Emerging Europe | 25 May 2021
In Kazakhstan’s mammoth legal battle with two Moldovan investors, the pendulum is swinging in favour of the Central Asian state
by Marek Grzegorczyk
Kazakhstan claims that two Moldovan investors, Anatol and Gabriel Stati, fraudulently won an arbitration award of 500 million US dollars. Several of the world’s leading experts in international arbitration agree. The country’s efforts to defend itself against enforcement of the award are beginning to bear fruit.
An ongoing dispute between the state of Kazakhstan and two Moldovan businessmen, Anatol Stati and his son, Gabriel Stati, is often described in the media, and by legal experts, as one of the most complex cases of international investment arbitration in recent history.
For Kazakhstan, the matter is far simpler: it says the case is crucial to upholding the rule of law and defending its reputation as a safe, secure and welcoming destination for foreign investment.
“It is a highly unusual case of abuse of a system that is designed to protect investments made in good faith,” says Almat Madaliyev, vice minister at the Kazakh Ministry of Justice.
“By defending itself against fraud and money laundering, Kazakhstan is protecting the rule of law and guarding a healthy investment climate in the country.”
The legal battle between the Statis and the Kazakh government began in 2010 when the Ministry of Oil and Gas of Kazakhstan terminated contracts for oil and gas exploration and production of Kazpolmunai LLP and Tolkynneftegaz LLP – companies owned by the Statis in Mangistau province, in the west of the country.
The Statis subsequently sued Kazakhstan under the terms of the Energy Charter Treaty (ECT), of which Kazakhstan is a signatory, and in 2013 the arbitral tribunal composed under the rules of the Arbitration Institute of the Stockholm Chamber of Commerce awarded the Moldovans a compensation of over 500 million US dollars.
The arbitral tribunal ruled that the Statis’ companies had been subjected to “coordinated harassment” by Kazakh authorities, culminating in the termination of their oil and gas contracts.
The amount was based on the alleged value of the Statis’ oil and gas contracts and a liquefied petroleum gas (LPG) plant, in construction of which the Statis claim to have invested as much as 245 million US dollars.
Kazakhstan challenged the award, initiating annulment proceedings at the Svea Court of Appeal. Simultaneously, the Statis set about enforcing the award in the United Kingdom, and later in several other jurisdictions.
During the annulment proceedings Kazakhstan discovered new information which it said demonstrated that the Statis had fraudulently inflated the amount of their alleged investment in the LPG Plant, and thus fraudulently obtained the award. The Statis opposed these arguments.
In December 2016, the Stockholm court, while not ruling on the merits of this alleged fraud, accepted the Statis’ arguments that their alleged fraud did not violate Swedish concepts of public policy and, on that basis, refused to annul the award.
Subsequently, Kazakhstan says that it discovered substantially more evidence of the Statis’ alleged fraud – including more evidence supporting its claims regarding the LPG plant and a different fraud scheme that the Statis ran using their Kazakhstan operations. Kazakhstan attempted to bring this new evidence to the attention of the Swedish courts but the courts rejected this effort – finding that under Swedish law a party only has one opportunity to attempt to annul an arbitral award.
Still, Kazakhstan says that the totality of the evidence, including the new evidence discovered after the December 2016 Stockholm ruling, confirms that the Statis are fraudsters.
“A number of globally-leading independent experts have analysed [the case] and there is irrefutable evidence that the award was procured by fraud and the activity conducted by the Statis in Kazakhstan was fraudulent – it had nothing to do with bona fide investment,” says Mr Madaliyev.
One of those experts is Patrik Schöldström, now a judge on the same Svea Court of Appeal that did not annul the award.
In his expert report, he analysed the December 2016 Stockholm decision and the Statis conduct during those proceedings, and says that the Swedish courts have “not found” that the Statis did not commit fraud, money laundering and bribery of public officials. Indeed, he adds that “the relevant arbitral award and its enforcement in Sweden violate Swedish public policy. This is because the award is based on false evidence.”
‘The interests of justice require examination’
Momentum first shifted in 2017 when the English High Court (Justice Knowles) found that Kazakhstan had established a “sufficient prima facie case” that the award was obtained through fraud in connection with the LPG Plant.
Under English law, allegations that an arbitral award was obtained by fraud are generally permitted to trial when both the evidence establishing the fraud was not available to the party alleging the fraud at the time of the initial arbitration; and there is a prima facie case of fraud sufficient to overcome the extreme caution of the court when invited to set aside an award on the grounds of public policy.
