On Hiatus until September

With apologies for the low level of posting, I am going to formally put the blog on hiatus until September.  Because of obligations arising from the report that I am currently preparing for the European Parliament on arbitration across the European Union and Switzerland, I will realistically not have time for the blog until after the report is submitted.  The blog will, however, resume with much greater regularity of posting at that point.

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Arbitration Unbound

Jan Paulsson, “Arbitration Unbound: Award Detached from the Law of Its Country of Origin”, 30 International and Comparative Law Quarterly 358-387 (1981)

This article is Paulsson’s classic first statement of his now long-running argument for “delocalisation” of international commercial arbitration.  Given that the article is now over 30 years old it might initially seem that the debate will have progressed too far for this article to be of any contemporary relevance.  Despite its age, however, this article remains arguably the clearest and most persuasive statement of the delocalisation position.  As a result, it is essential reading for anyone interested in the theory of international commercial arbitration.

As stated by Paulsson, the essence of the delocalisation position is the insistence that “international arbitration may create obligations even if no such effect is recognised by lex fori”.  (363)  More thoroughly, “the legal force of transnational arbitration is founded on the parties’ creation of a contractual institution; the effect of the proceedings may be left to be controlled by whatever legal system is requested to recognise the award once it is rendered, and that system need not necessarily be that of the place of arbitration”. (367)

In short, then, Paulsson’s argument is not that international commercial arbitration is entirely “delocalised”, and is therefore entirely detached from any legal system.  Rather, he wishes to make the more modest claim that an international commercial arbitration is detached from the legal system of its seat, and only connects with national legal systems when it is finally brought to a national court for the purposes of enforcement.  Because of this, the only legal system with any real right to interfere with an international arbitration is that of the enforcement jurisdiction, and only because one of the parties, by requesting enforcement, has invited it to do so.

Paulsson’s argument does not end there, however, as he does not wish merely to deny that any State other than the enforcement State has the right to interfere with an arbitration.  Rather, he also wishes to place constraints upon the grounds on which the enforcement State itself can interfere in an international commercial arbitration, by refusing to enforce the resulting award.  Paulsson argues, that is, that the courts at the place of enforcement have no right to refuse enforcement on any grounds that reflect solely national laws and policies, but instead may only legitimately refuse enforcement when an the arbitration from which the award arose violated “transnational minimum standards”. (370) 

The enforcement State, that is, on Paulsson’s view, has no more legitimate a right to interfere with an international commercial arbitration than does any other State, including the seat of the arbitration, but it can legitimately act as a mechanism for the enforcement of a form of “transnational” public policy, reflecting the non-domestic nature of international commercial arbitration.  It is a fairly major claim, and one that needs a fair bit of justification, but unfortunately Paulsson never develops a clear argument for this view.

This is a serious problem because it is not ultimately clear that a sound argument for Paulsson’s particular version of delocalisation is actually available.  Paulsson, that is, wants to argue not just that the state of enforcement of an arbitral award retains the power to grant or deny that award legal effect within its territory.  That much would be uncontroversial even under a non-delocalised understanding of international commercial arbitration.  A State can, after all, give legal recognition to any type of agreement that it wishes to give legal recognition to.  Arbitration agreements and arbitral awards are, in this respect, unexceptional.

Paulsson, however, simply cannot rest his argument on this traditional acknowledgement of a State’s power to give recognition to any agreement of which it approves because the understanding of State authority on which this view is based also acknowledges that because States have the freedom to decide whether or not to give their recognition, they also have the freedom to dictate the terms on which it will be done.  That is, on the non-delocalised understanding of international commercial arbitration an enforcement State effectively has the right to say “You are welcome to use my power to collect on your arbitral award, but only on my terms, and they are these…”

Paulsson, however, as already noted, wants to limit the grounds on which an enforcement State can refuse enforcement, so cannot agree that States are free to decide for themselves the terms on which they will enforce arbitral awards.  Rather, he wants to argue that they are bound to refuse enforcement only if arbitral awards are inconsistent with certain standards that those States themselves did not develop, ie. “transnational minimum standards”.

The difficulty is that although Paulsson enunciates and adopts this view, he never clarifies its justification.  He does cite to expressions of the same view by French courts; but such statements by French courts merely reflect a French national policy regarding arbitration, so cannot be taken as reflecting a view binding on other States.  Similarly, he refers to statements by prominent arbitrators endorsing his view; but these are just the opinions of prominent individuals, and again cannot affect the rights or obligations of States.  Paulsson himself, that is, simply does not provide any adequate explanation of precisely where the obligation on enforcement States to adhere to “transnational minimum standards” comes from.

How big a problem this is for Paulsson is important to recognise.  There are, that is, really only two ways in which such an obligation can arise, but neither can ultimately be acceptable for Paulsson.

It might, for example, be possible to base such an argument on the legal framework that has developed at the international level to support international commercial arbitration.  Paulsson, for example, points to the recognition given to such a principle in international agreements and documents such as the UNCITRAL Rules.  An argument based on the UNCITRAL Rules, however, has two problems.  Firstly, while it is true, as Paulsson notes (369) that documents such as the UNCITRAL Rules acknowledge the primary responsibility of arbitrators to adhere to the will of the parties, rather than to the will of any particular national jurisdiction, this  has no direct relevance to the existence on the part of enforcement States to adhere to “transnational minimum standards”, rather than to their own domestic law.  The UNCITRAL Rules, that is, are practical rules designed to guide members of a particular profession, not principles developed to bind States to a particular understanding of their rights and obligations.

