Trapped in Tbilisi

Last October an oil trader and would-be pipeline mogul named Rony Fuchs received an unusual invitation from Nika Gilauri, the Prime Minister of Georgia. Gilauri asked Fuchs to visit Batumi, a resort on the Black Sea, "to finalize the settlement" of a $100 million commercial dispute—money that Fuchs had been demanding from the Georgian government for almost 15 years. "Such a meeting will avail us of the opportunity to discuss all the details and will undoubtedly positively affect amicable solution of the matter," the Prime Minister wrote in English. The stationery bore the official seal and letterhead of the former Soviet republic, and Gilauri had signed it with a looping flourish. Fuchs decided to make the trip. The Israeli businessman has investments in Turkey and serves as a Turkish honorary consul, a position combining economic development with off-the-record diplomacy. He worked as an energy trader in New York for 15 years and counts Israeli President Shimon Peres as a friend. Based on decades of experience at the murky crossroads of trade and politics, Fuchs interpreted Gilauri's letter as a signal that Georgia was finally prepared to resolve a controversy that traces that country's chaotic history since its separation from Moscow in 1991.

Going into the meeting in Batumi, the Israeli thought he had a strong hand. In March 2010 an arbitration panel in London had ruled that the Tbilisi government owed Fuchs and a Greek investing partner $98 million, plus interest, for an oil project Georgia had expropriated in the mid-1990s. Georgia, unsurprisingly, wasn't eager to pay up and sought to appeal the binding judgment. In September 2010, Fuchs met with Georgian representatives in a luxury hotel room in Istanbul to discuss a settlement. After nearly four hours of bluster and copious consumption of cognac, they reached a verbal deal: Rather than continue the legal fight, Georgia would pay a reduced sum of $72 million—on one critical condition. Fuchs agreed to return $7 million out of the $72 million to Georgian officials in an under-the-table side payment. Call it a sweetener or a kickback or baksheesh—whatever the terminology, this is not the ethics taught at Harvard Business School. That did not stop Fuchs. And now he had the Prime Minister's personal invitation to close the deal. All he had to do was travel to Batumi, shake hands in front of Georgian TV cameras, and sign a few pieces of paper to make it all official.

It would not be that simple. When Fuchs and an Israeli colleague, Ze'ev Frenkiel, arrived in Batumi on Oct. 14, they were toasted at an elaborate supra, or feast, organized by the Georgian Finance Ministry. Just as the signing ceremony was to begin, a deputy minister asked Fuchs to speak privately upstairs in the restaurant, purportedly to clarify details of the press announcement. While his attorneys were distracted by other government officials in the downstairs dining room, Fuchs and Frenkiel were told they were under arrest. The letter from Gilauri had been bait—part of a three-month Georgian sting operation. The liquor-fueled meeting in Istanbul had been recorded on a video camera hidden in an innocent-looking hanging plant.

Fuchs and Frenkiel were escorted to separate rooms, searched, relieved of their passports, and interrogated on videotape. The tape shows Fuchs, a bulky man in a dapper gray suit, glaring at a Georgian prosecutor going through his wallet, counting out bills in various currencies. The prosecutor methodically transfers Fuchs's belongings to a clear plastic evidence pouch. Two grim- looking security agents crowd the defendant. Mopping his brow with a folded white linen napkin, Fuchs turns to his right to stare bleakly out a window.

Since its brief, disastrous war against Russia in 2008—a conflict sparked by rivalry over two breakaway Georgian regions—the Tbilisi government has redoubled efforts to woo outside business. It is not an easy sell. The country, slightly smaller in area than South Carolina, has a population of 4.6 million, including about 200,000 people displaced by the Russian conflict. Its per-capita gross domestic product of $4,400 ranks 149th in the world, having contracted 7 percent in 2009. In the last two years, Georgia has staved off economic devastation as a result of postwar international aid that will ultimately total $4.6 billion, including $1 billion from the U.S.

