The New Face of Investment Arbitration
THE NEW FACE OF INVESTMENT ARBITRATION*
Like many other industrialized nations, the United States has traditionally favored arbitration for resolution of investment disputes with foreign host states, particularly with respect to expropriation claims. The past decade, however, has seen a noticeable sea change in outlook. Congress has enacted trade legislation giving evidence of an intention to restrict arbitration in investment treaties. And open criticism of investment arbitration has been voiced by significant elements of the media, as well as advocacy groups that focus on environmental and regulatory issues.
The cause of this attitude shift is not difficult to find. In 1994 the North American Free Trade Agreement (NAFTA) entered into force,1 bringing with it an adjudicatory regime that gives investors the right to require arbitration of disputes arising out of investments in another member country, in connection with matters such as expropriation, discrimination, and unfair treatment. The United States and Canada each became respondents pursuant to claims brought by investors from the other country.2
The result was an awareness of the downside of arbitration, including the prospect that key economic and political matters would be decided in confidential proceedings by a tribunal consisting in majority of foreigners. In the United States, however, the new face of investment arbitration caused a shiver of apprehension. Media attacks and legislative initiatives were launched with the aim of hobbling the neutral adjudicatory process which for years had served to underpin investor confidence in the protection of investments abroad.
This chapter suggests that arbitration under investment treaties such as NAFTA will enhance the type of asset protection that facilitates wealth-creating cross-border capital flows, bringing net gains for both host state and foreign investor. While there may be benefits from minor tinkering with this investment protection regime, general attacks on investment arbitration are likely to backfire, creating for all countries involved more problems than they solve.
B. The Contours of Investment Arbitration
NAFTA brings investment arbitration full circle, to a time more than two centuries ago when the United States was principally a debtor nation. In 1794 the so-called “Jay Treaty” (named for its American negotiator John Jay, later Chief Justice of the U.S. Supreme Court) gave British creditors the right to arbitrate claims of alleged despoliation by American citizens and residents.3
More recently, however, it was African and Latin American nations that were required by multinational corporations to submit investment disputes to arbitration, either through arbitration clauses contained in custom-tailored concession agreements or through bilateral and multilateral investment treaties.4 Such arbitration has often implicated natural resources and elements of industrial infrastructure no less critical to the economic sovereignty and well-being of those countries than the NAFTA cases that have caused controversy in the United States and Canada.
During the late nineteenth and early twentieth centuries, developing countries often perceived investment arbitration as little more than an extension of gunboat diplomacy. Investor nations were seen to control the arbitral process in a way that permitted it to be used simply as a tool for extracting concessions from the host country. In state-to-state proceedings, private investors participated only vicariously through their governments. Latin American states were often forced to submit disputes to European sovereigns such as Britain’s Queen Victoria, Russia’s Tsar Alexander II, Germany’s Kaiser Wilhelm II and King Léopold I of Belgium, whose predispositions and sympathies did not always inspire confidence among developing countries.
Not surprisingly, host states reacted to what they perceived as foreign control of their economies. Invoking principles articulated by the nineteenth-century Argentine jurist Carlos Calvo, Latin American countries came to require similar treatment for foreign and domestic investors.5 This effectively eliminated as options both diplomatic protection6 and arbitration. In 1974 the Calvo Doctrine was pushed further in the so-called “New International Economic Order” adopted by the United Nations General Assembly in an attempt (unsuccessful as history has shown7) to require host state courts rather than international arbitrators to determine the measure of compensation for expropriated property.8
Ultimately an increasing number of capital-importing countries came to realize that their self-interest was served by agreeing to arbitrate investment disputes. Equally as significant, arbitration became a fairer process. Representatives from developing countries began to participate more actively in international arbitral institutions such as the International Chamber of Commerce (ICC), The International Center for Settlement of Investment Disputes (ICSID) and the London Court of International Arbitration (LCIA), as well as in the formulation of new procedural rules such as those of the United Nations Commission on International Trade Law (UNCITRAL).9
Developing countries also came to realize that the greater the risk, the higher the cost of investment. Untrustworthy enforcement mechanisms tend to chill cross-border economic cooperation to the detriment of those countries that depend most on foreign capital for development. To the extent that arbitration promotes respect for implicit bargains between investor and host country, it came to commend itself to developing countries as a matter of sound international economic policy.
