Big Davids, small Goliaths
Fanatic Studio/Alamy Stock Photo
Behind his desk in Caracás, Bernard Mommer is reading through his correspondence. It’s 2006 and Hugo Chávez’s government wants to earn more from Venezuela’s oil. Senior adviser Mommer is involved in tough conversations with the 41 foreign oil companies in the country.
He opens a letter from Eni, an Italian oil company. ‘We accept your arbitration offer,’ it reads, ‘on the basis of the Dutch investment treaty with Venezuela.’
The first thing Mommer thinks is: ‘What on earth have I done?’ He knows that arbitration means that two companies which disagree about something can submit their dispute to a commercial jury to judge who is right according to the terms of the contract. But Mommer has not proposed anything to anyone. Moreover, the ministry of oil is certainly not a company. And what have the Netherlands got to do with it?
Then Mommer makes a few disturbing discoveries. One: a previous government has signed an investment treaty with the Netherlands which includes an open offer to any Dutch investors who feel they are not being treated properly by their host to summon Venezuela before an arbitration panel at the World Bank, where commercial arbitrators may levy a fine on the country. There is no possibility of appeal.
Two: Eni recently placed its Venezuelan activities under a Dutch holding company, thereby effectively becoming a Dutch investor.
‘The state is a villain with a high hat.’ Investment lawyer Gerard Meijer is sitting on a terrace in the business district of Amsterdam, in front of the entrance to his office at NautaDutilh. ‘This is an old quotation, but there is a ring of truth to it. Perhaps some people feel sorry if a country is levied a big fine. The taxpayer suffers. But people forget that their government has undeservedly enriched itself to the same amount.’
Meijer has a trendy beard, which gives him a youthful charisma despite being 50. As president of the Dutch Arbitration Association, he really believes in what he is doing.
Suppose, he says, that you are an investor in a developing country. You’ve put all your money into a project – an oil well in Venezuela, say, or a textile factory in Egypt. ‘If you end up in a conflict with such a country, where would you go? To the local judge? Do you think you would have any chance at all?’
But there’s always arbitration. ‘It’s something between mediation and a court case. If both parties agree, they [each] choose an arbitrator, and these two arbitrators choose a third. Their verdict is binding. It’s a kind of independent jurisdiction. That is very important. After all, there are many banana republics in the world.’
Investment arbitration, also known as Investor-State Dispute Settlement (ISDS), is under fierce scrutiny thanks to the TTIP negotiations, but it has existed for a while, and its popularity is growing. The number of cases has increased from 15 in 2000 to some 60 a year now. Significantly, the value of the claims is also growing.
More than half of the claims are submitted to the World Bank’s International Commission for the Settlement of Investment Disputes (ICSID); 63 per cent of the tribunals involve a small group of just 15 Western lawyers (13 white men, 2 white women) acting as arbitrators. In 22 per cent of cases, this group of lawyers provide two of the three arbitrators, which means that they can make or break the case.
The first letter was no big deal for Mommer. Eni was prepared to settle. But when Venezuela announced a rise in oil tax and plans to buy half the shares of each oil concession, Mommer received two more letters, from US petrol giants ConocoPhillips and Mobil (which had recently become ‘Dutch’ companies too). They were not open to a settlement and demanded $42 billion for lost profits.
Mommer became the main negotiator. If you expropriate shares, you have to pay, he explains. ‘We never denied that. That’s why we struck a deal with 39 of the 41 companies. But not with ConocoPhillips and Mobil, which later merged with Exxon. These companies were engaged in a long-term plan to get their tax bill down to zero. When they refused to negotiate, we expropriated their projects.’
Companies like ExxonMobil want the world to know that they have unlimited resources to litigate, so a country will think twice about challenging them
There was a lot at stake. The oil price was undergoing a historic rise, from $40 a barrel in 2004 to $150 in 2008. Venezuela wanted to compensate the companies at the going oil price during the 2006 negotiations. But if the expropriation were ruled invalid, the oil giants would demand to be compensated at the 2008 price – a difference of billions of dollars.
However, according to observers, it’s about more than money. Companies like ExxonMobil want the world to know that they have unlimited resources to litigate, so that a country will think twice about challenging them.
Though Exxon eventually won the case, the jury judged the expropriation of shares by Venezuela legal and thought that the oil giant should get more or less what Venezuela had offered: around $1 billion. But then something weird happened. The jury in the Conoco case concluded that the expropriation was illegal. Or, rather, two of the three arbitrators did. According to the third, Georges Abi-Saab, his colleagues were biased against Venezuela and the decision made a ‘mockery’ of arbitration. The compensation still has to be determined, but it could easily be more than $20 billion, which is a tenth of Venezuela’s GDP.