Given its size, the country commands what might seem like a disproportionate amount of attention in Washington and other Western capitals. That is explained, in large part, by its location. Georgia controls strategically important ports on the Black Sea and much of the Caucasus Mountains, which form part of Russia's southern border. Tbilisi's government is as democratic as any in its region and is more pro-American than its neighbors'. The main road to the Tbilisi airport is named President George W. Bush Street.

Although much of the Georgian country- side is poor, hilly Tbilisi boasts thriving residential enclaves, broad commercial boulevards, charming restaurants and galleries, and stolid Orthodox Christian churches that never entirely knuckled under to the Communists. Tbilisi also has a florid tradition of cronyism and graft. In the past year it has spent heavily on advertising on CNN (TWX) and the BBC to promote its reform attempts. An ad campaign running in The Wall Street Journal describes Georgia as "the world's number 1 in fighting corruption."

Others are not so sanguine about the Georgian business climate. A May 2010 report from the nonprofit Transparency International accused the Tbilisi government of practicing "tax terrorism": using its Financial Police to intimidate businesses and even throw employees in jail as a way of collecting additional revenue and fines. "The government is too quick to resort to incarceration for what would be seen in the West as minor civil and tax matters," says David Lee during a conversation in the ornate lobby of the Tbilisi Marriott (MAR). The president of the American Chamber of Commerce in Georgia, Lee is also the general director of Magticom, a privately held, American-owned company that is the largest telecommunications operator in Georgia. He describes "several cases" in just the past year in which employees of foreign-owned companies have been jailed without trial for periods of up to several months. Locally owned businesses are even more vulnerable, he says.

Worried about irritating Georgian officials, Lee hastens to accentuate the positive: "Compared to many of its neighbors in the region," he says, "this country has been remarkably successful in cleaning up corruption." Asked what message the Fuchs episode sends, Lee sighs. "That case," he responds, "isn't doing anyone any good."

After their arrest on Oct. 14, Fuchs and Frenkiel were driven to jail cells in downtown Tbilisi. Denied bail, they have remained behind bars for more than five months. Each is allowed three 15-minute phone calls to family a month. The two spend Mondays, Wednesdays, and Fridays in a chilly, dimly lit Tbilisi courtroom on trial for bribery. If convicted, they face up to eight years in prison.

Fuchs has impressive legal talent on retainer: In addition to a prominent Georgian law firm, his team includes President Barack Obama's former White House counsel Gregory B. Craig, now a partner in Washington, D.C., with Skadden, Arps, Slate, Meagher & Flom, and Geoffrey Robertson, a Queen's Counsel in London simultaneously representing Julian Assange in the WikiLeaks founder's effort to resist extradition to Sweden. Still, the odds are not with Fuchs and Frenkiel. In 2010, 99.96 percent of defendants prosecuted in the Tbilisi courts were convicted, according to statistics analyzed by, a Georgian news website.

There is one way Fuchs could get out of jail immediately: renounce the arbitration judgment. According to his lawyers, a Georgian Justice Ministry official privately told the Israeli ambassador to Georgia in October that all Fuchs had to do to win his freedom was relinquish the $100 million claim.

Fuchs refused. "We are being held hostage here, and the Georgian government wants a $100 million ransom. We will not pay it," he told a reporter attending court in Tbilisi last month. Barred from talking to journalists, Fuchs conveyed the message via his lead local lawyer, Archil Kbilashvili. A knowledgeable diplomat in Tbilisi confirmed the Georgian offer to free Fuchs in exchange for nullification of the award; this person requested anonymity to avoid angering the government.

Whatever the result of Fuchs's trial and a potential appeal, his story illustrates the unpredictable danger of commerce in Georgia and the rest of the former Soviet empire. Fuchs claims he was entrapped by a government determined to evade an expensive legal judgment. "Anyone thinking about doing business in Georgia should be forewarned," his attorney Craig says. "You do so at your peril."

