Reports from the Economic Front

a blog by Marty Hart-Landsberg

Korea-US Free Trade Agreement: The Investment Chapter

President Obama has said that the U.S. needs to compete more effectively for exports.  That is why he is calling on Congress to ratify U.S. free trade agreements with Korea, Columbia, and Peru.

In the public back and forth about these free trade agreement most of the arguments are about whether the designated tariff reductions mandated by the agreements will produce jobs for U.S. workers.  In fact, there is little reason to believe that they will.  But, more importantly, little attention has been focused on the fact that these free trade agreements contain many chapters that have far reaching implications beyond employment numbers.

In fact, the U.S. free trade agreement with Korea includes 24 chapters.  One of those chapters deals with investments.  In broad brush, the investment chapter establishes broad limits on the ability of governments (at all levels) to regulate or interfere with private profit seeking investments by (foreign) corporations. 

According to the chapter, the investments covered by the agreement include:

every asset that an investor owns or controls, directly or indirectly, that has the characteristics of an investment, including such characteristics as the commitment of capital or other resources, the expectation of gain or profit, or the assumption of risk. Forms that an investment may take include:

(a) an enterprise;
(b) shares, stock, and other forms of equity participation in an enterprise;
(c) bonds, debentures, other debt instruments, and loans;
(d) futures, options, and other derivatives;
(e) turnkey, construction, management, production, concession, revenue-sharing, and other similar contracts;
(f) intellectual property rights;
(g) licenses, authorizations, permits, and similar rights conferred pursuant to domestic law; and
(h) other tangible or intangible, movable or immovable property, and related property rights, such as leases, mortgages, liens, and pledges.

This chapter is supposed to secure the protection of Korean investors in the U.S. and U.S. investors in Korea.  In actuality, it will ensure that Korean and U.S. investors will enjoy these protections in their own countries as well.  Although this agreement does allow governments to offer foreign investors protections that exceed those they offer their own investors, it is highly unlikely that they would do so.  Thus, the freedoms granted to foreign investors under the terms of this chapter will, sooner or later, be extended to domestic firms as well, thereby expanding corporate power more generally.  And since, as the above list makes clear, a wide range of activities are to be protected under the terms of this chapter, it is likely that many corporations can expect to benefit from it.

One protection granted to foreign companies is the freedom from government imposed performance requirements.  According to the chapter

Neither Party may, in connection with the establishment, acquisition, expansion, management, conduct, operation, or sale or other disposition of an investment in its territory of an investor of a Party or of a non-Party, impose or enforce any requirement or enforce any commitment or undertaking:

(a) to export a given level or percentage of goods or services;
(b) to achieve a given level or percentage of domestic content;
(c) to purchase, use, or accord a preference to goods produced in its territory, or to purchase goods from persons in its territory;
(d) to relate in any way the volume or value of imports to the volume or value of exports or to the amount of foreign exchange inflows associated with such investment;
(e) to restrict sales of goods or services in its territory that such investment produces or supplies by relating such sales in any way to the volume or value of its exports or foreign exchange earnings;
(f) to transfer a particular technology, a production process, or other proprietary knowledge to a person in its territory; or
(g) to supply exclusively from the territory of the Party the goods that such investment produces or the services that it supplies to a specific regional market or to the world market.

This protection clearly limits the ability of a government to implement any meaningful industrial policy. 

The chapter also grants foreign corporations protection from expropriation.  According to the chapter, “Neither party may expropriate or nationalize a covered investment either directly or indirectly through measures equivalent to expropriation or nationalization.”  Critical here is the notion of indirect expropriation or nationalization. 

Indirect expropriate refers to a government action or regulation that has an “effect equivalent to direct expropriation without formal transfer of title or outright seizure.”  A direct nationalization is relatively easy to define, since it involves an explicit government seizure of title and/or assets.  Determining whether an indirect nationalization has occurred is far more difficult.  According to the chapter, such a determination will require:

a case-by-case, fact based inquiry that considers all relevant factors relating to the investment, including:

(i) the economic impact of the government action, although the fact that an action or a series of actions by a Party has an adverse effect on the economic value of an investment, standing alone, does not establish that an indirect expropriation has occurred;
(ii) the extent to which the government action interferes with distinct, reasonable investment-backed expectations; and
(iii) the character of the government action, including its objectives and context. Relevant considerations could include whether the government action imposes a special sacrifice on the particular investor or investment that exceeds what the investor or investment should be expected to endure for the public interest.

Given the broad range of covered investments, this definition will likely mean that many government actions, including those dealing with health and safety concerns or land use planning, could conceivably result in an indirect expropriation from the perspective of the investor.  This is especially true given that an investor can, as noted above, claim an indirect expropriation if a government action “interferes with distinct, reasonable investment-backed expectations” or “imposes a special sacrifice on the particular investor or investment that exceeds what the investor or investment should be expected to endure for the public interest.” 

There is enough ambiguity in all of this, that one can easily imagine foreign corporations challenging many government regulations.  And, if a corporation does feel that it is the victim of an indirect expropriation, this chapter gives it the power to directly sue the unit of government that has implemented the offending rule or regulation. 

