Mariano Gomezperalta explores contributory fault in investment disputes by taking an in-depth look at some of the cases in which it has played a role.

After hours of discussing the investors’ problems with local communities, the mayor ended the meeting by saying, “If someone would have asked us, we would have never suggested our province for the project.”  Three different ethnic groups lived in the project location. They all spoke different dialects and had conflicting political views on foreign investment in the region. A renowned group of international investors was now facing serious difficulties with these local groups who were blocking the construction phase of a multi-million dollar project.

The investors returned to their headquarters and retrieved the project files to determine if someone had checked with the mayor whether he thought the investment site was viable. A quick review of the files revealed that the mayor was right. Despite all of the studies showing that the project site was commercially feasible, there was no indication of someone actually asking the local authorities for their views on the viability of the project site from a social/political perspective. While there was a substantial amount of documents showing that the investors had applied for and obtained all relevant licenses and permits from the local authorities and numerous papers addressing the company’s efforts to educate local communities about the purpose and effects of the project, no one bothered to ask the mayor’s office what they thought about the project site. A more detailed review of the company’s due diligence process also revealed that the existence of a bilateral investment treaty between the investors’ state and the host country was almost irrelevant for purposes of deciding the project location. The investors’ due diligence questionnaire consisted of hundreds of questions but only one of them (phrased as a statement) related to the existence of a BIT with the host government: “There is a Bilateral Investment Treaty in place with the host government. Yes

.” The mayor’s remarks evidenced serious deficiencies in the due diligence process and suggested that the investors may have been at least partially responsible for the project’s failure.

The principle of contributory fault

The principle of contributory fault has become increasingly relevant in investment disputes, as it allows respondent states to question whether the liability and/or the damages are in fact wholly attributable to the state’s actions or omissions. In investment arbitration cases, claimant investors must demonstrate to the tribunal that the unlawful act or omission by the respondent caused the claimant’s loss. The United Nations Draft Articles on Responsibility of States for Internationally Wrongful Acts (the “ILC Draft Articles”), which have been supported by the U.N. General Assembly and the International Court of Justice, provide that a responsible state is obliged to make full reparation for the injury “caused by the intentionally wrongful act of a State.” If the respondent state, however, is able to prove that the claimant contributed to that loss, it is likely that the amount of compensation will be reduced or maybe even voided. The contributory fault defense is a means to weaken the claimants’ submissions with respect to the causation link between the state’s conduct and the injury caused to the investor. It can also be an important factor in determining the state’s liability in the first place.

Article 39 of the ILC Draft Articles provides the basic rules for contributory fault:

“In the determination of reparation, account shall be taken of the contribution to the injury by willful or negligent action or omission of the injured State or any person or entity in relation to whom reparation is sought.”

Even though the ILC Draft Articles deal primarily with diplomatic protection, an ICSID annulment committee has stated that there is no reason not to apply “the same principle of contribution to claims for breach of treaty provisions brought by individuals.”

The Commentaries to the ILC Draft Articles (which are highly persuasive in arbitration cases) provide that:

“…not every action or omission which contributes to the damage suffered is relevant for this purpose. Rather, [the principle of contributory fault] allows to be taken into account only those actions or omissions which can be considered as willful or negligent, i.e. which manifest a lack of due care on the part of the victim of the breach for his or her own property or rights […] It follows that something which is not willful, negligent or otherwise culpable falls out with the principle expressed in Article 39.”

A less restrictive approach towards contributory fault can be found in the UNIDROIT Principles of International Commercial Contracts, which are a private codification of certain rules governing private commercial contracts. The UNIDROIT Principles seem to be cited less in investor-state cases given that UNIDROIT’s focus is on private law (with occasional incursions into public law). They do provide, however, a useful perspective on contributory fault:

“Where harm is due in part to an act or omission of the aggrieved party or to another event as to which that party bears the risk, the amount of damages shall be reduced to the extent that these factors have contributed to the harm, having regard to the conduct of each of the parties.”

Arbitration tribunals have had different views towards contributory fault defenses. For example, in Cargill Inc. v United Mexican States, Mexico alleged that US claimant investors from the high fructose industry had contributed to their own losses by pressuring the US government to adopt a restrictive interpretation of NAFTA to block Mexico’s sugar exports to the US. When the US cancelled Mexico’s access to the US sweeteners market, Mexico retaliated with a special tax on soft drinks sweetened with US fructose which forced Mexican bottlers to use Mexican sugar instead of US fructose. The tribunal did not accept Mexico’s arguments that the claimants had contributory fault and determined that the special tax was discriminatory and inconsistent with Mexico’s obligations under NAFTA. In CME Czech Republic B.V. (The Netherlands) v. The Czech Republic and Lauder v. The Czech Republic, the Czech Republic faced two cases with identical facts. The arbitral tribunals, however, accepted the Czech Republic’s contributory fault defense in only the Lauder case and relieved the state from liability. Not all respondent states have been successful with their contributory fault defenses but tribunals tend generally to accept the existence of the principle as a valid defense.

