Arbitration Costs: Myths and Realities in Investment Treaty Arbitration

By Susan D. Franck

Oxford University Press, March 2019

398 pages; ISBN:9780190054434

Susan D. Franck’s Arbitration Costs: Myths and Realities in Investment Treaty Arbitration is a fascinating, provocative and important book. It is timely too. The system of investor-state dispute settlement (to which the author refers as investment treaty arbitration or ‘ITA’) is increasingly under siege. Indeed, there are serious questions as to whether it will long survive in its current form, if at all. That is perhaps not surprising at a time when nationalism is on the rise and globalism is under attack – often by the leaders of nations where such sentiments have not (until recently) dominated the political discourse. Those who believe that ITA has a positive role to play in promoting and protecting foreign direct investment – and more broadly, in fostering the rule of law and the peaceful resolution of disputes between investors and States – should welcome and embrace this empirical study of the ITA system.

Susan D. Franck, a Professor of Law at American University in Washington, D.C., is well-known for her data driven studies of various facets of ITA and international arbitration more broadly. The main title of her book – ‘Arbitration Costs’ – hardly does justice to the range and depth of the work. In many respects, Prof. Franck uses the subject of costs to explore the more challenging (and more interesting) topic reflected in the subtitle: the myths and realities of ITA. It should not come as a surprise to anyone who studies or practices in the field that the myths are many and that the realities are easily lost among them.

There is a remarkable amount of information, analysis and scholarship in this 398-page book (which include 60 pages of explanatory appendices on methodology, along with a very thorough and helpful index). Prof. Franck deploys her impressive knowledge of history, cognitive psychology, demographics, and statistics to shed light on the subject of ITA costs – and, more broadly, why the myths surrounding ITA so often obscure the realities.

In the first half of the 20th century, a ‘host’ State could take adverse measures against foreign investors – including expropriating the investment without compensation – and face no legal consequence. The typical investor would have limited (if any) ability to assert claims directly against the State. Even if an investor could overcome issues of sovereign immunity, the domestic courts of many States were not hospitable to the claims of foreign investors. Unless foreign investors had the foresight and leverage to negotiate an arbitration agreement with the host State – or unless they could persuade their own government to espouse and bring the claim at the International Court of Justice – they were often left without recourse when their investments were taken or harmed by the host State. Many potential investors chose not to invest given the risks.¹

Although the first bilateral investment treaty (between Germany and Pakistan) was signed in 1959, it was not until the late 1960s that treaty negotiators began including provisions to allow investors from one State party to bring international arbitration claims directly against the other State party for alleged breaches of the treaty’s investment protections.² They believed that ITA would promote foreign direct investment in States that desperately needed it, and that it would benefit both investors and host States, by (among other things) (i) affording a fair and neutral forum for the resolution of investment disputes, (ii) avoiding ‘gun-boat’ diplomacy (and other forms of pressure by powerful States against less powerful ones), and (iii) placing different types of investors (including smaller ones, with less political influence) on the same playing field. They also believed that providing for the disputes to be resolved by one or more neutral arbitrators – who are independent from the host State and the investor –would provide a forum free from bias (whether perceived or actual) and from pressure from either side.

Although the general framework for ITA was in place by the 1960s, investors were slow to use it until the mid-1990s, when the number of cases began to grow at a considerable clip. For example, the International Centre for Settlement of Investment Disputes (‘ICSID’), which was established in the mid-1960s by the multilateral Washington Convention, registered fewer than three cases a year between 1987 and 1996. By 2013-2017, ICSID registered around 40-50 cases each year.³

As more ITA cases were registered, adjudicated, and reported in this period of growth, many gave ITA ‘overwhelming praise’ for its ‘unmitigated success’.⁴ But such positive commentary was quickly buried in an avalanche of attacks ‘from various quarters, including international organizations, nongovernmental organizations (NGOs), academics, and states’.⁵ As Prof. Franck writes, the attacks typically came in the guise of articles and ‘reports’ featuring ‘emotionally evocative and tantalizing headlines’ asserting, for example, that ITA amounts to ‘profiting from injustice’, or that States that agreed to investment arbitration ‘have accepted to be sued by the devil in hell’.⁶ The author cites an extraordinary volume of similar articles and reports, with titles referring, for example, to the ‘Zombie ISDS’, the ‘legal monster’ created by ITA, and the ‘dark side’ of foreign investment.⁷ The attacks often specifically target the lawyers and arbitrators who participate in the system as greedy profiteers seeking to line their pockets with money taken from developing States.

The mistake made by many of us who work and believe in the system of ITA is our collective failure to take such attacks seriously and to provide any sort of meaningful response. In one of the book’s most interesting chapters, ‘Cognitive Psychology and Empirical Insights for ITA’, Prof. Franck undertakes an extensive analysis as to why such simplistic and wildly distorted views on ITA have been so broadly accepted. Observing that ‘psychology has been remarkably under-scrutinized’ with respect to ITA,⁸ Prof. Franck embarks on a sweeping discussion of how cognitive psychologists have approached other areas of law, and indeed, other areas of society. Invaluable insights from cognitive psychology include that ‘bad is stronger than good’ – i.e. negative images typically exhibit a stronger effect on cognition than positive ones. People tend to remember that Philip Morris used ITA to challenge Australia’s and Uruguay’s regulation of tobacco products; they tend to forget that Philip Morris ultimately lost both cases. The cases that are outliers attract most if not all of the attention.⁹ When the person in question is a person of power, the effect is greatly magnified. The late President of Venezuela, Hugo Chavez, justified Venezuela’s withdrawal from ICSID by claiming that ‘ICSID has ruled 232 times in favour of transnational interests in the 234 cases heard throughout its history’.¹⁰ That assertion is demonstrably false, yet when spoken by a person of considerable influence and widely spread across the Internet, it became broadly accepted – especially in the absence of any effective rebuttal. In an age where we are overwhelmed by information, we tend to seize on what is easy to remember or on pieces of information that support our pre-existing beliefs. As Prof. Franck writes:

