Dems’ Better Deal: A Global Dimension

As the agenda acknowledges, there’s much left to fill in, especially on the international front. As the jobs portion part of the plan notes, “In the coming days and weeks, we will also propose new trade and tax policies that will help American companies grow, and encourage investment in American workers and wages.”

A transformative new agenda will require thinking of global governance not just in terms of job impacts, but also about broader regulatory frameworks. For example, the Better Deal promises to overhaul health policy by allowing Medicare to negotiate for bulk discounts with pharmaceutical companies. This policy shift will be stronger if supplemented with changes to our negotiating priorities in international agreements, which increasingly involve such questions.

Indeed, domestic and international issues are not separate concerns. As I wrote last week, the international treaties that countries have signed up for increasingly contain obligations on how they regulate the financial sector at home. And, as this post shows, recently disclosed international tribunal decisions indicate that the same is true of anti-trust and corporate taxation policy.

Anti-Trust Learnings of Kazakhstan for Make Benefit Glorious Nation of America?

Take AES Corporation v. Kazakhstan, a 2013 decision under the Kazakhstan-U.S. bilateral investment treaty that just surfaced into the public domain this year. In the legal dispute, the Virginia-based company complained that the former Soviet republic’s introduction of an anti-monopoly framework in the 2000s harmed various treaty guarantees. Namely, by requiring monopolies and oligopolies to register with the government and be subject to higher regulatory standards, the company complained of damage to its investment into privatized electrical utilities in the 1990s. Even if the country were to tighten anti-trust requirements for the economy as a whole, AES maintained that U.S. investors should have been exempted from their application by virtue of the treaty, and claimed $1.29 billion in damages.

A tribunal of Pierre Tercier of Switzerland, Klaus Sachs of Germany, and Vaughan Lowe of the UK sided with the company on some counts but not others. To the government’s luck, they maintained that:

[the company’s rights] cannot mean that an investor is entitled to cherry-pick favorable provisions in a new legislation and request to be exempted from the application of unfavorable provisions. This would not only be unmanageable, but it would also create problems of transparency and predictability as to which provisions apply to a particular investor and which do not…

The amendment of the Kazakh Competition Law in 2001, 2006, and 2008 followed a political will to further develop competition. The privatization of the electricity generation sector constituted a clear improvement beneficial to Claimants and the aim of the various legal amendments implemented by Kazakhstan was to establish a competitive market in the field of energy generation and trading. It is undisputed that the establishment of a competitive market would have been to the benefit of Claimants. Moreover, the changes made to the Kazakh Competition Law and which are the subject of Claimants’ complaints are not of an extraordinary nature and similar principles exist in other countries. They follow a common approach to the regulation of markets in the general public interest.

In short, AES would not have even been able to operate in Kazakhstan were it not for the privatization process. Since it is reasonable to accompany privatization with competition laws, the company should have expected the latter.

Why then, did the tribunal find the government guilty of a treaty violation? After 2009, the government became concerned about possible electricity shortages, and thus required utilities to reinvest their profits locally. While finding avoidance of electricity disruption “per se a legitimate policy goal,” the tribunal argued that international law has a “general principle that investors should be entitled to make a reasonable return on and of their investment” (para. 361, 400). While noting that governments may be justified in such a policy aimed at “preventing an imminent danger,” they cannot take such action as “part of a longer-term plan to renovate the national electricity distribution system” (para. 409). (In the end, Kazakstan owed no damages because AES’ damage calculations were flawed (para. 467).)

The case leaves me with two questions.

First, what if there had been more downsides than upsides to the government’s anti-trust policies, from the company’s bottom line perspective? Governments that get into the market structure business will inevitably make decisions that hurt some companies. In contexts like the U.S., many companies that merger watchers might target were not once state-owned. Thus, unlike the Kazakh case, U.S. market participants’ very participation is not contingent on some prior government decision in the same way.

Second, investors operating in the U.S. have been doing a poor job of reinvesting earnings in productive capacity. If we took on a more muscular agenda to change those incentives, at what point would these arbitrators’ identification of a semi-common law right to make money be triggered?

Investment policy gets in tax governance’s lane

More recently, a tribunal in Schooner Capital LLC v. Poland split over just how much governments should defer to companies over corporate taxation matters. The U.S. company had bought state-owned margarine company in the post-Soviet privatizations, and argued that it was entitled to deduct its claimed management expenses from its taxable income. The Polish authorities agreed in principle, but found that the investor had not adequately documented this expenditure (indeed, backdating receipts in a way that brought them under the scrutiny of criminal prosecutors). The company claimed over $108 million in damages, arguing the tax enforcement was an expropriation, unfair and inequitable, and other treaty violations.

On one side, the tribunal majority of Makdoom Ali Khan of Pakistan and Claus von Wobeser of Mexico sided with Poland on most points, and did not ultimately find a violation of the U.S.-Poland bilateral investment treaty. For them, the key issue was that the treaty language sharply restricts investors’ access to relief when it comes to tax matters. Thus, they did not even examine whether the government’s treatment of Schooner was “unfair” or “inequitable,” a particularly capacious treaty standard that is the basis of most successful investor-state dispute settlement (ISDS) claims.

On the other, a tribunal dissent by Francisco Orrego Vicuna of Chile determined that it is unfair and inequitable for governments to not exercise enforcement lenience in cases involving foreign investors. Thus, he would exercise arbitral discretion to shelve the clear tax “carve-out.” Clearly, a one-vote bullet dodge for the government.

There are some implications here for tax governance more broadly. First, a country that does not have a clear “tax carve-out” can have its corporate taxation policies second guessed by an ISDS tribunal. Second, even a country with a carve-out must convince the arbitral pool to apply the clear language of the treaty. As the dissent shows, not all are willing to do so. Finally, both the majority and the dissenter agreed that ISDS cases can take a stab (to a lesser or greater extent) at reviewing tax policy, even parallel to national courts or the provisions of specific tax treaties. If policymakers want to more clearly divvy up labor on international tax (and academics have a number of appealing ideas in this regard), they’ll need to be aware of this mission creep from ISDS and deal with it head on.

Summing up

Does any of this even matter? The attentive reader will notice that neither of these cases challenged a U.S. policy; the cosmopolitan reader will note that Eastern European countries like Poland aren’t the most sympathetic actors on the global stage at the moment. In neither case did a tribunal majority even award the payment of damages.

But there are bigger issues at stake. Tribunals like these are writing the rules of the global economy. Their decisions and dicta will be cited by tribunals in other cases, and will inform companies’ future legal strategies. Smart companies will not avoid some of the missteps of AES’ and Schooner’s arguments in cases to come.

If we want to create presumptions in favor of anti-monopoly and anti-tax avoidance policies, these cases show we have a way to go. Our policymakers can more clearly flip the script by rewriting the global rules in favor of workers and citizens. We proffer some ideas here.