By Elizabeth Sheridan

The International Centre for Settlement of Investment Disputes (ICSID) was created in 1966 to promote international investment by providing confidence in the dispute resolution process. In many developing countries, it is essential to attract consistent foreign investment to provide necessary capital and infrastructure conducive for long-term economic and institutional development. Investor-state dispute settlement is a central mechanism for incentivizing foreign investment, particularly by mitigating the risks associated with institutional instability and weak governance. As levels of corruption around the globe have risen in response to globalization, various international conventions stress a commitment to anti-corruption reform.

_{“Investor-State Dispute Settlement: A Reality Check” by CSIS: Center for Strategic & International Studies is licensed under CC BY-NC-SA 2.0.}

In light of the growing international response to corruption, arbitral bodies created under ICSID are embracing the availability of the “corruption defense”— a defense employed by hosts states when they are accused of violating investor rights, in which the state uses allegations of corruption to convince the arbitrator to dismiss the claim entirely. The defense is underpinned by international principles condemning corruptionand nemo auditor propriam turpitudinem allegans (no one shall be heard who invokes his own guilt) and essentially bars investors from recovering expropriated assets when the bilateral investment treaty (BIT) or other contract involved corruption in its inception or throughout its duration. The defense was first applied in investment arbitration in World Duty Free v. Kenya (2006), where the investor seeking compensation for alleged expropriation had bribed the then-president of Kenya to obtain a government contract as “a payment for doing business.” The ICSID tribunal relied on Kenyan and English law and emphasized international public policy viewing corruption as an “international evil,” in its decision to reject enforcement of the investment contract, thereby denying a favorable award to the investor.

The fundamental question is whether ICSID tribunals should investigate and consider the issue of corruption. Some argue that it is not the purpose of the ICSID to address this issue. For now, the strongest and most able bodies of deterrence exist at the state level, where domestic governments have the power to employ significant resources to investigating and prosecuting corruptive acts. For example, after the Siemens A.G. v. The Argentine Republic arbitration where the arbitral body awarded the company $217 million absent a corruption defense, a Foreign Corrupt Practices Act (FCPA) investigation later uncovered Siemen’s systemic global bribery scheme and imposed an $800 million penalty on the company, the largest enforcement fine in FCPA history. Across the board, it is acknowledged that domestic bodies are better-equipped to fight corruption, and have a significant incentive to do so to protect fair competition at home.

Proponents and critics of the corruption defense often assess the supply and demand side of anti-corruption reform. Supply-side reform aims to stem corruption by persecuting corrupt investors, and includes both the corruption defense and domestic regulations such as the United States’ FCPA and the United Kingdom’s Bribery Act. Demand-side reform is much more difficult. In investor-state disputes involving bilateral corruption, sovereign governments are typically those receiving bribes or other political influence in exchange for favorable concessions.

Proponents of the corruption defense stress that investors, specifically corporations, are more likely to react to financial incentives while states are less likely. States, and specifically their government officials, react to political objectives rather than fiscal returns and punishing them for corruptive practices may be ineffective when they can scapegoat or demonize the investor’s home country as a public enemy. Additionally, corporations possess a greater level of flexibility in rearranging its corporate structure by replacing managers and heads of departments, whereas states may face more severe obstacles in removing heads of state from power. For these reasons, proponents of the corruption defense champion the supply-side approach of eradicating corruption.

However, states hoping to continue attracting foreign investment may actually be responsive and willing to initiate anti-corruption reform as a strategy of signaling a trustworthy business environment for potential investors. Moreover, the asymmetric application of the corruption defense, especially when the corrupt state would otherwise be liable for their expropriative behavior, hardly seems just nor conducive for legitimizing the arbitral bodies that oversee investor-state disputes. Rather than incentivizing investors to comply with international anti-corruption principles, the availability of the corruption defense may instead deter investors from investing in developing countries they perceive to suffer from institutional risk—working directly against the ICSID’s principal purpose.

For the foregoing reasons, critics most often cite to concerns of fairness and unjust enrichment, infringement on investor’s procedural rights, and the moral hazard problem to advocate against the corruption defense. The moral hazard concern assumes that the corruption defense creates an incentive for states to deliberately engage investors in corruptive schemes with the knowledge that they can expropriate the assets with no consequence. However, as a concession to proponents of the defense, the moral hazard issue is likely more theoretical than actual. Regardless of individual government officials’ personal pursuits, corruption hurts host states’ economies. Corruption does not perpetuate in states necessarily because they seek it out, but rather because anti-corruption reform is incredibly difficult to achieve.

As such, the most convincing criticism of the corruption defense is its preclusive procedural framework. In every case where the corruption defense was successfully employed, its application was at least in part based in “international legal principles.” However, the persistence of cross-border corruption indicates anti-corruption norms remain far from attaining jus cogens status—peremptory principles of international law that supersede other incentives.  Many large-scale cross-border investments are contaminated by unclean hands by both the investor and the host state, and the availability of a corruption defense renders ICSID arbitral bodies paralyzed. Most often, jurisdiction is denied from the very start of a case, effectively barring investors from the chance to resolve their disputes at all.[1] The promulgation of an effective international rule of law cannot be done merely by appealing to abstract or purportedly shared moral norms, but by preserving and strengthening existing enforcement mechanisms such as arbitral awards. The preclusive effect of the corruption defense bears significant consequences for ICSID tribunals to exercise that mechanism.

“The promulgation of an effective international rule of law cannot be done merely by appealing to abstract or purportedly shared moral norms, but by preserving and strengthening existing enforcement mechanisms such as arbitral awards.”

_{Elizabeth Sheridan}

The resulting incentive structures illustrate how the corruption defense in investor-state arbitration is largely ineffective for curbing wide-scale corruption. Neither the availability nor the unavailability of the corruption defense as applied in investor-state dispute resolution materially affects state’s incentives to engage in corruptive transactions. Rather, the more meaningful incentive shift lies in investors’ decision to invest and submit to ICSID jurisdiction. The corruption defense may disincentivize investors from continuing to invest in developing countries where institutional risks are perceived to be high. Alternatively, investors may simply avoid consenting to ICSID jurisdiction. Eliminating the corruption defense is unlikely to create additional incentives for investors to engage in corruption, as those that choose to bribe officials already take on the more costly risk of domestic prosecution, as seen in the Siemens case. Therefore, ICSID tribunals should not take on the responsibility of addressing corruption. Their capacity to influence incentives around corruption is extremely limited and the corruption defense risks delegitimizing investor-state dispute resolution and deterring investment into the developing world. ICSID tribunals should continue to focus on the object and purpose of its Convention, fostering investor confidence to incentivize investment across the globe.

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[1] E.g. Metal-Tech, Ltd. v. Republic of Uzbekistan, ICSID Case No. ARB/10/3 (Oct. 4, 2013); World Duty Free Co. Ltd. v. Republic of Kenya, ICSID Case No. ARB/00/7 (Oct. 4, 2006); Inceysa Vallisoletana S.L. v. Republic of El Salvador, ICSID Case No. ARB/03/26 (Aug. 2, 2006).