FDI Magazine | 7 October 2008
Out of order
Luke Peterson examines the crisis in the international investment arbitration system.
Is there a backlash brewing against the international legal system used by states and investors to settle FDI disputes? For several years, lawyers and academics have been debating whether the current system - consisting of more than 2600 bilateral investment protection treaties - is ensuring the security and protection of investor assets and contracts without unnecessarily handcuffing the sovereignty of governments to regulate business activity within their borders.
Over the past decade, hundreds of these bilateral investment protection treaties have been sewn up, altering dramatically the power balance between investors and governments. The treaties not only protect against outright nationalisation or expropriation of foreign assets, they also oblige governments to treat foreign investors in an even-handed, non-discriminatory fashion.
A generation ago, foreign investors quarrelling with a host country might have found themselves at the mercy of local law and the local courts. However, these bilateral investment treaties opened up a different path by providing the consent of host governments to submit disputes with foreign investors to an international arbitration process. If an investor believes that its host is failing to live up to the promises contained in one of these treaties, it can swallow deeply and demand that an arbitration tribunal be created to hear such claims. While suing one’s host country is rarely done lightly, these treaties have given rise to an increasing number of lawsuits between foreign investors and their host countries.
The Washington-based International Centre for Settlement of Investment Disputes (ICSID) handles several dozen major arbitrations a year, with billions of dollars in potential damages at stake. A further, unclear number of these investor-state lawsuits takes place in other less-transparent arbitration centres around the world.
Cases run the gamut from classic nationalisation cases to more thorny regulatory disputes, where investors and governments are clashing over who should bear the cost of new environmental regulations, health and safety laws or tax measures. A number of disputes arise out of privatisation experiments - railways, refineries, electricity generators, etc - which never quite lived up to expectations.
In one of the more recent high-profile investment arbitrations to arise in recent years, a group of European-owned mining companies sued the Republic of South Africa, alleging that various elements of the country’s Black Economic Empowerment programme are at odds with commitments made to foreign investors in investment protection treaties.
The financial stakes of the South Africa suit, with potential damages running into the hundreds of millions of dollars, are eclipsed by the larger political stakes, with a signature social policy of the ruling African National Congress coming under the scrutiny of a panel of international arbitrators.
The increasing stakes of investor-state arbitrations - both in policy and financial terms - have served to highlight a series of perceived deficiencies in the current patchwork system of FDI protection.
Treaties under scrutiny
Most fundamentally, debate rages as to whether these agreements show sufficient deference to governments wishing to regulate their economies in the wider public interest. Most agree that governments should pay compensation when they confiscate or destroy assets. Few can agree, however, on how to handle other forms of state intervention in the marketplace - and who should bear the cost of new regulations or new policy initiatives.
Recently, the Canadian government moved to ban the hazardous agricultural chemical Lindane. A US company that produces that product responded by suing Canada under an investment treaty for compensation for lost business opportunities. It now falls to a panel of international arbitrators to determine whether - and to what degree - a foreign company should be compensated for such business losses.
Not surprisingly, the process by which such investor-state disputes are arbitrated - and by whom - is coming in for particular scrutiny.
A recent conference at Harvard Law School explored the backlash against investment arbitration. Professor Detlev Vagts, a man whose Harvard teaching career began in 1959 - the same year that Germany signed the very first bilateral investment treaty with Pakistan - observed that the scope of protection provided under these treaties may be “greater than the countries that signed on thought they were”.
Professor Vagts might have pointed to any number of countries where these treaties were negotiated by a handful of lawyers and brought into force without wider scrutiny by other government officials, much less the wider public.
Indeed, in widely reported comments made in 2006, Pakistan’s then attorney general, Makhdoom Khan, told a Washington gathering of investment arbitration specialists that such treaties were long viewed as “photo-op agreements” - something that governments would sign with visiting foreign dignitaries so as to provide an excuse for a photo opportunity.
“These [treaties] are signed without any knowledge of their implications. And when you are hit by the first investor-state arbitration you realise what these words mean,” Mr Khan added.
However, governments are now awakening to the concrete - and often substantial - commitments made in these treaties. And now that investors are suing governments under these treaties as a matter of course, some governments are wondering if the floodgates can be closed again.
Closing the floodgates
In May of last year, the government of Bolivia shook up the world of investment arbitration when it notified ICSID that it was withdrawing from the World Bank Centre. Bolivian government officials cited unhappiness with a succession of threats by foreign investors to sue the country at ICSID over moves by president Evo Morales to take greater control of gas and oil resources.
Although several other Latin American governments, including those of Venezuela, Nicaragua and Ecuador, have made noises about withdrawing from ICSID, to date only Ecuador has taken any steps in that direction: a modest (non-binding) statement that it does not wish to see disputes with foreign resource companies arbitrated at the Centre.
Emmanuel Gaillard, an arbitration lawyer with Shearman & Sterling, speaking at the Harvard Law School conference, stressed that Bolivia’s rejection of ICSID arbitration does nothing to invalidate the series of binding investment protection treaties that the country made throughout the 1990s. Gaillard, whose firm has represented the interests of foreign energy companies in Bolivia, reminded the Harvard audience that Bolivia’s treaties often give investors several different arbitration options.
(As if to underline Gaillard’s point, the multinational energy company Ashmore responded with the equivalent of a shrug to Bolivia’s withdrawal from ICSID, by filing an arbitration in June of this year at the Stockholm Chamber of Commerce - an alternative to ICSID provided under Bolivia’s treaty with Luxembourg.)
