Reports from the Economic Front

a blog by Marty Hart-Landsberg

Free Trade Agreements And Corporate Power

Corporate power has steadily grown over the last three decades.  And corporations have aggressively used their growing power to boost profits and the well-being of those at the top of the income pyramid at the expense of majority living and working conditions.

This development has often been presented as a force of nature.  The implied takeaway is that there really isn’t much we can do about it.  In reality, this development is the outcome of carefully devised policy.

A case in point: the two major free trade agreements that our government is currently negotiating, the Trans-Pacific Partnership Free Trade Agreement (TPPFTA) and the Trans-Atlantic Free Trade Agreement (TAFTA).

These agreements are being negotiated largely in secret.  For example,  President Obama has repeatedly rejected requests by members of congress to see drafts of the U.S. position in TPPFTA negotiations.  At the same time, more than 600 transnational corporations know everything about these negotiations because they are involved in shaping our government’s position thanks to their membership on official advisory boards.

Investment Chapters

Free trade agreements have many chapters.  While the specific terms may vary, all free trade agreements include an investment chapter.  One can see the terms of the Korea-U.S. FTA investment chapter here.  And thanks to a leak we can see the general make-up of the likely TPPFTA investment chapter here.

The draft TPPFTA chapter includes, as is typical, “minimum standard of treatment” protections for investors. More specifically:

Each Party shall accord to covered investments treatment in accordance with customary international law, including fair and equitable treatment and full protection and security.

The TPPFTA investment chapter also includes an investor state dispute settlement mechanism (ISDSM) which allows a transnational corporation to sue a host government in an international tribunal if it believes that any of the rights granted to it under the terms of the chapter have been abridged.

Most investment chapters have ISDSMs.  When corporations use them to sue a government, the case is usually heard by a three person panel that is not bound by national law.  Each party chooses an arbitrator and the two select the third.  Most cases are heard by arbitrators registered with the International Center for Settlement of Investor Disputes (ICSID), the World Bank’s body for administrating disputes.  These arbitrators are overwhelmingly corporate lawyers.  In fact, according to a study of the workings of the system by Corporate Europe Observatory and the Transnational Institute:

Just 15 arbitrators, nearly all from Europe, the US or Canada, have decided 55% of all known investment-treaty disputes. This small group of lawyers, referred to by some as an ‘inner mafia’, sit on the same arbitration panels, act as both arbitrators and counsels and even call on each other as witnesses in arbitration cases. This has led to growing concerns, including within the broader legal community, over conflicts of interest.

International trade lawyers make a great deal of money when a corporation sues a government regardless of whether they serve as council to one side or the other or sit in judgement as arbitrators.  Not surprisingly, then, they actively support the inclusion of ISDSMs in agreements and their use by corporations.

A recent study by UNCTAD highlights the rapid growth in cases brought by transnational corporations (see the two charts below):

  • In 2012, 58 new cases were initiated, which constitutes the highest number of known treaty-based disputes ever filed in one year and confirms that foreign investors are increasingly resorting to investor-State arbitration.
  • In 66% of the new cases, respondents are developing or transition economies. While the number of cases initiated by developing country investors has increased, the majority of new cases (64%) still originate from developed countries.
  • Claimants have challenged a broad range of government measures, including those related to revocations of licenses, breaches of investment contracts, irregularities in public tenders, changes to domestic regulatory frameworks, withdrawal of previously granted subsidies, direct expropriations of investments, tax measures and others.
  • At least 42 arbitral decisions were issued in 2012, including decisions on objections to tribunal’s jurisdiction, merits of the dispute, compensation and applications for annulment of an arbitral award. 31 of these decisions are in the public domain.
  • In 70% of the public decisions addressing the merits of the dispute, investors’ claims were accepted, at least in part. Nine public decisions rendered in 2012 awarded damages to the claimant, including the highest award in the history of ISDS (US$ 1.77 billion) in Occidental v. Ecuador, a case arising out of a unilateral termination by the State of an oil contract.

Recent

Trend

As UNCTAD notes, “Since most arbitration forums do not maintain a public registry of claims, the total number of cases is likely to be higher.”

A Problematic System: The Case of Ecuador

The Occidental v. Ecuador case referred to above provides a powerful example of what is wrong with investment chapters and their associated ISDSM.  The tribunal hearing the case decided that Ecuador had violated Occidental’s right to “fair and equitable treatment.”  In addition to the $1.77 billion judgment, the tribunal also ordered Ecuador to pay $589 million in backdated compound interest, plus post-award interest and half of the costs of the hearing for a total of $2.4 billion.

Public Citizen offers the following summary of the events that led Occidental to sue Ecuador using the ISDSM contained in the U.S.-Ecuador Bilateral Investment Treaty, with the paragraphs cited below referring to the tribunal’s ruling:

In May 1999, Oxy signed a 20-year contract with Ecuador and the state oil company to explore for oil in Block 15, a segment of Ecuador’s Amazon, and extract from any discovered reserves (paras. 112, 115).  In exchange for taking on all expenses, Oxy was contractually entitled to 70% of the oil produced, with Ecuador maintaining a right to the rest (para. 117).  The contract also stipulated that while Oxy could sell the oil, it could not sell off any portion of its rights to produce and profit from the oil without government authorization.  The contract stated that transferring the rights to the oil production without authorization “shall terminate” the contract, meaning legal annulment and forfeiture of investments (para. 119).  This provision explicitly enforced Ecuador’s hydrocarbons law, which protected the government’s ability to vet companies seeking to gain control over oil production in its territory, a particular concern in the Chevron-ravaged Amazon region (para. 121).

