Investment arbitration a 'self-serving' industry, says study

Rather than acting as fair and neutral intermediaries, the international investment arbitration industry has 'a vested interest in perpetuating an investment regime that prioritises the rights of investors at the expense of democratically elected national governments and sovereign states', according to a new report.

Kanaga Raja

A REPORT by the Transnational Institute (TNI) and Corporate Europe Observatory (CEO) describes the international investment arbitration industry as 'a multimillion-dollar, self-serving industry, dominated by a narrow exclusive elite of law firms and lawyers whose inter-connectedness and multiple financial interests raise serious concerns about their commitment to deliver fair and independent judgements'.

'As a result, the arbitration industry shares responsibility for an international investment regime that is neither fair, nor independent, but deeply flawed and business-biased,' say TNI and CEO.

These findings are highlighted in the joint report published in November by the two organisations titled 'Profiting from injustice: How law firms, arbitrators and financiers are fuelling an investment arbitration boom.'

Says the report: 'The international investment arbitration industry is dominated by a small and tight-knit Northern hemisphere-based community of law firms and elite arbitrators. Three top law firms... claim to have been involved in 130 investment treaty cases in 2011 alone. Just 15 arbitrators, nearly all from Europe, the US or Canada, have decided 55% of all known investment-treaty disputes. This small group of lawyers, referred to by some as "inner mafia", sit on the same arbitration panels, act as both arbitrators and counsels, and even call on each other as witnesses in arbitration cases. This has led to growing concerns, including within the broader legal community, over conflicts of interest.'

The TNI-CEO report seeks to 'shine a light on law firms, arbitrators and litigation funders that have profited handsomely from lawsuits against governments,’ and shows that the arbitration industry ‘is far from a passive beneficiary of international investment law.’

‘They are rather highly active players, many with strong personal and commercial ties to multinational companies and prominent roles in academia who vigorously defend the international investment regime. They not only seek every opportunity to sue governments, but also have campaigned forcefully and successfully against any reforms to the international investment regime.’

The report reveals that investment lawyers amongst others have:

* actively encouraged cases and sometimes even pushed corporations to pursue arbitration, exploiting loopholes in investment treaties to create an explosion in the number and the costs of dispute settlement cases, and acted behind the scenes to push countries to adopt investment treaties;

* tended to approach investment law from an almost exclusively commercial angle rather than public interest, ignoring or even denouncing arguments based on human rights and sustainable development;

* aggressively and successfully fought to maintain and expand the current system of investment treaties and arbitration, both through academic circles and by lobbying against reforms that would serve the public interest, and worked alongside speculative investment funds to provide the finance for corporations to bring more cases, at the expense of states and taxpayers.

‘These actions have not only confirmed the pro-corporate bias of current investment agreements, they have tilted the regime even further in the favour of large multinational corporations. The result is a system driven by commercial interests rather than the delivery of justice.'

The arbitration industry

The report explains that in international investment disputes, multinational companies can sue governments if the government has done something that the multinational considered harmful to its profits. These cases take place before an international tribunal of arbitrators, three people who decide whether private profits or the public interest are the most important. The legal bases for these disputes are investment treaties between states.

The idea of investment arbitration as a fair and independent space to resolve disputes between multinationals and governments is one of the key justifications for a system which has cost taxpayers dearly and undermines the capacity of sovereign governments to act in the interests of their people.

According to the report, ‘the alleged fairness and independence of investment arbitration is an illusion. The law and the consequential disputes are largely shaped by law firms, arbitrators and, more recently, a phalanx of speculators who make a lot of money from the disputes.’

Driven by their own profit interests, this ‘arbitration industry’ actively encourages an ever-growing number of corporate claims, while creating the necessary legal loopholes and funding mechanisms for its continued functioning. This industry is also responsible for growing its own business with pro-investor interpretations of the treaties.

It further notes that investment arbitration lawyers, arbitrators and funders have largely escaped public attention. Many of their cases are unknown and some never become public. The vested interest behind their actions is well hidden by ‘a thick layer of legal rhetoric about judicial independence, fairness and advancing the rule of law’.

Wave of disputes

International investment agreements give sweeping powers to foreign investors, including the peculiar privilege to directly file lawsuits at international tribunals, without necessarily even going through the local courts. Companies can claim compensation for actions by host governments that have damaged their investments, either directly through expropriation, for example, or indirectly through regulations of virtually any kind.

There are currently more than 3,000 such agreements. The vast majority are bilateral investment treaties (BITs) between two countries. Others include free trade deals with investment chapters such as the North American Free Trade Agreement (NAFTA) between Canada, Mexico and the United States, and multilateral agreements such as the Energy Charter Treaty which regulates investments in the energy sector.

