Arbitration Helps Tip the Scale in Latin America’s Investment Market
In 2007, Goldman Sachs took a pass on many investments in Latin America. Today, just 10 years later, the investment bank has jumped in with both feet. In 2016, its Latin American revenue soared 50 percent compared to the previous year’s results.
What is behind Goldman’s change of heart? Major improvements in Latin American financial market regulations and regional tax stability certainly played major roles. But another factor was equally important and provides a thermometer of investment safety in developing markets: The stability of the legal system as evidenced by foreign companies turning confidently to local arbitration when disputes arise. Businesses must be confident in the prospects of an investment, but they also need to know that should a contract dispute arise, it can be resolved in a fair and transparent manner.
Several Latin American governments are building that confidence, fairness and transparency by bolstering the effectiveness of local arbitration. Confidence in arbitration is crucial for Latin American governments, as they realize they must attract global investment banks and hedge funds to underwrite the increasingly large infrastructure projects essential to economic growth. Goldman Sachs’ 2016 Latin American bonanza, for example, came mainly from a large infrastructure-financing deal and the sale of hedging strategies.
Latin American infrastructure projects are often very large and, consequently, governments can’t fund them on their own. For example:
- In the wake of a massive earthquake in 2010, Chile is planning some $28 billion in infrastructure improvements, including new highways, reservoirs and airports.
- Brazil’s National Energy Agency is earmarking $9.2 billion to build a hydroelectric power plant.
- Colombia is devoting about $7.5 billion to expand Bogota’s subway system and is in the process of spending more than $8 billion to build highways across the country.
- Peru is spending more than $5 billion to develop a new subway system in Lima.
Changes in Attitude
Although governments in developing economies have often resisted business transparency to shield questionable practices in which government officers can enrich themselves, officials in several Latin American countries increasingly are getting behind the concept of fairness and transparency in arbitration proceedings. Not surprisingly, government officials in these nations are finding themselves on much more solid professional and legal footing.
An all-too-common scenario in Latin America is now becoming a thing of the past. Previously, when a contract dispute rose between a foreign company and a government agency, an agency official would typically be instructed by a superior to pay damages (determined by the government) to the foreign company. The official charged with making the payment could then become the subject of onerous audits and investigations to determine if the payment was aboveboard. If the payment’s legitimacy came into question, the official who made it could be tarred with the same brush as the superior who ordered it. If, on the other hand, trusted arbitrators grant the award, the government official making the payment is on safe ground, judged to be simply following the law.
As Latin American arbitration tribunals develop reputations for being transparent and fair, word spreads. As it does, private entities increasingly become willing to settle disputes in-country. The International Chamber of Commerce (ICC) reports that locally seated arbitrations in Latin America jumped by 230 percent between 2005 and 2015. Many of these cases are against governments; now the disputes are being adjudicated by local arbitration tribunals, whereas not long ago they would have been brought to international courts, such as the ICC’s International Court of Arbitration in Paris or the International Center for Dispute Resolution (ICDR) in New York.
- In a pending case filed in Colombia in 2016, U.S.-based mining enterprise Cosigo Resources is turning to local arbitration in a $16.5 billion claim against the Colombian government. Cosigo alleges that the Colombian government passed a resolution in 2009 that designated a large region in the country’s southeast as a natural park, prohibiting mining and excavation. Cosigo had signed an exploration and exploitation agreement to mine gold in the area… which was now essentially worthless.
- In another case in Colombia, the country’s national infrastructure agency, ANI, is using local arbitration to take Brazilian construction conglomerate Odebrecht to task for corruption, in an attempt to oust it from the country. After Odebrecht admitted to paying more than $11 million in bribes to Colombian officials, ANI wants to annul a toll-road concession contract granted to the company.
- Gramercy Funds Management, based in the United States, is in arbitration with the Peruvian government because of changes the government made in the repayment scheme for Peruvian Agrarian Land Reform Bonds. The bonds were issued during the 1960s to Peruvian citizens whose land was expropriated for agricultural purposes. Gramercy had acquired some 10,000 of the bonds and says that the new scheme reduces their value from $1.6 billion to $1.1 million.
- A major construction company has turned to arbitration against the Peruvian government over the construction of a new metro system in the capital city of Lima. The contract with the company calls for the digging of tunnels and construction of subway stations. However, after a year and a half, the government has not yet made all the necessary land available to the company. The company wants to finish the project or be compensated for its sunk costs.