Under the terms of the dispute-settlement mechanism, the corporation can have its claim judged under the World Bank sponsored ICSID (International Centre for Settlement of Investment Disputes) Convention and the ICSID Rules of Procedure for Arbitration, the UNCITRAL (United Nations Commission on International Trade Law) Arbitration Rules, or any other arbitration institution if it is agreed to by both parties. 

For example, if the ICSID is chosen to judge the claim, which is the most common choice in agreements like this, three arbitrators will be selected from a listing of international trade and investment specialists. Each side selects one with a third to be chosen by agreement of the two sides.  In other words, this dispute-settlement mechanism allows a corporation to challenge a governmental action outside the legal system of the host nation and have its case decided according to terms that differ from that nation’s legal system.

As Public Citizen reports:

The special threat is posed by the fact that there is a huge number of U.S. and Korean companies cross-established in each other’s national markets. If the Korea FTA were to be passed with its current text, at least 1,030 corporations with 2,055 establishments across the United States and South Korea would obtain new FTA rights to demand taxpayer compensation through challenges of U.S. and Korean federal and subfederal laws in foreign tribunals. The scale of investment going in both directions is very unlike previous U.S. FTAs with small developing nations.”

We already have an example of how this process could conceivably work.  NAFTA has a similar investor-state dispute settlement mechanism.   In 1996, The Loewen Group, a Canadian funeral home company, lost a $500 million verdict to a Mississippi funeral home business that had accused it of fraudulent business practices.  Loewen appealed the case to the Mississippi Supreme Court, which refused to overturn the decision.  In 1999, the Loewen Group took its case to a NAFTA tribunal, arguing that the verdict against the company should be invalidated because the court proceedings were tainted by anti-Canadian bias.  Loewen asked the tribunal for compensation for what it had to pay to settle the case and for additional damages to compensate the company for the harm done to its business reputation.

The tribunal issued its decision in 2003, ruling in favor of the United States.  The Dispute Resolution Journal describes the reasoning and conclusions of the tribunal as follows:

In its 71-page award, the tribunal . . . acknowledged that this was a difficult case. The award addressed the Loewen Group’s claims of an unfair process as well as the United States’ numerous arguments that it was not liable under NAFTA. In so doing, the tribunal chronicled the injustices suffered by the company and its founder, co-claimant Raymond Loewen. Ultimately, it found, among other things, that “the conduct of the trial judge was so flawed as to constitute a miscarriage of justice amounting to a manifest injustice as that expression is understood in international law.” The tribunal also said that the jury verdict was grossly excessive to the amounts in dispute and therefore the claimants had “strong prospects” of a successful appeal. . . .

After recounting its findings, the tribunal explained that its decision to dismiss the NAFTA claims on the merits was ultimately based on a lack of jurisdiction. It reasoned that it had no authority to determine the Loewen Group’s NAFTA claims because the company had reorganized under Chapter 11 of the Bankruptcy Code as an American corporation and then assigned its NAFTA claims to a newly formed Canadian corporation “owned and controlled by an American corporation.” NAFTA, the tribunal pointed out, was not intended to address investment-related claims by domestic investors against their government.

In other words, the tribunal found it within its authority to rule on this case, even though its decision could potentially overturn a decision made by a U.S. court.  And it gave strong indication that it felt that such action was justified by its reading of the submitted documents.  It rejected the claim only because the Loewen Group, by reorganizing itself as a U.S. registered company, was no longer a “foreign” company and thus no longer had standing under the terms of NAFTA.  If the tribunal had ruled in Loewen’s favor, the U.S. government would have been forced to compensate the company.

Interestingly, the recently completed U.S.-Australia FTA does not include an investor-state enforcement mechanism, but rather relies on state-state enforcement of the FTA’s investment, services and financial services chapters.  It appears that the U.S.-Korea FTA includes an investor-state mechanism because of U.S. insistence.  As Public Citizen reports

Korean civil society organizations report that Korean government officials expressed concern about investor-state, which was characterized by Korean negotiators as a U.S. demand. The FTA text itself reveals Korea’s concerns: Korea insisted on and obtained a limitation on investor-state enforcement. Under this limitation, if a U.S. firm starts proceedings in a Korean court or administrative tribunal about a Korean policy that they claim breaches the various property rights established in the FTA, then they may NOT also use the investor-state system. U.S. firms have to pick domestic OR investor-state.  USTR did NOT make that exception apply to us. . . . That the Korea government would be concerned is reasonable: there are hundreds of U.S. firms in Korea that would be newly empowered to use the investor-state mechanism to privately enforce the FTA’s extraordinary foreign investor rights that extend beyond Korea domestic law, which like U.S. law does not generally recognize compensation claims for “regulatory” takings. 

It seems safe to say that this investment chapter will create an environment in which governments will  understandably be leery of doing anything that might be viewed as harmful to corporate activities, present or future.  Make no mistake, this is the outcome desired by those who drafted the agreement.  

I bet you have read or heard little about this chapter, or the others that have a similar aim, in the public discussions of the U.S.-Korea FTA.  And that is also no accident. 

It is hard to see how this agreement will serve the public’s interest in either Korea or the U.S.   President Obama is pushing Congress to ratify it as soon as possible.  It is very important that we push back.  Our goal must be the defeat of this and the other so-called free trade agreements.

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