Since the late 1990s, these agreements have triggered a wave of investor claims against states.

In 1996, only 38 investor-state disputes had been registered at the then 30-year-old World Bank International Centre for Settlement of Investment Disputes (ICSID), the main handler for these arbitrations. In 2011, there were 450 known investor-state cases, the majority of which were filed by corporations from industrialised countries against countries from the Global South.

The report highlights some 'emblematic' examples of investor-state disputes:

* On the basis of bilateral investment treaties, tobacco giant Philip Morris is suing both Uruguay and Australia over their anti-smoking laws. The company argues that compulsory large warning labels on cigarette packs prevent it from effectively displaying its trademarks, causing a substantial loss of market share.

[In the case of the dispute against Australia, according to posts on the International Economic Law and Policy Blog, the Philip Morris subsidiary in Hong Kong appears to have bought shares in Philip Morris Australia some months after Australia made public its plans to introduce further regulatory measures for plain packaging to discourage smoking. The share purchase was aimed at enabling the Hong Kong subsidiary to use the Hong Kong-Australia BIT to sue Australia.]

* In 2009, Swedish energy multinational Vattenfall sued the German government, seeking 1.4 billion euros ($1.9 billion) plus interest in compensation for environmental restrictions imposed on one of its coal-fired power plants. The case was settled out of court after Germany agreed to water down the environmental standards, exacerbating the effects that Vattenfall’s power plant will have on the Elbe River and its wildlife.

In 2012, Vattenfall launched a second lawsuit seeking 3.7 billion euros ($4.6 billion) for lost profits related to two of its nuclear power plants. The case followed the German government's decision to phase out nuclear energy after the Fukushima nuclear disaster. Both actions were taken under the Energy Charter Treaty, which includes BIT-like investment protection provisions.

* In 2007, Italian investors sued South Africa over its Black Economic Empowerment Act which aims to redress some of the injustices of the apartheid regime. It requires, for example, mining companies to transfer a portion of their shares into the hands of black investors. The dispute (under South Africa’s BITs with Italy and Luxembourg) was closed in 2010 after the investors received new licences requiring a much lower divestment of shares.

* When Argentina froze utility rates (energy, water, etc.) and devalued its currency in response to its 2001-02 financial crisis, it was hit by over 40 lawsuits from investors. Big companies like CMS Energy (US), Suez and Vivendi (France), Anglian Water (UK) and Aguas de Barcelona (Spain) demanded multimillion compensation packages for revenue losses.

Skyrocketing costs

As the number of international investment disputes has grown, arbitration has become ‘a money-making machine’ in its own right, says the TNI-CEO report. Arbitration lawyer Nicolas Ulmer from Swiss law firm Budin & Partners is cited as explaining: 'Arbitration institutions vie for their market share of disputes, legislatures pass arbitration-friendly measures to attract this business, various conference and workshops are held year round, a class of essentially full-time arbitrators has developed and a highly specialised “international arbitration bar” pursues large cases avidly. A veritable “arbitration industry” has arisen.’

The report stresses that investment arbitration is expensive - long before the final settlement is made. Both the state and the investor have to pay for the administration of a case. They also have to pay arbitrators, witnesses and experts who are often scattered across the globe and require translation services and travel and living allowances. And they have to pay their lawyers.

According to the United Nations Conference on Trade and Development (UNCTAD), ‘costs involved in investor-state arbitration have skyrocketed in recent years'. For the known cases with available data, the Organisation for Economic Co-operation and Development (OECD) recently found that legal and arbitration costs averaged over $8 million, exceeding $30 million in some cases. The Philippine government spent $58 million to defend two cases against German airport operator Fraport - the equivalent of the salaries of 12,500 teachers for one year, vaccination for 3.8 million children against diseases such as tuberculosis, diphtheria, tetanus and polio, or the building of two new airports.

According to the TNI-CEO report, the lion's share ends up in the pockets of the parties’ lawyers. Industry insiders estimate that more than 80% of all legal costs in arbitration are spent on counsel. The tabs racked up by elite law firms can be $1,000 per hour per lawyer - with whole teams handling cases. According to figures from ICSID, arbitrators also line their pockets, earning a $3,000 daily fee plus travel and living allowances.

An empirical study of investment arbitration costs found that ‘tribunals most frequently required parties to share tribunal and administrative costs equally and absorb their own legal fees’. This means that even when corporations do not win, taxpayers still have to pay millions in legal fees.

