Investor-state disputes

November 2011 | TALKINGPOINT | LITIGATION & DISPUTE RESOLUTION

financierworldwide.com

FW moderates a discussion focusing on investor-state disputes between John Whittaker at Clyde & Co. LLP, David Herlihy at Skadden, Arps, Slate, Meagher & Flom LLP, and Marco Tulio Venegas at Von Wobeser y Sierra.

FW: Have you seen an increase in disputes between governments and foreign investors operating in their country? Are emerging markets a hotbed of such conflict?

Whittaker: Yes, there has been an increase. Bilateral and multilateral investment treaties are an important framework for the protection and stimulation of foreign direct investment in the host country. Naturally, states have always looked to conclude such treaties with a view to enhancing new investment and, more recently, emerging markets have similarly been attracted by the perceived capital flows from the conclusion of such treaties. There are now about 3000 treaties in place. Capital investment in natural resources has increased substantially in the last five years. The increase in activity in this area has increased the likelihood of disputes. At the point of conclusion of an investment treaty, the focus is on the treaty benefits, particularly economic development of these emerging markets. However, eagerness to conclude such treaties can blind states to the high levels of protection granted to investors and some states, notably in South America have sought to withdraw. Emerging markets are not the only reason for the increase in disputes; other factors include greater investor awareness and a willingness to pursue claims, particularly in the context of additional triggers such as poor economic performance of investments and government austerity measures.

Venegas: The increase is due to various reasons, but mostly because of the growth in foreign investment across the globe, the rising number of investment protection treaties executed worldwide, the awareness of foreign investors with respect to their rights under international law, and the relative success of international arbitration as an effective means to resolve these types of controversies, many of them highly politicised. States with emerging economies are often involved in these conflicts and have been the usual respondents in those arbitration cases made public. Emerging economies sometimes lack the knowledge, expertise, and resources to deal with various aspects of public administration and governance, which often leads to problems giving rise to investor-state disputes. Nonetheless, states with developed economies have also been sued.

Herlihy: The main institution administering foreign investment disputes is the International Centre for Settlement of Investment Disputes (ICSID), part of the World Bank. Since 2000, ICSID has registered 300 new investment disputes, compared to just 66 in total between 1965 and 2000. 2011 looks set to be ICSID’s busiest ever year. Of the new cases registered by ICSID during the first six months of 2011, 28 percent involved countries in South America, 25 percent were based in Eastern Europe and Central Asia, 19 percent centred on Sub-Saharan Africa, 16 percent involved South and East Asia, with a further 9 percent in Middle Eastern and North African countries. In our own practice, we’ve seen a substantial upturn in new disputes involving African states.

FW: In recent years, what developments have you seen in international law governing investor-state rights, obligations and protections? How have these developments influenced claims and dispute settlement mechanisms?

Venegas: Investor-state arbitration is currently the most important area in the application of international law. Although awards are binding only on the parties involved in the dispute and do not constitute mandatory precedent, arbitral tribunal’s decisions have shaped many figures of international law. Awards are often made public and are always reviewed by academia under high scrutiny. Many articles and publications on international law criticise the decisions and arguments adopted by tribunals in their awards. Also, previous awards often influence the decision made by tribunals in subsequent cases. The Articles on State Responsibility for International Wrongful Acts, which many argue are a reflection of customary international law, have been interpreted and applied by several arbitral tribunals. To mention an example, the cases filed against Argentina have in some ways shaped the scope of the necessity defence, particularly in light of an economic crisis.

Herlihy: We are seeing a wider cross-section of investors waking up to the protections available to them under bilateral and multilateral investment treaties. Whereas this field was historically the focus of lawyers in the hydrocarbon sector, the latest data illustrate the breadth of international investment law and its relevance to all aspects of the global economy. Recent disputes involved not only oil and gas but other sectors including mining, energy, telecommunications, agriculture, finance, construction, transportation, and service. 2011 also witnessed the first ‘class action’ investment treaty claim, when an ICSID tribunal accepted jurisdiction over a dispute lodged by several thousand Italian bondholders against Argentina. Given the turmoil in the financial sector at present, many expect an upturn in investment treaty claims against other sovereigns who default on their debt.

