[South Bulletin 69 Article]

By Carlos Correa

An arbitral tribunal is expected to issue soon a decision on jurisdictional matters in a case brought by Philip Morris against the government of Uruguay. The claim, based on a bilateral investment treaty (BIT) between that country and Switzerland, challenges packaging and labeling requirements for cigarettes adopted by Uruguay to reduce tobacco’s consumption.

Many developing countries have, like Uruguay, entered into BITs and other agreements to protect foreign direct investment (FDI), which entail substantial restrictions on the sovereignty of recipient countries. At the end of 2011, 2,833 BITs had been signed worldwide.  The granting of legal protection to foreign investors under BITs and other agreements (such as chapters in free trade agreements negotiated with developed countries) has often been seen as necessary to attract FDI. However, it is doubtful whether they have actually been effective in generating investment flows and promoting development gains.

Moreover, ‘BITs turned out to be much more “hazardous” than they seemed to be: many developing countries have been sentenced by international arbitral tribunals to pay millions of dollars as a result of alleged violations to these treaties’ (Lavopa, Barreiros and Bruno, 2012). Most of these awards based their decisions on overly expansive interpretations of such legal standards and concepts. This is the result of several typical features of BITs.

First, BITs generally include overbroad definitions of ‘investment’, which encompass almost any kind of business asset, such as movable and immovable property, equity in companies, claims to money, contractual rights, intellectual property rights, concessions, licenses and similar rights are included. This concept is broader than FDI, as it includes portfolio investments as well.

Second, protection is conferred on the basis of ambiguous legal standards such as “fair and equitable treatment” and “indirect expropriation”. As a consequence, international arbitration tribunals have a lot of discretion to judge governments' behavior. BITs empower such tribunals (composed of ad-hoc appointed arbitrators not subject to any jurisdictional authority) to condemn policies adopted in the public interest, on the basis of vaguely defined ‘investors’ rights’.

Third, BITs generally include a Most Favored Nation (“MFN”) clause, which assures equally favorable treatment to the investments by the nationals of a contracting party as the host country grants under other BITs to the investors of any other country. This means that the highest standard agreed upon by the host country in any BIT may be invoked by investors entitled to a lower protection under the BITs with their own home countries.

Fourth, and most significantly, BITs provide for the investor’s right to directly sue the government of the country where the investment has taken place. This is radically different from the State-to-State dispute settlement mechanism established under the World Trade Organization (WTO). Adjudication of disputes under BITs is generally done through arbitration tribunals that are not rooted in the judicial system of the contracting parties, in accordance with the rules of the United Nations Commission on International Trade Law (UNCITRAL) or, most commonly, under the auspices of the International Center for the Settlement of Investment Disputes (ICSID). By the end of 2011, the total number of known treaty-based cases had reached 450; in 2011, the number of known Investor-State dispute settlement cases grew by at least 46,  with the potential of billions of dollars in compensations to be paid to allegedly affected investors. The growing number of cases submitted to arbitration and the multi-million awards issued against the complained countries, without the possibility of an appeal, has led to a growing discontent and to initiatives to exclude international arbitration clauses from BITs, as well to withdraw from the ICSID Convention.

As a result of these features, investors can challenge and claim compensation for the alleged effects of core public policies they consider negatively affect their business prospects, as illustrated by the case initiated against public health measures adopted by Uruguay.

Anti-tobacco measures in Uruguay

Uruguay is one of the 173 signatories of the World Health Organization’s Framework Convention on Tobacco Control (FCTC) whose stated objective is ‘to protect present and future generations from the devastating health, social, environmental and economic consequences of tobacco consumption and exposure to tobacco smoke…’ (article 3). In accordance with article 5 of the Convention ‘[E]ach Party shall develop, implement, periodically update and review comprehensive multisectoral national tobacco control strategies, plans and programmes in accordance with this Convention and the protocols to which it is a Party’. Article 11 provides for specific measures to be adopted with regard to ‘Packaging and labeling of tobacco products’, further developed by the ‘Guidelines for implementation of Article 11 of the WHO Framework Convention on Tobacco Control (packaging and labeling of tobacco products)’.

