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July 05, 2012

Railroading Sovereignty

Last Friday was a sad day for Guatemalans, a day that unveiled the merits ruling on the first investor-state case brought under CAFTA. The case, Guatemala vs. Railroad Development Corporation (RDC), produced an $11.3 million judgment in favor of Pittsburgh-based RDC and against Guatemala, which has the second-lowest human development index in the Western Hemisphere.  The decision of the ICSID-hosted tribunal not only sacked the Guatemalan government with a fine equivalent to its health care provision for over 160,000 Guatemalans, but created a precedent that threatens to breach sovereignty and curtail policy space throughout Central America.

The dispute between the RDC and the Guatemalan government arose over RDC’s operation of Guatemala’s railway system. In 1997, RDC won a government contract to operate the country’s newly-privatized rails for 50 years (para. 30). For the following decade, RDC reopened several defunct rail lines, but did not restore the rail network to the extent the government had envisioned. In particular, it started but did not finish a planned corridor to link Guatemala with Mexico. (It seems that RDC’s sluggish investment stemmed from sub-par financial performance—in its first eight years, the company was not able to turn a profit on its Guatemala operations, a fact that the tribunal acknowledged—see para. 269.)

After months of negotiations with RDC failed to produce results, in August 2006, Guatemala’s executive branch declared RDC’s contract to be lesivo—or injurious to the interests of the State. The lesivo is a legal carve-out for the executive branch that has existed on the books for decades in several Latin American countries. In Guatemala, an executive declaration of lesivo initiates a legal process in which an administrative court weighs the executive branch’s accusations against the defense of the investor, which has the right to appeal the resulting decision to the Supreme Court (para. 91). Yet, RDC argued before the ICSID tribunal that the lesivo declaration itself gravely tarnished the company’s image, causing it to lose business contracts, lines of credit, potential investors, and even police protection (para. 124). While defending itself in Guatemala’s lesivo-prompted administrative court process, RDC opted to also sue the government under CAFTA to the tune of $64 million for having used the lesivo.

In the suit, RDC accused Guatemala of three trade “crimes” forbidden by CAFTA: indirect expropriation of RDC’s investment, national treatment (such as for favoritism for domestic over foreign investors), and failure to afford the company a “minimum standard of treatment.” The ICSID tribunal nixed the first two accusations as baseless, but upheld the third as sufficient cause for slapping Guatemalan taxpayers with an $11.3 million blow.

Before delving into RDC’s accusations, it’s worth underscoring the radical nature of the entire investor-state dispute mechanism enshrined in CAFTA and employed in this case. Here, CAFTA’s investment chapter has granted authority to a trade tribunal—three unelected men from foreign countries—to determine the legitimacy of a sovereign government’s contracts. Governments sign contracts for all manner of public purposes, including the provision of essential infrastructure, such as railways. Should foreign tribunals be permitted to rule on the validity of such public contracting, or to fine the government millions of dollars when they opine against its practices? The answer of course has been an adamant “no” from activists, scholars, and governmental representatives seeking to defend democracy and the public interest.

However, it now appears that US trade negotiators intend to mimic such sovereignty-breaching investor protectionism via the Trans-Pacific Partnership (TPP). The leaking of the TPP’s investment chapter last month sparked outrage when it revealed that the TPP would permit foreign corporations to directly sue the US and other participating governments over contract claims, once again to be decided by a foreign tribunal. (The U.S. appears to be pushing especially hard in this respect, such as by insisting that “investment agreements” with governments be subject to investor-state dispute settlement.) Just as CAFTA’s investment chapter subjected Guatemala’s railroad contracting practices to a multi-million dollar fine, the TPP’s expansion of this extreme investor-state system threatens the environmental, human rights, and Buy America conditions that the US places on its contracts.

While the legitimacy of the entire RDC vs. Guatemala suit should thus be challenged, so should the merits of RDC’s accusations. Here’s an initial take on each of RDC’s three claims against the government:

National Treatment: RDC accused Guatemala of declaring lesivo in order to show railway favoritism to one Ramon Campollo, a Guatemalan owner of a sugar business. How might the government’s opinion of a railroad contract be a gift to a sugar producer? As it turns out, it’s not. Despite RDC’s interesting theory that the government was secretly scheming to annul the contract so as to hand a rail line to Campollo to transport his sugar, the tribunal was “not persuaded” (see paras. 153-155). They duly noted that the government has made no such moves in the nearly six years since the lesivo. The tossing of the national treatment accusation means that, on the facts, Guatemala did not treat RDC any differently than domestic investors. Indeed, the government of Guatemala has declared domestic contracts lesivo on 14 occasions.  In these cases, the Guatemalan companies had the opportunity, just as RDC did, to challenge the lesivo through the country’s normal administrative tribunals.  What they did not have was RDC’s CAFTA-granted privilege to completely circumvent this national process by suing the government in a CAFTA-established tribunal.  As such, Friday’s CAFTA-based ruling against Guatemala for its usage oflesivo once again demonstrates that foreign investors enjoy greater rights than national ones under CAFTA. But, of course, such a preferential option for the foreign investor is CAFTA’s raison d'être.