Whittaker: One of the key recent developments in international law now concerns the role of the EU law in the investor arena in light of plans by the European Commission to kill off intra-EU investment treaties. However, this effort to create a level playing field for investment in Europe may have the unintended consequence of driving European companies that wish to invest in another European country to incorporate in jurisdictions such as Switzerland or Singapore, and thereby preserve the investor protections.

It would be a bizarre result. Other developments are not directly related to investment treaties but to sovereign immunity which may be relevant to enforcement. There is a growing divergence between countries on this issue; for example China – and now Hong Kong – has absolute immunity compared to countries such as France which treats a submission to arbitration as a waiver of both jurisdictional and execution immunity.

FW: In your experience, what are some of the common causes of investor-state disputes? What role do bilateral and multilateral investment treaties play?

Herlihy: Certain disputes arise from an outright expropriation. Recent examples include the approximately 20 pending claims against Venezuela arising out of President Chavez’s policy of nationalisation; a recent successful claim against Georgia for expropriation of an oil pipeline; and claims by the former Yukos shareholders against the Russian Federation. Most claims, however, involve state conduct which is more nuanced. Common triggers for investor-state claims include the state’s breach of an investment contract; changes to industry regulation; changes in taxation, including ‘windfall’ taxes; revocation or non-renewal of operating permits; restrictions on the repatriation of dividends; denial of justice by the local courts or administrative agencies; or discrimination against foreign firms. Investment treaties are key in such cases, because they offer a wide range of protections, including the ‘fair and equitable treatment’ standard which aims to protect investors’ legitimate expectations.

Whittaker: Arbitration cases have involved the whole range of investment activities and all kinds of investments, including privatisation contracts and state concessions. Measures that have been challenged include emergency laws put in place during a financial crisis; value-added taxes; rezoning of land from agricultural use to commercial use; measures on hazardous waste facilities; issues related to the intent to divest shareholdings of public enterprises to a foreign investor; and treatment at the hands of media regulators. Probably the greatest challenge is reconciling the civic duties of a government in terms of raising revenue during times of economic difficulty against the reasonable expectations of investors who are looking for a consistent fiscal regime.

Venegas: Investor-state disputes have a wide variety of causes including the implementation of decisions adopted during an economic crisis; treatment provided to a foreign investor by the judiciary; tax measures; preferential treatment of domestic investors; corruption of public officials; lack of predictability in the domestic legal framework; and, of course, direct takings or expropriations. Bilateral and multilateral investment treaties play a major role in investor-state arbitration. Through these treaties states consent to submit their disputes with foreign investors in the event that any provision of the treaty itself is breached. The usual rights conferred to investors in these treaties are: prompt, adequate and effective compensation in the event of a direct or indirect taking; national treatment; most favourable nation treatment; fair and equitable treatment; and full protection and security. Different tribunals have shaped the meaning of these different rights in various manners, sometimes with contradictions.

FW: What general advice would you give to an investor that finds itself embroiled in a dispute with a foreign government? What factors should be considered when deciding whether to stop negotiation efforts and begin an investor-state arbitration? Is retaliation from the state common?

Whittaker: As with any legal advice, the answer depends on the facts. Generally, the first consideration ought to be the protections offered under the investment treaty governing the dispute and the rules under which that dispute would be conducted. As an investor claimant, this is the framework within which every decision must be made. Whether and when to move from the negotiating table will depend on the state party’s ability to put forward a realistic pre-action offer. It would be wrong to rush into an arbitration which can be protracted and expensive and may have longer term implications for a company wishing to maintain good relations with the host state. Every effort should be made to resolve the dispute by negotiation, including diplomatic means. According to PricewaterhouseCoopers, 38 percent of investor claims are settled before arbitration. This consensual approach makes sense both economically and reputationally – no state will want to lose out financially and neither will a state wish to be seen as an easy target in relation to investment disputes.

Venegas: Investment arbitration is a specialised field that requires advice from counsel with experience in handling these types of cases. Domestic remedies sometimes exclude remedies under international law and vice versa, so it is important to receive this advice at the early stages of the dispute. Investor-state disputes are often politicised and they must be handled with the utmost precautions. Arbitration cannot be rushed and settlement negotiations should be exhausted. If it is clear that the state is not willing to compromise, then arbitration should be considered, and the pros and cons evaluated. An investor must always have in mind that effective representation in investor-state arbitration could cost a few million dollars, and that receiving non-effective advice at a lower cost can lead to more troubles, and damage the relation with the state even more. Finally, retaliation from a state being sued is not common, but it depends on a case by case basis. Particularly in countries with smaller economies, retaliation could exist.