Pulling the plug on a dispute settlement channel like ICSID does not alter the reality that governments may have signed up to dozens of treaties which oblige them to protect foreign investment.
And, as Gaillard emphasises, it can be a much more difficult and protracted process to terminate those treaties. Often the treaties remain in force for a minimum number of years, after which a party can give notice that it plans to denounce the treaty. Even still, so-called survival clauses in the treaties may ensure that existing investments enjoy residual protection for many years after a treaty has been torn up.
Governments looking to alter course are recognising that it can take years, even decades, for current agreements to be phased out.
However, this has not prevented a handful of governments from devoting far greater care and attention to the drafting of any new treaties.
Earlier this year, Norway published a new-model investment treaty which it proposes to use in future negotiations with developing countries. The treaty reins in some of the broader protections offered in these types of treaties and also requires that foreign companies pursue claims in the local courts prior to turning to international arbitration.
The move by Norway follows earlier efforts by Canada and the US to develop revised negotiating templates, which clarified that certain types of government regulations (for example, health or environmental regulations) were a legitimate cost of doing business for foreign investors.
Any perceived roll-back of the protections accorded in earlier treaties is viewed with some scepticism by investor interests.
Indeed, Norway has found itself besieged on all sides as it pursues a more “balanced” investment treaty model. When the country’s trade ministry circulated a draft text for public comment earlier this year, business groups and public interest groups responded warily to the compromises embodied in the draft text.
While different interest groups battle over how much legal protection and immunity should be granted to foreign investors in these treaties, a parallel debate has been raging as to who should be entrusted to interpret and apply the treaty provisions in cases of disputes.
By and large, investors seem to like the arbitration model, especially when contrasted with the local courts of a given host country. However, governments - and the wider public - are starting to ask whether the treaties go too far in catapulting a broad range of legal disputes into international arbitration, thereby bypassing local courts and a country’s own constitution.
However, even where an international form of dispute settlement is accepted, there is a debate as to who should be in a position to judge such cases.
Presently, lawyers can shuttle back and forth between working as advocates on behalf of investors and states, and sitting as arbitrators charged with interpreting treaty provisions. Those in favour of this status quo like to point to the value of having arbitrators who have hands-on experience in investment disputes, and understand the technical legal considerations at play.
Playing both sides
However, the flipside is that arbitrators who also engage in advocacy are open to the criticism that they are in a position to make legal rulings (as arbitrators) which could help (or hurt) clients they represent in other matters.
Gabriel Bottini, an Argentine government lawyer speaking in a personal capacity at the recent Harvard conference, indicated that developing countries feel that there are “legitimacy” problems with investor-state arbitration as it has evolved.
One academic, Gus Van Harten, who teaches at York University in Canada, told the same Harvard conference that a permanent court of tenured full-time judges would be preferable to the current system of arbitration. “It’s a positive step for states to resort to international adjudication to resolve sensitive disputes,” he said. “But to do that properly they should ensure that the system is free from perceptions of bias.”
Mr Van Harten added: “The lack of tenure of arbitrators raises a serious concern because only the investors bring claims and so arbitrators are perceived to interpret the law in ways that often favour investors in order to advance their own careers and the arbitration industry.
“Having a proper judicial body would be good for states and their taxpayers, but it would also be good for investors because most investors will never bring a claim,” said Mr Van Harten, whose PhD thesis at the London School of Economics focused on the case for such a court. “So the benefit they get from the system comes from its legitimacy and the capacity of the system to deter abusive treatment by states. If the system is structured in a way that favours the investor interests quite patently, then that legitimacy is lost. The only real loser from a judicial body is the arbitration industry.”
Not surprisingly, many arbitration practitioners have less enthusiasm for such a proposal Doak Bishop, a Houston-based partner at the law firm King & Spalding, thinks that the current system works pretty well, and that governments appear to win more cases than investors. Mr Bishop, who represents a number of energy companies in arbitrations with South American governments and also serves occasionally as an arbitrator, expresses wariness about a permanent court whose appointees would likely be selected by governments.
“There is a substantial chance that the present ad hoc (arbitration) system that, by most accounts, has worked reasonably well would be replaced by a system that is one-sided, is perceived by investors as unfair and does not provide a real measure of protection to investments,” he says. “I think we should tread carefully to avoid creating more problems than we solve.”
It seems certain that experts will continue to debate the merits of a full-fledged court, as well as the more fundamental question of which types of protections should be extended to foreign investors. However, given the sheer number of treaties that have come into existence in recent years, the reform debate takes place not in an academic vacuum but against the backdrop of a vast network of existing (and not easily extinguished) legal agreements.
A change of nationality
Indeed, a giant question mark looming over the so-called backlash against investment arbitration is that investors have the luxury of ignoring (or detouring around) the types of “more balanced” investment treaties being developed by countries like Norway. Already, investors from dozens of countries incorporate mail-box companies in the Netherlands, so as to take advantage of an extensive (and generous) number of treaties negotiated between the Netherlands and other countries. Through this simple step, UK, US, or Norwegian investors can transform themselves into Dutch investors - at least for purposes of laying claim to the protection of Dutch investment treaties with third countries.
Arbitration specialist Michael Polkinghorne, of the law firm White & Case, says that the ubiquity of nationality-planning reminds him of a quotation attributed to Cecil Rhodes, to the effect that 99 out of 100, if given a choice of nationality, “would prefer to be Englishmen”. The only difference being that foreign investors are increasingly clamouring to go Dutch.