Shell, shell, shell companies

Last year, we reported on how a Canadian-Cayman mining company, Pac Rim Cayman LLC, was using the U.S.-Central America Free Trade Agreement to challenge El Salvadoran mining policy. There are seven parties to CAFTA, and none of them is Canada or the Cayman islands.

In the months before launching a CAFTA case, Pac Rim Cayman LLC changed its incorporation from Cayman Islands to Nevada. El Salvador reasonably got suspicious about this convenient change of nationality, and is asking a CAFTA court convened at the World Bank (ICSID) to dismiss the case because of a lack of jurisdiction.

The case represents the most detailed analysis of corporations' "nationality planning" by an investor-state panel under a U.S. trade or investment agreement. Some of the key highlights from El Salvador's most recent objection to ICSID jurisdiction:

"77. In fact, Claimant has been forced to admit that CAFTA was at least a consideration in the decision to change the nationality of Pac Rim Cayman from the Cayman Islands to the United States. Mr. Shrake states, "[a]s part of this overall assessment of the Companies' organizational structure, I also considered the Companies' potential avenues of recourse if a dispute with El Salvador were ever to arise in the future."...

86. On the record there can be no doubt that the main reason to move Pac Rim Cayman to the United States in December 2007 was to gain treaty protection for the existing dispute related to the El Dorado mine. In its Counter-Memorial, Claimant does not dispute the facts: Pac Rim Cayman was not "repatriated" as Claimant asserted in its August 17, 2010 letter to the Tribunal; it has no office or assets in the United States; the capital invested in El Salvador was transferred from Canada; and there were no other changes to Pac Rim Cayman as a Nevada company.

87. Nevertheless, Claimant now alleges that the change of nationality was to save money. But, despite Claimant's suggestion that 2007 differed from other years because Pacific Rim Mining Corp. recorded a big loss, the truth is that Pacific Rim Mining Corp. has a history of losses, including $4.6 million for fiscal year 2005, $6.9 million for fiscal year 2004, and $2.8 million for fiscal year 2003. Moreover, although Claimant claims that the move saved it "the costs of maintaining Pac Rim Cayman in the Cayman Islands," Claimant presents no evidence that the costs of maintaining a limited liability company in Nevada are significantly cheaper than being incorporated in the Cayman Islands.

88. In fact, given the actual costs involved, the assertion that cost savings was the primary reason and access to CAFTA just a convenient afterthought, is hardly credible. According to the Cayman Islands Chamber of Commerce, a non-resident company currently pays between U.S. $488 and $689 to register and as an annual fee in the Cayman Islands, while an exempt company pays between $573 and up to $2400 for companies with maximum shareholder capital. Cost could not have been a major concern. Moreover, Claimant spent at least $575 to register, submit an initial list of managers, and acquire a business license in Nevada...

106. As discussed above and in El Salvador's Memorial, there is no evidence of Pac Rim Cayman having any business activities whatsoever. It is a shell moved around for the purposes of Pacific Rim Mining Corp. This is hardly disputed. All that Claimant argues is: "Pac Rim Cayman is . . . engaged in the substantial business activities of holding and managing investments in El Salvador from its headquarters in Nevada." Even this statement is misleading. The evidence produced by El Salvador clearly demonstrates that Pac Rim Cayman—a company with no employees, no office space leased under its name, no telephone, no office equipment, and no bank account—has no capacity to manage anything. Moreover, while there is no doubt that it is a holding company, Pac Rim Cayman does not even hold "investments" in El Salvador. It holds shares in Salvadoran companies used as investment vehicles by the common parent company Pacific Rim Mining Corp. Pac Rim Cayman's only "activity" is the purely passive holding of shares in two other companies under its name.

107. As El Salvador stated in its Memorial, holding shares in its name cannot be substantial business activity: "every shell company set up by a non-Party national to try to gain CAFTA jurisdiction will have 'holding' activities related to the investments of the non-Party parent company." The denial of benefits provision would be rendered meaningless if merely holding shares or investments qualified as "substantial business activities in the territory of any Party."

108. Moreover, the fact that an officer of the Canadian parent company was located in the United States when he made decisions about what other subsidiaries the Cayman Islands subsidiary, Pac Rim Cayman, would hold, does not amount to business activities for a U.S. enterprise. Like Claimant's other arguments, this would defeat the purpose of a denial of benefits clause. The alleged substantial activities must be connected to the enterprise when it is a national of the Party.

