By Leo Le Borgne
South America’s fight against COVID-19 has left governments vulnerable to a lurking legal danger. As multiple countries enforce strict lockdowns in failed attempts to keep the virus at bay, which in turn has led to completely shutting down various sectors of their economies, expected foreign investor profits have become collateral damage.
These foreign investors will want to hold South American governments legally accountable for these actions and seek compensatory claims. However, it remains to be seen exactly these investors can obtain indemnifications from governments, and what the socioeconomic implications of such actions would be during the ongoing global pandemic. To predict these actions and trends, we must shift our attention towards the genesis of this impending issue: bilateral investment treaties (BITs).
BITs promote and liberalise foreign investment between two contracting nations, whilst providing financial assurance to foreign investors with an extensive set of legal protections, such as banning discrimination against foreign investors and limiting a state’s ability to expropriate (where a state takes formal control of a private company for public use). BITs also lay out non-precluded measures (NPM) clauses, which limit a government’s liability during a severe state of emergency.
In many cases, a BIT is established between an investor state, where most of the foreign investors reside, and a host state, typically a developing nation in need of foreign investment. In 1959, Germany and Pakistan agreed upon the first BIT ever, marking the beginning of the BIT era and firing up a trend that has resulted in almost 2900 BITs being signed worldwide, with more than 2300 of them still active as of today. It is important to note that each individual BIT is unique, with a nuanced set of legal provisions and implications.
During the late 80s, South American economies were battered by debt crises and political upheaval. Seeking financial aid, they desperately turned to the International Monetary Fund (IMF) and the World Bank for loans, which required them to liberalise and restructure their foreign investment regulations. Consequently, the number of BITs entered into force by South American nations (Brazil being the notable exception) burgeoned in the 90s to accommodate the requests of those financial institutions.
There are specific mechanisms established in BITs and other treaties that provide a legal path for investors to sue states, whilst reliably enforcing the payment of any compensation awarded. Previously, BITs only recognised state-to-state disputes regarding investment, meaning if an investor sought compensation, the investor state would generally settle with the host state. However, more recent BITs adopted by South American governments recognise direct investor-state claims, commonly known as investor-state dispute settlement (ISDS) claims.
ISDS claims can be pursued by a foreign investor against the host state through the International Centre for Settlement of Investment Disputes (ICSID), which is specified as the adjudicating organisation by an overwhelming majority of BITs signed by South American nations. This stipulation allows foreign investors to sue host states in international arbitral tribunals, outside of the state’s domestic jurisdiction.
One may ask what exactly forces a state to recognise any award made by a foreign court: The New York Convention, which legally requires that awards officiated by foreign courts and arbitration centres be recognised by all contracting states (with some exemptions), was signed in 1958 by nearly all South American nations and thus applies in these situations.
Although BITs initially granted economic stability in South America, their implications in the wake of the COVID-19 pandemic have put the continent on edge. Foreign investors can use BITs to their fullest extent in order to claim hefty indemnification sums for lost profits as a result of government-sanctioned lockdowns. What first appeared as a helping hand could end up being a stab in the back.
South America is no stranger to extortionate BIT violations. Amid the 2001 Argentine financial crisis, the government took drastic measures to buffer the economic aftershocks, putting foreign investors at a loss. The Argentinian government then found itself the respondent of dozens of ISDS claims, each claim ranging from tens to hundreds of millions of US dollars. One expert on international law, William Burke-White, noted, “Argentina’s potential liability from these [ICSID] cases alone could be greater than $8 billion, more than the entire financial reserves of the Argentine government in 2002.” Despite the NPM clauses set in place to prevent government liability during such a crisis, many of the tribunal decisions, which formed from the Argentine crisis, nevertheless granted awards to the claimants.
However, what was once a sporadic and localised issue is transforming into a nearly universal occurrence for pandemic-ravaged states. States will be sued based on an array of legal arguments, such as indirect expropriation. In the case of Tza Yap Shum v. Peru, the claimant, who was a Chinese investor and majority shareholder of Peruvian company TSG, sued the Peruvian government following the temporary freezing of TSG’s assets as the result of a tax investigation. The tribunal found that Peru violated the indirect expropriation clause under the China-Peru BIT. The argument behind indirect expropriation entailed that TSG’s profits were harmed due to the freezing of its assets, and that the freezing of such assets had an effect equivalent to direct expropriation, which requires proper compensation.
The fundamental winning argument behind the Tza case can become applicable in cases involving COVID-19 measures. Potential claimants can argue that their assets were indirectly expropriated as a result of government lockdowns. An article published by the International Institute for Sustainable Development warns of ‘mega-awards,’ where states could be liable for over $100 million in just one case. If the number of awards pile up, governments could face an unprecedented debt crisis. With poverty rates surging across South America, whilst GDPs contract at an unparalleled rate, ISDS claims will only be pouring oil into a fire that is already out of control.
The legal aftershocks of the COVID-19 pandemic will be severe, but they will also put the BIT regime under heavy scrutiny and will bring into question whether BITs are still a viable option for foreign investment in South America. Will this post-COVID era bring the end of BITs, or will the BIT regime live to see another decade? The pending ICSID cases will determine the outcome of the survival of not only BITs, but the economic health of South America as well.
The views expressed in this article are the author’s own, and may not reflect the opinions of the St Andrews Economist.
Image source: Unsplash