Economics & Corporate Law

Cairn Arbitration Case: Unwinding the Bancec Guidelines

Livie Jain

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The arbitral award in the Cairn Energy case proves to be an alarm bell for modifications in India’s taxation policy while at the same time stirring up fears over the enforcement of the Bancec Guidelines.

 

Introduction

Cairn Energy has recently filed a lawsuit in the U.S. District Court for Southern District of New York against Air India seeking the enforcement of the arbitral award against India. On December 21, 2020, a decision was delivered by the international arbitral tribunal seated in the Netherlands in Cairn Energy v the Republic of India (Cairn case). It held that India had failed its obligations arising out of the 1994 Bilateral Investment Treaty between India and the UK because of the introduction of retrospective taxation that violated the Fair and Equitable Treatment (FET) under the Treaty. While India has appealed against the judgment, Cairn has planned to enforce the arbitral award by applying the Bancec guidelines across at least nine countries. This post analyses the key themes around Cairn’s move and the major concerns and opportunities that it offers.


The case Unfolds

The Government of India introduced the Finance Bill in 2012, with the hope to remove loopholes in the provisions that might have allowed companies to benefit from the taxation law, but it ended up opening Pandora’s Box. The Finance Act introduced certain clarificatory amendments in the Income-Tax Act 1961 allowing the government to retrospectively tax cross-border transactions if the assets are located in India. The first of its evils surfaced in the form of the decision of the Permanent Court of Arbitration at The Hague (the PCA) in the Vodafone case where India was asked to pay a sum of Rs. 450 million as compensation for breaching the FET by the imposition of retrospective taxation. It was followed by an even greater evil – the PCA decision in the Cairn case.

The core of the dispute in the Cairn case, similar to the Vodafone case, was retrospective taxation. Cairn Energy Plc is one of the leading oil and gas exploration companies in Europe. As part of its internal rearrangement, around 2006, Cairn UK transferred shares of Cairn India Holdings to Cairn India. This transfer was subject to taxation as per Indian income tax authorities. In 2011, Cairn UK was barred from selling about 10% of Cairn India’s shares to Vedanta as a part of a larger transfer. The income tax authorities cited pending taxation issues due to which the payments of dividends were frozen, tax refunds withheld, and shares liquidated. Cairn then raised the dispute before the PCA against the demand raised by the Indian tax department of payment of Rs 10,247 crore in taxes.

The PCA ruled in favour of Cairn Energy asking India to pay a sum of $1.2 billion with interests and costs which totals around Rs. 126 billion. Though India has filed a petition before the Dutch Court of Appeals to set aside the arbitral award, Cairn has planned to enforce the award by tracing India’s assets across nine countries that have signed the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Interestingly, India’s appeal does not bar Cairn from recovering the amount under the arbitral award.


The Bancec Guidelines: Areas of Concern

Cairn is going to rely upon the Bancec Guidelines that deal with determining how a judgment against a foreign state can be enforced against its agencies, by applying the familiar doctrine of piercing the corporate veil.

These guidelines were laid down in the US Supreme Court case of First National City Bank v Banco Para el Comercio Exterior de Cuba (Bancec case). The court held that, as per the general rule, companies or government instrumentalities are presumed to have a separate legal entity. The veil of this separate entity can be pierced in exceptional cases allowing a judgment creditor to attach those instrumentalities of a foreign sovereign that are the sovereign’s alter ego, or where the existence of the veil causes injustice. Due care is to be taken because enforcement is being ordered against an entity that is not originally a part of the dispute. To summarize the guidelines – whether the corporate veil can be pierced in a given case is decided by looking at numerous factors, predominantly the ‘alter ego’ and ‘fraud or injustice’ tests.

