Date: 15 Junes 2015
Author: Claire Provost and Matt Kennard
Fifty years ago, an international legal system was created to protect the rights of foreign investors. Today, as companies win billions in damages, insiders say it has got dangerously out of control
Luis Parada’s office is just four blocks from the White House, in the heart of K Street, Washington’s lobbying row – a stretch of steel and glass buildings once dubbed the “road to riches”, when influence-peddling became an American growth industry. Parada, a soft-spoken 55-year-old from El Salvador, is one of a handful of lawyers in the world who specialise in defending sovereign states against lawsuits lodged by multinational corporations. He is the lawyer for the defence in an obscure but increasingly powerful field of international law – where foreign investors can sue governments in a network of tribunals for billions of dollars.
Fifteen years ago, Parada’s work was a minor niche even within the legal business. But since 2000, hundreds of foreign investors have sued more than half of the world’s countries, claiming damages for a wide range of government actions that they say have threatened their profits. In 2006, Ecuador cancelled an oil-exploration contract with Houston-based Occidental Petroleum; in 2012, after Occidental filed a suit before an international investment tribunal, Ecuador was ordered to pay a record $1.8bn – roughly equal to the country’s health budget for a year. (Ecuador has logged a request for the decision to be annulled.)
Parada’s first case was defending Argentina in the late 1990s against the French conglomerate Vivendi, which sued after the Argentine province of Tucuman stepped in to limit the price it charged people for water and wastewater services. Argentina eventually lost, and was ordered to pay the company more than $100m. Now, in his most high-profile case yet, Parada is part of the team defending El Salvador as it tries to fend off a multimillion-dollar suit lodged by a multinational mining company after the tiny Central American country refused to allow it to dig for gold.
The suit was filed in 2009 by a Canadian company, Pacific Rim – later bought by an Australian mining firm, OceanaGold – which said it had been encouraged by the government of El Salvador to spend “tens of millions of dollars to undertake mineral exploration activities”. But, the company alleged that when valuable deposits of gold and silver were discovered, the government, for political reasons, withheld the permits it needed to begin digging. The company’s claim, which at one point exceeded $300m, has since been reduced to $284m – still more than the total amount of foreign aid El Salvador received last year. El Salvador countered that the company not only lacked environmental permits but also failed to prove it had obtained rights to much of the land covered by its request: many farmers in the northern Cabañas region, where the company wanted to dig, had refused to sell their land.
Every year on 15 September, thousands of Salvadorans celebrate the date when much of Central America gained independence from Spain. Fireworks are set off and marching bands parade through villages across the country. But, last year, in the town of San Isidro, in Cabañas, the festivities had a markedly different tone. Hundreds had gathered to protest against the mine. Gold mines often use cyanide to separate gold from ore, and widespread concern over already severe water contamination in El Salvador has helped fuel a powerful movement determined to keep the country’s minerals in the ground. In the central square, colourful banners were strung up, calling on OceanaGold to drop its case against the country and leave the area. Many were adorned with the slogan, “No a la mineria, Si a la vida” (No to mining, Yes to life).
On the same day, in Washington DC, Parada gathered his notes and shuffled into a suite of nondescript meeting rooms in the World Bank’s J building, across the street from its main headquarters on Pennsylvania Avenue. This is the International Centre for the Settlement of Investment Disputes (ICSID): the primary institution for handling the cases that companies file against sovereign states. (The ICSID is not the sole venue for such cases; there are similar forums in London, Paris, Hong Kong and the Hague, among others.) The date of the hearing was not a coincidence, Parada said. The case has been framed in El Salvador as a test of the country’s sovereignty in the 21st century, and he suggested that it should be heard on Independence Day. “The ultimate question in this case,” he said, “is whether a foreign investor can force a government to change its laws to please the investor as opposed to the investor complying with the laws they find in the country.”
Most international investment treaties and free-trade deals grant foreign investors the right to activate this system, known as investor-state dispute settlement (ISDS), if they want to challenge government decisions affecting their investments. In Europe, this system has become a sticking point in negotiations over the controversial Transatlantic Trade and Investment Partnership (TTIP) deal proposed between the European Union and the US, which would massively extend its scope and power and make it harder to challenge in the future. Both France and Germany have said that they want access to investor-state dispute settlement removed from the TTIP treaty currently under discussion.
