By Brendan Moore, Managing Consultant, Quadrant Economics^[1]

A dispute between Odyssey Marine Exploration, Inc. (“Claimant”) and Mexico (“Respondent”) concluded with an award finding that Mexico breached NAFTA Article 1105(1) by failing to grant Claimant’s investment fair and equitable treatment.  While the Respondent was ordered to pay damages to Claimant, the compensation awarded was only US$ 37.1 million plus interest, or about 1% of the over US$ 3 billion claimed by the Claimant.

The dispute stemmed from Mexico’s denial of the environmental permit for the Don Diego phosphate deposit (the “Project”) located off the coast of Baja California.  In 2012, the Claimant obtained a 50-year concession for the Project. 

Claimant’s experts asserted that Don Diego was at the development stage with demonstrated economic viability and that, but for the denial of the environmental permit, would have materialized into a commercial operation worth over a billion US dollars.  They arrived at this value by primarily using income-based methodologies – i.e., the discounted cash flow (DCF) method for Phase I and the real option valuation (ROV) method for Phase II. In addition, the Claimant included amounts relating to the alleged strategic value of Don Diego and the alleged value of the additional phosphate that would have eventually been discovered in the unexplored areas of the concession. 

Respondent’s quantum and technical experts, Quadrant Economics and Watts, Griffis and McOuat Limited (WGM), respectively, disagreed with the Claimant’s position and opined that Don Diego was at an earlier stage and that the economic viability of the Project was unproven.  Respondent’s experts explained that the area had been discovered decades earlier in the 1950s and explored by other companies prior to Claimant’s involvement − including Innophos, a major global phosphate company with a history of operating in Mexico.  Yet, these companies decided against moving forward with a commercial operation.  As explained in the expert submissions, in the eyes of a prudent willing buyer assessing the economic prospects of Don Diego, these facts would be taken into account and consequently, increase the level of uncertainty with the Project.

Based on this historical context, Respondent’s experts determined that Don Diego was an exploration stage project, not a more advanced development stage project as Claimant’s experts posited.  There was no pre-feasibility study (PFS) or feasibility study (FS), which are required under industry standards to be considered a Development Property.^[2]  In addition, the Project did not have mineral reserves, offtake agreements, and had not secured financing for development.  For these reasons, Respondent’s experts asserted that the income-based valuation method was too speculative in this case and at odds with accepted industry valuation standards.  Instead, given that Odyssey was a publicly traded company, the experts relied on the market capitalization method to calculate damages of US$ 41.5 million.

A Tribunal formed by Mr. Felipe Bulnes Serrano, Dr. Stanimir Alexandrov, and Prof. Philippe Sands rejected the use of an income approach:

• “[T]he Tribunal agrees with the Respondent that the use of an income approach – whether the DCF or the ROV methodology – to determine the FMV of an asset poses the risk of being too speculative absent a sufficient track record of profitable operations to reliably project future cash flows.”^[3] 
• “The uncertainties involved would have been considered by an informed buyer in a hypothetical transaction, and given these uncertainties, the Tribunal is not convinced that such a buyer would have accepted the income approach postulated by Claimant as a reliable method to value the Don Diego Project.”^[4]

To support its decision, the Tribunal notes that Don Diego was not a “classic” mining project and takes into account:

• “(i) what has been stated in the WGM Expert Report that underwater phosphate deposits exist in many parts of the world (Namibia, South Africa, Peru, the United States, New Zealand, et cetera); however, no mining company has been able to successfully exploit such deposits, a fact that as such is not disputed by Claimant; and (ii) the point made by Quadrant Economics that the phosphate deposits in the Don Diego Project area have been known for more than 50 years and that, although at least two other companies – including Innophos, one of the largest phosphate producers in the world – have obtained concessions to exploit the deposit, no commercial operation has ever been developed.”^[5]

The Tribunal applied the sunk cost methodology to calculate damages of US$ 37.1 million as of October 12, 2018, the date in which the environmental permit was denied for the second time.  The Claimant had calculated sunk costs as of December 31, 2020, but the Tribunal did not accept that calculation, as it included costs incurred after the second permit denial.  The Tribunal found that October 12, 2018 “appears to have marked the end of Claimant’s interest in proceeding with the Project.”^[6]

Following the issuance of the Award, Odyssey announced that “most or all” of the US$ 37.1 million would go toward satisfying its obligations to third-party funders.^[7]  With the support of third-party funders, the Claimant spent US$ 21,265,683.40 on this case, relying on submissions from more than 10 different experts.^[8]  As pointed out by Prof. Sands in his dissenting opinion, this is a “jaw-dropping figure given the relatively discrete and straightforward nature of this case.”  Prof. Sands went on to put this amount in context with other investor-state cases:

• “For broader context, a recent report has cited the mean cost for claimants in investor-State cases to be US$ 6.4 million, less than one-third of what the Claimant has claimed in costs in this case.  The Respondent’s costs amount to US$2,590,212.44, about ten per cent of the Claimant’s figure if the ICSID costs (US$400,000 paid by each Party) are taken out of the equation. Remarkably, the Claimant spent more on a single quantum expert (Compass Lexecon, paid a staggering US$2,897,657.72). No less remarkably, Compass Lexecon came up with a headline claim for compensation of US$3.1376 billion, about one hundred times more than the amount eventually awarded by the Majority (US$37.1million).”^[9]

The proceeding was held under the 1976 UNCITRAL rules and administered by the International Centre for Settlement of Investment Disputes.  Instructed by Respondent’s counsel, Dr. Daniel Flores submitted two expert reports and testified at the hearing in January 2022.  Dr. Flores was assisted by a Quadrant team including Brendan Moore, Ivan Lopez, and Dario Gatti.

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