The Bancec Guidelines were also followed in the seminal case of Crystallex International Corporation v Bolivarian Republic of Venezuela (the US Court of Appeals for the Third Circuit) (Crystallex) where Crystallex Corp. was looking to enforce a judgment against Venezuela by attaching shares held by one of its holdings. Even though this question was not before the court, the Third Circuit held that Petróleos de Venezuela, S.A. (PDVSA) was an alter ego of Venezuela as it passed the ‘extensive control’ test (or the alter ego test), and allowed Crystallex Corp. to recover its judgment amount. In this case, the ‘fraud or injustice’ test was not fulfilled and the decision was delivered solely on the basis of the ‘extensive control’ test. In this way, the court went further than the Bancec case to characterize its tests as disjunctive; meaning that either of the tests is sufficient to pierce the corporate veil of an instrumentality owned by a foreign state.

Though this looks rosy, it raises certain concerns. Firstly, there is no uniform definition of the ‘alter ego test’ across countries which allows them to use numerous distinct factors to satisfy the test. The court in Crystallex had the opportunity to clarify the nature and scope of the ‘extensive control’ test but it chose to forego the exercise of clarification and the threshold of ‘control’ was again left unattended. So, even when the Bancec case mentioned that the presumption of a separate entity must not be “taken lightly”, this becomes a very likely result in the absence of a uniform standard. Also, Crystallex has categorically stated that a nexus between the instrumentality and the liability of the foreign state is not required to be proved, leading to a further dilution of the Bancec Guidelines. 

Secondly, it is still unsettled whether it is sufficient to prove jurisdiction of courts over the foreign state (as part of the process of enforcing arbitral award), or if there is a need to prove such jurisdiction upon the state entities also. This becomes a major issue as an affirmative answer to the latter part of the question would make it difficult to enforce judgments against such entities in the future by creating an additional obstacle.

More issues may branch off from these points because the way the Bancec Guidelines have been adopted, gives a very wide ambit to the ‘alter ego’ test making it easier to be satisfied.


India in Peril and the way forward

At present, with Cairn’s intention to attach assets owned by the Indian government citing the Bancec Guidelines, India’s situation seems bitter. Cairn has approached the US, the UK, Canada, France, Singapore, the Netherlands, and three other countries to register the arbitral award and pursue its enforcement, along with starting such proceedings in the U.S. courts. Almost all of these countries follow the restrictive doctrine of foreign immunity. This doctrine furthers a restrictive approach allowing for state immunity only in the performance of sovereign functions. Thus, states cannot claim the benefit of immunity in the case of commercial activities and related assets. Another exception, specific to the US, is that the state cannot claim immunity against the enforcement of an arbitral award. This setting makes it more than clear that India is in a weaker position. Also, it is highly likely that India’s assets in those nine countries would satisfy the ‘extensive control’ test. Even though it is not yet clear which particular assets or entities will become a part of Cairn’s claim, the diluted standard of the test makes its job easier. The Bancec Guidelines do not provide any more protection than provided by the sovereign’s (in this case India’s) own laws. So if those assets or instrumentalities are not considered separate from the state in India, much of the job for Cairn is already done. It will become easier for the courts to rule in favour of Cairn and pierce the corporate veil, if any.

This is the second decision in quick succession against India, concerning the retrospective taxation policy introduced by it. It is high time for India to amend the terms to better suit the international investment standards. It is already skating on thin ice with two judgment debts involving humongous amounts. The offer presented to Cairn for settling by paying half the amount due to it was already rejected by Cairn. It had offered to forego $500 million if India agrees to pay off the rest of the debt, but it looks unacceptable to India. Looking at the situation, this settlement seems a better option for India as compared to continuing the litigation. The longer the domestic laws remain not in tune with the international standards, the more is India prone to such cases being filed and decisions being given against it. This case might be a warning before an even mightier storm hits the Indian shores.

Moreover, since Cairn has pursued its claim in the U.S. District Court, it is an extremely crucial opportunity for the court to build upon and clarify the operations of the Bancec Guidelines. It is a chance to streamline the ‘alter ego’ and the ‘fraud or injustice’ tests and specify the accurate threshold for piercing of corporate veil in these peculiar circumstances. With the increase in globalization and expansion of state-owned entities all across the globe, it is necessary for the nations to have clarity about which of their assets abroad are prone to attachment as part of enforcement of arbitral awards. This calls for an improvement in the set of rules at the earliest.


The author is a third-year law student at the National Law University, Delhi.