Investors have used this system not only to sue for compensation for alleged expropriation of land and factories, but also over a huge range of government measures, including environmental and social regulations, which they say infringe on their rights. Multinationals have sued to recover money they have already invested, but also for alleged lost profits and “expected future profits”. The number of suits filed against countries at the ICSID is now around 500 – and that figure is growing at an average rate of one case a week. The sums awarded in damages are so vast that investment funds have taken notice: corporations’ claims against states are now seen as assets that can be invested in or used as leverage to secure multimillion-dollar loans. Increasingly, companies are using the threat of a lawsuit at the ICSID to exert pressure on governments not to challenge investors’ actions.
“I had absolutely no idea this was coming,” Parada said. Sitting in a glass-walled meeting room in his offices, at the law firm Foley Hoag, he paused, searching for the right word to describe what has happened in his field. “Rogue,” he decided, finally. “I think the investor-state arbitration system was created with good intentions, but in practice it has gone completely rogue.”
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The quiet village of Moorburg in Germany lies just across the river from Hamburg. Past the 16th-century church and meadows rich with wildflowers, two huge chimneys spew a steady stream of thick, grey smoke into the sky. This is Kraftwerk Moorburg, a new coal-fired power plant – the village’s controversial next-door neighbour. In 2009, it was the subject of a €1.4bn investor-state case filed by Vattenfall, the Swedish energy giant, against the Federal Republic of Germany. It is a prime example of how this powerful international legal system, built to protect foreign investors in developing countries, is now being used to challenge the actions of European governments as well.
Since the 1980s, German investors have sued dozens of countries, including Ghana, Ukraine and the Philippines, at the World Bank’s Centre in Washington DC. But with the Vattenfall case, Germany found itself in the dock for the first time. The irony was not lost on those who considered Germany to be the grandfather of investor-state arbitration: it was a group of German businessmen, in the late 1950s, who first conceived of a way to protect their overseas investments as a wave of developing countries gained independence from European colonial powers. Led by Deutsche Bank chairman Hermann Abs, they called their proposal an “international magna carta” for private investors.
In the 1960s, the idea was taken up by the World Bank, which said that such a system could help the world’s poorer countries attract foreign capital. “I am convinced,” the World Bank president George Woods said at the time, “that those … who adopt as their national policy a welcome [environment] for international investment – and that means, to mince no words about it, giving foreign investors a fair opportunity to make attractive profits – will achieve their development objectives more rapidly than those who do not.”
At the World Bank’s 1964 annual meeting in Tokyo, it approved a resolution to set up a mechanism for handling investor-state cases. The first line of the ICSID Convention’s preamble sets out its goal as “international cooperation for economic development”. There was sharp opposition to this system from its inception, with a bloc of developing countries warning that it would undermine their sovereignty. A group of 21 countries – almost every Latin American country, plus Iraq and the Philippines – voted against the proposal in Tokyo. But the World Bank moved ahead regardless. Andreas Lowenfeld, an American legal academic who was involved in some of these early discussions, later remarked: “I believe this was the first time that a major resolution of the World Bank had been pressed forward with so much opposition.”
Global development remains the ICSID’s stated goal. “The idea,” said the institution’s current secretary-general, Meg Kinnear, “is if an investor feels that there is a fair, impartial mechanism should they ever get to a dispute, then they will have that much more confidence and it will help to promote investment … and when you invest in a country you obviously bring jobs, revenue, technology and the like.”
But now governments are discovering, too late, the true price of that confidence. The Kraftwerk Moorburg plant was controversial long before the case was filed. For years, local residents and environmental groups objected to its construction, amid growing concern over climate change and the impact the project would have on the Elbe river. In 2008, Vattenfall was granted a water permit for its Moorburg project, but, in response to local pressure, local authorities imposed strict environmental conditions to limit the utility’s water usage and its impact on fish.
Vattenfall sued Hamburg in the local courts. But, as a foreign investor, it was also able to file a case at the ICSID. These environmental measures, it said, were so strict that they constituted a violation of its rights as guaranteed by the Energy Charter Treaty, a multilateral investment agreement signed by more than 50 countries, including Sweden and Germany. It claimed that the environmental conditions placed on its permit were so severe that they made the plant uneconomical and constituted acts of indirect expropriation.
