COMMENTARY: Freeport's threat of arbitration simply a ploy to block mining reform

Vincent Lingga
The Jakarta Post

"PT Freeport Indonesia [FI] reserves of all its rights [...] including the right to commence arbitration to enforce all provisions of the contract," Freeport-McMoRan's CEO Richard C. Adkerson asserted on Monday, referring to a protracted dispute with the Indonesian government.

That threat is quite similar to those made by many other multinational companies (MNCs), which fear decreases in their huge profits following reforms by their host governments.

Until around eight years ago international arbitration within the investor-state-dispute settlement (ISDS) mechanism had become a powerful weapon exploited by MNCs to circumvent national regulations and bully governments, notably in developing countries, to postpone or annul any reform or to silence environmental NGOs.

At the time of its launch several decades ago, ISDS was indeed vital to encourage foreign investment into developing countries where legal systems were still weak and where many governments were corrupt. It was a forum designed to resolve conflicts between investors and host governments.

ISDS has therefore been written into bilateral investment and trade agreements or treaties. One of the most popular arbitration tribunals is the Washingtonbased International Center for Settlement of Investment Disputes (ICSID), a unit of the World Bank.

The ISDS mechanism allows foreign investors to bypass local courts and seek compensation in international tribunals such as the ICSID, for what they claim to be damages caused by expropriation or policy or contractual changes by host governments.

The problem is that within the ISDS scheme only investors or companies can bring lawsuits. A government may defend itself but it cannot sue a company. The mere threat of an ISDS claim by big MNCs can alarm host governments, especially those with bad international reputations, to act in favor of the investor.

An 18-month study in 2014 and 2015 by the BuzzFeed News online platform on arbitration cases within the ISDS system in Indonesia, India, Africa, Central America and the United States, involving the inspection of tens of thousands of pages of legal documents, revealed how big corporations have turned the threat of ISDS legal action into a fearsome weapon to enable them to have their demands met by host governments in developing countries.

Under the ISDS scheme there seemed no longer a balance between protection of investors and the right of governments to regulate.

It was as striking for its power as for its secrecy, with its proceedings. Of all the ways in which ISDS is used, the most deeply hidden are the threats, uttered in private meetings or ominous letters that invoke those courts, the BuzzFeed study concluded.

The threats are so powerful they often eliminate the need to actually bring a lawsuit. Just the knowledge that it could happen is enough.

Arbitrators who decide the cases are often drawn from the ranks of the same highly paid corporate lawyers who argue ISDS cases. These arbitrators have broad authority to interpret the rules however they want. And there is no meaningful appeal.

Especially for Indonesia, which still grapples with many mining contracts awarded under the authoritarian Soeharto administration (1967-1998), the mere threat of an ISDS claim could trigger alarm.

Indonesia suffered the pang of an international arbitration in 2000 when the government, groaning under the economic crisis, canceled a geothermal power plant contract with Karaha Bodas, a local subsidiary of two US companies, in West Java.

But Karaha went to an international arbitration tribunal, which in December 2000, awarded it US$261 million, even though the company had not yet ploughed even half that amount into the project. In other words, Indonesia owed a quarter-billion dollars to a private company for electricity it would never receive, from a power plant that had not been built.

Formerly, the dominant view in ISDS circles was simply "the sanctity of a contract must be honored" as long as it was concluded with a legitimate government, however immoral, incompetent or corrupt the leader who signed the contract.

However the perception within international arbitration tribunals now no longer sees a corporate contract as being absolute but a balance between corporate rights and fairness, and, especially, overall economic benefits. When circumstances change after a contract was signed that make it impractical, or uneconomic or inefficient, to comply with contractual obligations, courts may relieve a party of its commitments.

The prevailing opinion now even tends to excuse parties, especially governments in developing countries, from fulfilling contracts if they were entered under compulsion (duress) or corruption or if one party is not competent and the terms of investment arrangements seem imbalanced.

Even the United Nations Conference on Trade and Development (UNCTAD) has criticized the ISDS regime as already going far beyond its original intention, as the system now suffers from a lack of coherence, consistency and predictability.

No wonder many governments in Asia, including Indonesia, Australia, Africa, Europe and Latin America, have decided to remove ISDS provisions from their investment or trade agreements because of the tendency of its mechanism to favor large foreign investors over national governments. Even within the ICSID there has been an increasing trend not to see corporate contracts as being absolute.

Last December an ICSID tribunal decided in favor of the Indonesian government in its dispute with mining firm Churchill, rejecting the British company's claim over $1 billion in damages, after what the latter alleged to be the expropriation of its rights over huge coal reserves in East Kalimantan.