Even more problematically, the most important international document relating to arbitration, and the one that explicitly addresses the obligation of States to enforce arbitral awards, the New York Convention, simply does not embrace the delocalised view for which Paulsson is arguing.  The New York Convention does not, it is true, obligate States to refuse enforcement to arbitral awards that have been set aside by the courts of the seat of the arbitration.  It does, however, specifically identify the courts of the seat as the only courts with the power to set aside an award, and expressly includes the fact that an award has been set aside by the courts of the seat as one of the very few grounds on which an enforcement court can legitimately refuse to enforcement an arbitral award.  The New York Convention, that is, while not embracing a conception of arbitration in which every arbitration fundamentally belongs to the jurisdiction in which it is seated, nonetheless expressly grants that jurisdiction powers and an importance that are simply inconsistent with the conception of delocalisation for which Paulsson is arguing.

Most problematically for Paulsson, however, even if the international agreements that create the legal framework of international commercial arbitration did reject the importance of the jurisdiction in which an arbitration is seated, and embraced the importance of the enforcement State that Paulsson argues is appropriate, this would not support Paulsson’s argument for delocalisation.  These documents, after all, only have any relevance because they have been agreed to by States.  This means, however, that if a State is bound to adhere to “transnational minimum standards” because that is what  is required by the international agreements of which it is a member, then ultimately the source of the State’s obligation to adhere to those “transnational minimum standards” is not those international agreements, but the State’s own consent.

Once this is recognised, however, it is clear that Paulsson’s delocalisation has simply collapsed back into a form of the non-delocalisation.  The enforcement State does indeed have a unique power to “control” international arbitral awards, and does have an obligation to do so in accordance with “transnational minimum standards”, but only because this is what the enforcement State has agreed should be the case.  It cannot be, then, that the obligation on an enforcing State to respect “transnational minimum standards” arises from the international framework to which Paulsson alludes, as such a situation simply would not support Paulsson’s view of delocalisation.

The only alternative argument available to Paulsson, however, is that States, including the enforcement State, have no right to impose their own national laws and policies on an international commercial arbitration because they have no role in the creation of the arbitration’s legal status.  Paulsson indeed does suggest that this might ultimately be the case: “The message seems clear: one is authorised to conclude that the binding force of an international award may be derived from the contractual commitment to arbitrate in and of itself, that is to say without a specific national legal system serving as its foundation.” (368)

Again, though, Paulsson doesn’t provide a clear argument as to why the parties’ agreement to arbitrate should be seen to create legal effects, rather than any other type of effect.  There is, after all, certainly no question that an obligation binding on the parties can arise from an agreement between the parties, whether or not that agreement is given legal recognition by any State at all.  This is not, however, enough for Paulsson’s argument to succeed, and what Paulsson needs to do is explain why the obligation arising from the parties’ agreement is a legal obligation, and why it is binding on the enforcement State, even though the enforcement State is not a party to that agreement.

Even more problematically for Paulsson, however, if the obligation on the part of the enforcement State to respect “transnational minimum standards” is ultimately founded on an obligation on the part of the enforcement State to respect the arbitration agreement between the parties, then it is the agreement of the parties, and not the legal system of the enforcement State, that is the source of the legal nature of the arbitral award.  The enforcement State, that is, has merely interposed itself between the subject of the legal obligation (the award) and the source of the legal obligation (the parties agreement) because it has a favourable mechanism for the enforcement of the obligation.  The obligation itself would still exist even if every State improperly refused enforcement of the award.

What this means, though, is that Paulsson’s approach to delocalisation connected to the legal systems of enforcement States ultimately just collapses into full-blooded delocalisation, in which the parties, through their agreement, can create legal obligations independent of any national legal system, and thereby bind national legal systems to their will.

Paulsson’s approach to delocalisation, then, is ultimately just not workable, and collapses either into non-delocalisation, or into a full-blooded delocalisation that is entirely divorced even from the legal system of enforcement States.  That being said, however, his attempt to develop such an approach is theory of arbitration at its best, and essential reading for anyone with an interest in the subject.

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On Integrity in Private Judging

Alan Scott Rau, “On Integrity in Private Judging”, 14 Arbitration International 115-156 (1998)

Alan Rau’s central goal in this article is to explicate the consequences of his view that “what the arbitration process is all about is private ordering and self-determination” (116).  This might initially seem like an unobjectionable proposition, as the essentially “private” nature of arbitration clearly lends itself to a picture of arbitration as a mechanism for “private ordering”.  One great strength of Rau’s article, however, is that it makes clear that this statement is not as innocent as it may seem, and that if one takes seriously the notion that arbitration is a fundamentally “private” dispute mechanism then significant consequences follow for how arbitration should be regulated, and in particular for how challenges to arbitrators should be resolved.

Rau’s primary focus in this article is on the proper understanding of the role of arbitrators, and particularly on the meaning of arbirator “neutrality” and “partiality”.  The traditional view, of course, is that arbitrators can legitimately be challenged when “justifiable doubts” exist as to an arbitrator’s “impartiality” or “independence”.  Any other approach, it is standardly argued, would be inconsistent with the ultimately pseudo-judicial nature of the arbitrator’s role, which necessarily requires that both parties be treated equally.