“It was a total surprise for us,” the local Green party leader Jens Kerstan laughed, in a meeting at his sunny office in Hamburg last year. “As far as I knew, there were some [treaties] to protect German companies in the [developing] world or in dictatorships, but that a European company can sue Germany, that was totally a surprise to me.”
Vattenfall v Germany ended in a settlement in 2011, after the company won its case in the local court and received a new water permit for its Moorburg plant – which significantly lowered the environmental standards that had originally been imposed, according to legal experts, allowing the plant to use more water from the river and weakening measures to protect fish. The European Commission has now stepped in, taking Germany to the EU Court of Justice, saying its authorisation of the Moorburg coal plant violated EU environmental law by not doing more to reduce the risk to protected fish species, including salmon, which pass near the plant while migrating from the North Sea.
A year after the Moorburg case closed, Vattenfall filed another claim against Germany, this time over the federal government’s decision to phase out nuclear power. This second suit – for which very little information is available in the public domain, despite reports that the company is seeking €4.7bn from German taxpayers – is still ongoing. Roughly one third of all concluded cases filed at the ICSID are recorded as ending in “settlements”, which – as the Moorburg dispute shows – can be very profitable for investors, though their terms are rarely fully disclosed.
There are now thousands of international investment agreements and free-trade acts, signed by states, which give foreign companies access to the investor-state dispute system, if they decide to challenge government decisions. Disputes are typically heard by panels of three arbitrators; one selected by each side, and the third agreed upon by both parties. Rulings are made by majority vote, and decisions are final and binding. There is no appeals process – only an annulment option that can be used on very limited grounds. If states do not pay up after the decision, their assets are subject to seizure in almost every country in the world (the company can apply to local courts for an enforcement order). While a tribunal cannot force a country to change its laws, or give a company a permit, the risk of massive damages may in some cases be enough to persuade a government to reconsider its actions. The possibility of arbitration proceedings can be used to encourage states to enter into meaningful settlement negotiations.
In Guatemala, internal government documents obtained through the country’s Freedom of Information Act show how the risk of one of these cases weighed heavily on one state’s decision not to challenge a controversial gold mine, despite protests from its citizens and a recommendation from the Inter-American Commission on Human Rights that it be closed down. Such an action, the documents warned, could provoke the company, owned by Canadian mining giant Goldcorp, to activate the ICSID or invoke clauses of the Central American Free Trade Agreement (Cafta) to gain “access to international arbitration and subsequent claims of damages to the state”. The mine was allowed to stay open.
As the claims made by companies get bigger, it seems increasingly likely that the massive financial risks associated with investor-state arbitration will effectively grant foreign investors a veto over government decisions.
* * *
When companies are unsuccessful in their claims against states, there may be other advantages to be gained. In 2004, South Africa’s new, post-apartheid Mineral and Petroleum Resources Development Act (MPRDA) came into force. Along with a new mining charter, the act sought to redress historical inequalities in the mining sector, in part by requiring companies to partner with citizens who had suffered under the apartheid regime. The new system terminated all previously held mining rights, and required companies to reapply for licences to continue their operations. It also instituted a mandatory 26% ownership stake in the country’s mining companies for black South Africans. Two years later, a group of Italian investors, who together control most of the South African granite industry, filed a landmark investor-state claim against South Africa. The country’s new mining regime, they argued, had unlawfully expropriated their investments and treated them unfairly. They demanded $350m in compensation.
The case was filed by members of the Foresti and Conti families, prominent Tuscan industrialists, and a Luxembourg-based holding company, Finstone. They cited two bilateral investment treaties, both signed in the late 1990s, during Nelson Mandela’s presidency. Jason Brickhill, a lawyer at the Johannesburg-based Legal Resources Centre, said the new, post-apartheid government seemed to view these agreements “more as acts of diplomatic goodwill than serious legal commitments with potentially far-reaching economic consequences”.
During that time, officials would be invited to meetings in Europe, he said, “and there would be all sorts of discussion about [South Africa’s] economic and trade direction, and part of that was an expectation that they would conclude an investment treaty – but they had no real understanding of what they were committing to in law”. Peter Draper, a former official in the South African Department of Trade and Industry, put it more starkly: “We were essentially giving away the store without asking any critical questions, or protecting crucial policy space.”