Business Risk and Contributory Fault

In the late 1990s, a group of Malaysian investors intended to develop a self-sufficient satellite city in an agricultural site in Santiago de Chile. The project included the construction of houses and apartments for diverse socioeconomic strata as well as schools, hospitals, universities, supermarkets and other service structures. Although the Chilean government issued the initial approvals by the Foreign Investment Committee and publicly endorsed the project (the Malaysian investors alleged that the President of Chile even toasted for the success of the project at a gala dinner), the zoning licenses were never issued by the government and the Malaysian investors sued Chile in arbitration for their lost capital expenditures (the “MTD case”). The arbitral tribunal decided that Chile had breached the fair and equitable treatment obligations contained in the Chile-Malaysia BIT by authorizing an investment that could not take place given Chile’s urban policies. It was clear, however, that the investors were also at fault as they failed to perform adequate due diligence and exercised poor business judgment during the initial phases of the project. The investors missed the fact that the land had been declared an exclusive agricultural site two years before the investment was made and apparently based their investment decision on a favorable recommendation to invest in Chile issued by a two-man team after only four days in the country. The investors also paid full price, up-front, for the project landsite and made aggressive assumptions with respect to the issuance of the required development permits. The tribunal recognized that the investors had made decisions which significantly increased their risks in the transaction and accepted Chile’s contributory fault defense. In its decision, the tribunal stated that:

“The BITs are not an insurance against business risks and the Tribunal considers that the Claimants should bear the consequences of their own actions as experienced businessmen. Their choice of partner, the acceptance of a land valuation based on future assumptions without protecting themselves contractually in case the assumptions would not materialize, including the issuance of the required development permits, are risks that the Claimants took irrespective of Chile’s actions.”

Once the MTD case tribunal established that the investors had contributed to their own loss, the arbitrators had to address the question of proportion. Needless to say, deciding how much compensation should be reduced in respect of contributory fault is a very complicated issue. Tribunals may take an “all, half or nothing” approach towards the compensation payable by the respondent state, but there are no clear guidelines (other than the need to evaluate it on a case by case basis). In the MTD case, the arbitral tribunal determined that the actions of both parties were material for the losses and decided to split the damages 50/50. Chile challenged the 50/50 split in an ICSID Annulment Committee, but the decision to share the losses equally was confirmed by the committee.

Management Risk and Contributory Fault

When an investor clearly has contributed to the injury it may have suffered with its own negligence or willful misconduct and such negligence or misconduct is a direct, foreseeable and proximate cause of the injury, a tribunal will likely reduce the state’s liability or, if there are no other intervening state causes, it may relieve the state entirely from liability. What happens, however, in cases in which no negligence or willful misconduct can be found in the investor’s “contributory” actions? This situation is illustrated by Gemplus & Talsud v. United Mexican States—one of the most shocking fact patterns in the history of investment arbitration, which also resulted in one of the longest awards ever written (382 pages).

Car theft in Mexico had historically been linked to serious criminal activities such as kidnappings and drug trafficking. Increased social concerns over the widespread theft of vehicles led to strong public support for a national vehicle registry. In 1995, Presidential Candidate Ernesto Zedillo promised the establishment of a reliable, first class, national vehicle registry (the “RENAVE”). Given that the registry would contain all relevant information relating to the ownership and use of vehicles, there was no question from the government or the general public that the registry’s database had to meet the highest security standards. President Zedillo determined that the national vehicle registry would best be operated by a private concessionaire, especially since all prior government attempts to establish a vehicle registry had failed. He also designated Dr. Raul Ramos, a talented and internationally respected public official, as the technical leader of the project within the federal government.

Dr. Ramos carried out an impeccable bidding process. Under the terms of the tender, the national registration of vehicles and the payment of the registration fees were to be mandatory for all vehicles in all Mexican states. This made the project very attractive for both local and foreign investors—over 90 companies registered for the bidding process. In December of 1999, Mexico awarded the concession to a consortium formed by Argentine and French investors. The consortium appointed Argentine citizen Ricardo Cavallo, a shareholder of one of the investors, as the general manager of the project. The consortium initiated operations under a pilot program shortly after the concession was awarded. The government published an official bulletin requiring all vehicles to be registered by December 15, 2000.

