Chapter 6. Closing Case Emerging Markets Ethical Dilemma The Debate Over Investor-State Dispute Settlement

Closing Case Emerging Markets Ethical Dilemma The Debate Over Investor-State Dispute Settlement In international business, it is well known that MNEs may encounter liability of foreignness in host countries (see Chapter 1). A major concern is that in disputes with host-country governments, host-country courts are not likely to rule in favor of foreign entrants. Such homecourt advantage enjoyed by host-country governments makes many foreign entrants uncomfortable. At the same time, host-country governments, in the name of national sovereignty, are typically unwilling to use courts of MNEs’ home countries to resolve disputes. As a result, a lot of firms—in fear of losing their investments due to host-country government actions—are deterred from engaging in FDI. Therefore, many countries cannot benefit from FDI. Starting in the 1950s, one elegant institution-based solution has emerged to resolve this intractable problem. Basically, signatories of investment agreements—typically foreign MNEs and host-country governments—agree that disputes between investors and governments would be settled by independent arbitrators in a neutral country, not courts in the host (or home) country where FDI takes place. If a host-country government loses but is unwilling to pay the arbitration award, the MNE can present the winning case to courts in any signatory member of a UN treaty known as the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (hereafter the “New York Convention”) signed in 1958. Currently 168 countries are New York Convention members. Excluding the host and home countries of any FDI, there are 166 other “third” countries. As long as courts in one of these numerous third countries agree to enforce the award (primarily seizing host-country government assets such as airplanes and ships in that third country), the MNE will still be compensated for its losses in the host country. These complicated mechanisms, known as investment-state dispute settlement (ISDS), have boosted MNEs’ confidence that their FDI would be safe. They have helped unleash significant FDI dollars around the world since the 1950s. Bilateral investment treaties (BITs) negotiated between numerous pairs of countries often commit governments to provide “fair and equitable” treatment to foreign investors. Failure to provide such treatment could trigger MNEs to initiate ISDS actions. An ISDS arbitration panel generally consists of three neutral arbitrators. Typically, each party nominates an arbitrator and a president of the tribunal is chosen by the two arbitrators nominated by the parties in dispute. While arbitration may take a number of years to reach an award, the award is binding. Note: Arbitration is a parallel legal (or extralegal) system that is not part of any country’s courts. But enforcement of an award will still have to go through courts. If a host-country government loses and it voluntarily pays up the award enforced by the host country’s courts, the complicated ISDS mechanisms via the New York Convention do not need to be activated. However, courts in many countries are not independent and may refuse to enforce awards against their own governments. It is at that point the New York Convention becomes an institution-based weapon of choice for MNEs. Some firms specialize in asset tracing around the world to assist MNEs that win arbitration awards. Undoubtedly ISDS curtails some sovereignty of New York Convention member countries. However, the fact that 168 of the 193 UN member countries chose to sign up—the two largest nonsignatories are Iraq and North Korea—is indicative of the belief held by most countries that the pros outweigh the cons of participating in ISDS. As of January 1, 2021, the total number of known ISDS cases reached 1,104 (some cases are kept confidential). Approximately 75% of the ISDS cases have been filed by MNEs from developed economies against governments in developing economies. This makes sense because a majority of MNEs are from developed economies, and some developing economies are known to have institutional turbulence and policy unpredictability. With 60 cases filed against it, Argentina leads the world. For example, Argentina expropriated Spanish oil MNE Repsol’s operations in 2012 and was hit by an arbitration award of $5 billion. In another case, in 2001 Argentina defaulted on $100 billion national debt—the largest sovereign default of all time. The US-based hedge fund NML Capital that invested in $1 billion Argentine bonds won an ISDS award, and successfully seized an Argentine navy training ship that sailed to Ghana after securing a court order there. Having won an ISDS award, a US investor successfully seized an Argentine navy training ship that sailed to Ghana after securing a court order in Ghana Always controversial, ISDS has no shortage of critics. The single most important criticism is the risk of foreign investors challenging legitimate domestic policies. This becomes an explosive case when several arbitrators in nontransparent proceedings make decisions against