The companies’ case against South Africa dragged on for four years, before ending abruptly when the Italian group dropped its claims and the tribunal ordered them to contribute €400,000 (£290,000) towards South Africa’s costs. At the time, a government press release celebrated it as “successful conclusion” – despite the fact that South Africa was still left with €5m in unreimbursed legal fees. But the investors claimed a more significant victory: the pressure of the case, they said, allowed them to strike an unprecedented deal with the South African government that allowed their companies to transfer only 5% of their ownership to black South Africans – rather than the 26% mandated by the state mining authority. “No other mining company in South Africa has been treated so generously since the advent of the [new mining regime],” one of the investors’ lawyers, Peter Leon, boasted at the time.
The government seems to have agreed to this deal, which goes against the spirit of post-apartheid reparations in South Africa, to prevent a flood of other claims against it. “If the merits of the case were decided against the government, they thought, ‘That’s it, we are going to go down.’ And I think that’s why they were happy to agree to that settlement,” Jonathan Veeran, another of the company’s lawyers said, in an interview at his office in Johannesburg. His clients, he said, “were most pleased with the result”.
* * *
A small number of countries are now attempting to extricate themselves from the bonds of the investor-state dispute system. One of these is Bolivia, where thousands of people took to the streets of the country’s third-largest city, Cochabamba, in 2000, to protest against a dramatic hike in water rates by a private company owned by Bechtel, the US civil engineering firm. During the demonstrations, the Bolivian government stepped in and terminated the company’s concession. The company then filed a $50m suit against Bolivia at the ICSID. In 2006, following a campaign calling for the case to be thrown out, the company agreed to accept a token payment of less than $1.
After this expensive case, Bolivia cancelled the international agreements it had signed with other states giving their investors access to these tribunals. But getting out of this system is not easily done. Most of these international agreements have sunset clauses, under which their provisions remain in force for a further 10 or even 20 years, even if the treaties themselves are cancelled.
In 2010, Bolivia’s president, Evo Morales, nationalised the country’s largest energy provider, Empresa Eléctrica Guaracachi. The UK power investor Rurelec, which indirectly held a 50.001% stake in the company, took Bolivia to the permanent court of arbitration in the Hague demanding $100m in compensation. Last year, Bolivia was ordered to pay Rurelec $35m; after months of further negotiations, the two sides settled on a payment of just over $31m in May 2014. Rurelec, which declined to comment for this article, celebrated the receipt of this award with a series of press releases on its website. “My only sadness is that it has taken so long to reach a settlement,” said the fund’s CEO in a statement. “All we wanted was a friendly negotiation and a handshake from President Morales.”
Even states that first objected to the introduction of the investor-state dispute system at the 1964 World Bank meeting have since signed dozens of agreements expanding its reach. With the rapid growth in these treaties – today there are more than 3,000 in force – a specialist industry has developed in advising companies how best to exploit treaties that give investors access to the dispute resolution system, and how to structure their businesses to benefit from the different protections on offer. It is a lucrative sector: legal fees alone average $8m per case, but they have exceeded $30m in some disputes; arbitrators’ fees at start at $3,000 per day, plus expenses. While there is no equivalent of legal aid for states trying to defend themselves against these suits, corporations have access to a growing group of third-party financiers who are willing to fund their cases against states, usually in exchange for a cut of any eventual award.
Increasingly, these suits are becoming valuable even before claims are settled. After Rurelec filed suit against Bolivia, it took its case to the market and secured a multimillion-dollar corporate loan, using its dispute with Bolivia as collateral, so that it could expand its business. Over the last 10 years, and particularly since the global financial crisis, a growing number of specialised investment funds have moved to raise money through these cases, treating companies’ multimillion-dollar claims against states as a new “asset class”.
One of the largest of these funds to specialise in backing corporations’ suits against governments, Burford Capital, is based just a few blocks from East Croydon train station, on the fifth floor of a nondescript brown brick building. Companies rarely disclose when their cases are being financed by one of these third-party investors, but in the Rurelec suit against Bolivia, Burford issued a triumphant press release celebrating its “groundbreaking” involvement. Typically, funders like this will agree to back companies’ claims against states in exchange for a cut of any eventual award. In this case Burford gave Rurelec a $15m loan, using the claim against Bolivia as security.
“Rurelec did not need capital to pay its lawyers. Rather, it needed capital to continue to grow its business,” Burford said in a statement. “This is a good demonstration that the benefits of litigation finance go far beyond that of simply helping to pay legal fees,” the CEO added, “and in many cases can provide an effective alternative method of financing to help companies achieve their strategic goals.” It was highly rewarding for Burford as well: it announced a net profit of $11m from the dispute.