Indirect Expropriation: “Indirect expropriation” under CAFTA is akin to the rarely successful “regulatory takings” concept under domestic law. RDC declared that the pronouncement of lesivo, by hurting the company’s business relationships, amounted to such an expropriation. The government found this ridiculous on two counts. First, if RDC was so concerned with its reputation, it probably should not have taken out newspaper ads immediately following the lesivo pronouncement in which the company declared itself to be a “dead man walking” (para. 60). It seems that RDC’s reputational losses were partially self-inflicted. Second, the mere declaration oflesivo, which is not a binding decision, did not revoke RDC’s right to use the railways. Indeed, the tribunal noted in its rejection of RDC’s expropriation claim that the company has continued to lease out railway usage ever since the lesivo, an income stream accounting for 92% of RDC’s Guatemala revenue (para. 152). While the tribunal ruled in Guatemala’s favor on this count, it did not totally close a dangerous line of interpretation in past investor-state tribunals that something less than 100 percent appropriation or destruction of real property can constitute an expropriation. Indeed, it favorably cited several awards that said that only a “substantial deprivation” had to occur (para. 151) – a threshold that is lower than that provided for under U.S. law.  

Minimum Standard of Treatment: CAFTA stipulates that participating governments should grant foreign investors a “minimum standard of treatment” that is “in accordance with customary international law, including fair and equitable treatment” (par. 212). The ICSID tribunal borrowed a more detailed interpretation of “fair and equitable treatment” (FET) from the NAFTA investor-state case Waste Management II, which defines a violation of the minimum standard as any government action that is “arbitrary, grossly unfair, unjust or idiosyncratic” (para. 219).

Idiosyncratic? Really? A foreign investor can sue a sovereign government for having a law that is particular to its own context? Would New York City’s ban on trans fats qualify? It’s certainly not on the books in most countries, in part because it responds to the US’s unique challenges with obesity. Perhaps that’s why even the US State Department seemed to take issue with such a sweeping interpretation of the minimum standard. As an observer to the suit, and citing a 1926 international law case, State Department officials argued that the minimum standard’s obligation to comply with “customary international law” should be interpreted as the law practiced by “States themselves,” rather than being based on the pronouncements of other unelected trade tribunals (para. 207). El Salvador and Honduras – and of course Guatemala – also concurred in this analysis (para. 160, 210-211).

However, the tribunal declined to limit its consideration of “customary international law” to state practice, coyly suggesting that the actual parties to CAFTA had misread the 1926 precedent (para. 216). Indeed, the panel suggested that the governments’ own citations to NAFTA and CAFTA case law confirmed that arbitral decisions contribute to an understanding of “evolving” international investor rights (paras. 217-218).

Proceeding with this ample interpretation, the tribunal declared the government’s lesivo to be “arbitrary, grossly unfair, [and] unjust” (par. 235). (At least idiosyncrasy was not invoked.) They provide two rationales: one specific to this particular usage of lesivo, and one concerning the usage of lesivo in general. For the former, the tribunal took issue with the government’s specific legal basis for the lesivo—that a particular railroad equipment contract with RDC was legally dubious. The tribunal argued that the government had contributed to said dubiousness and had operated as if the contract was valid before its lesivo declaration (par. 235). While both these points may be technically correct, they miss the broader rationale for the government’s actions: it wanted a functioning railroad system. RDC had been contracted for the purpose of fulfilling that goal over five decades. Though the company complied with the contract’s initial stipulations, the government clearly felt that RDC’s slack investment thereafter had shown the company to be incapable of building the national railroad it had promised its citizens (see par. 56). Government officials were probably not keen to endure 50 years of RDC’s failing finances before signing a new contract.

However, according to the tribunal, even this broader rationale for the lesivo would not have been permissible. Beyond merely commenting on the particular case of RDC, the tribunal felt compelled to offer their disparagement of the lesivo as a policy tool in general. They argued that lesivopronouncements are arbitrary decisions, and that future usage, except in “truly exceptional circumstances such as in cases of corruption,” could well violate CAFTA’s mandated minimum standard of treatment (para. 233).

First, are lesivo declarations indeed arbitrary decisions? While the lesivo could certainly be used to make unjustified claims, the pronouncement of lesivo cannot be called an arbitrary decision, since it is not actually a binding decision, but the beginning of a legal process. As mentioned, after alesivo, the company in question has the opportunity to present its case before an administrative court and then still appeal the resulting decision. Indeed, RDC was taking advantage of this opportunity by defending itself in the still-undecided Guatemalan court case, even while suing the government under CAFTA for its non-binding pronouncement.  Until the Guatemalan court reaches a decision, the company’s contract remains intact, which is why RDC has continued earning revenues off of Guatemala’s rail for nearly six years since the lesivo (par. 152).