‘The real winners? Law firms who collect multimillion-dollar payments, regardless of the result,’ the report underlines, citing, for example, the case of Plama Consortium v Bulgaria, where Bulgaria's legal fees totalled $13,243,357 for defending a claim that was ultimately found to be fraudulent. Although Bulgaria was awarded $7,000,000 of these legal fees, it was still forced to pay out the remaining $6,243,357. At that time, Bulgaria was grappling with a healthcare crisis due to a shortage of nurses - the money could have paid the salaries of more than 1,796 Bulgarian nurses.

Critical objection

Originally, investor-state arbitration was envisioned for instances of straightforward expropriation, such as when the government took over a factory. But the system has spun out of control, with multinationals using it to chase down lost profits. The last two decades have seen a number of multimillion-dollar claims against the alleged effects of public legislation.

‘Developed and developing countries on every continent have been challenged for tax measures, fiscal policies, bans on harmful chemicals, bans on mining, requirements for environmental impact assessments, regulations relating to hazardous waste etc. Sometimes, the threat of a dispute has been enough to freeze government action, making policymakers realise they would have to pay to regulate.’

According to the report, these legal challenges have raised a global storm of critical objection to investment treaties and arbitration. Some countries have realised the injustices and inconsistencies of international investment arbitration and are trying to abandon the system.

In spring 2011, the Australian government announced that it would no longer include investor-state dispute settlement provisions in its trade agreements.

Bolivia, Ecuador and Venezuela have terminated several BITs and have withdrawn from ICSID, sending a clear political message that they refuse to cooperate in the future. Argentina, which has been swamped with investor claims related to emergency legislation in the context of its 2001-02 economic crisis, refuses to pay arbitration awards.

South Africa has announced that it will not renew old investment treaties due to expire. And India is reported to have decided not to include investor-state dispute provisions in future free trade agreements (after the government was sued for carrying out the orders of the country's Supreme Court to cancel some 2G band telecommunication licences over scam and corruption charges).

[In another case, just reported in the Economic and Political Weekly, a Singapore-based arbitral tribunal has criticised the Supreme Court of India and the Indian judiciary for its delays in hearing and disposing of cases, and asked the Indian government (which under the Indian Constitution has no control over the judiciary) to compensate an Australian party, having a contract dispute with an Indian firm, for these delays.]

According to the TNI-CEO report, the UN has recognised that international investment agreements can severely curb states' abilities to fight financial and economic crises.

Argentina has been sued more than 40 times as a result of the economic reform programmes implemented after its economic crisis in 2001. By the end of 2008, awards against the country had reached a total of $1.15 billion. That’s the equivalent of the average annual salary for 150,000 Argentinian teachers or 95,800 public hospital doctors.

Potential conflicts of interest

Globally, says the report, three firms have emerged as market leaders in the investment arbitration business: Freshfields Bruckhaus Deringer (UK), White & Case (US) and King & Spalding (US). Freshfields alone claims to have acted in more than 165 investor-state disputes.

Such dominance creates a reputation for these firms, which in turn brings new cases and leads to a concentrated market that is difficult for newcomers to enter. One practitioner estimates that 25 out of 30 new cases at ICSID go to the heavyweights in the field. Non-Western law firms from the countries most sued by investors scarcely get a look in.

As many as two dozen senior lawyers in the top firms also act as arbitrators, 'opening a Pandora's box of potential conflicts of interest because of their vested interest in growing their own business'. An arbitrator might, for example, be tempted to make a decision that will favour a client whom they represent as counsel in another case. Some suggest that the dual role of arbitrator and counsel is 'one of the most significant problems of the investment arbitration regime'.

According to the report, when companies sue governments in international arbitration tribunals, investment arbitrators have the power to divert taxpayers’ money to corporations. They can decide to penalise governments for ensuring people's human rights to health, access to water or electricity as well as the right to a healthy environment.

Advocates claim an international arbitration system is needed because national courts are not sufficiently neutral. They say that only international arbitration courts can provide the neutral ground to deal with investors’ concerns. That means that investment arbitrators become the guardians of investment arbitration, and confidence in the system is based on their perceived independence.

‘Yet investment arbitrators are hardly neutral guardians, who stand above the law. In fact, they are crucial actors in the arbitration industry, with a financial interest in the existence of investment arbitration. Arbitrators, to a far greater degree than judges, have a financial and professional stake in the system. They earn handsome rewards for their services. Unlike judges, there is no flat salary, no cap on financial remuneration,’ the report underscores.

Arbitrators’ fees can range from $375 to $700 per hour depending on where the arbitration takes place. How much an arbitrator earns per case will depend on the case's length and complexity, but for a $100 million dispute, arbitrators could earn on average up to $350,000. It can be far more. The presiding arbitrator in the case Chevron and Texaco v. Ecuador received $939,000. In another case, the tribunal president billed for 719 hours at an hourly rate of $660 plus VAT.

