A hard-fought victory for the rule of law
The multi-billion dollar Gazprom-Naftogaz settlement shows how persistent resort to legal means can defeat apparently superior opponent.
On 30 December 2019, Ukrainian Naftogaz and Gazprom settled a number of multi-billion dollar disputes. Gazprom paid USD 2.9 billion to Naftogaz and accepted a five-year contract for transit of Gazprom gas through Ukraine, measures which Gazprom had vehemently resisted only some 10 days earlier. This article analyses the state of the disputes immediately prior to the settlement, and shows that Gazprom’s concessions largely resulted from Naftogaz’s successful use of legal means to resolve its disputes with Gazprom since 2014. The authors were lead counsel for all of Naftogaz’s legal efforts.
The disputes arose under the Gas Sales and Transit contracts entered into between Naftogaz and Gazprom in January 2009. The contracts were inherently imbalanced in Gazprom’s favour, with extraordinarily strict take-or-pay obligations on Naftogaz under the Gas Sales contract, and more lenient shipping obligations on Gazprom under the Transit contract. Also, the gas price was wholly indexed to oil product prices and increased accordingly, while the transit tariff was only partly indexed to EU inflation and stood practically still. This imbalance perpetuated a pattern of Ukrainian and Naftogaz difficulties in paying for Russian gas supplies mitigated by political deals seen since Ukrainian independence, most notoriously the 2010 prolongation of Russian naval basing rights in Crimea in exchange for a gas price “discount”.
This vicious cycle ended in 2014, with the Russian Federation’s political, military and economic assault on Ukraine following the Euromaidan revolution. The Russian Federation and Gazprom cancelled previous discounts, doubling the gas price overnight. Naftogaz’s new, young and reform-oriented management abandoned the previous practice of political deals and fought back by legal means. Naftogaz commenced arbitrations under the contracts, requesting a price review and revision of the take-or-pay provisions under the Gas Sales contract, and damages for breach of contract under the Transit contract.
Naftogaz succeeded, with the Tribunal finding in their favour on both issues under the Gas Sales contract in a Separate Award and a Final Award rendered in May and December 2017 respectively. In those awards, the gas price was adapted to European levels, and Gazprom’s USD 46 billion take-or-pay counterclaims were rejected because the take-or-pay provisions in the Gas Sales contract exceeded market practice and contradicted general principles of competition law.
Those decisions were followed by a final Transit Award rendered in February 2018, were Naftogaz was awarded damages for Gazprom’s breaches of the Transit contract, resulting in a net payment obligation for Gazprom of USD 2.56 billion.
Gazprom refused to comply with the awards. Instead, Gazprom challenged all three awards in the courts, and initiated a new arbitration before a new Tribunal aimed at reversing the damages awarded to Naftogaz. In May 2018, Naftogaz initiated enforcement proceedings to collect the USD 2.56 billion awarded in February 2018. In England, The Netherlands and Luxemburg, Naftogaz attached significant Gazprom assets.
Naftogaz also submitted counterclaims in the arbitration commenced by Gazprom, most notably an almost USD 12 billion claim for revision of the Transit contract tariff. The latter relied on a regular application of the Transit contract tariff revision clause, and was for an adaptation of the tariff to European tariff practices and levels, covering the costs of the transit system. These costs included substantial depreciation costs, due to Gazprom’s then apparent intent to cease all Ukrainian transit at the end of 2019, when the Transit contract was due to expire. Naftogaz also submitted a complaint against Gazprom’s abusive practices in the gas market to the European Commission.
In negotiations, Gazprom insisted that any new transit contract could not last more than one year, and that Naftogaz had to waive the USD 2.56 billion awarded.
The main elements of the settlement are a new transit contract on ship-or-pay terms with a duration of five years, worth approximately USD 7 billion and accounting for much of the depreciation costs included in Naftogaz’s tariff revision claim, Gazprom payment of the damages previously awarded to Naftogaz with interest, USD 2.9 billion, and waiver of all on-going legal proceedings and other existing and future claims arising out of or connected with the 2009 contracts. The latter inter alia meant that Gazprom waived a claim of around USD 2.6 billion for gas allegedly delivered under the Gas Sales contract to the temporarily occupied areas of Donetsk and Luhansk regions in Ukraine.
Why the settlement was reached
Shortly prior to the settlement, two major developments took place in the on-going disputes.
First, on 1 November 2019, Naftogaz submitted its first substantive pleading in the new arbitration, thoroughly rejecting Gazprom’s claims and substantiating the counterclaims.
Second, on 27 November 2019, Gazprom’s challenge of the Separate Award was rejected on its merits, without leave to appeal. This left Gazprom’s challenge of the Final Award, which relied on alleged errors in the Separate Award, with no prospects of success, and meant that Gazprom’s possibility to resurrect its take-or-pay claims and the associated leverage against Naftogaz in practice was lost. Also, the reasoning in the judgment significantly reduced the already slim prospects of success for Gazprom’s challenge of the Transit Award.
Further, US sanctions targeting the Nord Stream 2 pipelined designed to complete Gazprom’s bypass of Ukraine’s gas transit system were imposed on 21 December 2019. The pipe-layer Allseas immediately suspended operations. This reduced Gazprom’s leverage even further.
These three developments added to the constant pressure and fatigue from the setbacks suffered in the various other proceedings, Gazprom’s loss of credibility from its disregard for the Awards and political pressure. Most likely, they were decisive for Gazprom’s relinquishment of its unreasonable demands in the negotiations, paving the way for the settlement.
What the settlement means
For Naftogaz and Ukraine, the settlement marks the end of the post-Soviet pattern of Ukrainian and Naftogaz debts to Russia and Gazprom for gas supplies, which the latter used to extract financial and/or political concessions until 2014.
For outside observers, the most important lesson from the settlement may be that contracts and the law provide certainty, even when relationships between states deteriorate and politically motivated concessions are withdrawn. A persistent and tenacious insistence on your legal rights is likely to bring gains even against a seemingly superior opponent.