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July 08, 2009

What Happens in Guatemala...

One of the first CAFTA investor-state cases is underway, and it has been brought against Guatemala by a U.S. company (Railway Development Corporation, or RDC) that won a contract to take over operation of Guatemala's privatized railroad system in 1996-97. (As Sarah reported, another case has been launched against El Salvador related to mining issues.) In 2006, Guatemala's government initiated the process of declaring the contract "injurious to the interests of the state," known in Spanish as a "declaración de lesividad."

The company alleges that this administrative proceeding, and the events that it set off (loss of other contracts, a fall-off in police protection of the railway, etc.), violate the company's CAFTA rights, including provision of a "minimum standard of treatment" (Article 10.5), national treatment (Article 10.3), and protection against measures "equivalent to expropriation" (Article 10.7). A great part of their case rests on the observation that the Oscar Berger administration appeared to be on the side of Guatemalan sugar oligarch Ramon Campollo, who wanted to take over part of the railroad concession that RDC had not built out.

RDC is asking for Guatemalan taxpayers to compensate it over $64 million, which is the equivalent of the total annual income of over 26,000 Guatemalans. Guatemalan papers report that it has already cost that country's taxpayers (among the poorest in the hemisphere) hundreds of thousands of dollars to defend the case.

I've scanned the "Claimant's Memorial on the Merits," which is basically a detailing of RDC's version of the events leading up to and following the declaration. Here are some of my initial reactions to the document:

  • The lesividad declaration is a long-established practice within Spanish administrative law, dating back to the 19th century. It is on the books in Guatemala and other Latin American countries with Spanish legal systems. Indeed, in the memorial, RDC surveys a long history of "lesivo" resolutions brought by the Guatemalan government, dating back to 10 years prior to RDC's initial negotiations with the government. Presumably, some of these many cases were also brought against Guatemalan nationals. In other words, RDC should have known what it was getting into when it invested in a country that had lesivo declarations as part of their legal system.
  • Lesivo declarations could be seen as blunter form of backstop regulation, and an alternative to other measures, such as expropriation or renegotiation of contracts. So, to the extent that RDC's claim is successful in arguing that lesivo declarations violate CAFTA's minimum standard of conduct, CAFTA can be seen as pushing deregulation, even when domestic regulations are used against both domestic and foreign corporations.
  • It is worth pointing out that RDC's business model is thoroughly wrapped up with pushing railway deregulation and privatization, often in developing countries. This is a choice that RDC makes, to invest capital in developing nations rather than at home. There's a simple reason for this: companies can often make higher returns in developing nations, for minimal investments with minimal regulatory oversight. According to textbook economics, this higher return compensates investors for taking the higher risks associated with investments in developing nations. Heads, you make a killing; tails, your investment goes under. It should not be the role of public policy (such as trade pacts) to remove these risks - after all, the home country public gets none of the upside if the investment works out. Again, if RDC didn't want to deal with lesivo declarations, it could have invested in a country that didn't have them on the books, rather than call on the nanny state to bail it out when it got into trouble.
  • Part of RDC's concession was the exclusive right to use at least five different "routes" in Guatemala. While RDC indicated that they would build out all the routes, they decided (as per their apparent contractual rights) that business conditions did not favor building out any but one of the routes. The Berger government, and Ramon Campollo, for whatever their faults, wanted to build out the other routes. RDC didn't want to build them out, and didn't want to let others build them out. Instead, they wanted to sit on the route and let nothing happen. This is rentier type behavior if I have ever seen it. This is an important part of the backdrop to the CAFTA claim, and one that should serve as a warning sign to governments that auction off exclusive rights to use privatized assets.
  • RDC gripes about some of its contracts falling through, and faulty police protection of their railway installations following the lesivo resolution. While the fall out does sound rather unpleasant, the question remains: how much liability should the state have for actions that are indirectly caused by government action?
  • This case illustrates how FTAs bind the room for maneuvering of successive governments, and thus frustrate democracy. RDC signed the original contract with the civil war-ending Alvaro Arzu government, tangled with the right-wing Berger government over the lesivo declaration, but then decided to bring the CAFTA case against the (relatively) progressive government of Alvaro Colom, in office since early 2008. Why should the Colom government, not to mention the Guatemalan people, be liable for the behavior of the man - Oscar Berger - that they defeated in the last election?

Finally, a wide number of bilateral trade and investment cases have dealt with this notion that measures can be "tantamount to" or "equivalent to" expropriation (or be an indirect expropriation) without actually being an expropriation. I'll run an update on this later today or tomorrow, with some of my notes on the recent Glamis ruling.

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