Investor claims under bilateral investment treaties are mounting up in the arbitration courts, but their real test will be on the streets, says Maria Kielmas

Is the Calvo Doctrine returning to Latin America? Carlos Calvo, a 19th century Argentine diplomat and lawyer, spent much of his life developing and codifying international law. In 1868, he first enunciated the principle, since known as the Calvo Doctrine, that people living in a foreign country should settle claims in local courts and not resort either to diplomatic pressure or armed intervention from their own government. He justified this as a way of protecting weak nations from abuse by powerful ones.

This principle passed into the 20th century constitutions and legislation of most Latin American countries.

It all seemed to change in the 1990s. Latin American countries had shed their dictatorships and nationalism. They reformed their economies, opened up to foreign investment in the most guarded of state sectors. Democracy was embraced as a passport to prosperity, a view shared even by leftist parties in the region who did not discover democracy until the Berlin Wall fell down. Most governments in the region signed bilateral and multilateral investment treaties which contain provisions for the settlement of investor disputes under international arbitration. Foreign investors in public services, energy and infrastructure particularly welcomed the treaties as they overrode, apparently, national constitutions and legislation, and provided an extra protection for their investments on top of political risk insurance. The Calvo Doctrine was dispatched to history.

"That was a different world. People expected continued capital flows to emerging economies," says Riordan Roett, head of the Western Hemisphere Program at Johns Hopkins University in Washington DC. "But they didn't monitor what was happening in the privatisation programmes and, in the 21st century, countries are taking a risk and confronting their creditors," he adds.

Claims mount

Over the period 1991-1999, Argentina had signed 53 bilateral investment treaties (BITs), more than even the US which had promoted them in the first place. Today the country faces over 70 claims totalling anything between $20bn and $27bn from foreign investors in the World Bankis arbitration tribunal, the International Centre for the Settlement of Investment Disputes (ICSID). This is in addition to pending lawsuits from overseas holders of $94.3bn of defaulted public sector bonds. Claims in excess of $1bn on political risk insurance are expected. Arbitration between foreign investors and states has become one of the most ferocious political issues in Argentina and throughout Latin America, the outcome of which will change the investor climate in the region.

Mr Roett warns that this is not an issue which will be settled by international lawyers meeting at tribunals in London or Washington, or even international business as a whole. This is a clash between two worlds: the world of daily demonstrations on the streets of Latin America which push governments to adopt ever more extreme attitudes towards foreign investors; and that of Washington DC and the international financial institutions. In an increasingly fragile world economy, rich country governments which bankroll the IMF do not want to witness a complete Argentine collapse, even though in world terms Argentina is a small market. Investors pressing their claims at the arbitration tribunals will find these will take longer, cost more and produce far less than they expect. "This is a brand new territory," says Mr Roett.

New international legal order

BITs first came into force in the 1960s and assisted capital-exporting countries to invest in the developing world. But initially the treaties were used only by governments to settle diplomatic issues, notes Philippe Pinsolle, partner at law firm Shearman & Stirling in Paris. In the 1970s, the Paris-based Organisation of Economic Co-operation and Development (OECD) allowed private sector investors the possibility of suing a government.

Two decades later this has created the seeds of a different type of international legal order, according to James Loftis, co-chair of the international dispute resolution practice at law firm Vinson & Elkins in Houston.

The BITs and other quasi-commercial treaty obligations can affect the international legal order in two principal ways, he explains. First, they influence how states conduct themselves with foreign investors. An individual BIT between two states is much easier to negotiate and sign than a large, ambitious multilateral treaty. It is also far more likely to contain specific protections and rights of redress. So such treaties force states to consider more carefully the financial consequences of any proposed action that would hurt foreign investors. "Thus you have a sort of bottom-up growth of international legal obligations as a network of these treaties grows," says Mr Loftis. He adds that obligations are easier to enforce and have greater power to affect government conduct than traditional international law obligations and institutions, which in the modern era adopted a 'top-down' methodology.

Second, with over 2,000 BITs in force today containing specific promises of fair and equitable treatment for foreign investors, one could argue that fair and equitable treatment has now become a rule of customary international law. But Mr Loftis warns that this is still a hotly-debated topic in international law circles.

Popular response

Such advantages for foreign investors are judged differently on the streets of Latin America, especially when populations perceive that unelected judges at international tribunals are making decisions on a country's public services and taxation. Under a programme which began tentatively in 1989 and consolidated with the approval of the 1991 Convertibility Law, which pegged the peso to the US dollar, Argentina undertook a far-reaching programme of privatising public services, utilities and extractive industries, as well as controlling inflation. Most of the subsequent investment was made under this foreign exchange regime and investors remained confident of their future profits.