A spokesman for Burford explained further: “Burford did not fund Rurelec’s arbitration claim, which had been under way for two years before our involvement with the company. Rather, we provided a corporate debt facility to enable Rurelec to expand its South American operations, but we looked to the arbitration claim (a contingent asset) to assist in the repayment of the loan.”
From the beginning, part of the justification for the international investor-state dispute system has been to create a “neutral forum” for conflicts to be resolved, with investors giving up the right to seek diplomatic support from their home countries when they file cases like this. But documents obtained in response to a Freedom of Information request reveal that Rurelec was also able to rely on the British government, which actively intervened to support its case.
The 44-page disclosure includes dozens of emails and internal briefing notes from May 2010 to June 2014, several of which explicitly reference British lobbying on behalf of the company. One email, to the UK ambassador to Bolivia, Ross Denny, whose sender has been redacted, includes the line “Lobby on Rurelec, yes.” Another, from Denny, said: “Our regular high-level lobbying on behalf of Rurelec has helped to demonstrate the seriousness with which we take protection of our companies’ interests.” Yet another said simply: “Rurelec needs our help.”
It seems the British embassy was aware that the arbitration system is supposed to be impartial. One email, which appears to be about how to respond to an enquiry from a member of the public, said: “All things being equal, our line would be that HMG does not get involved in legal proceeding as brought under the investment treaties we have signed.” The message, whose sender and receivers are both redacted, continues: “If FCO [the Foreign and Commonwealth Office] has had an ongoing dialogue with the company on this topic, it would probably be more appropriate for you to respond with some general lines from us on the benefits of investment treaties.”
* * *
El Salvador has already spent more than $12m defending itself against Pacific Rim, but even if it succeeds in beating the company’s $284m claim, it may never recover these costs. For years Salvadoran protest groups have been calling on the World Bank to initiate an open and public review of ICSID. To date, no such study has been carried out. In recent years, a number of ideas have been mooted to reform the international investor-state dispute system – to adopt a “loser pays” approach to costs, for example, or to increase transparency. The solution may lie in creating an appeals system, so that controversial judgments can be revisited.
Last year, David Morales, El Salvador’s human rights ombudsman (a state post created as part of the peace process after the country’s civil war, fought between 1979 and 1992) took out a full-page ad in the national newspaper La Prensa Gráfica calling on the government to review all of the international investment treaties it has signed, with a view to renegotiating or cancelling them. Luis Parada, representing El Salvador in its dispute with Pacific Rim, agrees that this would be a wise move: “I personally don’t think countries get as much from these treaties than the risks that they incur in international arbitration.”
Other countries have already decided to cut their losses, and tried to get out of these trade treaties. Shortly after settling the lawsuit with foreign mining companies over its new post-apartheid mining rules, South Africa began to terminate many of its own investment agreements.
“What was concerning for us was that you could have an international arbitration – three individuals, making a decision – on what was in effect a legislative programme in South Africa that had been arrived at democratically, and that somehow this arbitration panel could potentially call this into question,” said Xavier Carim, a former deputy director-general in South Africa’s Department of Trade and Industry. “It was very, very clear that these treaties are open to such wide interpretations by panels, or by investors looking to challenge any government measure, with the possibility of a significant payout at the end of the day,” said Carim, who is now South Africa’s representative to the World Trade Organisation in Geneva. “The simple fact is that these treaties give you very little benefit and they just pose risk.”
Before moving to terminate its agreements, the South African government commissioned an internal study to help determine whether such treaties actually did help boost foreign investment. “There was no pattern between signing treaties and getting investment,” Carim explained. “We’ve had huge investments from the US and Japan and India and a number of other countries where we don’t have investment treaties. Companies don’t come and invest in a country or not because it does or doesn’t have a bilateral investment treaty. They invest if there is a return to be made.”
Brazil has never signed up to this system – it has not entered into a single treaty with these investor-state dispute provisions – and yet it has had no trouble attracting foreign investment.
Parada said it would take “a broad consensus of determined states” in order to truly rein in this system. “The states that created the system are the only ones that can fix it,” he said. “I have not seen a critical mass of states with the political will [to do this] … much less a broad consensus. But I still hope it happens.”