One year after signing the contract, Oxy sought to sell off a portion of its investment in Block 15 oil production so as to gain capital and reduce expenditure risks.  In October of 2000, it signed with the Alberta Energy Company (AEC, a Canadian firm) a contract in which Oxy kept “nominal legal title” to the oil production contract with the government, but AEC purchased 40% of Oxy’s oil rights and agreed to foot 40% of ongoing costs (paras. 128, 129).   The two companies formed a “Management Committee” comprised of one AEC representative and one Oxy representative with the “power and duty to authorize and supervise Joint Operations” (para 136).  Oxy mentioned the deal to the government, but neither presented the contract nor sought government authorization for AEC’s acquisition of a significant economic and operational stake in the Amazonian oil project (paras. 147-160).

After an audit of Oxy in 2004, Ecuador’s Attorney General determined that the confidential Oxy-AEC contract in 2000 had bypassed necessary government authorization and thus violated Oxy’s contract with the government, prompting him to initiate a process to annul it (para. 177).  In May 2006, after a long delay filled with a presidential ouster and political tumult, the government terminated the contract with Oxy and repossessed the land and oil equipment of Block 15 (paras. 199, 200).

Strikingly, despite finding that Occidental did indeed violate its contract, and that the government’s decision to cancel it was consistent with the terms of the contract, the tribunal ruled that Ecuador did not provide the company “fair and equitable treatment.”  Since, in its opinion, Ecuador did not suffer materially from Occidental’s violation, it concluded that canceling the contract was too great a penalty.

The tribunal then estimated the loss of revenue suffered by Occidental assuming that its 20 year contract had not been prematurely canceled and it did not sell 40% of its oil production rights to AEC.  Finally, the tribunal concluded that Ecuador bore 75% of the responsibility for the loss and the company only 25%, which was the basis for the final monetary award to Occidental.

Public Citizen concluded its discussion of the case as follows:

In the end, the tribunal’s runaway interpretation of FET [fair and equitable treatment], disregard for the rule of law, defiance of basic English, selective weighing of evidence, and arbitrary blame game have not only saddled Ecuador with a cost tantamount to health care for half the country.  They have saddled all Parties to NAFTA-style treaties with a precedent of twisted reason.  Let’s hope it isn’t followed.

Not surprisingly, Ecuador is refusing to pay and its national assembly is considering a bill to terminate its bilateral investment agreement with the United States.  In addition, the country recently hosted a “Ministerial Conference of Latin American States Affected by Transnational Interests” with the aim of sharing information about the workings of investor-state tribunals and developing an alternative investment framework.  Twelve governments attended.

The Corporate Agenda

Investment chapters advance the corporate agenda in many other ways.  For example, all contain, including the draft TPPFTA, restrictions on performance requirements which make it illegal for governments to set export or import requirements or require foreign investors to use local parts or components, hire local labor, or transfer technology to domestic enterprises.  These restrictions effectively undermine any meaningful government attempt at industrial policy.

Perhaps most damaging to the public interest is another provision found in all free trade agreements, one designed to protect corporations from direct and indirect expropriation.  Indirect expropriation refers to a government action that “unfairly” limits the profit-making potential of a foreign investment.

According to the draft chapter of the TPPFTA,

(a) The determination of whether an action or series of actions by a Party, in a specific fact situation, constitutes an indirect expropriation, requires a case-by-case, fact-based inquiry that considers, among other factors:

(i) the economic impact of the government action, although the fact that an action or 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.

(b) Except in rare circumstances, non-discriminatory regulatory actions by a Party that are designed and applied to protect the legitimate public welfare objectives, such as public health, safety, and the environment, do not constitute indirect expropriations.

In other words, a transnational corporation can sue a host government in response to any perceived violation of any provision in the investment chapter.  Thus any government action that a foreign corporation believes “interferes with [its] distinct, reasonable investment-backed expectations” could trigger a suit.  As the Ecuador case shows, even corporations that are themselves in violation of their contracts can sue and win large judgments.  Given the track record of tribunal decisions, it should not be surprising that governments have become reluctant to pursue any regulations that might challenge corporate prerogatives.

Bloomberg News recently published an article discussing some of most serious ongoing disputes between transnational corporations and governments.  Among other things, it point out that:

Arbitration clauses were originally included in treaties to deal with the nationalization of a company’s assets. Now arbitrators hear claims for lost business or costs stemming from public-health laws and environmental regulation and financial policies, with billions of dollars at stake.

In some instances, investors are even demanding that national laws or court judgments be overturned.

Once a “shield of last resort,” arbitration has become a “sword of first resort,” according to a paper by Howard Mann, a senior law adviser at the International Institute for Sustainable Development, a Winnipeg-based nonprofit.

Free trade agreements include many other chapters that help transnational corporations to pursue profits at the public expense.   U.S. financial service firms, for example, have become quite aggressive in promoting the use of financial service chapters to avoid domestic regulation of their activities.

As Bloomberg News explains:

U.S. bankers and insurers are trying to use trade deals, which can trump existing legislation, to weaken parts of the Dodd-Frank Act designed to prevent a repeat of the 2008 financial crisis.

While the companies say they are seeking agreements that preserve strong regulations and encourage economic growth, their effort is drawing fire from groups who argue that Wall Street wants to make the trade negotiations a new front in its three-year campaign to stop or alter the law.

The Korea-U.S. FTA included a strongly pro-business financial service agreement. We have no idea whether the U.S. government seeks to include a similar chapter in the TPPFTA, although it is likely.

Final Thoughts

Corporate power is buttressed and promoted by many policies, including free trade agreements.  These agreements have one major goal: restricting our ability to use public power to defend majority living and working conditions.  And, as we can see, the U.S. government is hard at work securing U.S. participation in such agreements.  Reversing negative social and environmental trends requires recognizing this reality and building a movement powerful enough to challenge and transform government policy.

 

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