Do Investment Arbitration Treaty Rules Encourage Corruption?

Is it possible that current investor-state arbitration rules actually encourage states to tolerate corruption? A terrific 2012 note by Zachary Torres-Fowler in the Virginia Journal of International Law raises that question. Here’s the gist of his argument: According to the widely discussed arbitral decision in World Duty Free v. Kenya, states in investment treaty arbitration can escape liability by proving that the aggrieved investor engaged in corrupt activities in connection with the investment under dispute–even if senior state officials were full participants in the corrupt transaction. That being the case, states that receive inbound foreign investment have a perverse incentive to tolerate corruption in the officials who deal with foreign investors, because that corruption may help shield states from legal liability should the state subsequently renege on its agreement with the investor. This is a great insight, and one which I think could actually be expanded a bit further.

Although cases like World Duty Free v. Kenya suggest that corruption may provide a defense for states in arbitral proceedings, other arbitral decisions have suggested that corruption within a state’s bureaucracy can also be grounds for an investor’s claim against a state. In the leading case, EDF v. Romania, the tribunal indicated that a state official’s attempt to solicit a bribe from the claimant might violate the guarantee of “fair and equitable treatment” under the relevant bilateral investment treaty (BIT). The logic of EDF, in tandem with the cases like World Duty Free, has some strange implications for investment treaty arbitration. The participation of state officials in corruption, though perhaps a violation of the state’s obligations under a BIT, does not prevent states from using such corruption to establish a complete bar to sovereign liability for other violations of the BIT. Applying that principle to the reverse situation – where the investor is the party alleging corruption – would mean that an investor could potentially allege a treaty violation if its own employees and state officials engaged in corruption! (It’s certainly debatable whether the no-contributory-liability principle should apply symmetrically in the investor-state arbitration context, but I’ll accept that that argument is at least tenable). And it’s also worth noting that in the World Duty Free context, the actions of state officials (including the President!) are not attributed to the state (on the logic that the officials are acting in their personal capacity when soliciting bribes), but in the EDF context, the corrupt acts of the state’s officials are grounds for finding the state itself in violation of the BIT.

At the risk of too much speculation, this kind of system probably leads to even more complex and potentially perverse incentives than Torres-Fowler recognized. When deciding how strictly to enforce anticorruption norms, investors and states must consider both the possibility that corruption will harm their case in a future arbitration, and the possibility that it will strengthen their legal position. Ultimately, the problem seems to be that arbitral tribunals haven’t established a comprehensive framework for regulating corruption – and haven’t decided whether to prioritize penalizing supply-side or demand-side violations. But if arbitral tribunals were to begin thinking about the two issues together, that alone would be a significant step forward.

9 thoughts on “Do Investment Arbitration Treaty Rules Encourage Corruption?

  1. Pingback: Links: Learning Econometrics; Conflict Data; BITs and Corruption - IR Blog

  2. Thank you for your post, Sam. I found it insightful and thought provoking, and I agree that arbitral tribunals should think comprehensively about bribery and figure out ways to discourage both supply- and demand-side bribery.

    World Duty Free and EDF contain clues for how tribunals may do so. World Duty Free is, like the Foreign Corrupt Practices Act and a number of extraterritorially-applicable antibribery laws, a supply-side check on bribery. Investors cannot enforce a contract based on bribery, because “bribery is contrary to the international public policy of most, if not all, States.” (World Duty Free, at para. 157). Supply-side restrictions may significantly impact corrupt practices — investors should fear not only extraterritorial antibribery legislation, but unpunished breaches of contract. And states aren’t off the hook — Kenya is likely to have suffered reputational (and, derivatively, economic) damage from President Moi’s solicitation of bribes.

    EDF might fill the demand-side void. If bribery solicitation violates the terms of Bilateral Investment Treaties, especially if tribunals hold states accountable for the actions of their officials, states have an incentive crack down on corruption.

    Even after thinking comprehensively about bribery, tribunals will struggle to establish rules for future cases. In World Duty Free, ICSID dealt with a clear case of bribery — a suitcase filled with $500,000 cash to obtain “the agreement of the President on the contemplated investment.” (World Duty Free, at para. at 136). I wonder what the Tribunal — and others — will do with harder cases.

    • Let me follow up on something David gets at in his last paragraph: Might it be the case that, despite all the ink spilled on World Duty Free (and, to a much lesser extent, EDF), in the end corruption allegations will play a marginal–perhaps trivial–role in most investor-state arbitration? After all, my understanding is that even thought the tribunal in EDF suggested that bribe demands could violate fair and equitable treatment, the tribunal ultimately concluded that the evidence (which seemed pretty strong) was not sufficiently clear and compelling to find a violation. And as David points out, World Duty Free is kind of a weird case in that the claimant freely admitted having paid bribes. So maybe World Duty Free was a weird anomaly, and the usual posture of tribunals in these cases will be to refuse to consider the possibility of corruption because the evidence is too murky.

      Of course, even if that’s right (and I have no idea if it is — I’m no expert on international arbitration), there’s still a normative question about what tribunals ought to do. Should they allow investors to use corruption allegations as a “sword”–that is, as the basis of a claim for relief under the treaty? Should tribunals allow states to use corruption allegations as a “shield”–that is, as a defense to liability for breach of an agreement that was arguably procured through unlawful means? Or is the international arbitration system so ill-suited to deal with these issues that it should generally ignore them? I think these are some of the questions that Sam’s post gets us (or at least me) thinking about, and I’m still not sure how I come out on them.

