Accounting for “Country-Risk” in Assessing Damages in Investor-State Arbitration: Gold Reserve Inc. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB(AF)/09/01, Award (Sept. 22, 2014). The careful treatment of the parties’ valuation submissions in this Award provides valuable insight into the approach to valuation of natural resource assets in the context of investor-state arbitration.
An arbitral tribunal under the auspices of the International Centre for Settlement of Investment Disputes (“ICSID”) recently awarded the claimant Canadian mining company over U.S. $713 million in damages for violations of the Canada-Venezuela bilateral investment treaty (the “Agreement Between the Government of Canada and the Government of the Republic of Venezuela for the Promotion and Protection of Investments”, dated July 1, 1996 and in force January 28, 1998, or the “BIT”), for wrongful termination of its mining concessions, as well as pre- and post-award interest and a portion of its costs.
Gold Reserve owned two mining concessions in Venezuela conferring upon it the right to extract gold, copper and molybdenum, with “mineral reserves… estimated to be 9.087 million ounces of gold and 985 million pounds of copper”. Gold Reserve had invested approximately U.S. $300 million in developing the project, but it had not yet commenced commercial mining when Venezuela wrongly rejected a request to extend one concession at the expiry of its initial term, and purported to terminate both.
Gold Reserve commenced proceedings for breach of the BIT under the ICSID Additional Facility rules. The Tribunal found Venezuela to be liable for breach of the BIT by denying Gold Reserve’s “due process rights by failing to initiate a specific administrative procedure to revoke the extensions” of Gold Reserve’s concessions.
The Tribunal’s valuation of Gold Reserve’s investment relied on the principles of public international law established by the Permanent Court of International Justice in the Chorzów Factory case, namely that “reparation should as far as possible eliminate the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed.” To calculate the damages required to achieve this effect, the Tribunal adopted a discounted cash flow “DCF” analysis to determine the market value of the concessions at the date of the treaty breach. The Tribunal’s approach to the country risk premium applicable in this analysis is particularly noteworthy.
Although both parties’ experts agreed that the discount rate to be applied should reflect the claimant’s weighted average cost of capital “WACC”, the parties disagreed over several elements of its calculation. As the Tribunal noted, “the largest discrepancy concerned the country risk premium applied as part of the cost of equity.” Gold Reserve asserted a country risk premium of 1.5% and Venezuela advanced rates between 6.7% and 16.4%. The discrepancy was due in part to Venezuela’s financial expert applying a risk premium that “took account of Venezuela’s policies at the time, including the President’s policy of ousting North American companies from the mining sector, thus increasing the risk significantly.”
The Tribunal agreed with Gold Reserve’s expert, who contended that it “was not appropriate to increase the country risk premium to reflect the market’s perception that a state might have a propensity to expropriate investments in breach of BIT obligations.” Although finding the risk premium advanced by Gold Reserve’s expert too low (because it posited a “but for” scenario in which the host State would not misuse its sovereign power), the Tribunal found that Venezuela’s risk premium was too high because it “include[d] some element reflective of the State policy to nationalise investments”. The Tribunal ultimately adopted a country risk premium of 4%, explaining that this rate was reasonable “but has not been over-inflated on account of expropriation risks”.
This analysis may be contrasted with another recent ICSID award, in Exxon Mobil v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/27, Award, (Oct. 9, 2014), also stemming from the late President Chávez’s nationalization policies. In that case, the Tribunal stated that it “…considers that the confiscation risk remains part of the country risk and must be taken into account in the determination of the discount rate.” For some commentators the Exxon Mobil Tribunal’s reasoning might inadvertently encourage a host State to create a higher perception of expropriation risk in the markets, by political acts or statements, prior to expropriating a strategic asset in the hope of lowering its exposure on damages in the event that it is later sued.