In line with the requirements under the FCTC, Uruguay strengthened in 2008-2009 its anti-tobacco policies. Philip Morris has claimed that three of the measures adopted by the Uruguayan government violate the BIT entered into that country and Switzerland. Such measures are the following:

·  Article 1 of Ordinance 514 of the Ministry of Public Health (August 2008) required that one of a new series of pictograms designed by the Ministry of Public Health –depicting with disturbing images the health impact of tobacco - be included on cigarettes’ packaging. In accordance with a statement by Philip Morris, the mandated pictograms include ‘repulsive and shocking pictures, such as a grotesquely disfigured baby. We do not oppose the use of graphic health warnings but believe that images should accurately depict the health effects of smoking’. Many developed and developing countries have adopted similar measures. For instance, in Latin America, since the adoption of the FCTC in 2005, nine countries adopted pictorial labels and six passed legislation that is pending of implementation.

·  Article 3 of Ordinance 514 of the Ministry of Public Health introduced a “single presentation requirement” that prohibited cigarette manufacturers from marketing more than one product under a single brand name. The purpose of this measure is to avoid the false belief (which has been found to be common in Uruguay) that ‘light’ or ‘mild’ cigarettes are less harmful to health than others. This requirement prevented Philip Morris from selling different types of cigarettes (‘Red’, ‘Gold, ‘Blue’ and ‘Green’). The company has argued that ‘arbitrarily removing brands has simply led to consumers changing to local brands or contraband and counterfeit cigarettes, when they can no longer find their preferred products legally for sale in Uruguay’. Restrictions on branding have been implemented in many countries. In Latin America, for instance, seventeen countries have banned brand descriptors.

·  Decree 287/009 (June 2009) increased the size of the health warnings on cigarette packages from 50% to 80% of the front and back of the cigarette packages. In accordance with Phillip Morris’ statement, ‘[A]lthough we support regulations requiring prominent health warnings, the requirement of 80% leaves virtually no space on the pack for display of legally protected trademarks’. However, Uruguay’s measure is consistent with the FCTC rules. In accordance with the Guidelines for article 11 of the Convention mentioned above, ‘Given the evidence that the effectiveness of health warnings and messages increases with their size, Parties should consider using health warnings and messages that cover more than 50% of the principal display areas and aim to cover as much of the principal display areas as possible’ (paragraph 12).

Uruguay’s response to Philip Morris’ claim focuses on the lack of jurisdiction of ICSID to decide on the matter, rather than on the substance of the case. Uruguay’s arguments are solid.

 The Uruguay-Switzerland BIT includes a provision unusual in BITs: article 2(1) provides that ‘The Contracting Parties recognize each other’s right not to allow economic activities for reasons of public security and order, public health or morality, as well as activities which by law are reserved to their own investors’.

This provision defines areas where investors’ rights cannot be claimed. Its wording is significantly different from the typical ‘non-precluded measures’ provisions in BITs, which generally provide for an exception in cases where some measures are ‘necessary’ to preserve the ‘public order’. The Uruguay-Switzerland BIT specifically refers to ‘public health’ (anti-tobacco measures obviously fall under this category), recognizes the contracting parties’ ‘right not to allow’ certain activities (that is, it is not framed as an exception), it does not contain a ‘necessity’ test, and defines the scope of measures outside the BIT in accordance with their intended objective (public security and order, public health or morality). Therefore, measures adopted in the framework of article 2(1) fall outside the BIT; they cannot be subject under an investor-State claim to the standards of “fair and equitable treatment” nor to other disciplines contained in the treaty.

In addition, the BIT chosen by Philip Morris to challenge Uruguay’s anti-tobacco measures requires complaining investors to submit a dispute to ‘the competent courts’ of the Contracting Party in the territory of which the investment has been made; only if within a period of 18 months after the proceedings have been instituted no judgment has been passed, is the investor entitled to appeal to an arbitral tribunal (article 10(2)). Philip Morris does not ignore this requirement nor does it argue that it has complied with it. It relies on a MFN clause contained in the same BIT to invoke other BITs with ‘more favorable’ treatment. However, as formulated in the Uruguay-Switzerland BIT (article 3(2)), the MFN applies to substantive matters relating to “fair and equitable treatment” and not to jurisdictional issues.