Georgian prosecutors, in stark contrast, describe the case in terms of routine law enforcement. "It is not true that a government representative has asked for the waiver of the award," says Davit Sakvarelidze, Georgia's first deputy chief prosecutor. Instead, he says, the Office of the Chief Prosecutor has identified "the preconditions for any settlement: guilty plea, cooperation with the investigation, and rectification of the damage incurred to the state"—a reference to a financial penalty that presumably would be covered by dropping the arbitration claim. "These are regular preconditions provided by the criminal legislation of Georgia," Sakvarelidze adds. He portrays the Fuchs prosecution as part of a larger initiative to clean up the hard-knock country and make it more appealing to honest foreign investors. "We have very strong evidence supporting the charges," he says. "We believe this case, the true facts of the case, not the speculations of Mr. Fuchs, shows once again that Georgian government takes fight against corruption very seriously."

Sitting in courtroom No. 2 of the Tbilisi City Courthouse, a yellow pillared building refurbished with American aid dollars, Fuchs seems remarkably composed. Bearing a resemblance to a younger William Shatner, he wears a dark blazer over a white dress shirt with an open collar. His wavy salt-and-pepper hair is far longer than before his arrest. He suffers from heart problems, and Georgian authorities have denied him access to medications from Israel, substituting other medicines, his lawyers say. While he has lost weight, he appears vigorous. He whispers avidly during the proceedings to his attorney, Kbilashvili.

Fuchs was born and raised in Haifa. He served three years in the Israeli army and graduated from the University of Haifa with an economics degree, according to Orna Asia, his younger sister and only sibling. After working for several years for his father's marine-survey company, he spent his late 20s and 30s in oil-trading jobs in New York. Fuchs has three grown children in Israel; his ex-wife lives in Miami. "Rony talks to everyone—politicians and the doorman of his apartment building" in Tel Aviv, his sister says. "He has so many projects, so much energy."

Most of those projects have to do with buying and selling sources of energy. In 1991, Fuchs was introduced by a Georgian-born member of the Israeli Parliament to representatives of the newly independent Tbilisi government. A prosperous trader then in his early 40s, he aspired to the top tier of Israel's business elite. And he correctly identified a tremendous opportunity created by the demise of the Soviet Union. Georgia was seeking foreign investors to repair and expand decrepit Soviet-era facilities to transport Caspian oil and gas from underexploited fields in Azerbaijan westward to outlets on the Black Sea. Although he had not attempted something on this scale before, Fuchs said he could raise the capital and provide the leadership to get the trans-Georgian pipeline and port facilities working. Desperate for cash and impressed by Fuchs's drive, officials of the Georgian state oil company, Sak- Navtobi, formed a joint venture with Tramex International, a corporation Fuchs co-owned with Ioannis Kardassopoulos, a Greek businessman.

It would not be a smooth collaboration. The abrupt ouster of Georgia's first post-independence President interrupted the venture's launch. But Fuchs didn't give up, according to the three-person arbitration panel convened by the International Centre for Settlement of Investment Disputes (ICSID), an affiliate of the World Bank. While other investors abandoned Georgia, Fuchs told the panel: "We don't leave the country. We come back, and they see that we were serious."

In 1993 the Georgian government ratified a 30-year exclusive concession under which the joint venture would oversee and operate the country's energy transportation network: pipelines, storage facilities, and rail stations. Redesign and repair work commenced. Fuchs hired local contractors and spent considerable time himself in Georgia. By 1995, Tramex had invested capital of more than $12 million in the project, according to Fuchs's lawyers.

Then, gradually, uncertainty and unrest brought work to a halt, according to the ICSID panel. The venture "was clearly encumbered at different points due to security concerns, including theft of project materials and insurgent fighting in certain regions proximate to project sites." The main reasons Tramex's commitment waned, however, were "rumors and steps taken within the Georgian government" calling into question the joint venture's exclusive pipeline rights, the tribunal concluded.

By this time, Eduard Shevardnadze, a former Soviet Foreign Minister under Mikhail Gorbachev and, before that, leader of the Georgian Communist Party, had taken over as head of state. In 1995, Shevardnadze was elected President and soon began negotiations with a consortium of large Western energy companies eager to do business in the Caspian region. The potential value of a modernized pipeline across Georgia was growing rapidly. Fuchs had been prescient—but the sums that stood to be made were now so large, and the international politics so complex, that it was unlikely that a small operation like his would retain a leadership role. To clear the way for doing business with the multinational consortium, the Shevardnadze government issued a decree in February 1996 terminating all energy rights granted earlier to any parties. "This," the arbitration panel said, "brought to an abrupt end" Fuchs's adventure in the Caucasus.