Mommer is not surprised. ‘The whole system works this way. It has been established by the World Bank to benefit investors.’ Somewhat less diplomatically, he adds: ‘It is there to screw us.’
Arbitration was developed as a way of settling disputes between states, says Bryant Garth, professor of law at the Southwestern Law School in Los Angeles. ‘But during the decolonization period it became popular in contracts and concessions between companies and the former colonies.’ This was called commercial arbitration.
Then, in 1987, a British investor in Sri Lanka, whose shrimp farm was destroyed in the civil war, went to ICSID. He wanted his money back from the state. He referred not to his contract but to the investment treaty between the two countries, in which they promised to treat each other’s investors properly. Normally a company cannot refer to a treaty between states; however, in this case the tribunal ordered Sri Lanka to pay damages, thus setting a precedent.
When the North American Free Trade Agreement was signed by the US, Mexico and Canada in 1994, it included an arbitration clause which ‘became a template for other investment treaties,’ says Garth.
International law firms, often of US origin, have enthusiastically jumped on the bandwagon. ‘The state, with all its tentacles, is inherently mighty,’ explains investment lawyer Meijer. ‘We help to submit states all over the world to the law.’
George Kahale III doesn’t agree, and he doesn’t mince his words. His firm, Curtis, Mallet-Provost, Colt & Mosle, is handling most of the world’s current ‘mega’ cases, including 24 of more than $1 billion each, both investment arbitration and old-school commercial arbitration. In principle, however, the firm defends only states, banana republics or not.
The oil cases in Venezuela are an example of how badly the system works, says Kahale. ‘These are not $10-million cases. These are cases of billions of dollars, about issues of crucial importance to countries which often have only a small GDP. Any mistake has far-reaching consequences.’ Especially as you cannot appeal. ‘There are almost no checks and balances, so companies can easily try to put forward absurd claims,’ says Kahale.
Look at the verdicts, he continues. ‘In the case of Exxon, the tribunal thinks what Venezuela did was perfectly legal. In the case of Conoco, two of the three judges have another opinion. So four out of six think that Venezuela was right.’ Nevertheless, Venezuela will be levied a fine of billions. ‘How is that possible?’
On the seventh floor of a drab office building in Brussels sits a law firm specializing in arbitration. Hanotiau & Van den Berg was founded by a Belgian and a Dutch arbitrator, two of the top 15 arbitrators mentioned above. Together, they sit on nine per cent of all ISDS-tribunals for which we could determine the arbitrators’ names.
Bernard Hanotiau, sitting at a big shiny table, clearly considers any criticism of ISDS stupid. ‘People don’t know what they are talking about. They think you cannot be an arbitrator if you have not been appointed as a judge by the state. But that is nonsense. Do you think that a judge who is appointed by his own state can be independent in a case against that state? No, of course not. Arbitrators often have an impressive academic background and are very specialized, more so than ordinary judges. We deal with the largest projects in the world.
‘I see myself purely as an arbitrator. I am a judge, but I am not appointed by the state. I am completely independent.’
‘There are almost no checks and balances, so companies can easily try to put forward absurd claims’
According to Gus van Harten, things are a bit more complicated. Van Harten is professor of investment law at the Osgoode Law School in Toronto. Independence sounds very nice, he says, but the rules are extraordinarily vague and leave room for personal interpretation.
‘My own extensive research shows that in three-quarters of the cases arbitrators interpret the rules “expansively”, in a way that invokes more arbitration cases.’ In short, they say they follow the rules, but they are driven by a political viewpoint. All in all, says Van Harten, ‘in some cases the arbitrators have changed the treaties into a kind of catch-all insurance for investors’.
One particular arbitrator stands out in this respect, says van Harten – Yves Fortier, a Canadian who pops up time and again in arbitration cases where the rules are ‘extended’. A former Rio Tinto board member, industry favourite and one of the Conoco arbitrators, he was involved in a case against Argentina in 2002 in which it was decided that an investor can make two claims in two different courts at the same time. ‘That opened the door for an explosion of ISDS cases,’ explains van Harten. Fortier was also a member of the arbitration trio in a case of former shareholders of oil and gas company Yukos against Russia. The arbitrators came up with the dizzying award of $50 billion, the highest fine ever. For that case, Fortier sent in a bill of $2.3 million. Van Harten stresses that this says nothing about the integrity of the man. ‘But it is the same amount a Canadian High Court judge earns in seven years. Does that give the impression of an independent jurisdiction, with no strings attached?’
Fortier is prepared to talk to us, provided that he can approve the quotes. When we lay out countries’ criticisms of the settlement mechanism, he cuts the conversation short and advises us to read up on ISDS. He is only willing to talk to people who are familiar with the subject. ‘I could not detect that you were sufficiently familiar with the topic,’ he writes in an email.