Herlihy: Plan ahead. Well-advised investors hedge against state interference by structuring their investment in a way that takes advantage of an investment treaty signed by the host state. But this is best done at the outset – when the investment is made, or during its operation – and before the state takes action against the investment. When a dispute arises, seek legal counsel early. This will reduce the risk of making statements, or generating internal documents, which might prove to be harmful in a subsequent arbitration. Investors sometimes fear that filing a claim will worsen their position, but in our experience the opposite is often true. Many times politicians defer hard choices, or the decision-making structure within the state can be slow and rigid, leading to fruitless negotiations over months or years. Although it is always best to resolve a dispute through negotiation, if possible, the filing of a claim can sometimes bring the state to the table. Each case, however, turns on its specific circumstances including the particular government involved.

FW: Could you provide a general overview of the types of international arbitration available to resolve investor-state disputes?

Venegas: International arbitration can be categorised under different criteria. A common criterion is to distinguish between institutional and ad hoc arbitration proceedings. Institutional arbitration proceedings are managed by an international institution under a predetermined set of rules, while ad hoc proceedings are not. Nonetheless, although ad hoc arbitration is not monitored by an institution, the proceedings in this type of disputes are usually followed under the arbitration rules of the United Nations Commission on International Trade Law (UNCITRAL). The role of administrating institutions is limited to the organisation of the proceedings. Arbitral institutions do not deliberate or render awards. This task is exclusively left to the arbitrators working alongside the institution.

Herlihy: Foreign investors benefit from three main routes to international arbitration. First, they can include an arbitration clause in their contracts with the host state. A second and more common path to arbitration is to invoke a bilateral or multilateral investment treaty between the host state and the investor’s home country. There are more than 3000 such bilateral investment treaties (BITs) worldwide. The right to arbitrate under those treaties exists irrespective of whether or not a contract has been signed between the investor and the state. Any qualifying investor under a BIT can have its dispute resolved by an independent tribunal under one of the main institutional rules, for example ICSID, UNCITRAL or the Stockholm Chamber of Commerce. A right to international arbitration sometimes exists also in states’ domestic investment laws – these need to be checked alongside the applicable treaties.

Whittaker: The basic elements of the types of international arbitration rarely differ to a significant extent. A vast majority of investment treaties offer, as a central protection element for the investor, the possibility of resorting to international arbitration under ICSID or ad hoc arbitration using the UNCITRAL rules. Sometimes, investment treaties do not even require recourse to the national courts of the host country. Other arbitration frameworks include ICC, SIAC and LCIA. Similar types of dispute settlement provisions can also be found in concession contracts, privatisation schemes, stabilisation agreements or ordinary state contracts, whereby an alleged violation will not be heard by a national court but by an international tribunal.

FW: What is the average cost and duration of an investor-state arbitration proceeding? When it comes to damages and awards, is it often a challenge for winning parties to receive due payments from the losing party?

Herlihy: Investor-state disputes are often slow and expensive, although ultimately effective. Many claims achieve a successful outcome before the hearing: 38 percent of ICSID claims have been settled or otherwise discontinued. The remaining 62 percent were decided by a tribunal. The length of an investor-state arbitration will vary according to the facts and legal issues. A recent study of 115 ICSID cases found that the average length from the request for arbitration until the tribunal’s award was 3.6 years. If there is no challenge to jurisdiction, the timeline is likely to be shorter. Historically, virtually all investor-state awards were paid voluntarily by the losing state. Most states still pay when so ordered by a tribunal. But in an increasing number of cases, investors are having to take enforcement proceedings against commercial assets of the state to satisfy their awards or trigger a settlement. This is a challenge but often a surmountable one.

Whittaker: On a broad basis the duration is likely to be three to four years; shorter if there is no jurisdictional challenge. The cost will depend on the case, but pursuit of these claims will be a substantial investment. Enforcement difficulties appear to be confined to particular states rather than being a general problem.