There are other arguments (such as that Philip Morris investment is not protectable, since the costs to the host country widely exceed its benefits; the primacy of the FCTC over BITs, etc.) that the tribunal may consider to come to the conclusion that it has no jurisdiction over this dispute. In any case, the explicitly recognized right to protect public health and the non-compliance with procedural requirements, would seem to be sufficient to reach that conclusion.

The decision in this case is not likely to address, however, the key substantive issue raised by this and similar cases, i.e., whether investors’ rights can be recognized a supremacy over the States’ right to adopt measures to protect public health, particularly when such measures are consistent and adopted pursuant to an international convention. Nevertheless, such decision – although deprived of precedential value - will be important to assess the degree to which BITs can actually intrude into domestic policy-making in the area of public health and other. 

Even if Uruguay prevailed in this litigation, the mere existence of this claim suggests that the scope of interference of BITs with domestic policy-making can be significant. Developing countries that have signed BITs should start a process of review and eventual renegotiation or denunciation.  Although many legal problems are likely to arise, such as how to deal with the post-termination effects of BITs provisions, it seems important to act before unexpected problems arise. South-South cooperation may be crucial in this process, not only to share expertise and experiences, but to improve the countries’ bargaining position and avoid the risk of being singled out as a country where investment is unprotected.

Carlos Correa is Special Advisor on Trade and Intellectual Property of the South Centre.

Bilateral investment treaties pose many challenges to developing countries, and initiatives are underway to move towards a new framework. This message is contained in a closing speech by Mariama Williams on behalf of the South Centre at the 6th Annual Investment Forum for Developing Country Negotiators, Port of Spain, Trinidad and Tobago, 29-31 October 2012, which was co-organised by the South Centre.

By Mariama Williams

On behalf of the South Centre I would like to acknowledge the co-sponsors, the International Institute for Sustainable Development and the Ministry of Trade and Industry of the Government of Trinidad and Tobago for hosting this 6th Annual Investment Forum for Developing Countries Negotiators which focuses on Understanding and Harnessing New Models for Investment and Sustainable Development.

Undeniably this 6th forum  is quite timely and a great success. The attendance by 75 participants from 36 countries from Asia, Africa and Latin America, as well as international organizations, including the Commonwealth Secretariat, the United Nations Economic Commission for Africa (UNECA), the CARICOM Secretariat, the Caribbean Export Development Agency (CEDA), the Southern African Development Community (SADC), the United Nations Conference on Trade and Development (UNCTAD) is a testimony to the importance of the subject matter under discussion.

The previous two days of this forum have been focused on the urgent need for reform of the institutional architecture for investment agreements both in the bilateral investment treaties and in international investment agreement within Free trade agreements. In this regard it is important to take a step back and explore the contextual framing for the reform of the institutional architecture, instruments and processes of international investment.  Ultimately, a broader more political nuanced approach is critical for the uploading at all levels of the decision-making chain. As beyond the technical issues, there is a  also the imperative to change the mind frame and demystify some of the strangleholds about foreign direct investment (FDI) that still control the thinking about FDI as at many levels in developing countries.

Context: Challenges posed by Bilateral Investment Treaties (BITs) & International Investment Agreements (IIAs)

According to Oxfam more than 170 countries are involved in BITs and investment agreements that allow foreign direct investors  access to international investor-state arbitration to settle disputes before using national courts. As noted by Oxfam ‘such arbitration fails to consider the public interest, basing decisions exclusively on commercial laws.’ Now however, there is a growing backlash against the overly, and, in some cases, egregious interpretations of  key provisions of international investment agreements by arbitration tribunals that are increasingly making BITs/IIAs a mercenary exploit having not much to do with investor protection but rather allowing  legal raids on developing countries’ treasuries.