While arbitrators are expanding their jurisdiction, and the value of the claims is increasing, new players are also accessing this market: so-called ‘Third Party Funders’. Investors like Mick Smith, a Briton whose Calunius Capital fund (worth $128 million) provides money to companies that want to indict a state but cannot pay the legal costs themselves.
Smith’s method is simple. ‘We pay the legal costs for a company that wants to indict a state. It could be $1 million, but also more than $10 million. In exchange, we get a part of the fine that the state has to pay.’ That could be as much as 40 per cent. And when the case is lost, Calunius gets a fixed amount.
It is often the story of David against Goliath, says Smith. ‘Think of a mining company with only one asset, a mine. And that mine has been confiscated by a state. States often have inexhaustible means at their disposal, while an investor is left empty-handed.’ One of the ‘Davids’ that Smith is helping is a Canadian mining company that is claiming $400 million from Venezuela.
Critics describe Smith’s work in a different way. They say that he is speculating on court cases against states.
It is unknown how many cases are being financed by external parties, but it is clear that some arbitrators and lawyers are concerned. After all, the most important thing in a case is that the arbitrators have no interests in it. What if a funder has friendly relations with a law firm which is providing an arbitrator in a case in which he has invested?
Or what if the arbitrator himself is involved in the investment? Vannin Capital, a British funder registered in the tax-haven of Jersey, reported last year that Bernard Hanotiau had joined its fund. Hanotiau now says that he withdrew his application because of potential conflicts of interest.
At the top of the list of countries where most of the claims have originated since 2012 sits the Netherlands. Yet only a sixth of the companies making claims are genuinely Dutch; the rest are mailbox companies.
The Dutch government has promoted the Netherlands as an attractive place of residence for transnational corporations, not just for its tax regime and favourable investment protection policies. A key part of the appeal is the network of 95 Bilateral Investment Treaties (BITs) that it has signed with other countries. Countries in the Global South have believed that BITs are necessary to attract investment, only to discover later that this can backfire.
The text that the Netherlands used for its BITs belongs to the broadest type available. Companies don’t even have to show that they perform any substantial economic activity in the Netherlands to be able to claim the status of a Dutch investor. That’s why even ExxonMobil and ConocoPhillips can make use of Dutch arbitration clauses, even though they registered in the Netherlands after the dispute arose.
‘We call it the Dutch sandwich,’ says Kahale. ‘You put a Dutch company in between and you call yourself Dutch. It is a blatant misuse of the system.’
Though companies have filed complaints against Canada and the US, a clear picture emerges when we look at cases that have led to a fine or settlement. The US, for example, has never lost a case, and ISDS is mainly successful against ‘developing’ or ‘emerging’ countries and those in eastern Europe. Arbitration is an instrument by which rich countries discipline poorer countries.
‘ISDS is unfit for its aim,’ says Xavier Carim, permanent representative for South Africa at the World Trade Organization. ‘There are deep problems. We have signed many BITs in the past. Back then there was little knowledge about where that could lead. We really did not know what we signed.’
For lawyers this is unthinkable. ‘I simply call it laziness,’ says Meijer. ‘If you don’t know what you have signed, you have been asleep.’
Meanwhile, the UN Conference on Trade and Development (UNCTAD) speaks of a ‘crisis of legitimacy’. Venezuela, Ecuador, Indonesia, South Africa and India are in the process of annulling existing BITs. This is difficult, however, since bilateral treaties remain in force for 15 or 20 years after their annulment. Russia and Argentina refuse to pay fines. Even Australia does not want BITs any more, following claims for billions of dollars from Philip Morris in response to tighter anti-smoking legislation.
Arbitrators, investment lawyers and officials in Western countries insist that there is no legitimacy crisis. ‘The countries signed the treaties themselves. Just because some people do not think it’s fair doesn’t mean it actually is not fair,’ says Hanotiau.
This seems remarkable. The whole idea of arbitration is, after all, that it is voluntary. If this is not the case for an ever-larger part of the world, don’t we have to talk about a problem of legitimacy? Yet this does not seem to matter to most of the players in the world of arbitration. Rules are rules, they say; I am simply doing my job.
‘The arbitration system was made to protect investments, with the help of the law,’ confirms Garth. ‘From the perspective of the lawyer, only these rules count. They see it as a technical game, but it is a game associated with a neoliberal worldview.’ Law is always political. There is no universal law outside of power structures that we can roll out across the world.
In this technical game, the fact that a dispute between oil companies and Venezuela is decided in the US, based upon a Dutch treaty and interpreted by a Canadian entrepreneur, is logical. After all, they are just sticking to the rules.
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