Having one's investment nationalized or expropriated is a fundamental risk of trying to profit in a volatile emerging market. Fuchs knew that, but once it happened to him, he and his Greek partner demanded to be made whole: paid cash for the opportunity that had been summarily taken away from them. The Shevardnadze government repeatedly signaled that "proper compensation would be paid," the panel found.

It was not paid. For years, while he pursued other trading in Turkey and Israel, Fuchs met with Georgian officials to try to negotiate a settlement. The talks proved fruitless. Fuchs retained the New York consulting firm Kissinger Associates, and in January 2003 the firm's chairman, former U.S. Secretary of State Henry Kissinger, wrote to Shevardnadze on Fuchs's behalf. Kissinger also dispatched a colleague from his firm to meet with Georgian officials in Tbilisi. "Shevardnadze accepted what Dr. Kissinger wrote to him," Fuchs told the panel, "and everything was on the verge of solution."

Reached by telephone at his home in Tbilisi, Shevardnadze, 83, says he doesn't want to revisit old controversies. In a separate interview, his former chief of staff, Peter Mamradze, says that when Shevardnadze first decided to do business with the multinational consortium, the ex-President didn't know about the exclusive rights that had been granted to Fuchs and his partner. "This reflects how chaotic and disorganized Georgia was at that time," Mamradze says.

In any event, political events intervened again. "There was the Rose Revolution, whatever they call it," Fuchs told the arbitration panel, "and everything [was] upside-down."

Named for flowers that protesters carried in Tbilisi's Freedom Square, the Rose Revolution ousted Shevardnadze in November 2003 after he was accused of election-rigging. The revolt empowered Mikheil Saakashvili, an English-speaking opposition leader who had studied law at Columbia University and worked as an intern for the New York firm Patterson Belknap Webb & Tyler. After winning the Presidency in 2004, Saakashvili led an effort to promote the rule of law—by, for example, ending payoffs to judges. He showed no public sympathy, however, for the Fuchs-Kardassopoulos claim.

Invoking treaties between their home countries and Georgia, the investors took their complaint to the ICSID, beginning in 2005. Fuchs secured financing for the litigation from Allianz, the German insurance and banking company. The ICSID panel's 218-page decision last March offered the claimants' powerful vindication: the $98 million award—now exceeding $102 million with interest, according to Fuchs's attorneys—reflects foregone profits and considerable legal costs. "The Georgian government's repudiation of any liability towards the claimants," the panel concluded, "was a clear breach of their rights under international law."

Such a ruling is enforceable in the same way a U.S. federal court decision can be made to stick: If the losing party fails to pay, the winners seek to "attach" their assets. Unless, of course, things get hung up on appeal.

After losing the arbitration, Georgia hired a new law firm, New York-based Dewey & LeBoeuf, and sought to get the ICSID to set aside the award. Dewey also commenced negotiations with Fuchs's attorneys in the London office of Skadden Arps. Avenues for appeal of an international arbitration award are narrow, but Georgia's lawyers indicated the country would fight to the end—unless Fuchs and his partner would accept a sharply reduced settlement. Armed with the generous ruling, Fuchs was not receptive to settling for mere pennies on the dollar.

Georgia wasn't content to let the high-priced lawyers hash it out, however. While the outside attorneys skirmished, the Tbilisi government opened a direct line of communication with Fuchs. In August the Finance Ministry assigned a 30-year-old official named Avtandil Kharaidze to make the contact. In an affidavit dated Sept. 2, 2010, Kharaidze reported that he identified a "Jew businessman acting in Georgia [who] had tight relations with Rony Fuchs." That intermediary was Ze'ev Frenkiel, an Israeli formerly employed by Fuchs in Georgia. Kharaidze met Frenkiel, who agreed to serve as a middleman. According to the Georgian's affidavit, Frenkiel told him that "Rony was ready to pay me 5,000,000 USA Dollars as a bribe providing this deal would be finished with the result beneficial to him, and this statement was showed by him [Frenkiel] with his palm open in five fingers." Kharaidze added: "I for show agreed with Ze'ev Frenkiel and told him that if he helped me to receive this bribe I would give him [the] sum 500,000 USD as a mediator."