Most Mexican states cooperated with the federal government and the concessionaire during the establishment of the RENAVE and its pilot phase. The exception was Mexico City. At the time, Mexico City was one of the few states that was governed by the opposition party. The mayor of Mexico City politically and publically embraced the idea that the registration fees were too onerous for the people of Mexico City. Her views on the project had a nationwide effect, since Mexico City was the state with the largest number of cars (around 5 million). If Mexico City challenged or questioned the validity of the RENAVE project, other states would find it politically appealing to relieve vehicle owners—the Mexican middle class—from the payment of the registration fees. The general manager of the concession, Mr. Cavallo, moved quickly to launch an aggressive campaign to explain the benefits of the RENAVE, appearing in television interviews and in a significant amount of newspaper reports. Cavallo became the face of the project. His marketing campaign included hundreds of ads and even pictures of himself inside a registration booth, encouraging citizens every day to register their vehicles.

On August 24, 2000, the people of Mexico woke up to a surprising revelation on the front page of their main newspaper: Cavallo had been identified in a photograph by five former political prisoners in Argentina as the person who had tortured them in the Mechanics School of Argentinean Navy during the Argentine dictatorship of the 1970s. The front page, which read “Director of RENAVE accused of being a criminal,” also revealed that Cavallo was being accused of auto theft, document forgery, terrorism and torture by Judge Baltazar Garzon in Spain. Cavallo attempted to flee Mexico that day but was arrested at the Cancun airport by the Mexican police and Interpol. Spanish authorities requested that Mexico extradite Cavallo so that he could be tried in Spain for crimes of genocide, terrorism and torture committed against Spanish nationals in Argentina. The allegations in Spanish courts included widespread torture, murder, forced dispossession of prisoners’ property and systematic forgeries made to facilitate thefts of property, including vehicles. These allegations were lethal to the RENAVE concession, as no one would expect vehicle owners to provide personal information to someone with Cavallo’s reputation. The issue was no longer whether this information could be used for car theft, but whether it could be used for other criminal activities such as kidnappings, extortion or murder.

Dr. Ramos informed the concessionaire that the government would perform an immediate inspection of the RENAVE computer system and asked the concessionaire to provide all security passwords and files to the government and delete all back up information to ensure no one would be able to make improper use of the RENAVE database. Shortly after the inspection, the government ordered a “technical intervention” of the RENAVE in an effort to calm the Mexican public and the huge media storm generated by the Cavallo story.

Ten days after these government measures were taken, Dr. Ramos was found dead in a forest just outside Mexico City. The circumstances surrounding his death remain unknown. The initial news reports indicated that he had committed suicide as a letter (allegedly written by him) was found at the scene. This was also the version supported by all expert police reports. It was widely believed, however, that Dr. Ramos had been murdered by criminal interests in Mexico who either opposed the RENAVE project or were seeking to use the RENAVE as a means to facilitate criminal activities.

The RENAVE concession was unilaterally terminated by the government several months later. The investors claimed that the government’s termination had been contrary to Mexico’s obligations under the France and Argentina BITs and submitted their claim to international arbitration. Mexico’s defense in the arbitration proceedings was, among other things, that there had been contributory fault by the investors who were responsible for appointing Cavallo as the general manager of the concession and making him the face of the project. Mexico stated during the hearings that “whatever prospects [the Concession] had for its public acceptance and viability were destroyed by the Cavallo scandal.”

The tribunal rejected Mexico’s contributory fault defense at the liability stage, concluding that none of the investors had any actual knowledge of Cavallo’s criminal past and they were not at fault in failing to discover Cavallo’s identity. During the quantum review, Mexico requested that the tribunal reduce any damages payable to the claimants by 50% given that the claimants had been responsible for appointing Cavallo. The tribunal rejected Mexico’s submission and stated that there was no way the investors could have known or foreseen the Cavallo scandal. They also pointed out that not even the government of Mexico had been able to find any evidence in its direct, state-to-state, consultation process with Argentina that Cavallo had been involved in any criminal activities; Argentina’s response to Mexico was that Cavallo’s record was clean. The tribunal determined that neither Mexico nor the claimants knew or could have known of Cavallo’s alleged crimes and that the investors did not contribute to the project failure and did not have any fault in this case. Interestingly, the tribunal did not question at all the importance of the Cavallo incident with respect to the concession. It acknowledged that it had been a “highly significant event” which “[damaged] the public confidence” in the project. The tribunal therefore seems to have been comfortable with the conclusion that the “Cavallo risk”, i.e., the risk associated with the investors freely appointing Cavallo as the general manager of the concession, had to be borne entirely by the respondent state.

Country Risk and Contributory Fault

Other countries have claimed in investment arbitration proceedings that external intervening circumstances have been the direct cause of the injury to investors. In particular, Argentina submitted in several of its investor-state cases that the critical economic conditions of the country (as opposed to state actions) caused several projects to fail during the Argentina crisis of 2001. In the RENAVE case, however, Mexico did not point to extraneous elements which were outside the control of both the claimant and the respondent but to a specific decision by the investors to appoint Cavallo as the manager of the concession. Perhaps this is not a question of contributory fault, but rather one of allocation of risk: if the RENAVE dispute would have been between two private parties, who would have borne the Cavallo risk?  ■