The court held that there was a sufficiently strong prima facie case that the Statis committed a “fraud on the Tribunal” and that relevant documents had been fraudulently withheld from the arbitration, which materially affected its outcome, and therefore the issue should be allowed to proceed to trial.
In his reasoning, Justice Knowles wrote that: “I am satisfied that [Kazakhstan] did not have access before the award to the evidence of the alleged fraud on which it now seeks to rely, and that the evidence of the alleged fraud could not with reasonable diligence have been discovered before the award had [Kazakhstan] used reasonable diligence.
“It will do nothing for the integrity of arbitration as a process or its supervision by the Courts, or the New York Convention [Convention on the Recognition and Enforcement of Foreign Arbitral Awards], or for the enforcement of arbitration awards in various countries, if the fraud allegations in the present case are not examined at a trial and decided on their merits, including the question of the effect of the fraud where found. The interests of justice require that examination.”
The Statis, to avoid trial on their alleged fraud, voluntarily discontinued their own enforcement case in the UK. This tactic was initially rejected by Justice Knowles but then was permitted on appeal, but only on condition that the Statis agreed to give an undertaking to pay Kazakhstan’s substantial legal costs and to not attempt again to enforce the award in England.
The Statis went elsewhere in order to enforce the award.
On the basis of the then-available evidence, the award has been granted recognition by courts in the US, Belgium, Luxembourg, the Netherlands, and Italy, and at one stage the Statis succeeded in freezing 22 billion US dollars in assets owned by Kazakhstan’s Sovereign National Fund (although this was subsequently reduced to match the circa 500 million US dollars amount of the award).
The alleged fraud
At the core of the dispute is Kazakhstan’s claim that the Statis acted fraudulently — both in the way that their companies’ operations in Kazakhstan were run, and in the subsequent case that eventually led the ECT arbitral tribunal to make the 500 million US dollars award.
This, it says, runs counter to global public policy that judicial determinations – whether court judgments or arbitral awards – should not be products of false evidence.
Kazakhstan claims that the Statis falsified the financial statements of their three companies Tristan Oil, Kazpolmunay, and Tolkynneftegaz, by undertaking a series of inflated related-party transactions that they concealed from their auditors, KPMG, and the rest of the world.
It claims that the Statis then used the audited financial statements to raise capital from investors. Around 420 million US dollars were attracted in 2006 and 2007.
However, in 2016 auditors KPMG wrote to the Statis stating that it had become aware of facts which may have caused its audit reports to be amended, had such facts been known at the audit report date.
KPMG also pointed out that the Statis would be unable to rely on its audit reports unless further explanations or representations were made.
Among the issues KPMG raised were a series of charges, worth tens of millions of US dollars, paid by Tolkynneftegaz to Perkwood, a company that the Statis subsequently admitted they owned.
Perkwood is of particular concern to Kazakhstan as it believes the Statis created it as a shell company for the purpose of diverting funds that were purportedly spent on the construction of the LPG Plant.
In April 2019, the former chief financial officer of various Stati companies, Artur Lungu, admitted in a sworn deposition in the United States that the Statis had repeatedly made materially false statements to KPMG to conceal the fact that Perkwood was a Stati company and that the Statis’ financial statements were therefore materially false.
After reviewing Mr Lungu’s testimony and other evidence, and conducting their own independent investigation, KPMG in 2019 took the almost unprecedented step of withdrawing its audit reports, stating that no person should rely on them given that “those reports had been based on false accounting”.
KPMG has subsequently refused requests by the Statis to reinstate the reports.
The effective ‘withdrawal’ of an audit opinion is a last resort by an auditor and only arises in rare circumstances, including for example when management can provide no explanation for repeated material false statements by management to the auditor and/or when management can provide no explanation for material misstatements in the accounts and resulting financial statements.
A PwC report from January 2020 puts the actions of KPMG in context.
“We have consulted with our own audit standards team at PricewaterhouseCoopers LLP. They have informed us that in the UK, there has only been one occasion that they can recall over the past fifteen years, a period during which PricewaterhouseCoopers LLP has issued tens of thousands of audit opinions, when PricewaterhouseCoopers LLP has had to take similar actions to ‘withdraw’ a previously issued audit opinion.”
Reversal of fortunes
Over the past 12 months, the pendulum would appear to have slowly swung further away from the Statis. In 2017, the Statis had obtained an ex parte order from a Luxembourg district court enforcing the award. That decision was confirmed by the Luxembourg Court of Appeal two years later, which held there was insufficient evidence of fraud to violate Luxembourg public policy.
In February of this year however, Luxembourg’s Supreme Court found that the lower Court of Appeal had violated due process by commenting on KPMG’s withdrawal letters, but without permitting Kazakhstan to submit arguments on the consequence of those letters to the Statis’ alleged fraud.