Rau, however, rejects this view.  Most importantly, though, he rejects it not merely by saying that it is wrong, but by arguing that such a view is simply inconsistent with another traditional view of arbitration, namely its private and contractual nature.  Rau argues, that is, that if we take seriously the basis of arbitration in a private agreement between the parties, then we are obligated to acknowledge that since contracts are often one-sided, to the benefit of the more-powerful party, any arbitration arising out of such an agreement should equally be one-sided.  A balanced and impartial arbitration, in short, misrepresents the nature of the unbalanced agreement to arbitrate into which the parties have entered: “Should not the ultimate resolution of an arbitrable dispute reflect with some accuracy the power imbalances and allocation of risks already reflected in the parties’ underlying agreement?  Why should it be thought desirable that this resolution be somehow isolated and abstracted from such questions of relative economic strength?  The arbitrator, after all, has been entrusted by the parties to work out all the implications of their ‘dickered’ bargain – even, if necessary, to complete their negotiations imaginatively by attempting to replicate the result that they themselves would have arrived at.” (133)

While counter-intuitive to most arbitration specialists, Rau’s argument is a strong one.  It might initially seem clear that by agreeing to arbitration the two parties have agreed to a neutral dispute resolution process, but there is simply nothing inherent in arbitration that requires that it be neutral.  National laws and international agreements relating to the enforcement of arbitral awards certainly require that both parties at least be given the opportunity to present their case, but even this constraint is consistent with a fair amount of imbalance in the actual procedure adopted for the arbitration.  More importantly, though, it is far from clear that arbitrations that do not meet these conventional standards of fairness are simply not “really” arbitrations.  If Rau is right, that is, that “what the arbitration process is all about is private ordering and self-determination”, then surely it follows that parties have the right to agree to an unfair arbitral procedure, just as they have the right to agree to an unfair substantive contract.

One response to Rau’s position would be to argue that there is indeed something inherent in arbitration that requires a fair and impartial process, and that if parties agree to a procedure that does not meet these standards then they may still have agreed to a dispute resolution process, but they have certainly not agreed to arbitration.  The difficulty with such a view, stated in this blunt a fashion, is that it introduces into arbitration a substantive constraint that seems fundamentally at odds with the party-centred concept of arbitration that clearly dominates the field.  One of the primary reasons that parties select arbitration, after all, is precisely the procedural freedom it gives them, including the right to select their own arbitrators.  An unbalanced arbitration that is nonetheless consistent with the parties’ agreement, then, would still seem to be an arbitration, just as a negotiation in which one party merely yells at the other and refuses to compromise is still a negotiation.  It is a poor example of negotiation, and an unbalanced arbitration is a poor example of arbitration, but they are respectively negotiation and arbitration nonetheless.

A stronger argument against Rau’s view can be made, though, that doesn’t impose arbitrary restrictions on what qualifies as arbitration, and also does not question the traditional view of arbitration as fundamentally “private” and “contractual”.  This argument focuses on what parties to an arbitration agreement should be taken to have agreed.  Rau’s argument is that they should be understood to have entered into an arbitration agreement that reflects precisely the imbalances in power that the underlying substantive contract reflect.  This is certainly not an implausible position, as both the substantive contract and the arbitration agreement are usually entered into at the same time.

Rau’s view ignores, however, the larger legal structure in which the agreement to arbitrate exists.  The significant growth of international arbitration over the last couple of decades, that is, has not been driven primarily by a sudden desire on the part of parties to design their own dispute resolution system, but because of the increased enforceability of arbitration awards created by the adoption of the New York Convention and the spread of the principles captured in the Model Law.  By choosing arbitration, then, parties are not opting out of a system of State control of their dispute resolution procedure, but are instead opting in to a system of State enforcement of their privately-generated awards.

Arbitration, that is, remains a “private” and “contractual” procedure, but the contract captured in the arbitration agreement is to engage in a pseudo-public dispute resolution process, not a purely private one.  As a result, parties that have chosen arbitration should also be understood to have chosen to arbitrate in accordance with the substantive standards that States have agreed to apply when determining whether or not to enforce an award.  An enforceable award, after all, is the ultimate goal for which the parties agreed to the process.

Parties not desiring to adhere to these State-generated standards remain free to opt out of them, and can simply include in their arbitration agreement a statement that any resulting award is not intended to be enforceable in court.  They would then be free to pursue their arbitration in accordance with any standards to which they have agreed.  Notably, however, such agreements are extraordinarily rare.

Arbitration, then, is indeed still a private process, but it is now a private process co-opted for public purposes, and this part-public/part-private nature of contemporary international arbitration results in very different conclusions on the issues on which Rau’s article is focused than does his preferred conception of arbitration as a purely private process.  Nonetheless, Rau’s article is an insightful and thoughtful piece of first-rate scholarship that is worth reading by anyone in the field.