Safe and Stormy Harbors
Not every Latin American country offers the same degree of sophistication in local arbitration, and things can change and improve quickly. The ICC International Court of Arbitration announced in 2017 that it will open offices and handle cases in Brazil. Despite the country’s many government corruption scandals, the ICC believes Brazil is ready for the transparent dispute resolution process provided by local arbitration.
Colombia, Peru and Chile have been leading the charge for robust local arbitration processes. Not coincidentally, these three countries are among the largest spenders on infrastructure in Latin America. They also have lower levels of corruption than many other Latin American countries, according to InSight Crime. [See Figure 1, “2015 Corruption Perceptions Index Rankings for Latin America.”] Lower levels of corruption go hand-in-hand with sophisticated arbitration capabilities as governments seek to gain the confidence of business leaders.
Figure 1. Source: Transparency International, Corruption Perceptions Index 2015
The efforts on the part of these three countries to be stable destinations for investments include developing respected local arbitration capabilities. In Colombia, almost all arbitration, even cases with large claims, takes place at the Bogota Chamber of Commerce. In Chile, the Santiago Chamber of Arbitration follows ICC rules and has become a prominent venue for alternative dispute resolution. Similarly, the Lima Chamber of Commerce has established new rules to improve the efficiency of arbitration proceedings in Peru based on international standards.
A Tale of Two Disputes
When it comes to resolving disputes in Latin America, the difference between the past and the present can be striking. Before the advent of transparent and trustworthy arbitration, it was very difficult for arbitrators and experts to gain access to information and potential evidence, making the true nature and details of disputes nearly impossible to discover. Legal and financial experts had to answer questions without being allowed to investigate thoroughly. Making matters worse, experts were often hired by the arbitration tribunal, not the litigants. Consequently, both sides in the dispute saw the experts as outsiders, which severely curtailed the amount of information either side was willing to disclose.
A case brought by the Bogota Water and Wastewater Administration, a local government agency, against a private company in 2012 illustrates the problem. The government alleged the private entity didn’t perform what it had been contracted to do, including operating and maintaining the water utility network and installing new hydrants and meters. The company became illiquid and stopped paying salaries to its employees. The government wanted to recoup what it would cost to hire another company to complete the contract.
I served as the investigator for the arbitration tribunal. Since there was no formal process of discovery, each side revealed all the evidence it planned to use, and I had to request specific documents. But neither side had any real reason to provide them, especially if they felt the documents weakened their case. I requested 24 documents, including the minutes of meetings between the company and the agency and the records of the work schedules to which both parties had agreed.
Of the 24 documents I asked for, I received eight. The private entity invited me to go to a warehouse where I could go through thousands and thousands of files at my convenience and hunt for the proverbial needle in a very big haystack.
Although it was clear that the private company was likely at fault, it was nearly impossible to get the probative documents to establish its alleged actions. Eventually, I demonstrated that the company had neither paid its staff for about a year nor lived up to its contractual obligations. In addition, the arbitration process allowed the government to liquidate the private company’s assets to pay retroactive salaries and compensate the government for its losses.
Fast forward to 2017. In a pending case, a large construction company building bridges and roadways in Colombia is requesting additional payments because geo-technical issues were discovered that weren’t part of the original agreement. Instead of eight documents and an invitation to rummage through a warehouse, I received hundreds of folders of documents from one party, with a detailed table of contents for reference, making the analysis much easier, broader and more effective.
Colombia’s local arbitration tribunal has increasingly adopted international arbitration standards to match those of organizations such as the ICC. For example, each side of a dispute now hires an expert, not the arbitration court. Therefore, these experts have the trust of the parties that hired them. And most importantly, investigators get all the information they need while maintaining their independence – and objectivity – throughout the case.
Know the Arbitration System Where You Want to do Business
Developing economies in Latin America need foreign investors, especially major investment banks and hedge funds. To create confidence in foreign investors, many Latin American countries are stabilizing their tax systems and meeting international regulatory standards in capital markets. But the sophistication of local arbitration is a critical variable, and it is not always on the radar of Western business leaders. It should be. In addition to Colombia, Chile and Peru, Latin American countries Ecuador and Argentina are now building strong local arbitration capabilities and practices.
It is critical to be confident that when doing business in a country that there is a transparent and trustworthy way to resolve the disputes that will inevitably arise. The standards of local arbitration are an accurate thermometer of business stability and an important way to gauge the safety of investing in a country.