Hafi (respondent’s nominee).

The award is available at http://www.italaw.com/sites/default/files/case-documents/italaw1554.pdf

Notes

[1] As Walid Ben Hamida puts it, arbitration under the Unified Agreement is “subordinated to an agreement between the parties.” See Walid Ben Hamida (2006), The First Arab Investment Court Decision, Journal of World Investment & Trade, Vol. 6, Issue 5, pp. 699-721 (p. 709).

[2] The Rompetrol Group N.V. v. Romania, ICSID Case No. ARB/06/3, Award.

[3] Mr. Franck Charles Arif v. Republic of Moldova, ICSID Case No. ARB/11/23, Award.

[4] PSEG Global Inc. and Konya Ilgin Elektrik Uretim ve Ticaret Limited Sirketi v. Turkey, ICSID Case No. ARB/02/5, Award.

source: IISD