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New Blog: Publications in Arbitration and Investment

This is just a short note to mention the creation of a new blog (http://arbitrationpublications.wordpress.com/), designed to serve as a companion to the Canon blog.  As this new blog requires no substantive drafting of entries, it will be updated on a far more regular basis than is possible at times for the Canon blog.  It will, therefore, hopefully be useful for those interested in staying on top of research in arbitration and/or investment law.  The description of the blog is as follows:

This blog is a companion to A Canon for Arbitration and Investment Law (http://arbitrationandinvestmentlaw.wordpress.com).  Whereas the Canon blog focuses on substantive discussions of publications in arbitration and investment law, the Publications blog merely reports on the existence of publications relevant to the field.  Consequently, the entries on the Publications blog consist only of the details of a publication accompanied by an abstract, the latter either taken from the publication itself or compiled for the blog.

There is, however, an evaluative component to the Publications blog as well.  While no commentary is offered, each publication mentioned on the blog is read and evaluated on a four-point scale:

  • Publications of no particular note are simply not mentioned, even if substantively relevant to arbitration or investment.
  • Publications judged to be worth reading by anyone with an interest in the specific subject matter of the publication are listed on the blog.
  • Publications judged to be high enough quality that they are worth reading by anyone who works in the fields of arbitration and/or investment law have an asterisk (*) placed at the beginning of their entry.
  • Publications judged to be important enough to be essential reading for everyone who works in the fields of arbitration and/or investment law will have two asterisks (**) placed at the beginning of their entry.
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Controlling the International Investment Law Agency

Jason Webb Yackee, “Controlling the International Investment Law Agency”, 53 Harvard International Law Journal 391-448 (2012)

One of the unavoidable consequences of the emergence of any new field is that in its early days it has no solid theoretical grounding.  New fields cannot simply invoke the same theoretical justifications as are used for the fields from which they have developed, as any new field’s existence as an independent topic of study and practice requires that it be substantively distinguishable from those older and more established fields.  Moreover, while a new field’s emergence as an identifiable topic of study means that a cadre of specialists is already working on its foundations, such efforts are intrinsically handicapped by the fact that new fields do not emerge “fully formed” from their parent disciplines, but begin their existence in a rapidly-changing and inherently-uncertain state.  As a result, even the most dedicated commentator is reduced to merely proposing an interpretation of the field’s future form, rather than identifying with any precision the form it currently has.

This is the situation international investment law currently finds itself in.  While the regulation of cross-border investment has existed for decades, if not centuries, it is only within the space of the last two to three decades that international investment law has emerged from the confines of public international law, and begun its existence as an identifiably independent legal discipline.  Moreover, the lack of development of international law at the moment of its “birth” was magnified by the fact that investment law did not emerge from public international law because of any recognition of its fundamental theoretical distinctness, but rather because of the development of investment arbitration as a field of legal practice.  That is, international investment arbitration created a specialised area of legal practice and a specialised legal community, along with a mechanism through which standards of investment law could be developed independently of the mechanisms of public international law.  As a result, international investment law developed a life of its own long before the intellectual work necessary to give it coherence had been performed.

Yackee’s article is the latest in a lengthening series of publications attempting to provide the theoretical shape the field still lacks.  His argument, as he acknowledges, is closely related to that advanced by authors such as Schill and Van Harten, who have attempted to give shape to international investment law by conceptualising it as a form of global administrative law.  Yackee argues, however, that previous authors have been mistaken in their willingness merely to draw a parallel between international investment law and domestic administrative law.  Instead, he claims, investment law can best be understood if the individuals engaged in the practice of investment law are themselves conceptualised as forming the functional equivalent of a domestic administrative agency – tasked not just with applying the law developed by legislative actors, but with filling out the substance of often-sketchy legislative rules, and thereby developing the law themselves.

It’s a bold contention, and suffers from the obvious objection that calling any collection of independent individuals an “agency” merely because they share an active interest in a particular field of law, is rather excessive.  Yackee, however, predicts this objection, and responds that while it is clearly true that no genuine agency exists, the operation of the collection of individuals who form the Agency, and in particular of the core of individuals that have the most direct impact on the development and application of international investment law, closely enough resembles an agency that the parallel is instructive as to how the individuals in that “agency” should act.  (406-07)  That is, although the “membership” of the International Investment Law Agency (IILA) may be huge, the “active membership” is actually quite small, very well-connected, and intellectually relatively homogenous.  As a result, he argues, the Agency analogy, which is all it is intended to be, can be justified.

Having argued for the existence of the IILA, Yackee then concludes the article with a set of recommendations, derived directly from administrative agency practice in the U.S.A., for changes in the operation of investment arbitration.   These recommendations include the adoption of notice-and-comment procedures, under which both the Home State of an investor and the Host State would receive a copy of a draft of the final award in an arbitration prior to it being delivered and released, so that they can comment on the draft and potentially have their comments reflected in its final form. (434)  In addition, he also proposes that Home and Host States should hold a form of “legislative veto”, allowing them to prevent awards being published if they do not agree with the legal views that they express, or to declare that an award cannot be relied upon in the future as an authoritative interpretation of a treaty to which they are party, even though the award itself would remain binding on the parties to the arbitration in which it was delivered. (440)

As already mentioned, Yackee’s central image of the “International Investment Law Agency” has a difficult credibility problem, and although Yackee attempts to mitigate the implausibility of his central contention by focusing his analysis on the few individuals most central to contemporary international investment law, that approach ultimately just isn’t enough.  He certainly demonstrates, that is, that parallels can be drawn between the international investment law community and a domestic administrative agency, but the mere existence of broad parallels simply can’t justify drawing conclusions of the strength that Yackee desires.  For the IILA to be anything more than the vaguest of analogies, Yackee would have to examine the possible parallels between the two groups far more closely than he does here, and would also need to identify ways that the two groups are importantly different.  After all, Yackee is not attempting to claim that the international investment law community is genuinely an administrative agency, but only that it resembles one in important ways.  This means, though, that it must also be dissimilar to one in important ways.  Knowing how the two are dissimilar, however, is just as important as knowing how they are similar, because only once both of these things are clear will it be possible to know when it is and is not appropriate to invoke the administrative agency parallel that Yackee wishes to invoke.