policies unleashed by democratically elected governments. Unlike popular conception, MNEs do not always win. UN data between 1987 and 2020 show that governments won 37% of the cases, MNEs won 29%, and 20% were settled. However, even when governments won, the costs would still be substantial. In 2012, Philip Morris sued the Australian government for its new cigarette packaging law banning the use of attractive, glamorous images on the packaging and mandating the printing of grisly pictures of lung-cancer victims. In 2015, Australia won, but only half of its hefty legal bill of A$24 million (US$18 million) would be paid by Philip Morris. In another case, the German government in 2011, against the backdrop of the nuclear disaster in Fukushima, Japan, passed a law to abandon the use of nuclear energy in the country by 2022. It thus cut short of the operational lifespan and investment returns of two nuclear power plants operated by Swedish multinational Vattenfall—without compensation. In 2012, Vattenfall sued the German government via ISDS. As of March 2021, the ISDS case is still pending. Recently as a number of European countries have launched decarbonization policies to phase out fossil fuels, a number of foreign-owned fossil fuel-fired utilities are making a nuisance of themselves by initiating ISDS actions against various European governments. Another criticism leveled at ISDS is about its fairness. ISDS offers a specialized and parallel legal system only available to foreign investors but not to domestic investors. Given the average award of $75 million and the average cost of $5 million for every case, only larger and more powerful MNEs are likely to avail themselves to ISDS, thus exacerbating economic inequality. The threat that such large foreign investors may be discriminated against, according to critics, may be “illusionary.” After being burned, a number of countries, such as Australia, India, Indonesia, and South Africa, are now phasing out of ISDS. However, as long as FDI continues, there will be disputes between MNEs and host governments. How to chart a middle path that can both encourage FDI and preserve governments’ legitimate rights to make domestic policy changes remains one of the leading institution-based challenges in the 21st century. Case Discussion Questions 1. As an MNE executive, would you prefer to launch an FDI project in a country where ISDS is available or unavailable? Why? 2. ON ETHICS: In 2004, British oil firm Cairn made a huge oil discovery in India. In 2007, it reorganized its assets and listed them on the Mumbai stock exchange. In 2012, the Indian government presented Cairn a retroactive tax bill of $1.6 billion for the reorganization. Such retroactive taxation, Cairn argued, violated the UK–India BIT in which India promised to treat foreign investors from the UK in a “fair and equitable manner.” In 2020, Cairn won an arbitration award of $1.7 billion in the Netherlands. Refusing to pay, the Indian government withdrew from the BIT. To enforce the award, in 2021 Cairn sued Air India, an Indian government-owned airline, in a New York court, requesting that the New York Convention be invoked and that Air India aircraft and other assets be seized. As I. An Air India spokesperson, II. A passenger who relies on Air India to travel between India and the United States, and III. The New York judge presiding over this case, what do you think the New York court should do? (Sources: [a] Economist, 2021, Seize and insist, April 10: 61; [b] Indian Express, 2021, Explained: Why is Cairn Energy suing Air India? May 20: indianexpress.com). 3. ON ETHICS: Do the pros of ISDS outweigh its cons? Sources: (1) Bloomberg Businessweek, 2014, In trade talks, it’s countries vs. companies, April 6: 36–37; (2) Conversation, 2019, When even winning is losing, March 26: theconversation.com; (3) Economist, 2014, The arbitration game, October 11: 78; (4) Economist, 2019, Kafkaesque, June 8: 63; (5) S. Jandhyala, 2014, Why do countries commit to ISDS for disputes with foreign investors? AIB Insights 16: 7–9; (6) J. Kyl, D. Feith, & J. Fonte, 2013, The war of law, Foreign Affairs July: 115–125; (7) L. Johnson & L. Sachs, 2014, The outsized costs of investor-state dispute settlement, AIB Insights 16: 10–13; (8) NPR, 2012, Why a hedge fund seized an Argentine navy ship in Ghana, October 22: www.npr.org; (9) New York Times, 2014, Respol in $5 billion settlement with Argentina, February 25: www.nytimes.com; (10) M. Olabisi, 2019, Bridging the enforcement gap in international trade, Journal of International Business Policy 2: 86–109; (11) B. Pinkham & M. W. Peng, 2017, Overcoming institutional voids via arbitration, Journal of International Business Studies 48: 344–359; (12) P. Satyanand, 2014, Once BITen, forever shy, AIB Insights 16: 17–20; (13) K. Sauvant & L. Well, 2021, Obsolescence of the obsolescing bargain, Columbia FDI Perspectives February 22; (14) UN, 2021, World Investment Report 2021, Geneva: UN; (15) Vattenfall, 2021, Understanding to terminate disputes on German nuclear phase out, press release, March 5: group.vattenfall.com.

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