To some observers a double standard toward investment arbitration seems to be creeping into American attitudes toward investment arbitration. Arbitration is good when it corrects misbehavior by foreign host states, but not so desirable when claims are filed for alleged wrongdoing by the United States. Many business and political leaders still support arbitration as the preferred method to resolve disputes between host countries and foreign investors. However, recent trade legislation has significantly impaired the vigor of future treaty-based arbitration of investment disputes, with the United States pursuing a course and a tone quite different from when negotiating NAFTA.10 Moreover, vocal opposition to investment arbitration has been expressed by important segments of the media and several non-governmental organizations.
Traditionally, American multinationals imposed arbitration as the mechanism for settling investment disputes with foreign countries, particularly in Latin America. Arbitration was justified as a way to level the playing field and to reduce the prospect of host state “home-town justice,” thereby safeguarding assets from expropriation without compensation.
Foreign investment was seen as a net good for both investor and host state, helping to reduce poverty through international economic cooperation. And arbitration was perceived as one way to promote respect for the rule of law underpinning investment stability.
The argument ran as follows. No supranational courts possess mandatory jurisdiction to decide the appropriate indemnity for nationalized assets.11 Absent assertions of diplomatic protection,12 litigation in the expropriating country remains the default mechanism for adjudicating investment disputes.13 Consequently, the real or imagined bias of host country judges can create an anxiety that inhibits wealth-creating transactions and discourages cross-border economic cooperation,14 and will inevitably either thwart cross-border economic cooperation or add to its cost.15
Arbitration responds to this apprehension by providing a forum that is more neutral than host country courts, both politically and procedurally. The relative impartiality of international tribunals bolsters investor confidence and inspires greater certainty that the contract will be interpreted in line with the parties’ shared ex ante expectations.
When NAFTA came into force, however, the rifle sights were turned in the opposite direction, and the United States and Canada became respondents in cases brought by investors based in other NAFTA countries.16 After claims for unfair treatment were filed against the United States government, arbitration looked different than when American companies were the investors.17 This was a new experience, since NAFTA represented the first time two of the so-called G-7 industrialized countries18 entered into mandatory arbitration arrangements with each other.19
Interestingly, role-reversal for the United States and Canada occurred not because investors from Mexico (a traditional host state) began bringing claims against its northern neighbors. Rather, it was Canada and the United States that began attacking each other, with claims by Canadian investors against the American government, and claims by American investors against Canada.20
As Americans and Canadians began to understand the host state perspective, praise for arbitration’s neutrality began to have competition in the form of complaints about infringement of national sovereignty and democracy. The level playing field no longer appeared as an unalloyed benefit. Environmental and consumer groups, as well as the media and Congress, began taking the position that NAFTA undermined legitimate governmental regulations, challenged legislative prerogatives, and opened decision-making to ill-informed foreign tribunals.21
The NAFTA process was attacked for the confidentiality of its proceedings (“lack of transparency”), uncertainty and absence of accountability to domestic constituents. A dispute resolution process that had been fair for the rest of the world came to be seen as a tool to put business before public interest.
In the present climate of public opinion, many Americans and Canadians fail to understand why arbitration should be available for foreign investors. Taking for granted the fairness of their own judicial systems, Americans in particular are often surprised that not everyone feels comfortable with civil juries and the prospect of large punitive damages.22
Regardless of whether such self-perceptions are valid, the fact remains that when NAFTA was being negotiated, it was the United States that insisted on arbitration as a protection for foreign investment. The business community’s longstanding hesitation toward foreign litigation made it vital to bolster confidence that investors would receive a “fair shake” in the event of controversy with the host government.
NAFTA also stipulated substantive standards of investor protection that would require interpretation. Reciprocal lack of trust among the three countries made it unlikely that host state courts would be acceptable to construe and apply these standards.
Understandably, this investor protection scheme was based upon equality of treatment among the three countries. For Mexico to accept arbitration of investment disputes within its borders, Canada and the United States had to respect a similar dispute resolution process. It would have been unwise and unworkable for Chapter 11 to be applied by American and Canadian courts when claims were brought against the United States and Canada, but to have arbitrators appointed for claims against Mexico.
C. NAFTA Chapter 11
Safeguarding cross-border investment23
NAFTA Chapter 11 gives business managers from a member country the opportunity to arbitrate investment grievances with the government of another NAFTA country, regardless of whether an agreement to arbitrate actually exists in a negotiated investment concession.24 This private right to direct action eliminates recourse to traditional state-to-state negotiations, in which a foreign investor asks for his country’s intervention against the host state.