But the downside to the country's boom was always visible. In the working class districts of Buenos Aires and other low income areas of the country the most widely recognised sign of privatisation was a vandalised utility meter. Industry organisations and consumer groups complained throughout the 1990s that, although public services had improved, the cost to consumers was becoming unsustainable. Utility tariffs which were indexed to US inflation during that countryis 1990s boom exacerbated the problem further. Growing domestic debt and current account deficit, high unemployment, contagion from financial crises in Mexico, Brazil, Russia and Asia, a crisis of confidence in the government and an inability of the politicians to agree on urgent reforms led to five changes of president in two weeks in December 2001 and economic collapse in January 2002. Under emergency economic legislation, Argentina ended the convertibility regime which provided parity between the peso and US dollar, ordered the renegotiation of all utility and public serve contracts made in foreign currencies, ended their tariff link with US inflation, and ordered the denomination of all tariffs in pesos (pesification).

What expropriation?

The cases pending against Argentina at the ICSID tribunal claim that these emergency measures are in breach of the country's obligations under the various BITs and are equivalent to expropriation. An affiliate of Enron, gas company Transportadora de Gas del Sur (TGS), argued that some taxes imposed by provincial government had a similar effect on its operations.

The Argentine government's response has been based on the argument that the country's economic crisis caused problems for everyone, not just foreign investors, that there has been no expropriation as the investors remain in charge of their assets, and that the questions of utility tariffs, taxes and economic policy cannot be decided by an ICSID arbitration court in a foreign country. Government officials are maintaining that ICSID arbitration is incompatible with the country's constitution.

The court did not admit Argentina's jurisdictional objections and the country continues to defend its case at that forum. But rather than conforming with the accepted convention that arbitration proceedings should be confidential, Argentina successfully argued in August at an ICSID tribunal in Paris that the national and international media should have knowledge of the proceedings in the name of transparency, democracy and open government.

So the first hearing, US firm CMS Energy v Argentina, began in Paris in the midst of a media scrum. Passers-by were brought into the fray as the tribunal's offices neighboured those of the French Football Association and they took an interest thinking a star such as Zidane may come along.

Instead, they saw a line of lawyers. But the strategy worked for the government and it received favourable reports of its defence of national sovereignty in Argentine and other Latin American media.

Clarification

From an investor's point of view the logic behind an arbitration request is to let people know that you are a creditor. So you have to start an arbitration, says Philippe Pinsolle. "But most investors go to arbitration as a last resort. Nobody likes to sue a government," he adds. In Argentina there is the added question of whether investor losses were due to political events, economic difficulties or commercial misjudgement. "The value that the ICSID cases may bring is that they may help resolve some of these uncertainties," says David Neckar, practice leader, political risk and credit insurance at Willis Ltd in London. If the tribunals can identify the criteria for determining whether an investor's (or lender's) fundamental rights have been abused then it should help insurance practitioners to draft policy language that links more closely to recognised international law via the rulings of the tribunal, he explains.

"It is our impression that the full importance of BIT arbitration is not considered by political risk insurers who insure an investor with a potential BIT claim," says Mara McNeill, associate at Washington DC law firm Morrison & Foerster. "If an insurer has to pay a loss, there is a greater potential to collect against a host government if the insured has rights under a BIT that can be assigned to the insurer," she adds.

Resistance

But future developments may not be quite so clear cut. Investor-state arbitration cases are gathering increasing political resistance throughout Latin America. Street demonstrations and calls for a renationalisation of privatised public services are, in their own context, little different from similar protests in Britain. But in a region with weak institutions and discredited, nominal democracies, these protests, some spontaneous, some organised by extremists from both sides of the political spectrum, have led to the removal of numerous heads of state and the enactment of near expropriatory legislation. This process is underway in Bolivia and could result in some $10bn of claims by foreign investors in the arbitration tribunals. Arbitral awards against the governments of Ecuador, Peru and Venezuela are stirring up similar protests. The unwillingness of governments to accept such rulings, or their clear inability to pay compensation, has led some governments to resort to appeals in domestic courts and various other jurisdictions. This has given rise to the term 'arbitral terrorism'.

First coined in reference to claims against Pertamina, the state oil company of Indonesia, many international lawyers believe this will become a growing rearguard action of defiance.

Some governments recognised their country's vulnerability in the face of BIT arbitration and took steps to protect their overseas assets when faced with a financial crisis. It was widely reported that Argentina took such steps prior to its 2002 economic emergency law. Local sources said that this action was a recognition that the BITs would permit legal action against the country.

Renew or reject?

Most BITs come up for renewal after 10 years and can be terminated after that period. "It would not be surprising to see some states seek to limit their exposure by cancelling or failing to renew their BITs," says James Loftis, even though this may not limit their exposure to existing claims.

Nevertheless Argentine government officials are seeking to limit the arbitration by requesting some foreign governments and the OECD to review how they interpret BIT language.

Philippe Pinsolle is taking a pragmatic approach. "I don't think that everybody (among the investors) expects full indemnity. They expect a political settlement at some point." But Latin American politics, as Riordan Roett notes, is not settled in the tribunals, it is settled on the streets.

- Maria Kielmas is a freelance journalist and consultant.

Topics