Taxation and expropriation - the destruction of the Yukos oil empire.

• Author: Stephan, Paul B.
• Position: I. Introduction through III. The Fall - Expropriation by Litigation, p. 1-27

1. INTRODUCTION II. THE RISE--YUKOS IN THE ERA OF COWBOY CAPITALISM A. The Yeltsin Period--1990 to 1999 B. The Putin Period--2000 to 2008 III. THE FALL--EXPROPRIATION BY LITIGATION IV. THE AFTERMATH--LITIGATION EVERYWHERE A. Russian Claims on Foreign People and Property B. Attacking the Yukos Transactions in National Courts C. International Adjudication V. IMPLICATIONS FOR THE GLOBAL ECONOMIC ORDER VI. CONCLUSION I. INTRODUCTION

   The rise, fall, and death agony of the Yukos conglomerate have all the elements of great literature. The tale features strong personalities, sudden twists of fate, and profound clashes of principle. The arc of the plot tracks Russia's deepest struggles in the two decades since the demise of the Soviet Union and Soviet Communism. Real individuals have suffered, one dying horribly in prison. The events have inspired books and movies, and the story is not close to ending. (1)

   This article does not have literary aspirations, but it does press the importance of the Yukos affair as a window into contemporary Russia and, more generally, modern efforts to impose order on the world economy. It focuses not on the human drama of the story, great though it is, but rather on the episode's significance in the ongoing struggle over economic freedom and state sovereignty. Most importantly, the Yukos story indicates the limits to the international rule of law.

   In a nutshell, the rise and fall of Yukos illuminates four narratives about the modern world economy. First, it exposes the challenges--some might say insuperable barriers--to creation of a liberal society on Russian soil. Second, it shows the deep problems with top-down law reform in societies undergoing rapid and wrenching political, economic and social change. Third, it demonstrates how renationalization works in a particularly high-stakes context. Finally, it reveals the capabilities and limits of international dispute settlement through courts, arbitration, and diplomacy when confronting profound conflicts between private rights and fiercely guarded national interests.

   As for the first point, one must carefully distinguish liberalism from democracy. A democratic society gives the population power and influence through effective mechanisms that translate the popular will into government policy. Liberalism entails the maintenance of institutions, both public and private, that check government power and open up a space for private transactions and expression. Russia since the fall of Communism has enjoyed a robust if imperfect democracy. By every conceivable indicator, President Putin enjoys widespread popular support, with his actions against Yukos in particular bolstering his approval. But democracy does not necessarily lead to constraining the state, as the Yukos affair demonstrates. The voice of the polis can call out for and cheer on the destruction of over-mighty private actors: In Russia, it did. (2)

   Law reform was a worldwide growth industry in the 1990s, the era that spawned the Yukos empire. The transition from totalitarian and authoritarian states with government monopolies over economic activity to something that might resemble liberal democracy inspired many to look to law as the midwife of a new order. Foreign specialists, myself included, flocked into the former Warsaw Pact countries in hopes of building new institutions, with law as the bricks and mortar. But for many of the reasons that liberalism did not take to Russian soil, legal reform all too often became a tool for expanding, rather than constraining, state power. The Yukos story is an exemplary tale of the perversion of legal instruments to empower arbitrary and exploitative bureaucrats to destroy private wealth. It also suggests something more general about the limits of law in shaping social change.

   On a technical level, Yukos provides a textbook example of how formal legal requirements, in particular tax law, can lend themselves to a program of renationalization of the commanding heights of the economy. Each element of the case that the Russian authorities brought against the company, in isolation, had an air of plausibility if not inevitability. Yet, once assembled as a whole, the case seemed preposterous. The government pursued two profoundly differently goals simultaneously, maintaining a veneer of legality while communicating clearly to the private sector that the state could act ruthlessly whenever it wished. At the end of the day, Yukos ceased to exist as a legal entity, a great energy empire ended up in government hands, and the Yukos shareholders (many of whom were foreign portfolio investors, not oligarchs and their minions) received nothing in return. In style if not in substance, these events resemble Falangist Spain's destruction of Barcelona Traction, a chestnut of international investment law. (3)

   Finally, the death throes of Yukos have spawned an extraordinary array of litigation in many national and international forums. More than a billion dollars in liquid assets resided outside Russia at the time of government's attack on the firm. Much of this became a war chest to fund lawsuits and arbitrations. Although the company has enjoyed considerable success in these ventures, the main purpose of the litigation seems to have been to clarify the extent of the Russian government's audacity and impropriety, with the possibility of a global settlement in the background. To date, however, the government has defended itself fiercely, if not always successfully.

   I employ all these narratives in the course of telling the Yukos story. This article begins with a brief account of the origins of Yukos and its rise to become the largest Russian energy company. The beginnings were sordid, and along the way abuses of corporate governance undoubtedly occurred, but the entity that entered the twenty-first century aspired to provide a new model of transparency and corporate probity for Russian businesses. The article puts the early years of Yukos in the context of the wild and contradictory period of Yeltsin's presidency, a time viewed as inspiring by many in the West and as disastrous by most Russians. It pays especially close attention to the role of U.S. technical advisers, in particular those who contributed to the design of the tax system that became the instrument of Yukos's destruction.

   The next section of this article describes Yukos's destruction in some detail, concentrating on the role of Russian courts in ratifying and enforcing the government's program of seizing the company's most productive assets. It follows with an account of the multijurisdictional and multinational litigation that ensued. It concludes with a review of the lessons learned from the affair, focusing on the potential of international law to mediate between private economic power and state interests. At the end of the day, the episode teaches us that the rule of law, both domestic and international, is a more fragile and uncertain enterprise than the optimistic architects of the Washington consensus may have believed two decades ago.

2. THE RISE--YUKOS IN THE ERA OF COWBOY CAPITALISM

   Any historical narrative of Russian events must frame them with presidential terms. This is not because Russian Presidents necessarily have any greater discretion or influence than political leaders in other countries, but rather because Presidents serve as the nexus of debate and administrative decisionmaking. It helps that the turnover of leaders was abrupt and specific, with Putin following Yeltsin just as the 1990s came to an end. The arc of Yukos's ascent cuts across both regimes, but took different shape in each. The legal background, especially the law reform project, also differed significantly during the two periods.

   1. The Yeltsin Period--1990 to 1999

      The first part of the story involves the 1990s, a time when Russia discarded the Soviet Union and embarked by fits and starts on the path of reform. Hordes of international advisors descended on Moscow and received an intermittently attentive audience. Many in the West, first and foremost the leaders of the United States, purported to be impressed with these changes and gave them their blessings as well as significant material support. Ordinary Russians, however, became increasingly disillusioned with a transformation that seemed to produce economic chaos, immiserization and injustice, rather than a better life. The tension between the hopes for reform and the actual practice of powerful actors frames the events around the rise of Yukos.

      To understand the pathway of reform in Russia, one must remember the challenges presented by the Soviet legacy. The Soviet economy relied on state ownership and management of nearly all productive activity, using quantitative targets rather than prices to determine outcomes. This system suppressed important information about performance and encouraged widespread corruption and rent-seeking. Not only did Soviet management ensure that the country could not compete internationally (which in turn required autarchy to protect the economy from the outside world), but it facilitated the accumulation of wealth and power among middle-managers that subverted the supposed hierarchy of central command and control. (4)

      In theory, reform would entail overturning these structural features. Assets would move from state to private ownership, markets would emerge, and competition and price transparency would direct economic activity towards its most productive possibilities. Lost in the confusion was two profound constraints on the project: Many powerful...