Ultimately, then, Yackee’s attempt to justify treating the international investment law community as a form of IILA is simply not rigorous enough to carry the argumentative weight he allocates to it.  This is a major problem for his article because unless this parallel is justifiable he cannot use it to justify importing into investment arbitration procedures from domestic administrative law – the fundamental goal of the article.

Yackee’s problem, though, is not merely that he does not adequately justify the parallel he wishes to draw.  Rather, he simply understates the problems inherent in drawing that parallel at all, as the dissimilarities between the international investment law community and a domestic administrative agency are far more significant than he appears to recognise.  Domestic administrative agencies, that is, are not mere random conglomerations of individuals from law firms that just happen to have been hired for the purposes of a particular case, or of commentators who have independently developed an interest in the subject matter being regulated.  They are, rather, notoriously coherent entities, peopled by individuals who often have a strong attachment to a particular set of “agency” values.  Once such an agency “culture” takes root it is inherently reduplicative, as individuals who don’t share the agency’s values are either not hired, leave, or simply fail to progress to the highest echelons.  A properly functioning agency, then, simply has far more coherence than it is possible to attribute to the international investment law community, even if one concentrates solely on the most important participants.

Moreover, the existence of an agency “culture” actually plays an important role in convincing governments to allocate decision-making power to administrative agencies, as the predictability that derives from that culture provides the government with some assurance of how the agency will use any powers it is given.  The international investment law community, however, comes nowhere near approaching such coherence, but is instead populated by extremely individualistic members with a variety of strongly held viewpoints.  Yackee, then, may be right that this community has been given powers similar those traditionally held by administrative agencies, but because of the weakness of his analysis he fails to recognise that this is potentially a serious problem with investment arbitration – it gives to the international investment law community the powers of an administrative agency, even though that community doesn’t have the characteristics that justify such a grant in the first place.

Even laying aside concerns with the success of the analogy Yackee attempts to draw in the first half of the article, however, an even more significant problem exists with respect to the second half.  To put it bluntly, the IILA analogy is completely irrelevant to the arguments Yackee offers for the adoption of certain administrative agency practices.  The only reason, that is, to argue that the international investment law community constitutes any sort of administrative agency is to allow specific conclusions to be drawn regarding how that agency should behave.  Indeed, the structure of Yackee’s article is consistent with this idea, as the first half of the article is spent building up a parallel between the international investment law community and a domestic administrative agency, and the second half argues that certain doctrines from administrative agency practice should be applied in the context of investment arbitration.

The problem is that the normative force on which Yackee relies for his argument in favour of the practices for which he argues does not derive in any way from the parallel he claims to have established.  That is, he does not argue, for example, that notice-and-comment procedures should be adopted in investment arbitration because the international investment law community is best understood as a form of administrative agency, and such a practice is required by the role of an administrative agency.  Instead, he simply emphasises that domestic administrative agencies have found such practices to be helpful, and that they might therefore also generate positive effects in the context of investment arbitration.

Such an argument, however, doesn’t rely to any degree on the existence of a parallel between the international investment law community and an administrative agency.  Rather, it relies entirely on substantive characteristics of investment arbitration.  So, for example, when arguing for the adoption of notice-and-comment procedures, Yackee relies heavily on the practical advantages such a process would bring, such as by increasing the legitimacy of investment arbitration.  Arguments that emphasise practical benefits rather than normative obligations, however, could be made even if no parallels existed at all between the international investment law community and an administrative agency.  Notice-and-comment, that is, might just be a good policy for investment arbitration, even if there is no IILA.

Yackee’s article, then, is admirably ambitious, and attempts to make genuinely important contributions to the development of investment law as a field of study.  Moreover, there is enough interesting material in the article to suggest that if Yackee continues to follow this line of reasoning he might in the future generate some genuinely important insights into the field.  At this point, however, he is not yet there.  The article is an interesting attempt, and is worth reading from that perspective, but it is perhaps an example of something published before it was truly ready.

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Indirect FDI

Kálmán Kalotay, “Indirect FDI”, 13 Journal of World Investment and Trade 542-555 (2012)

One of the primary, and growing, conflicts evidenced in contemporary international investment arbitration is that between a system of investment regulation designed to regulate and facilitate the movement of funds for investment between two States, and the contemporary reality that corporate deregulation throughout the world now allows investments to be structured in a way that undermines any real sense of an investment having a true “Home State”.  That is, simply because the “direct” investor of funds into a Host State comes from State A, this does not mean either that the funds actually originated in State A, or even that the ultimate control of the investment can be tied to citizens or corporations from State A.