Mechanisms for enforcing BITs and IIAs such as arbitration clauses, tribunal processes and  specific legal instruments such as host government agreements within mining and extractive sectors, provide companies with effective control and coercive power over legislation and regulation that may apply to their investment activities and which ultimately may lead to states  compensating them with monetary awards for  any new laws that affect corporate priorities. Researchers such as Hildyard and Muttitt  note that this is a deliberate strategy that law firms and some corporations have  created. In the words of one such law firm: “Without having to amend local laws, we went above or around them by using a treaty” (George Goolsby Baker Botts).

As a result of these types of actions, developing countries face:

· Costly and far reaching implications of BITs and IIAs;

· Claims for compensation by firms, which in some cases  vitiate ODA (see for example ,the case of El Salvador and  PacRim which sued it for $100 million, a claim which is double the amount of US foreign aid to El Salvador, which has 34.6% of population living on  less than $2 per day ( at the same time the economic benefit of mining in the country is only about  0.4% of its GDP) (The Guardian, February 2010);

· Claims for loss of expected future profits related to non-discriminatory environment, health, safety, land use and zoning policies;

· An unethical so-called judicial review process that is riddled with conflict of interest: In some cases, 3 lawyers rotate between suing government on behalf of corporation and being judges; law firms are incentivized to troll for cases and engage in lengthy proceeding;

· Investor-state dispute resolution used as threats  and coercion against governments’ ability and right to regulate in the public interest and for developmental and social priorities;

·Threat of charges of ‘Expropriation’, particularly indirect expropriation—raised against any governmental action that firms deem to  ‘reduce the value (and potential value) of their investments’.

These outcomes, as noted by legal experts and researchers, undermine the rules of law in the South and circumvent national legal systems as well as set double standards since national investors often do not have similar such recourse. Ultimately, they create a systematic bias and engender a system that is structurally loaded against the public interests (Oxfam, 2007).

There is thus a clear need to stop private firms exploiting poor states. It is also important to work to shift the understanding of policy makers from the old paradigm that promoted the ultimate freedom of investment at all costs and to help to shift towards a new sustainable development approach.

Foreign Investment, Trade and Economic Development—Myths and Realities

The old paradigm, the freedom of investment model, ‘assumed all investment is good and all investment promotes development.’ So proponents prescribe that ‘governments should liberalise investment regimes, reduce or limit regulations and conditions on investors in order to realize the benefits of FDI.’ This is the intellectual, political and ideological approach behind the first generation of BITs and which continues to dominate the thinking of developed country partners that governments negotiate with. Unfortunately, it is also the thinking that many developing countries still operate under.

But, the experiences of many countries show no clear relationship between signing BITs and seeing increased flows of FDI. South Africa, for example, reports that it has not received significant inflows of FDI from partners with whom it has BITs. But it received investments from jurisdictions with which it has no BITs. This reality leads to the conclusion that BITs are not decisive in attracting investment  (TWN Update 2012). Conventional wisdom would argue that FDI is a potent ingredient in development because it allows for the transfer of technology and capital and is hence a catalyst for development. But while, FDI may be associated with increased trade volumes, it may also have undesirable impacts on poverty eradication and gender equality strategies, the environment, labor laws, working conditions and  overall  economic and social development.

FDI, like trade and development, is a complex issue which is linked to the stage of foreign investment. The literature shows an initial complementary relationship between outward FDI and exports; but it could eventually turn into a substitute type relationship.

So the FDI development inter-relationship is a complex issue requiring more dis-aggregative analysis in specific industries and service sectors (WIDER, 2005). One must look at the impacts of FDI on economic development, employment, social development and social equity issues.

FDI impacts development via tangible and intangible aspects such as technology innovation, organization, managerial practices and skills, human resource development, access to markets, forward and backward linkages with domestic enterprises.

Foreign Investment impacts many development dimensions including: trade, employment, domestic savings, consumption pattern, capital formation, the ownership of productive and financial assets and resources, technology (Transfer of technology), competition and economic growth.

Foreign direct investment therefore can have critical impacts on economic development and economic growth.  The most widely known positive impacts include: Conduit for transfer of technology and human skills; New ideas and innovation; Sources of capital; and Catalyst for development (when the right linkages are present in sufficient amounts).