Second, is the tribunal correct in arguing that the only permissible lesivo declarations are those that address “truly exceptional” cases, such as corrupt contracts? Surely the lesivo could be used for a wider array of worthy policy ends. What if a government-contracted oil company spills tons of crude near the country’s coastline through gross negligence? Would it be permissible for the executive branch to accuse the contract of being “injurious to the interests of the state?” Even less dire but still harmful circumstances, such as failure to actually build a railroad system, may warrant such declarations. Again, the point is that it should not be up to three men on a foreign tribunal to decide. The tribunal’s warnings that lesivo may be categorically CAFTA-illegal transgress the bounds of sovereignty and impinge upon the policy space that governments may need to provide for their constituents.

++

In closing, I offer some conclusions. Overall, the tribunal’s decision sets a worrisome precedent. Will last Friday’s more ample definition of the minimum standard, which bars “idiosyncratic” policies, become the new rubric for deciding investor-state disputes? Will any government that from here on tries to use the lesivo, a policy tool in several Latin American countries, find itself slapped with similarly costly trade suits?

Core aspects of administrative law undermined. In the RDC case, the arbitral panel inserted itself unabashedly into the complexities of domestic contract and administrative law. The arbitrators opined that investors should be given the right to be heard before an agency has even taken final action (see paras. 122, 221). More broadly, are investor-state panels opening up wide avenues for foreign investors to challenge the core aspects of administrative law in a country? In the U.S. context, courts grant significant deference to agency actions, and corporations have very limited basis for challenging them under the Administrative Procedure Act. (See Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984)). When it comes to government contracts, there are even higher degrees of deference. (See Coalition for Common Sense in Government Procurement v. U.S., 821 F.Supp.2d 275 (2011); B- 283939 (Comp.Gen.), 2000 CPD P 19 (Comp.Gen.), 2000 WL 85036 (Comp.Gen.) (Matter of: SmithKline Beecham Corporation, 2000).) The message from the RDC ruling is that – if you don’t want arbitral panels inserting themselves into tricky aspects of domestic law – don’t sign investor-state deals.

Incentives to offshoring, non-incentives to invest. Indeed, once upon a time, it was precisely the differences in administrative procedures across countries that determined in part the international allocation of capital. If you don’t like Guatemala’s domestic legal system, don’t invest there. (Guatemala noted that the lesivo procedure played a key role in the country’s own constitutional checks and balances that RDC should have known about before investing – see para. 61.) Now, with CAFTA, this incentive against offshoring of jobs and capital is diminished. At the same time, agreements like CAFTA are sold to lawmakers on the notion that they incentivize investment. But the RDC investment was made back in 1996 (para. 30) – a decade before CAFTA went into effect. The trade deal didn’t lead to new investment, it just gave corporations a new tool to challenge regulations they don’t like.

CAFTA doesn’t fix the problem of runaway tribunals. It’s worth noting that the Bush II and Obama administrations made much hay over the inclusion of new annexes in CAFTA and subsequent U.S. trade agreements. These annexes were supposedly more protective of nations’ policy space, and designed to check runaway arbitrators. However, this RDC case shows that tribunals continue to feel themselves empowered to not tie their analysis to actual patterns of state actions. How many countries have lesivoprocedures? How many contract disputes have ended up in a similar fashion? In short, without some sort of cross-country benchmark, tribunals are just improvising these standards.  

Bad business decisions can lead to government liability. RDC had also challenged Guatemala for failing to provide full protection and security for its investment, which is closely related to the FET claim. The central issue in this part of the case was whether Guatemala should have evicted squatters on the railroad area. The government noted that RDC may have normalized the “squatting” by charging the “squatters” rent (para. 58). The arbitral panel – for reasons of judicial economy – didn’t rule on this question (para. 238). This leaves open the possibility that poor, administratively strapped governments could find themselves on the hook for situations that investors themselves encouraged. 

Guatemalans left on hook. While we don’t have full clarity on all of these points, what is clear is that Guatemalans will now have to foot an $11.3 million penalty for making pronouncements that a US company did not appreciate. (This is on top of the nearly $200,000 that Guatemalans will have to pay to RDC to cover the company’s costs from the earlier jurisdictional phase, see para. 283.) And they still don’t have a functioning national railroad.  

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Comments

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Hey guys, why last Friday was a sad day for Guatemalans. are you tell me clearly. i want to know about himself because i am a big fan of him. i want help him about any matter.

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RDC opted to also sue the government under CAFTA to the tune of $64 million for having used the lesivo.

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