‘To put it simply, if a doctor is sponsored by a pharmaceutical company, we might question whether the medicine prescribed is the best for our health; if a public servant receives money from a lobbyist, we might question whether the policies they promote are in the public interest. In the same vein, if an arbitrator’s main source of income and career opportunities depend on the decision of companies to sue, we should wonder how impartial their decisions are.’

And concerns arise not only from the financial benefits arbitrators gain. Arbitrators frequently combine their role with several other hats: working as practitioners, academics, policy advisers or as media commentators. With these various roles, this small group of investment lawyers can influence the direction of the investment arbitration system such that they can continue benefiting from it.

'Inner circle'

According to the report, arbitrators may not be well known in the outside world, but members of the arbitration club certainly know each other. International arbitrators are the epitome of a close-knit community. Academics, journalists and insiders have described the circuit of investment arbitration as ‘small, secret, clubby’, ‘an inner circle’, ‘a closed homogenous group comprised of “grand old men” or even “an arbitration mafia”.’

Most of the members of the arbitrators’ club are men from a small group of developed countries. The proportion of arbitrators from Western Europe and North America is 69% for all cases held at ICSID, and 83% for arbitrators who have sat in more than 10 cases.

Evidence shows that many of the arbitrators enjoy close links with the corporate world and share businesses’ viewpoint in relation to the importance of protecting investors’ profits.

Given the one-sided nature of the system, where only investors can sue and only states are sued, a pro-business outlook could be interpreted as a strategic choice for an ambitious investment lawyer keen to make a lucrative living.

‘How would investment arbitration look if it did not operate as a closed-shop? What would happen if many more lawyers motivated by the public interest sat in panels; if the interpretation of investment clauses was more heterogeneous, or if arbitrators tended to allocate people and environmental welfare higher value than property rights when deciding on the merits of a case?’ TNI and CEO ask.

Under such a scenario, they note, it is likely that many lawsuits brought by investors would be dismissed. In fact, the system may even collapse as investors would be more hesitant to pursue cases if the arbitration system became a level playing field.

The report further finds that banks, hedge funds and insurance companies also invest in international disputes.

Brokers and electronic marketplaces where claimants can shop for potential funders and funders can shop for claims are emerging. Commercial third-party litigation funding is most readily described as buying into someone else’s lawsuit in the hopes of sharing in the spoils if a payout is awarded. Typically, a funder will take between 20% and 50% of the final award.

Little is known about the industry, but occasional reports suggest that litigation finance shops such as Juridica (UK), Burford (US) and Omni Bridgeway (Netherlands) are becoming an established part of international investment arbitration. Top-tier financier Burford commits on average $8 million to a case, while Juridica averages $7.5 million. Returns vary between 30% and 50%.

‘No wonder litigation funders’ profits have been growing at staggering rates. Burford’s profits grew ninefold on their 2010 levels in 2011. In the same period, Juridica saw a 578% growth in its profits.’

By funding lawsuits that might otherwise settle quickly or die altogether, third-party funding has the potential to multiply the number of investment disputes brought before arbitrators, the report says, adding that lessons from the past support the claim that financing stirs up litigation. Australia saw an estimated 16.5% rise in litigation after liberalising its attitude towards third-party funding in general.

Recommendations for reform

In its overall conclusions, the report calls for a ‘root-and-branch review’of the investment regime.

It says that even within the current international investment regime, there are a number of options that could help prevent investment lawyers and law firms from exploiting the current investor-state dispute system.

Amongst others, investment disputes could be solved by independent and transparent adjudicative bodies, where sitting ‘judges’ enjoy objective guarantees of independence and impartiality, and the roster of ‘judges’ would represent every country in the world.

The report also recommends tougher conflict-of-interest regulations, including a binding code of conduct for investment arbitrators requiring that they can neither work as counsel nor as experts in investment cases during, but also for at least three years before and after service on the roster (cooling-off period), and that a cap be imposed on the costs of lawyers and arbitrators.

It further recommends clarification of the broad and vaguely formulated terms (such as 'fair and equitable' treatment, which can mean anything the arbitrator decides) used in investment treaties, in order to prevent arbitrators from making investor-friendly (expansive) interpretations of certain obligations and to give countries policy space to regulate.

Also recommended is the inclusion of binding investor obligations in investment treaties on issues such as environmental and human rights impact assessments, and compliance with all local and national laws on health, environmental, labour and taxation issues. In this way, the report says, arbitrators will be forced to take these issues into account when deciding on cases.                                     

Kanaga Raja is Editor of the South-North Development Monitor (SUNS). This article is reproduced from SUNS (No. 7496, 7 December 2012), which is published by the Third World Network.

*Third World Resurgence No. 268, Dec 2012, pp 9-13