Venegas: The answer to this question varies on a case by case basis. Sometimes, cases are charged depending on the time counsel spends in the defence of its client, and the duration of the proceedings could certainly be a factor determining counsel’s fees. In other occasions, both investors and states require a predetermined fee to be charged by its counsel at certain stages of the proceedings. The average duration of an investor-state arbitration ranges between two to five years, but there are exceptional cases that have lasted more than a decade. The average cost of these proceedings ranges from $3m to $15m and in some exceptional cases even more. The vast majority of states condemned by arbitral tribunals in their awards have ultimately paid. The economic and political consequences of not paying this compensation could be considerable. Also, it sends a bad signal to possible future investors in the country.

FW: What lessons can be learned from recent arbitration decisions in this area?

Whittaker: The main point to draw from recent developments is that certain governments do feel that they are becoming easy targets for investor challenges and are therefore strengthening their dispute resolution capabilities to meet the increase in these challenges. Having seen this occur, other states, such as African states, beginning their first substantial forays into investment treaty negotiation, will do well to closely consider the protections offered in these investment treaties and the obligations that such treaties impose on states. There are long term obligations which cannot easily be reshaped. It may also be the case that this re-think forces states to consider the actual benefits of investment treaties when reports indicate that investment treaties do not seem to have increased flows of investment and that countries that had concluded an investment treaty were no more likely to receive foreign investment than were countries without such a pact.

Venegas: International law is constantly developing, sometimes through the adoption of different views on the same issue by prominent legal authorities sitting as arbitrators. The fact that the vast majority of decisions are made public has widely increased the relevance and usefulness of international law, and has updated many programs at law schools worldwide. International law remedies are now available to several foreign investors suffering from the arbitrariness of the governmental authorities in power at the place they do business. Governmental authorities are now aware that they could be subject to arbitration and are exposed to liability in the way of compensation for their unlawful acts. States commonly refuse the jurisdiction of arbitral tribunals, making proceedings more costly and lengthier. Irrespective of this, several foreign investors have been compensated for the damages they have suffered and the system has proven to be successful to them.

Herlihy: My advice would be to plan ahead and structure your investments to maximise treaty protection. Periodically review your existing investments to see if they qualify for treaty protection and, if they do not, find out what can be done to improve their standing. Once a dispute arises, consult counsel early in the process. Finally, think outside the box. Clients sometimes focus on their contractual rights and have no idea that they also benefit from valuable international treaty rights, including fair and equitable treatment, non-discrimination, free repatriation of dividends, guarantees against uncompensated expropriation and the right to resolve disputes through a neutral, international tribunal.

John Whittaker is a partner at Clyde & Co. LLP. His primary focus is international arbitration and disputes arising from international trade under public international law. Mr Whittaker works closely with the firm’s international offices, particularly in Russia and Asia. He has handled disputes before many arbitral bodies such as LCIA, ICC, trade bodies and foreign tribunals. This includes a number of significant cases in the countries of the former Yugoslavia, Russia and S E Asia. He can be contacted on +44 (0)20 7876 5000 or by email: john.whittaker@clydeco.com.

David Herlihy is counsel in the International Arbitration Group of Skadden, Arps, Slate, Meagher & Flom (UK) LLP. He has successfully represented both investors and states in all aspects of investment arbitration, including ICSID and UNCITRAL arbitrations under investment contracts, BITs, the Energy Charter Treaty and the ASEAN Investment Agreement. He is also one of the few counsel worldwide to have defended both revision proceedings and annulment proceedings under the ICSID Convention. Chambers UK 2012 describes Mr Herlihy as “frankly outstanding.” He can be contacted on + 44 (0)20 7519 7121 or by email: david.herlihy@skadden.com.

Marco Tulio Venegas is a partner at Von Wobeser y Sierra. His area of practice includes constitutional and administrative proceedings; commercial litigation; industrial and intellectual property; national and international commercial arbitration; and tax advice and litigation. Mr Venegas is fluent in Spanish, English and French. He can be contacted on + 52 (55) 5258 1008 or by email: mtvenegas@vwys.com.mx.

THE PANELLISTS

John Whittaker

Clyde & Co. LLP

David Herlihy

Skadden, Arps, Slate, Meagher & Flom LLP

Marco Tulio Venegas

Von Wobeser y Sierra