The Luxembourg Supreme Court ordered that a new panel of judges in the appeal court consider the enforcement application, and awarded costs to Kazakhstan.
In the Netherlands, the Dutch Supreme Court in December 2020 set aside a decision upholding a 5.2 billion US dollars attachment to the Kazakh Sovereign Wealth Fund in regards to the award, and the same court is now hearing an appeal of a ruling granting recognition of the award.
This followed another setback for the Statis in November 2020, when on an application for permission to serve proceedings out of the jurisdiction, a court in Gibraltar found that there was a “serious issue to be tried” in relation to a claim of 470 million US dollars and 36 million euros made by Tolkynneftegaz – now in bankruptcy proceedings – against Terra Raf Trans Trading, a Gibraltar-registered company of which the Statis are directors and shareholders, the Statis themselves and Tristan Oil. This claim arises from the same alleged fraud of the Statis now at issue in several of the Statis’ enforcement proceedings.
In that particular case, Tolkynneftegaz claims that between 2005 and 2010 it produced and exported millions of barrels of oil and gas to a Dutch company, Vitol. It says that did so via intermediary companies all owned by the Statis, including Terra Raf. Tolkynneftegaz claims that Vitol made payments of approximately 665 million US dollars for the oil and gas but only approximately 437 million US dollars was paid to Tolkynneftegaz.
The balance, claims Tolkynneftegaz, was used by the Statis for other business interests or for their own personal use.
In an ongoing case in New York, Argentem Creek Partners, a hedge fund, is facing claims by Kazakhstan that it knowingly aided and abetted in the Stati’s alleged fraud. Outrider Management, a former bondholder of the Statis, has joined Kazakhstan in the lawsuit to assert its own claims against Argentem.
Courts in Belgium have also admitted Kazakhstan’s appeals to introduce the full fraud case to attempt to overturn enforcement of the award.
The end game
As the scale of the Stati’s alleged fraud and the way in which they – Kazakhstan claims – lied their way through arbitration proceedings and subsequent court proceedings is revealed, cases are beginning to go against them.
Furthermore, Kazakhstan’s claims are now backed up by some of the world’s leading experts in the field of international arbitration, not the least of whom is Judge Schöldström.
Another is Professor George A. Bermann, a professor of law at Columbia Law School in New York, founder and director of the Centre for International Commercial and Investment Arbitration (CICIA).
“The Statis’ conduct in this case reveals a pervasive lack of integrity and thus falls decisively short of the standards of truthfulness applicable to parties in arbitration and litigation. [These] are not isolated acts, but rather a full-scale and systematic pattern of deception that began at the start of their Kazakh operations and continued through both the arbitration and the post-award proceedings,” he says.
While Kazakhstan recognises that it will be difficult to annul the ECT Award, it does believe that it needs to continue to defend the rule of law by fighting against the Statis’ ongoing efforts to enforce the fraudulent award.
Bermann supports this defence, calling the award “a product of gross deceit and is unworthy of recognition or enforcement under the New York Convention”.
Eventually, Kazakhstan hopes that the Statis will be prosecuted for their alleged fraud.
In May 2019, the country filed a criminal complaint against the Statis with the Chief Investigating Magistrate in Luxembourg, alleging, inter alia, that the Statis engaged in criminal forgery, fraud and money laundering in connection with their attempts to enforce the arbitral award in Luxembourg. In January 2021, the district court of Luxembourg stayed enforcement proceedings of the Statis pending the outcome of this criminal action.
“For state parties like Kazakhstan, which are working with international organisations, such as the Organisation for Economic Co‐operation and Development (OECD), to introduce anti‐corruption and rule‐of‐law boosting reforms, enforcement of an arbitral award that is materially tainted with false or fraudulent evidence sends completely the wrong message,” says Catherine A. Rogers, a tenured law professor at Pennsylvania State University.
“In addition, recognising and enforcing an award in which false or fraudulent evidence was presented also sends the wrong message to foreign investors.
“If fraud‐tainted awards are nevertheless enforceable, the message to unscrupulous foreign investors is that there is little downside to defrauding an arbitral tribunal, as long as they can keep the falsehoods secret until after the award has been rendered.”
What’s important, concludes Mr Madaliyev, is that investors understand that the Stati case is a “remarkable exception”, not just in Kazakhstan but generally for investment protection and arbitration which need to be protected from abuse.
“In case of disputes or disagreements with investors,” he says, “in the overwhelming majority the government and foreign investors reach an amicable resolution or compromise swiftly, without even catching the attention of the media.”