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Fauwaz Abdul Aziz

Investor-State arbitration system needs ‘complete overhaul’

by Fauwaz Abdul Aziz

14 May 2014

A prominent international lawyer has launched a scathing critique of the international arbitration system that deals with investor-State disputes, calling for its "complete overhaul".

The investor-State arbitration system features strongly in bilateral investment treaties and recent bilateral and plurilateral trade agreements such as the controversial Trans-Pacific Partnership Agreement.

Delivering the keynote address to the Eighth Annual Juris Investment Treaty Arbitration Conference held in Washington, D.C. in late March, George Kahale III - who has been lead counsel in several of the world’s largest international arbitration cases, including a pending claim against Venezuela - also listed the top ten of what he viewed were the most troubling aspects of investor-State arbitration.

The chairman of the Curtis Mallet-Prevost Colt & Mosle law firm has also acted as lead counsel in some of the world’s largest and most publicised transactions and infrastructure projects in the international petroleum industry, representing energy ministries and national oil corporations in many oil and gas producing countries.

At the conference, themed around the question "New Developments in Investment Treaty Arbitration: A Return to Fundamentals?", Kahale said the pace and scope of change in the area of international trade and investment agreements, in particular, had overtaken the ability of governments to grasp the seriousness of the challenge, significance and impacts they posed.

This is in addition to the serious flaws of the current international arbitration system, such as its biasness and partiality in favour of foreign investors as against states, the use of private commercial arbitration law principles and practices to decide on matters traditionally deliberated on the basis of public international law, and the susceptibility to abuse of substantial provisions in international investment treaties, such as the Most-Favoured- Nation and Fair and Equitable Treatment standards.

Kahale also decried the preference in international arbitration for "speed" and finality" as opposed to due process and justice, the arbitrary and exorbitant claims and awards against states that often exceed the GDP of developing countries, the lack of a credible and uniform standard of conduct for arbitrators, and the recent phenomenon of third-party funding.


The first of the "top ten" concerns he has with current international arbitration is the fact that many governments are jumping on to the bandwagon of investment treaties - which Kahale described as "weapons of legal destruction" - often without scrutinising the serious implications and significance of the obligations contained therein.

Governments also often overlook the changing nature of investment treaties - which are expanding in breadth and ambiguity - in favour of investors with the corresponding effect that more and more types of State acts, gestures or Statements are becoming liable to challenge and compensation by foreign investors, said Kahale.

Secondly, a "club of international arbitrators" and a new body of international law were being built up through the international arbitration system, but arbitrators are seldom trained in international law and often have "other interests not necessarily consistent with their functions as arbitrators" nor their independence as supposedly impartial ‘judges’ between parties to international disputes.

In such an environment, said Kahale, "arbitrators are actually encouraged to trade points as if they are bargaining in a Turkish bazaar, acting more like party representatives negotiating a settlement than arbitrators deciding a momentous legal controversy."

Emphasising that the issue lies beyond the mere choice of which arbitrators are picked by disputing parties to a dispute - and acknowledging that "quite a few" arbitrators are competent and professional - Kahale stressed that the system itself of international arbitration is unsuitable for investor-State disputes.


The third criticism Kahale raised was that the provisions contained in bilateral investment treaties (BITs) and other international trade and investment agreements, such as Most-Favoured-Nation (MFN) and Fair and Equitable Treatment (FET) standards, are themselves "susceptible to abuse".

"Most of us intuitively sense that the drafters of these 3,000 treaties had little or no idea that FET meant anything other than the minimum standard of treatment under customary international law," for example, whereas MFN is "a dangerous provision to be avoided by treaty drafters whenever possible" and has been used as if it was a "magic wand" to impose obligations on governments to give protections "never imagined for virtually an entire world of investors," said Kahale.

Fifthly, rather than "the proper administration of justice", he said the premium placed in the international arbitration process on "speed and finality" has turned justice and due process into the main casualties of the system.

He cited the example of the refusal of the International Centre for Settlement of Investment Dispute’s (ICSID) Annulment Committee in 2007 to overturn an earlier ICSID award of US$133 million against Argentina despite finding "manifest errors" in the original decision that "could have a decisive impact on the operative part of the award."

As Kahale noted, the Annulment Committee nevertheless felt that it could not annul the award because it exercised jurisdiction under what it thought was a "narrow and limited mandate conferred by Article 52 of the ICSID Convention."

"How is Argentina supposed to feel when it loses a case that the Annulment Committee says was a product of manifest errors of law?" he asked.


The sixth criticism of international arbitration relates to the increasing normalisation of US$50-$100 million awards as well as the increasing frequency of billion-dollar "mega cases" and other claims exceeding the GDP of many nations. Such claims are being brought against States in the same "cavalier" manner as if they were the same as a "small demurrage claim under a charter party," said Kahale.

The case of Occidental (oil corporation) versus Ecuador has seen not only a foreign investor being awarded US$1.8 billion plus interest - which Kahale said is "the largest known award in investment treaty arbitration’s history" - and is currently the subject of annulment proceedings, but raises questions as to how the tribunal arrived at the decision to reduce the compensation by 25 percent.

"Did the arbitrators just throw darts? Did they sit around negotiating percentages? ‘How about 30, or maybe 40? No, that’s too high, let’s make it 25’", he quipped.