Kalotay’s article doesn’t contain any real analysis of the legal issues created by indirect FDI, such as arise under the jurisdictional provisions of BITs or the ICSID Convention.  Nonetheless, it does a good job of laying out the contemporary business reality of indirect FDI, and thereby makes clear just how problematic this new reality can be for international investment law as it is currently structured.

Kalotay provides a useful division of Indirect FDI into four categories, ranging from the classical to those that are more problematic from the perspective of international investment law.

Category 1 constitutes “classical” indirect FDI, in which a foreign investor sets up a subsidiary that  then has a significant level of discretion in its own subsequent investment decisions.  This “classical” model results in FDI that is virtually indistinguishable from traditional direct FDI, as involves the creation of a separate company that operates as a genuinely independent enterprise.  Arguably, then, this version of indirect FDI is non-problematic from the perspective of the current structure of international investment regulation.

Category 2, which Kalotay parallels with “nearshoring”, involves a similar structure to Category 1, but the parent retains significant control over the management and investment decisions undertaken by the subsidiary.  Kalotay uses as an example Deutsche Telekom’s (Germany) use of its Hungarian subsidiary to invest in Macedonia, in order to create a Macedonia company that nonetheless ultimately had German, rather than either Macedonian or Hungarian, senior management.

Category 2 manifests the traditional problem created by indirect FDI, as it involves an investor from State A structuring its investment in a way that allows it to take advantage of benefits offered by State B solely to investors from State C, while nonetheless ensuring that the resulting investment is from State A in everything but formal structure.  It is certainly true that Category 2 indirect FDI involves a manipulation of the legal structures created by the States involved, and so on that level it is clearly problematic.  However, any criticisms of Category 2 indirect FDI have to be moderated by a recognition that the structuring of transactions to maximise benefits is an essential feature of contemporary transnational business.  Moreover, it is a feature of which States are well aware.  Consequently, if the States party to a BIT did not want Category 2 indirect FDI to receive the benefits offered by the BIT, the BIT could be drafted in a way that prevented it happening.

That, at least, is the standard and not unreasonable response usually made to criticisms of the structuring of transactions to take advantage of BIT protections.  Moreover, States really seem concerned by Category 2 indirect FDI unless they are having to defend an arbitration or lawsuit brought by a Category 2 investor.  When things are going well, States generally seem only too happy to accept the additional funds that structuring of this type can bring.

The real concerns attached to Category 2 indirect FDI, then, are not really about Category 2 indirect FDI itself at all, but are rather about the difficulties involved in drawing a clear and enforceable distinction between Category 2 indirect FDI and Category 3 indirect FDI.  That is, if a State finds the former desirable, but the latter undesirable, it may nonetheless not be able to preclude the latter, without also impeding the former.

What distinguishes Category 3 indirect FDI from Category 2 indirect FDI is that the former moves away from Category 2’s openness, to become what Kalotay refers to as “concealed” or “hide and seek” indirect FDI.  In this model, foreign investors invest through affiliates located in financial centres such as the Cayman Islands, in order to conceal the ultimate source of the invested funds.

There are, of course, perfectly legitimate reasons why an investor may wish to conceal the ultimate source of indirect FDI, including the simple desire to avoid alerting competitors to an evolving strategy.  However, it is nonetheless clear that the opacity of Category 3 indirect FDI lends itself to attempts to subvert the efforts of States to control FDI, whether in terms of preventing foreign sovereign control over sensitive industries, restricting the entry into the State of foreign corporations suspected of involvement in illicit activities, or similar goals.

Category 3 indirect FDI, then, while potentially perfectly innocent, raises legitimate regulatory issues for a State.  The problem is that, as already noted, regulation of Category 3 indirect FDI, while certainly not impossible, is seriously complicated by the potential impacts such regulation might have on desirable Category 2 indirect FDI.  Moreover, as regulatory efforts will likely center on ensuring that full disclosure is made to the relevant authorities, States with limited resources to spend on investigating such transactions will likely find themselves particularly vulnerable to its less innocent varieties.

Finally, Category 4 indirect FDI includes what Kalotay refers to as “round-tripping”, in which investors from a State establish an entity abroad with which to invest back into their Home State, thereby accessing protections offered by the State to foreign investments, but not to domestic investments.

This category of indirect FDI was famously involved in Tokios Tokeles v Ukraine, resulting in a well-known split decision turning precisely on this question of the application of BIT protections to roundtrip investments.  There has, however, been little indication in the jurisprudence since Tokios Tokeles that this form of indirect FDI is likely to be treated any differently by tribunals than classical Direct FDI.

Nonetheless, it is clear that this form of indirect FDI raises the same sort of regulatory problems as were raised by Category 3 indirect FDI.  BIT benefits and protections were clearly never intended to be offered to investments of this type, and arguments supporting the extension of BIT coverage to such investments almost uniformly invoke the idea that if States wished to preclude such investments they could always draft their BITs in a way that did so.  Realistically, however, States attempting to preclude Category 4 indirect FDI through precisely worded treaty provisions risk incidentally impeding desirable Category 2 FDI.  It is, after all, a lawyer’s job to find a legitimate way around clear and precise legal language – precisely why many securities laws around the world are vaguely worded, with courts intended to enforce them in accordance with their spirit, rather than their strict terms.