At the same time, the most widely known negative impacts of FDI include:

·  Restrictive business practices of TNCs such as the parent company subjecting affiliates to be subjected to export restrictions and adverse (for the host country) transfer of technology agreement between affiliates and parent company; 

·  The distortive effect of transfer pricing (to avoid tax obligations) on government budgeting;

·  Instability in trade balance and Balance of Payments due to high import contents and profit repatriation;

·  Exercise of undue political influence;

·  Negative impact of foreign affiliates on domestically available financing and SMEs.

Due to these issues, there is no necessary automatic and unambiguous beneficial predisposition of FDI to development. Because of this, governments need the policy space to be able to regulate the flows of investments and the types of investments into their countries.

Therefore governments must proactively work to ensure balance between domestic and foreign investment in the context of national strategies at sectors level and macro level policies to promote the sustainability of the development process.

The ability of developing countries’ governments to ensure economic development depends on their ability to maximize technological transfer through such measures as performance requirements and technology transfer requirements.

A major concern is that investment treaties of the traditional type can constrain the ability of governments to regulate investments, or to formulate other policies.

Shifting from the Freedom of Investment Model (FIM) towards an Investment for Sustainable Development Model (ISDM)

As noted by Xavier Carim, Deputy Director General, Department of Trade, South Africa, the need for an alternative approach to FDI and the work towards a sustainable framework for international investment agreements arises from recognition of the above reality and the acknowledgement that FDI can make positive contribution to sustainable development; but benefits to host countries are not automatic; so regulations are need to balance the  requirements of investors with the need to make a positive contribution to sustainable development in the host state.

Clearly a sustainable investment framework must be premised on at least the following key pillars:

·  Right to regulate;

·  Enhancement of the development dimensions: Governments should seek to preserve aspects of trade related measures,  which promote development. These include option for and around local content requirements, trade balancing requirements, employment requirements, transfer of technology, balance of payments safeguards (emergency safeguard measures are available in GATS and could be a model for goods)  and protection for infant industries and SMEs. There must also be policy space for prudential measures, such as the central banks’ intervention to limit potential and actual harmful impacts of FDI. (This is currently undefined in the financial annex of the WTO.);

·  No mechanical application of national treatment. This could be harmful to development. This is  particularly sensitive due in part to the fact that  FDI are increasingly resorting to merges and acquisitions and in part to the size of TNCs, which is generally out of proportion to small and medium sized firms in the receiving economy. The issue of national treatment could pose serious drawbacks for women’s and minority groups’ empowerment in terms of the cooling effect on subsidies, grants or set aside for affirmative type actions for such groups as well as  women-owned businesses.

· Human rights and the social and gender dimensions;

·  Corporate social responsibility.

Already many developing and a few developed countries are raising challenges to the deeply flawed and corrosive practices that arise from  the current approach to BITs and IIAs. These include a moratorium on new BITs, a re-negotiation of existing BITs, and withdrawal  from investor-state arbitration  dispute processes.

    However, there is the difficult and unresolved question of what to do about BITs’ self-defense mechanism: MFN and tacit renewal-survival clauses that block effective exit strategy of these countries.

In the meantime, international organisations are seeking alternative and sometimes, complementary way to move forward on the Investment for Sustainable Development Model.

These actors are motivated by the imperative to develop a common standard of protection for all developing countries including, when necessary for those who cannot avoid investor-state provision, a mechanism or process for ensuring ethical, fair and consistent interpretation by arbitration panels, especially on similar matters. There is also the search for some ‘coordinating system (with input from developing countries) on the growingly complex evolving jurisprudence especially vis a vis investor state dispute provisions’.

Actors such as UNCTAD, the Commonwealth Secretariat and the Southern African Development Community (SADC) are developing new sustainable investment  model prototypes that pre-suppose an ethical and equitable framework for the relationship between investors and governments based on human rights, rule of law, due process, and sustainable development as well as the security of tenure and property rights.

Other organisations are offering support to protect governments against vulture fund litigation and to build the capacity of developing countries to  negotiate better contracts both with multinational corporations as well as within the framework of investment agreements.

Ultimately, if successful these processes and actions could help developing countries maximize the full benefits of foreign direct investment for sustainable development.

Mariama Williams is Senior Researcher of the South Centre.