Kahale also noted that the decision that had given rise to the Occidental versus Ecuador dispute in the first place - Ecuador’s termination of a contract with Occidental - was itself precipitated by Occidental’s violation of the prohibition against assigning an interest in the project to a third party without ministerial approval, on which point Occidental had actually lost.

"I can only assume that Ecuador was and remains puzzled as to how it is that it can win the underlying issue giving rise to the case and still lose the largest award in ICSID history. Can you imagine what the US Congress would have done if a multi-billion-dollar award had been rendered against the United States for exercising its right to terminate an oil lease for breach of its terms?" he asked rhetorically.


On the controversial decision of ConocoPhillips versus Venezuela, Kahale cited the dissenting arbitrator’s description of the majority’s findings as "a legal comedy of errors on the theatre of the absurd, not to say travesty of justice, that makes mockery not only of ICSID arbitration, but of the very idea of adjudication."

Kahale said that many objections registered against the conduct of arbitrators have been serious, but they did not succeed simply because the rules of the international arbitration system ensure that arbitrator conduct is not held to the same standards as those of domestic judicial systems.

"We have to acknowledge," said Kahale, "that conduct wholly unacceptable for a federal judge in the United States is commonplace in investor-State arbitration."

"I ask," he added, "Why should that be so if, in fact, investor-State arbitration often involves issues of international law having an impact far beyond the individual case, and matters of the highest public order and national security for the States involved? Under these circumstances, what possible excuse is there for not holding arbitrators to the highest, rather than the lowest, conflict standards?"


The lack of a credible standard of conduct is compounded by the finality of arbitrators’ decisions as well as the related matter of issue conflicts, Kahale said further. In most judicial systems around the world, he stressed, even if a judge were to have displayed his/her bias for or against certain issues, that judge would still be bound to follow the interpretation of a higher judicial authority, or otherwise risk reversal of his/her decision.

"But in the world of investor-State arbitration, where arbitrators feel free to follow their preferred school of thought or even to invent law without fear of appellate review, issue conflict has to be taken more seriously."

Related to the above criticism, Kahale contended, is that many cases can be predicted by experienced practitioners on the basis of the composition of the tribunal.

While this explains why it can take a long time for parties to agree on the tribunal of arbitrators for their dispute, the more significant question is how such a state of affairs can be squared with the notion of impartiality, which Kahale said is universally agreed to be the bare minimum qualification for arbitrators.

"The fact is that true impartiality is almost impossible to achieve on issues, and that’s a dangerous thing when combined with other features of the current system, including the manner of appointing arbitrators and the sovereignty of each tribunal."

Claimants have also demonstrated the tendency to grossly exaggerate claims: when ExxonMobil started its litigation against Venezuela’s State oil firm, it had initially sought US$12 billion in a claim against Venezuela’s State oil company PDVSA (the tribunal awarded Exxon 5 percent of that amount); ConocoPhillips began its case against Venezuela claiming over US$30 billion plus interest.

"Now, we’ve all heard the stories about multi-million dollar claims based on coffee spills. Gross exaggeration of a claim is nothing new, but with investor-State arbitration, it reaches a new level, first because of the amounts involved and second, because there is a greater chance that some tribunal will actually take such a claim seriously than there is in a national court which is subject to more checks and balances."

The next "disturbing phenomenon" connected to international arbitration is that of third-party funding, said Kahale, whereby commercial companies offer to pay some or all of a claimant’s legal fees and expenses in exchange for payment of the claimant’s direct costs and a share of the sum recovered by the claimant in the arbitration (typically between 15% to 50%).

"One can wax eloquent about the positive role played by funders in getting justice that would otherwise be denied," said Kahale, "but I think we should all be frank enough to admit that that isn’t the kind of investment BITs were meant to protect."


Kahale’s final criticism was on "the perceived bias against States" in the investment arbitration system, which is a result of the features discussed above as well as many others that have not been mentioned.

While such bias does not mean that States never win cases, that tribunals are always tilted in favour of investors, or that States never do wrong, Kahale said that such figures cited by proponents of the current international arbitration system showing that States win more than 50 percent of cases are "meaningless, if that figure happens to represent the percentage of cases that never should have seen the light of day or that would never survive a motion to dismiss in a national court."

"It is also cold comfort if 20 or 30 percent of those cases involve manifest errors, especially if some of those are mega cases."

In conclusion, Kahale said there are some quarters who believe the criticisms against the current international arbitration system are merely isolated, fixable "mistakes" and exceptions to the general efficacy and efficiency of the system.

"But I can assure you," Kahale pointed out, "there is a very large segment of the international community, including States, international law scholars, and even students trying to make heads or tails out of these decisions, that believe otherwise. And if that’s the case, as it undoubtedly is, it calls into question the legitimacy of the entire system."

While not purporting to have any one panacea for all the problems of the system, they do call for immediate recognition and attention, particularly since they are "serious problems that don’t often get sufficient air time."

"After all, the first step in solving a problem is always becoming aware of its existence," Kahale stressed.

According to a Curtis report on the 28 March speech, it was not the first time that Kahale has spoken out against investor-State arbitration.

In New York in 2012, he argued that ICSID suffered from a legitimacy problem, and that the institution had strayed from its original ambit.

His essay on the same subject, "Is Investor-State Arbitration Broken?", won the Burton Award last year for distinguished legal writing.

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