Kharaidze concluded the affidavit, which was addressed to Georgia's Chief Prosecutor, by volunteering to go undercover. "I am ready for collaboration with the investigation," he said, "and to render a helping hand in revelation of the people committing the crime." English translations of Georgian-language court documents were provided to Bloomberg Businessweek by Kbilashvili, the attorney who is representing both Fuchs and Frenkiel. A partner with the Tbilisi corporate law firm Mgaloblishvili, Kipiani & Dzidziguri, Kbilashvili says that Fuchs never authorized Frenkiel to offer a bribe. "This is a lie," the defense lawyer says. Frenkiel insists it was Kharaidze who raised the idea of a kickback—and then a 10 percent commission on the kickback, Kbilashvili says.

The sting accelerated quickly. "According to the investigation plan, on 14 September, 2010, I traveled to Istanbul to meet Rony Fuchs and Ze'ev Frankiel," Kharaidze reported in a statement dated three days later. In other words, the Georgian official went to Istanbul primarily to investigate, not negotiate—thus the secret camera concealed in the hotel room plant. On that morning the three men, along with a Georgian government translator, gathered in a sunny suite at the InterContinental near the famous Blue Mosque. The Georgian government's undercover video, obtained by Bloomberg Businessweek from defense lawyers, shows the quartet sitting on a red couch and adjacent easy chairs, surrounding a table crowded with liquor bottles and Middle Eastern snacks. Kharaidze, dressed in denim jeans and a blue button-down shirt, positions himself with his back to the camera; Fuchs, wearing a sweater draped casually over his shoulders, sits squarely in the middle of the camera's frame.

What follows is a rambling four-way conversation conducted in Russian, English, Georgian, and Hebrew. No one seems terribly shy about the idea of Fuchs paying Kharaidze, and possibly others, millions of dollars as a way to smooth a settlement. About 50 minutes into the InterContinental session, Kharaidze makes the first explicit reference to the side payment, apparently demanding that the amount be increased. "With regards to this whole scheme," he says, "the $5 million that has been said should be increased to $7 million."

The Georgian's comment suggests that "the $5 million" had been discussed before—and no one contradicts him. Instead, Fuchs inquires with equanimity whether the kickback, whatever its size, is to come out of the larger settlement amount. He is told yes.

That point established, Kharaidze announces, "Let's have another drink now." Fuchs, who has resisted earlier toasts, noting that it's only mid-morning, reacts with irritation. "In which round do we get to the truth?" he demands.

"It obviously depends on you," the Georgian responds.

"Too early in the morning," Fuchs says. "I took my children out until 1 o'clock." He then steers the exchange in a friendly direction, recommending the restaurant and disco his family patronized the night before. And, as the Georgian representative has requested, glasses are raised again.

A little while later, Fuchs asks the Georgian whether paperwork can be generated to make the side payment look legitimate. "Do we get an invoice?" Fuchs asks. "I don't have to explain what happens with this," he continues, "but I have to show it to the Germans, to the lawyers, because they are calculating our costs." He is apparently referring to Allianz and Skadden Arps.

Trying to be helpful, Fuchs further suggests an approach he says he employed in a separate deal. "I had another country—we had a case—where there was an account of the party, governmental party or something, and then we gave it as a donation to the party." The Israeli elaborates: "We got a receipt: 'Thank you for the donation.' But we know the money went to the people."

(Asked about Fuchs's apparent willingness to launder the earlier kickback as a political donation, his attorney Kbilashvili responds: "Rony thinks it possible the returnable money is to be returned to a governmental organization or governmental party. Under the Georgian law, neither of the two acts constitutes bribe offering." Kbilashvili says he doesn't know anything about the deal his client described with "another government.")

