During the summer of 2009, Mexican newspapers reported that a large international hemodialysis company operating in Mexico had allegedly been adversely affected by a bidding process managed by the Mexican Government’s social security agency. Specifically, it was suggested that the agency, in designing the bidding process so that a larger number of providers would be able to participate in the tender process, failed to follow health and other applicable regulations. The affected company stated that the bidding process had important deficiencies both in its design and in its implementation. The social security agency responded that the procurement process had been carried out properly under Mexican law.

Later reports indicated that the company had challenged the legality of the bidding process in local courts. Interestingly, there was some indication that the company might pursue international investment arbitration against Mexico if it could not obtain relief in local courts.

The scope of arbitration claims keeps widening

The possibility of having an investor file an arbitration claim relating to government procurement measures casts doubt on the traditional view that investor-state arbitration will be used solely to challenge “investment measures” while all other “trade” disputes (e.g., government procurement, market access, intellectual property, services, etc.) will have to be resolved through state-to-state dispute resolution mechanisms, such as those under NAFTA Chapter XX or the World Trade Organization (“WTO”).

The question of which mechanism applies is of great relevance to respondent states since the stakes in investor-state cases are much higher than in state-to-state procedures. In investment cases, respondent states face claims that can be initiated by private claimants for substantial sums of money. In the WTO, the remedy granted by a panel is a recommendation that the WTO-inconsistent measure be either removed or brought into conformity with the respondent state’s WTO obligations. As is the case with the WTO, remedies granted under state-to-state dispute resolution mechanisms are prospective remedies with no risk of exposure to pay monetary damages to a successful claimant. In addition, state-to-state mechanisms involve disputes between governments who are repeat users of the dispute settlement system and who frequently have broader agendas with a variety of political and diplomatic elements influencing their litigation decisions.

Given these differences, states are of the view that the right of access to international arbitration does not extend to all obligations contained in a free trade agreement (“FTA”), but rather is limited to the specific obligations contained in the FTA’s investment chapter or the relevant bilateral investment treaty (“BIT”). States tend to maintain that matters falling outside these obligations cannot be resolved through investment arbitration. In recent years, investors have presented (or threatened to present) as investment claims matters relating to a government’s procurement practices. For instance, in August of 2000, ADF Group Inc. brought an investor-state claim against the United States under NAFTA Chapter XI (i.e., the NAFTA Chapter dealing with investment arbitration disputes) to challenge the Federal Surface Transportation Assistance Act of 1982 and the Department of Transportation’s implementing regulations which required that federally-funded state highway projects use only domestically produced steel. More recently, the Buy American clause of the U.S. Stimulus Bill of 2009 (which restricted the use of federal funds to the purchase of U.S. origin materials in public projects) was considered by some as inconsistent with the international investment obligations of the United States.

The jurisdictional question of whether foreign investors can use investment arbitration to challenge measures that typically would only be challenged in state-to-state dispute resolution mechanisms has also arisen in the context of foreign trade measures.

For example, in 1998, S.D. Myers, an Ohio corporation that processes and disposes of PCB waste, filed a NAFTA Chapter XI arbitration against Canada arising out of Canada’s ban on exports of PCB wastes to the United States. S.D. Myers claimed that its investment suffered economic harm as a result of Canada’s ban on exports (which in and of itself was purely a trade measure). Mexico faced a similar situation in the Chapter XI case brought by Archer Daniels Midland Co. and Tate & Lyle Ingredients Americas Inc. These companies submitted that they were entitled to compensation not only for the damages they had suffered in their capacity as investors but also for damages suffered in their capacity as exporters into Mexico when Mexico adopted restrictions on the importation of fructose during its sugar crisis of 2002.

Under this expansive view of investment arbitration, claimants are increasingly attempting to use investment arbitration for a wider variety of measures, and cases are getting more and more complicated.

Arbitration cases are becoming more expensive

These developments have also had an impact on the costs of arbitration (i.e., legal counsel’s fees) and the amounts in dispute. A report by the Commission on Arbitration of the International Chamber of Commerce showed that legal fees incurred in connection with arbitration proceedings accounted on average for approximately 82% of the costs of arbitration. The growing complexity of arbitration cases will no doubt contribute to the continuing increase of legal fees. While a few years ago a “typical” arbitration case could cost between US $1.5 and US $3 million in legal fees, it is not uncommon nowadays to see legal fees above US $5 million. The same goes for the amounts at issue. It is not surprising to hear today of arbitration claims for well-beyond US $200 million.

The complexity of arbitration cases also appears to affect the likelihood of states prevailing over claimants. A number of commentators have stated that five or ten years ago states tended to prevail over claimants roughly 70% of the time but that percentage is rapidly decreasing to the detriment of respondent states.