On the whole, while Kalotay provides little in the way of legal commentary on the classification system he uses, the system itself is very useful, as it brings out clearly the different concerns that different types of Indirect FDI can give rise to.  This helps avoid any tendency to treat indirect FDI and corporate structuring of foreign investment as a unified whole.  Thus, while Kalotay’s article can’t be said to provide much insight into how indirect FDI might best be dealt with by States, it is at least useful in helping to clarify the problem.

Indeed, one concluding point is worth noting, that Kalotay himself never addresses, but that the discussion in his article helps bring to the fore.  This is emphasis he gives to the reality of contemporary corporate structuring, in which the use of Indirect FDI is no longer an occasional decision undertaken to achieve a specific purpose, but is instead simply a feature of the way contemporary corporations operate, with activities routinely being structured through the use of subsidiaries of one form or another.  Because of this feature of contemporary business, there is a very real sense in which it no longer makes sense to speak of FDI as originating in a particular State.  Such a characterisation simply doesn’t reflect the fractured reality of contemporary corporate ownership.

The consequence of this situation is that there is arguably now a growing fundamental inconsistency between the contemporary structure of international investment regulation and the contemporary structure of international investment.  The former evolved at a time in which business had a clear nationality and was located in a particular State, with the government of that State having an active interest in protecting and promoting its foreign investment “exports”.  There are, of course, certainly a significant number of cases in which this remains true, even at the most basic level, as not all investment is undertaken by huge multinational conglomerates.  Nonetheless, fractured corporate structuring has become such a standard feature of contemporary international business that even when an investor itself may clearly be identifiable as attached to a particular State, it can now easily structure its investment activities in ways that allow it to legally relocate itself elsewhere for the purposes of particular investments.

Some tribunals and commentators have attempted to address this situation by effectively ignoring the reality of the way international investment law is structured, and instead treating investment protections as effectively offered to the world (see, e.g. Schill and other proponents of the “multilateralisation” of international investment law).  This has always been a difficult argument to make, as not only are international investment agreements overwhelmingly bilateral, but no attempt at large-scale multilateral regulation of international investment has even approached success, because of the significant disparities that still exist between States as to how international investment should be regulated.

Instead, international investment agreements have been deliberately restricted by States to bilateral or limited multilateral situations.  Moreover, it has been done precisely so that States can indulge in the very balancing and privileging of certain States over others that the multilaterilisation proponents argue is no longer prevalent.  Ignoring this fractured reality of contemporary international investment law may enhance the protection of international investment, and it may even ultimately assist the global economy, but it does not reflect the reality of the law.

Instead, what has been happening is not the multilateralisation of international investment law, but the multilateralisation of international investment.  As a result, while international investment law has remained an irredeemably bilateral enterprise, the thing that it is attempting to regulate has become consistently less and less bilateral.  It is far from clear why tribunals should see this as a problem for them to resolve, particularly when the proposed resolution involves a creative redrafting of the law to achieve a goal it is unclear that all States actually want to achieve.  However, there also seems to be little question that international investment law as it is currently structured may simply not be up to the job it is still being asked to perform.

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Enhancing International Investment Law’s Legitimacy

Stephan W. Schill, “Enhancing International Investment Law’s Legitimacy: Conceptual and Methodological Foundations of a New Public Law Approach”, 52 Virginia Journal of International Law 57-102 (2011)

Although international investment has been regulated in one form or another for centuries, and has been recognised as central to the global economy since the middle of the twentieth century, it has only existed as a distinct academic discipline for less than two decades.  Work on the legal regulation of international investment was certainly done earlier than this, but it was undertaken through the conceptual framework of other disciplines, most notably public international law (PIL).  As with any newly-emerged discipline, then, one of the primary problems faced by specialists in international investment law (IIL) is establishing precisely how the field should be conceptualised.  Stephan Schill is one of the leading contemporary proponents of the view that IIL should be seen as a form of “global administrative law”, and the title of this recent article indicates his recognition of the need to provide IIL with a solid conceptual backing.  The article ultimately lacks the conceptual clarity needed to do the job it has been allocated, but it nonetheless constitutes an important statement of one view of how IIL should be understood.

As Schill acknowledges, one of the central problems faced by any attempt to promote a particular conceptualisation of IIL is that it was neither created in accordance with a conscious design (e.g. the WTO), nor old enough that broad agreement has been achieved on many central issues (e.g. PIL).  IIL is, instead, characterised by sharp disagreements on even its most basic features, and developed largely as a result of a fairly awkward combining of the world of commercial arbitration with that of inter-State treaties.  As Schill notes early on, the impact of the combination of these very different worlds is still identifiable in the debates that surround IIL, and has produced a discipline that raises many fascinating theoretical issues, has significant practical impacts, and yet still lacks any clear sense of what it is or what it is meant to do.

Schill’s article is an attempt to address this lack of conceptual coherence by arguing that IIL should best be understood on the model of domestic public law.  That is, that the role of IIL is to mediate the use of State power with respect to international investors, determining both the limits that should be placed on State freedom to regulate, and the limits that should be placed on investor freedom to operate.  Schill argues repeatedly that understanding IIL in this way would help address the “legitimacy” issues that currently plague IIL.

Intuitively this is not an implausible argument, as not only is it clear that IIL does indeed have an impact on the actions that States can take towards foreign investors, there is also no question that this is something that it was in fact invented to do.  The difficulty, however, lies in justifying any move from a simple recognition that IIL is intended to impact upon the actions that States may take towards investors, to an assertion that it is intended to regulate those actions.  To put it in domestic law terms, Schill is attempting to move from a model of IIL based on the resolution of contractual disputes, to a model based on public law adjudication.

