About the Yukos Affair
The "Yukos Affair," as it was labeled by the media, refers not only to the arrest and conviction of Mikhail Khodorkovsky and other Yukos employees but also to the dismantling of the company and discriminatory and unlawful expropriation of its key assets.
Background
After the collapse of the Soviet Union in 1991, the Russian Federation found itself with huge national industries run by ineffective management, resistant to modernization and change, and plagued by corruption. With advice from leading global economists, and facing a mounting financial crisis, the Russian Government decided to privatize key industries, including the oil industry.
Due to previous mismanagement and underinvestment, Yukos's infrastructure was crumbling as its wells produced a fraction of their peak capacity at inflated costs. When Mikhail Khodorkovsky and his associates purchased a majority stake in the company, it was producing a mere half a million barrels of oil per day, compared to 1.4 million in 1987, at a cost of up to $12 per barrel.
With their partners, Khodorkovsky and Lebedev rapidly raised standards at Yukos, employed professional management, aggressively rooted out corruption, introduced US GAAP accounting and adopted Western corporate governance standards. They reduced per barrel costs to $1.5 and increased production to over one million barrels per day. By 2002, Yukos was supplying 17% of all crude oil from the Russian Federation and was one of largest taxpayers in Russia, contributing 4.1% of the Russian federal budget.
By 2002, Yukos had published 3 years GAAP accounts in addition to its Russian accounts and was becoming the darling of Western investors who were unused to such transparency and corporate governance in a Russian company.
Yukos was the biggest oil company in Russia. At the time of his arrest in 2003, Khodorkovsky was negotiating with Western oil majors to create the world's largest energy company and was moving ahead with plans to build a pipeline to supply the increasingly energy-hungry Chinese market.
Tax Attacks
Between 2000 and 2003, Yukos paid in excess of $15 billion in taxes, amounting to an effective tax rate of 52%. Its audits had been signed off by PriceWaterhouseCoopers and, with minor adjustments in July 2003, by the Russian Tax Ministry. Nevertheless, in December 2003, the Tax Ministry began the first of what would become a series of extraordinary audits of Yukos's tax payments, reviewing Yukos tax payments for 2000.
Completed in only fifteen days, this extraordinary audit concluded that Yukos owed an additional $3.5 billion for the 2000 tax year. Subsequent audits leveled a total additional $27 billion in back tax and fines against the company, which meant that Yukos's total tax liability for the period was more than its market capitalization prior to the tax action. Combined with taxes already paid, Yukos's total liability (taxes and fines) for the period 2000-2003 became an incredible $42 billion.
Acting in concert with the Moscow City Court, the Tax Ministry justified the additional taxes and fines by inventing entirely new legal concepts, which were applied only to Yukos, and misapplying Russian tax law, notably by retroactively assigning profits made by Yukos's trading subsidiaries to the parent company (at a higher tax rate).
Yukos was given only days to pay the billions of dollars of additional claims (the authorities served the 2000 claim on April 14, 2004, giving Yukos until April 16, 2004 to pay). But the tax authorities did not even bother to wait, claiming it was unnecessary: the Moscow City Court froze all of Yukos's assets, so that the company could not restructure in order to pay down the claims, whilst simultaneously challenging their legitimacy.
Expropriation - The Seizure & Sale of Yuganskneftegaz
The spurious back tax claims, asset freezing orders and absurdly unrealistic payment deadlines ultimately led to the seizure of Yukos's crown jewel production asset, Yuganskneftegaz, in June 2004.
In November 2004, the Russian authorities announced the auction of Yuganskneftegaz would take place on December 19, 2004. This was in clear contravention of Russian law which stipulates that non-core assets must be sold first for the settlement of tax claims. Yukos had proposed to the tax authorities that the company could sell its recently-acquired shares in Sibneft, which would have allowed it to pay off most of the tax liability without affecting its core operations, but the tax authorities ignored the proposal.
At the time of its seizure, Yuganskneftegaz was responsible for over 60% of Yukos's total output. It had been valued by management at between $16.1 billion and $22.1 billion, and by Russian state-appointed evaluators Dresdner Kleinwort Wasserstein at between $14.7 billion and $17.3 billion. Nevertheless, prior to the auction, the Russian Ministry of Justice announced the value of Yuganskneftegaz was no more than $10.4 billion.
Russian authorities justified this under-valuation by leveling new tax claims totaling $4.5 billion, this time against Yuganskneftegaz itself and by threatening its production licenses, all timed for Dresdner Kleinwort Wasserstein's valuation. The authorities deducted the total additional liabilities from the lowest valuation mentioned by Dresdner Kleinwort Wasserstein.
The only participant in the auction besides Gazprom, Baikal Finance Group, was incorporated on December 6, 2004 (only weeks prior to the auction) with share capital of some $300 and headquarters in the same building as a liquor store, in Tver. Yet somehow, Baikal Finance Group was able to secure the $1 billion deposit needed to participate in the auction and financing for the $9.8 billion bid it needed to purchase the asset, against an auction starting price of $8.65 billion. Gazprom did not submit a bid.
The sham auction was denounced at the time by Kremlin Senior Economic Advisor Andrei Illarianov as the "scam of the year". Mr. Illarionov resigned from his Kremlin post in protest, asserting that Russia was "no longer politically free."
Two weeks after Baikal Finance Group purchased Yuganskneftegaz, state-owned Rosneft purchased Baikal Finance Group, its only asset being the stake in Yuganskneftegaz. Tax claims against Yugnaskneftegaz were soon dropped and threats to its production licenses disappeared.
Through this maneuver, Yuganskneftegaz was unlawfully expropriated with no consideration paid to Yukos shareholders. Artificially lowering the asset's valuation not only ensured that proceeds from the sale would remain insufficient to satisfy Yukos's tax liabilities, but also facilitated the purchase by Baikal Finance Group at a knock-down price.
It is worth noting that Rosneft subsequently included its stake in Yuganskneftegaz in its IPO for listing on the London Stock Exchange at a value close to $60 billion. Rosneft at the time described the purchase as "the most monumental bargain in Russia's modern history."
The Forced Bankruptcy of Yukos
Because of the freezing order on Yukos's assets, the company defaulted on payment of two loans from a consortium led by Société Générale, of $1.6 billion and $1 billion. Rosneft, in a confidential agreement with the consortium, agreed to purchase Yukos's debt in exchange for the consortium instigating bankruptcy proceedings, which it did on March 6, 2006. The Société Générale consortium did not inform the bankruptcy court of its agreement with Rosneft, which left the Russian authorities as the majority creditor of Yukos's estate.
Following the appointment of Eduard Rebgun as receiver, a creditors' meeting was called for June 2006. At the meeting a restructuring plan presented by Yukos that would have allowed the company to settle its liabilities and continue operating was rejected by a majority vote. At that meeting, the company was declared bankrupt; a decision confirmed by the Moscow Court on August 1, 2006.
The rejection of Yukos's restructuring plan forced a fire sale of Yukos's remaining assets, which included the production facilities Tomskneftegaz (including the Angarsk and Achinsk refineries) and Samaraneftegaz (with a further three refineries), and Rosneft shares held by Yukos, all of which were ultimately acquired by Rosneft for well below their market value.
Yukos shareholders again received no benefit from the auctions throughout 2006 and 2007 as liabilities were manufactured in order to soak up the profits from the sales. The Russian authorities paid no compensation for the expropriation of Yukos's assets.
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