The first part of Chapter 11 (Section A) imposes the substantive norms for cross-border investment, forbidding discrimination against investors from another member country,25 and requiring “fair and equitable” treatment as well as compensation for nationalized property.26 An entity incorporated and with substantial business activities27 in a NAFTA country qualifies as an investor without regard to any “origin of capital” limitations.28 Thus a Mexican corporation owned by French shareholders qualifies as an investor under NAFTA Chapter 11.
The compensation criteria adopted by NAFTA Chapter 11 were intended to be compatible with standards traditionally advocated by the United States.29 Expropriation must be justified by a public purpose and applied on a non-discriminatory basis.30 Compensation must be “equivalent to the fair market value” of the investment at the date of expropriation, must be “paid without delay and be fully realizable,” and must bear interest at a commercially reasonable rate until the date of actual payment. If paid other than in a hard currency,31 compensation must be in an amount which, at market rates of exchange, would convert into a sum no less than the hard currency equivalent of market value on the payment date. Compensation will not be affected because market awareness of the pending expropriation drove down the property’s price.32
The second portion of Chapter 11 (Section B) goes on to provide arbitration as a remedy for a host state’s breach of its duties. An aggrieved investor33 may choose either (i) arbitration supervised by ICSID (part of the World Bank group)34 or (ii) a proceeding conducted under arbitration rules adopted by UNCITRAL.35 Disputes raising common questions of fact or law may be consolidated into a single arbitration.36
Should the investor want ICSID arbitration there is a slight limitation. Neither Mexico nor Canada is yet party to the Washington Convention establishing ICSID. Consequently ICSID-style arbitration must proceed under the so-called ICSID Additional Facility designed for cases in which the Washington Convention does not apply. As discussed later, this will have significant consequences when one side wishes to mount a challenge to the arbitration.
The role of the arbitral situs
When a dissatisfied loser in NAFTA arbitration seeks to have an award set aside, the choice of arbitral forum may have a significant impact on the role played by courts at the arbitral situs.37 To understand the impact of local law, a brief contrast might be helpful. Under “pure” ICSID arbitration, the Washington Convention forecloses challenge to awards on normal statutory grounds38 in favor of ICSID’s special system of quality control under its own internal challenge procedure.39
However, since Canada and Mexico are not parties to the Washington Convention, investors currently have only two options for arbitral procedure: (i) the United Nations’ UNCITRAL Rules, which are entirely ad hoc, and (ii) the ICSID Additional Facility, supervised by ICSID but outside its treaty framework.
Whether under the UNCITRAL or Additional Facility Rules, arbitration will go forward within the framework of either the New York Convention40 or the Panama Convention,41 both of which require deference to valid arbitration agreements and awards but say nothing about proper or improper annulment standards.42 In contrast to ICSID, the New York and Panama Conventions leave each country free to establish its own grounds for vacating awards made within its territory.
The consequence of arbitration under the rules of UNCITRAL or the ICSID Additional Facility is that NAFTA awards are now subject to the judicial review mechanisms that exist at the place of arbitration.43 NAFTA Article 1136(3)(b) explicitly contemplates such review. Award enforcement for arbitration under ICSID Additional Facility or UNCITRAL rules may not be sought until a court either dismisses or allows an application to revise, set aside, or annul the award and there is no further appeal, or three months have elapsed without such application being made.
Investor protection in practice
Considerable grist for the arbitration mill has been supplied by two particular aspects of Chapter 11: the matters of (i) “minimum standard of treatment” and (ii) compensation standards for expropriation. Several recent cases illustrate the way NAFTA has been applied in practice in these areas.
Minimum standards of treatment
Article 1105(1) of NAFTA requires each country to “accord to investments of investors of another Party treatment in accordance with international law, including fair and equitable treatment and full protection and security.” Although the meaning of “international law” has been the object of controversy,44 at least two conclusions seem warranted. First, the “fair and equitable standard” has not been met simply by an extension of national or most-favored-nation treatment to NAFTA investors. Second, reference to “full protection and security” adopts the settled principle that a nation is liable for failure to exercise due diligence to prevent injuries to an investor caused by third parties.45
In Metalclad46 Mexico was held to be in breach of Article 1105(1) as a result of a lack of “orderly process” and “timely disposition” in relation to a NAFTA investor acting under the expectation that it would be treated fairly and justly in accordance with NAFTA. In SD. Myers47