      • The normative issue is a very interesting one. I’m hesitant to side with a bad guy, but one of Kenya’s arguments in World Duty Free is persuasive to me: “Claims founded on illegality have to be dismissed for the benefit of the public and not for the advantage of the defendant.” (para. 118). I’m not entirely clear on what this means for tribunals, but I think WDF was correctly decided insofar as it refused to uphold a contract founded on bribery. Kenya’s not having to pay can be considered an undesirable collateral consequence of the Tribunal’s decision, but I think that consequence is better than the alternative of upholding an agreement founded on bribery.

      • A couple of quick thoughts on these points:

        First, on the point that this isn’t really a significant issue because World Duty Free is a bit of an exceptional case. Based on my (admittedly, still developing) knowledge of this area, I think it’s accurate to say that the corruption issue hasn’t been a major one in ICSID jurisprudence up to this point. That said, I do think it’s possible the issue will become more significant in the future, particularly given that accusations of corruption tend to swirl around situations involving expropriation from foreign investors, even if they aren’t litigated out fully.

        Second, on the normative question about whether the system should favor the use of corruption allegations in arbitration as a “sword” or a “shield” – or neither. I confess don’t have a ready answer here. My U.S.-trained lawyer intuition is that the distribution of liability for corruption should focus on the party best able to prevent corruption (and for which liability would provide the best incentive to prevent corruption). As for whether that party is the investor or the state, however, that seems like an empirical question and it probably varies from case to case. In evaluating the normative question, it’s also probably worth weighing the importance of sovereignty and the asymmetry between investors and states, whether the structure or text of BITs provide any insight, and the extent to which domestic anticorruption regimes are already providing deterrence.

  3. Sam,

    World Duty Free does demonstrate that corruption can be a defense in investor-state disputes, but I doubt that it incentivizes corruption (except in theory). States are frequently unaware of the consequences of signing investment treaties, and of how these treaties implicate domestic policy-making.

    • I took Sam’s (and Torres-Fowler’s) point not to be about the incentives of states to sign investment treaties, but rather about their behavior once the treaties are in place. I think the idea is that once states notice cases like World Duty Free, and realize that corruption in the conclusion of a concession contract can provide a way to avoid liability (under the BIT) for subsequent breach, they will have less of an incentive to discourage such corruption (and in extreme cases might even encourage it). That said, I also have my doubts about how much of an effect the investment regime would have on this — the other factors encouraging or discouraging corruption might well swamp whatever marginal impact the World Duty Free doctrine might have.

      There’s also another way to think about this, which might put World Duty Free in a better light. Maybe the fact that corruption can be a defense to an investor’s claim of breach will create much stronger incentives for the investors to resist attempts at extortion, and to decide not to use bribery as a strategy to win contracts. After all, the investor might reason that a contract secured though bribery is not worthwhile, because the state party would then have a license to breach. So even if World Duty Free did weaken the incentives of states to eliminate corruption from these transactions, it would strengthen the incentives of foreign investors to do so — and since it takes two to tango, the latter effect might be more important. Thoughts?

      • I agree with Matthew that the effects pull in two different directions. But I would venture that at the end of the day, presently, this line of jurisprudence is having very little impact at all on investor behavior with respect to corruption. Empirical work to date raise doubts about whether the presence of investment treaty protections exerts much influence at all on actual investment decisions. Consider what this means in either a scenario where paying a bribe is necessary in order to realize an investment or to continue to reaping gains from an ongoing investment. In either scenario, the decision over whether to bribe or not is a binary decision. Unless the marginal loss associated with the loss of BIT protections is so significant so as to turn the net payoff negative, the investor will still find it rational to bribe. What changes is simply the investor’s anticipated rate-of-return from the bribery, but not the actual behavior.

        Only where the BIT protections are of significant meaningful value (and the investor is aware of such value) will the emergence of a corruption defense for states matter much for the supply side. We can debate how often these conditions will hold true, but I would posit that it is less than what we may hope. The fact is that corrupt states are often the ones that sign fairly weak BITs (when viewed from the investor’s perspective). If that is the case, then we should not expect to see much in the way of actual impact on investor behavior on bribery, since the marginal value of the loss of BIT protections is low. However, it does mean that to the extent that we hope to use the investment regime to create a supply-side effect, pushing for stronger investment protections in treaties with such states (e.g., through the investment chapters of trade deals) is the right approach.

        One further comment: Given the facts of World Duty Free and the lack of a significant line of corruption-related jurisprudence, I think the contours of the corruption defense for states remains undertain. This uncertainty makes it more difficult for the investor to determine properly the expected probability that the bribery will result in an actual loss of investment protection. Much turns on unanswered questions over how broadly (or narrowly) one should interpret the Tribunal’s decision on the defense, and whether, in a regime without stare decisis, how closely (or not) future Tribunals will follow its approach.

        • Picking up on the point that investment treaty protections are unlikely to influence investor behavior, it would be interesting to see if the corruption defense approach, rather than discouraging investors from paying bribes, discourages them from seeking investor-state arbitration.

          Of course, all this depends on future tribunals following World Duty Free’s corruption defense approach.

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