The difficulty involved in making such a move is that the essential difference between public law adjudication and contract adjudication is not merely that the former involves a governmental entity while the latter will generally involve two private parties, as Schill repeatedly suggests.  It is, rather, a matter of what the adjudicator is required to decide.  Contract adjudication, that is, involves determining whether the parties to the contract have adhered to the specific obligations to which they agreed.  As a result, any interpretation of the contract will impact upon the actions that the contracting parties may take towards one other.  Public law adjudication, on the other hand, relies upon the invocation of far more wide-ranging obligations relating to good governance and constitutional responsibility, that are binding on the governmental actor whether it has explicitly agreed to them or not.  The goal in public law adjudication, that is, is to regulate the State actor, in order to ensure that it meets certain standards of action judged to be appropriate to a governmental actor, not merely to ensure that it adheres to any obligations that it has voluntarily assumed.

The difficulty this creates for Schill is that while States have clearly entered into international agreements that impact upon the actions they may take towards States, the failure of all efforts that have been made to establish a multilateral international investment regime makes highly questionable that there exists the conceptual agreement necessary to underpin a public law regime.  That is, precisely because it is not contract-based, public law requires a shared conception of the nature of the relationship between the governmental entity being regulated and the private actor raising the claim, in order to clarify precisely what the governmental actor may and may not do.  There is, however, simply no broadly-shared understanding of the proper nature of the relationship between a Host State and a foreign investor.

The consequence of this situation is that a public law approach to IIL would necessarily involve imposing onto IIL a pre-decided conception of the nature of the proper relationship between a Host State and a foreign investor, rather than recognising one that is already inherent in the system.  Indeed, this exact problem can be seen in Schill’s own insistence that rather than attempting to fashion an IIL public law out of an egalitarian blending of the public law systems found worldwide, the approaches to public law found in the small number of business-friendly liberal democratic States should instead be given particular priority.  Schill’s “public law approach”, that is, is ultimately based on a pre-decided assumption of the “true” nature of IIL, which is then to be imposed on the large number of States whose own public law balances differently the interests of the State and private actors.

However, not only is it far from clear how imposing a particular conception of public law onto IIL would assist in addressing IIL’s legitimacy problems, as Schill repeatedly urges it will, it should also be noted that the liberal democratic States whose worldview is thereby favoured are not actually those most likely to be Host States of foreign investment.  That is, Schill’s suggestion effectively endorses the often-criticised habit of adopting the views of capital-exporting States and imposing them upon States with very different views of the nature of the relationship between a Host State and foreign investors.  Even leaving aside the correctness of the assertion that the liberal democratic approach to the regulation of foreign investors is clearly the best one, it is far from clear how this kind of imposition will help address IIL’s “legitimacy” concerns in the way that Schill insists it will.

This is certainly not to say, however, that Schill’s argument lacks any validity at all, as he is clearly correct when he argues that a comparative study of domestic public law systems may provide useful information on how the relationship between Host States and foreign investors should be understood to operate.  Schill’s problem, though, is that his argument is fundamentally tied into two different conceptions, namely comparative public law, and global administrative law.  Schill is certainly right that there are parallels that can be drawn between IIL and domestic public law, and his article is strongest when he is making this argument.  He makes a plausible case, therefore, for the view that domestic public law concepts should be drawn upon by IIL tribunals.

Schill, however, is not content with making this argument, and instead constantly vacillates between modest claims of the usefulness of domestic public law as a source of experience, and broader claims that IIL is simply a form of public law.  Indeed, it is this larger claim that underlies his more questionable assertions.  More problematically, however, it is also this claim that is likely to create the greatest legitimacy problems for IIL, due to the inherent inconsistency between any form of global public law and the arbitration-based structure of IIL.

That is, while it may well be true that under the right circumstances IIL could function as a form of international public law, international investment arbitration is simply not an institution capable of functioning as part of a public law system.  IIA arbitrators, after all, are simply not picked because States or investors believe those particular individuals would make good administrative law judges, and can be trusted with the power to overrule the decisions of legitimate governing bodies.  Instead, they are appointed strategically by parties involved in a specific dispute because it is believed that they will have a favourable perspective on the law and facts of that dispute.  Consequently, there is little reason to believe that those individuals Schill is urging to adopt a “public law approach” to investment law adjudication have any legitimate right to wield the power he is urging them to take.

Schill attempts to sidestep this problem by arguing that since States are clearly unwilling to accept structural changes to IIA, the current structure must be maintained and “system-internal” solutions adopted.  However, since it is the system itself that is the problem, it is unclear how any system-internal proposal can possibly be the solution.  It may simply be, then, that so long as IIL incorporates international arbitration as its dispute resolution mechanism, IIL cannot operate as a form of international public law.

Schill’s article is well worth reading as arguably the best statement thus far of the “investment arbitration as global administrative law” approach, but it is nonetheless ultimately unsuccessful, as he never solidly gets to grips with the contradictions inherent in his approach.  Instead, he slides repeatedly between plausible claims about the relevance of domestic public law to IIL, and grander claims that rely instead on conceiving IIL as a form of global administrative law, a position for which he has never expressly argued.

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