In the age of blogs, Facebook, and Twitter becoming news outlets, errors and misconceptions promulgated through social media can become exacerbated. Together, these influences arguably create the "perfect storm" of misperception about ITA.¹¹

In chapters such as ‘Introduction to Data and Basic Demographics’, ‘ITA Expansion, Time, and Costs’, ‘Claims and Outcomes in ITA’, and ‘Costs – Risks and Realities’, Prof. Franck undertakes extensive, empirical analyses to deconstruct many of the ‘myths’ that have come to surround ITA. For example, investors do not always or even usually win their cases. States win more often.¹² When investors do win, they typically recover significantly less than what they sought. Contrary to conventional wisdom, the ‘median claimant in ITA’ is not an elite, powerful, multinational company. According to the author, the evidence shows that although ‘larger commercial entities pursued ITA, they constituted neither the exclusive actors nor the majority’.¹³

Similarly, although the legal fees required to pursue or defend an ITA case are usually high, they are not necessarily higher than in comparable dispute resolution mechanisms involving cases of similar complexity. Moreover, in several instances, Prof. Franck discovered basic errors in highly cited publications that portrayed average ITA costs as significantly higher than the reality. For example, an OECD study indicated that average attorney costs for each party during the relevant time frame of the study amounted to roughly USD 3-4 million, resulting in a combined total of USD 8 million for both parties’ legal fees as well as tribunal and administrative costs. Both UNCTAD and the European Commission later misreported the OECD study to suggest that the average costs for each party was USD 8 million, and that therefore the average costs for both parties was USD 16 million – or twice the actual amount reported by the OECD.¹⁴ Prof. Franck writes:

While one might hope these were honest mistakes that can be rectified in future publications, the errors – whether influenced by cognitive illusions or otherwise – may prove difficult to dislodge from public perception, memory, and debate.¹⁵

Those readers looking for hard and fast rules or easy predictors concerning the costs of ITA may be disappointed by the study, which emphasizes that each case is different and that the costs are influenced by myriad factors. Nonetheless, the author provides data and analysis on numerous factors, including the possible correlation between ITA costs on the one hand, and the amounts claimed in the arbitration on the other: the outcomes achieved for claimants and respondents, the duration of the case, whether or not the proceeding is bifurcated, the presence of a separate opinion, etc. Some readers may find certain results surprising. For example, although there appears to be a correlation between legal spend and success for investors – i.e. the more investors spend on legal fees, the more likely they are to win – the same correlation does not appear to exist for States.¹⁶ Similarly, contrary to the assumptions of many lawyers, bifurcated cases are ‘not necessarily more (or less) expensive’ than non-bifurcated ones.¹⁷ As Prof. Franck observes, however, given the relatively small amount of data, the results should be viewed with caution:

In the interim, these results provide initial evidence of a reliable relationship between outcome and claimants’ legal fees but also the potential lack of links to other ITA costs.¹⁸

Prof. Franck and her research team ultimately ‘analyzed 202 different cases, generating 272 different awards from awards made public by 2012’.¹⁹ Given the author’s rigorous statistical methodology – which required detailed coding that generated over 500 variables and over 140,000 discrete pieces of data –²⁰the dataset had to be closed, so that the extensive, time-consuming work required for the analysis could be carried out. As the author acknowledges, numerous ITA cases have concluded since 2012 – including some that resulted in massive damages awards and involved huge costs (e.g. the Cystallex, Occidental, and Yukos cases) – but preliminary analyses of subsequent data tend to confirm the trends identified with respect to her dataset.²¹ Moreover, as Prof. Franck reminds us, the ITA system is still relatively new and evolving:

[M]ore research is needed to provide sufficient power, stability, statistical control, and enhanced validity for making more definitive conclusions. It will likely take years – if not decades – before there is a sufficient data pool.²²

Ultimately, the value of Prof. Franck’s book lies in the rigorous, empirical, and multi-disciplinary approach she takes to shed light on the serious and challenging questions that must be effectively addressed by those who believe in the ITA system. As Prof. Franck recognizes – hopefully with the rest of us who practice in this field – the ITA system has many problems that need to be fixed, ranging from the relative lack of transparency in many cases to the time and costs required to complete many disputes.

Prof. Franck’s book is also a powerful reminder that we are living in a time when expertise is increasingly derided as ‘elitism’, political leaders or persons of influence dismiss critically important science as ‘fake news’ or a ‘hoax’ and ‘alternative facts’ are treated as valid. The irony is that as nationalist sentiment continues to rise – and as multilateralism and globalism fall increasingly under attack – a robust ITA system will be more necessary than ever before. Those of us who want the ITA system to continue have a responsibility not only to improve it – but also to address its critics with the same rigour, vigour, and seriousness of purpose that Prof. Franck has brought to this book.

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