Closely related to this is the fact that most international claims are brought by claimants represented by large U.S. and European law firms with great depth of experience. Most of these firms have had successful international commercial arbitration practices for decades. Their substantive knowledge of international investment treaty law may not be much different or better than that of respondent states, but their skills and experience on the practical side of the arbitral process may be much greater. Moreover, claimants’ law firms, with the prospect of high hourly fees and sometimes contingency fees that enable them to share in an award, have a powerful incentive to recommend a vigorous arbitration effort rather than a negotiated settlement.

Challenges faced by Latin American states

The foregoing circumstances are particularly important for Latin American countries as an ancillary effect of the large number of BITs and FTAs that they have signed over the past 20 years has been a surge of arbitration claims. Mexico has faced 15 arbitration cases since NAFTA came into effect and Chile, Ecuador, Bolivia, Peru, Venezuela and others have also faced substantial claims over the past few years. There is little question that international agreements such as NAFTA (in the case of Mexico), DR-CAFTA (in the case of the Dominican Republic, El Salvador, Guatemala, Honduras and Costa Rica) or the free trade agreements that the United States has negotiated with Chile and Peru (and is still seeking with Panama and Colombia) will continue to increase the exposure of Latin American nations to arbitration claims.

In addition, Latin American countries face further challenges. International arbitration rules typically fuse together features of the civil and the common law systems. They reflect the former’s emphasis on documents and written submissions and the latter’s preference for “pre-trial” disclosure of documents by disputing parties and oral hearings at which witnesses can be confronted through the process of cross-examination.

Because civil law typically does not rely on oral testimony, most civil law attorneys, often unfamiliar with common law practice, are not trained in the art of witness examination and oral submissions and are, therefore, at a disadvantage when dealing with lawyers who have these skills. Civil law states and the lawyers who are charged with defending their interests must develop expertise in arbitration case management, a process derived from the common law system.

Latin American countries have unfortunately seen that it is in the practical aspects of an arbitration where cases are often won or lost. For example, issues such as the selection of arbitrators and experts, the drafting of pleadings and correspondence to the tribunal, the preparation of oral hearings or the development of case “themes” can have a major impact on the outcome of a case.

Most of these items relate to the practice of arbitration law as opposed to substantive knowledge of investment treaty law. This is not to diminish the importance of the latter, but rather to emphasize the fact that where Latin American states have been “out-lawyered” is usually in the imbalance of expertise and experience in conducting actual cases.

For this reason, Latin American countries have a vital interest in enhancing their ability to defend investment claims by (i) establishing and maintaining a well-integrated and highly competent defense team at a reasonable cost; (ii) developing internal governmental expertise in procedural and substantive aspects of international arbitration and (iii) creating a regional platform that facilitates the continuous exchange of information.

An advisory mechanism for investment disputes

Latin American countries have explored ways of accomplishing this goal. Perhaps their most important effort in this regard has been the attempt over the last couple of years to create a center that would assist in the defense of claims brought against Latin American states and modeled somewhat on the Advisory Center on WTO Law in Geneva. However, the enormous difficulty of setting up such a center (given that its constitutive text has been conceived as an international treaty requiring legislative and administrative action of member countries), together with the complexity of the center’s operation and financing, make it necessary for Latin American states to examine other alternatives that could yield far better results in terms of legal representation and internal capacity building.

An alternative approach would be for the countries, possibly through a multilateral development institution, to outsource the following core functions:

  • creation and maintenance of a roster of qualified external legal counsel experienced in the conduct of investor-state arbitration and who are committed to the following principles:
      • to work collaboratively with government lawyers with a view to contributing to their training and experience in the conduct of investor-state arbitration; and
      • to enter into fee arrangements with states at competitive rates.
  • provision of a forum for government lawyers to share information and discuss matters of mutual concern pertaining to, among other things, the content of investment treaties, the institutions administering investment disputes, the selection of arbitrators and experts, the importance of the procedural calendar, domestic law issues and others;
  • facilitation of the preparation and filing of agreed notes of interpretation or submissions with respect to the interpretation of treaty provisions (e.g. 1128’s under NAFTA, 10.20’s under CAFTA, etc.) that improve the defense of respondent states;
  • organization of specialized training sessions and seminars for government lawyers in both substantive law applicable to investment treaty claims and practical skills needed for the proper conduct of investor-state arbitration; and
  • initial review and recommendations for approaching potential arbitration claims.

By properly structuring long-term relationships between Latin American states and qualified law firms and with the creation of a platform for the exchange of information, Latin American states would not only enhance their ability to defend arbitration claims but would also benefit from a system that would increase transparency with respect to legal fees and promote the development of internal governmental capacity to reduce dependency on external counsel over time. ■