The notion of fabricating a fake political contribution fades as Kharaidze presses Fuchs to make clear what settlement and side-payment amounts he has in mind.

Running out of patience, Fuchs at one point snaps, "100," indicating sarcastically that he will settle for the full $100 million. At another point he indicates he feels as if he is being shaken down. "Do you want more?" he demands. "What, is this your money? That's not your money. That's my money."

Eventually, a compromise is forged: Fuchs and his partner will receive $72 million, and out of that they will return $7 million to Kharaidze and his unnamed associates. The Georgian official makes a show of calling his superiors in Tbilisi on his cell phone and receiving approval for the deal. "The main thing in this case has happened," he says to the others in the hotel room.

Five months later, in the Tbilisi City Courthouse, the maroon-robed Judge Vazha Pukhashvili is hearing a motion by defense attorney Kbilashvili. The lawyer argues in Georgian that the government's main evidence—the covert video from Istanbul—ought to be excluded because prosecutors misrepresented its provenance. The government, he says, described the video as an amateur production arranged by Kharaidze, a Deputy Finance Minister. The defense seeks to introduce testimony by an expert witness from London who will say that the highly proficient videotaping had to have been done by surveillance professionals. Fuchs's lawyers contend that Kharaidze is actually an Interior Ministry operative who was reassigned to the Finance Ministry specifically to ensnare Fuchs and get the arbitration award cancelled.

The judge is having none of it. As the three-member prosecution team looks on impassively, he rules that the proposed expert was hired by Skadden Arps in violation of Georgian legal procedures. The motion is denied.

Kbilashvili says later outside of the courtroom that he was not surprised by the judge's ruling. Practically every decision from the bench has gone against the defense, he says, including one denying a motion seeking to subpoena Prime Minister Gilauri. The defense lawyer wanted to ask Gilauri about his role in inviting Fuchs to the Oct. 14 signing ceremony-turned-arrest in Batumi. That's not going to happen, the judge ruled. (Kardas- sopoulos was also invited to Batumi but wisely stayed away.)

"We will fight and fight for Rony, but this is tough," says Kbilashvili, a hyperactive 39-year-old attorney who often carries on two conversations simultaneously, one in person and one via cell phone. He has strong connections in Georgian government and business circles—and few illusions. "It seems we know where this goes," the lawyer adds.

In recent months, Israeli President Peres has telephoned Georgia's Saakashvili to ask that he review the case. Israel's Foreign Minister, Avigdor Lieberman, has written to his Georgian counterpart in a similar vein. The Georgians have responded politely but noncommittally, according to Kbilashvili and a diplomat familiar with the exchanges. The trial is expected to continue in March, with a verdict from Judge Pukhashvili later in the month or in April.

Mamradze, the former Georgian Presidential chief of staff, says he doubts Fuchs and his co-investor deserve anything close to $100 million. "They did absolutely nothing" during their time in Georgia in the early 1990s, he says, despite the findings to the contrary by the arbitration panel. On the other hand, Mamradze acknowledges that the unfolding trial is an embarrassment for his country and will hurt Georgia's reputation. According to Israeli media reports, business leaders there are warning investors to steer clear of Georgia. The Fuchs case has "made a lot of people furious around the world," he says. "The damage is huge." Now that the Georgian government has allowed its sting to blossom into a full-fledged trial, it would be difficult to compromise without admitting that the country's criminal justice system has been used as a tool in what amounts to a commercial disagreement.

Any consternation suffered at the higher altitudes of Georgian officialdom can provide only slight consolation, at best, to Fuchs in his cell. Neither can he find comfort in a thought that occurs to his worried sister, Orna, back in Tel Aviv. If he had never gone to that Istanbul hotel room at all, she notes, but had left this mess in the hands of his attorneys, Fuchs would not be eating dinners prepared by the Tbilisi jailhouse kitchen. "I wish Rony did not go to Turkey," Orna says. "It was a trap, and they sure got him."

    Before it's here, it's on the Bloomberg Terminal.