109. Of course, some holding companies may be able to establish that they are legitimate entities functioning within the territory of a Party. Pac Rim Cayman is not such a holding company. This is clear from Claimant's misleading attempt to align itself with the AMTO claimant: "[m]uch like Pac Rim Cayman, AMTO was a holding company with two fulltime employees." In fact, unlike AMTO, Pac Rim Cayman has no employees. In response to El Salvador's request for information ordered by the Tribunal, Pac Rim Cayman was not able to produce any evidence that it pays the salaries of any employees, or even a portion of the salaries of its two managers, who are also officers of the Canadian parent company and paid by the Canadian company and other subsidiaries. In addition, unlike Pac Rim Cayman, AMTO paid income tax and social insurance payments for its two employees, had a bank account, and leased an office for several years during which the investment was made and the dispute arose. The only thing that Pac Rim Cayman and AMTO have in common is that they are holding companies. Pac Rim Cayman has none of the characteristics that led the AMTO tribunal to conclude that AMTO had substantial business activities.

110. Claimant is a shell company, with no employees, no office, and no revenue. Pac Rim Cayman's subsidiaries, PRES and DOREX, are investment vehicles in El Salvador that do not contribute to Pac Rim Cayman having any activities in the United States. The activities of Pacific Rim Exploration, minimal as they are, should not be counted as activities of Pac Rim Cayman, because Pacific Rim Exploration was only moved to be held through Pac Rim Cayman as part of the abusive scheme to gain jurisdiction, at the same time Pac Rim Cayman's nationality was changed from the Cayman Islands to the United States. The only business activity Pac Rim Cayman can claim—"holding" the shares in the investment vehicles in El Salvador—is clearly insufficient.

El Salvador's legal defense is doing its best to ward off the attack on its environmental policies, but the underlying rules on how "investor" is defined by CAFTA and other NAFTA-style agreements are pretty lame. For instance, Pac Rim Cayman LLC, in its counter memorial on jurisdiction, wrote:

"Far from being “passive” vehicles for questionable purposes, holding companies have been described as “the fundamental building block of the global economy,” a “common and legal device for corporate organization [that] face the same legal obligations of corporations generally.” A holding company is a “company formed to control other companies, usu[ally] confining its role to owning stock and supervising management.”...

there is nothing wrong with an investor’s decision to structure its business activities in order to gain CAFTA’s benefits after investing in the territory of a CAFTA Party and before a dispute with that Party has arisen. Respondent itself admits as much, acknowledging that “prospective nationality planning has generally been accepted by arbitral tribunals, even if the nationality of the foreign investor has been selected to gain tax advantages or treaty protection in the event of future disputes.” One such instance
was in the Aguas del Tunari case, where the tribunal noted that it was “not uncommon in practice” to “locate one’s operations in a jurisdiction perceived to provide a beneficial legal and regulatory environment in terms, for examples, of taxation or the substantive law of the jurisdiction, including the availability of a BIT.”...

Penalizing an investor for taking prudent steps to protect itself in the event that the host State later purports to deny CAFTA’s benefits to the investor would only serve to discourage investors from investing in the territories of the Parties, and would, moreover, undermine CAFTA’s purpose of providing for the settlement of investment disputes."

El Salvador had to agree, saying,"As Claimant points out, structuring an investment ahead of time in order to gain treaty protection may be acceptable, but changing nationality after a dispute has arisen in order to qualify for treaty protection is Abuse of Process."

We need a different set of rules to ward off against investor-state challenges from shell or near-shell companies. After all, NAFTA-style deals prohibit countries from requiring foreign investors to give back to the community or protect environment (so-called "performance requirements".) But the deals don't set up any economically meaningful threshold for an investor actually creating a significant number of jobs before they can use NAFTA- or CAFTA-style rights. This is putting investors ahead of the public and national interest, even when they're not making investments.

(Kind of an analogue to the U.S. tax policy debate, where both parties compete to give corporations back money so that they can invest it "without any government meddling", that they go on to hoard rather than invest.)

It is ridiculous that El Salvador is forced to argue about precedents that would have allowed as few as two employees to be considered substantial business activities. While we debate whether the stimulus package created or saved closer to a million or closer to two million jobs, it seems a little ridiculous to be advancing investment provisions of NAFTA-style trade policies that split hairs about whether as few as two employees entitles a company to massive investor rights. And we wonder why the U.S. government has a hard time creating jobs: we've forgotten how to protect the policy space to actually create jobs, either at home or abroad.

But, there's a fair trade way of re-writing these "denial of benefits" provisions of trade deals. We suggest some ways this could be done here.