25 May 2016

The most important legal case of this year was published last week. You've probably never heard of it.

The title of this post seem a bit click-baity, but it's not an exaggeration. The case that I'm going to discuss has a direct effect on Australia's public health efforts to require plain-packaging for tobacco products, will have a similar effect on other such efforts in other countries, and will have downstream effects on regulatory efforts on public health, environmental, and human rights issues around the world.

But here's the thing: this case isn't a US Supreme Court case, it's not a case from any of the European Union courts, and it's not even a case from the International Court of Justice. In fact, it's not a court case at all. It's a decision reached by a panel of three arbitrators, which is subject to little to no appellate review, and which is enforceable around the world.

For clarity: yes, I did just say that the most important legal case of this year is the product of arbitration proceedings rather than any national or international court; and no, I am not exaggerating.

There's an obscure area of international law that permits corporations to force countries into arbitration when the corporation believes that they have been unfairly and inequitably treated by the country, or when they think the country has taken their property without paying fair compensation. Corporations have been using this area of law to challenge public health and environmental regulations. The decision in this case may make it a little harder, and more risky, for corporations to do this in the future.

The case is: Philip Morris Asia Ltd. v. The Commonwealth of Australia, and is part of Philip Morris' ongoing efforts to fend off increased regulation of tobacco products.

I'm going to do my best to explain this case, and why the case is so massively important, as clearly and simply as I can. I'm going to simplify the living crap out of everything, drop as many of the boring and obscure technical details as I possibly can, and I can promise you that this is probably still going to bore the everliving shit out of most of you. But please try to stay with me anyway.  It's one of those areas where there's a lot of scary stuff hidden behind all the boring.

Here's the nutshell summary of what happened in this case:

Several years ago, when it became clear that the Australian government was serious about pushing for plain-packaging tobacco regulations, Philip Morris took a number of steps in response. Some of those measures included things that you'd expect, like lobbying to try and keep the measure from becoming law, or filing a court challenge in the Australian courts when it did become law. Those steps were predictable and reasonable, but some of their other measures involved a bit more creativity.

The measures that they took that were relevant to this case involved some fairly arcane corporate restructuring measures.  Philip Morris is a multinational, with a number of wholly-owned regional subsidiaries, some of which are the parent companies of other wholly-owned subsidiaries. When they finished the restructuring that was relevant here, their Australian operations were a wholly-owned subsidiary of their Philip Morris Asia subsidiary. That meant that, at least on paper, their Australian subsidiary was owned by a Hong Kong-based corporation. And that, in turn, meant that they could use the Hong Kong-Australia Bilateral Investment Treaty to bring a claim against Australia for billions of dollars of damages, and force Australia into mandatory arbitration before a panel of three arbitrators to determine whether Australia trampled all over Philip Morris' rights in their efforts to prevent future tobacco-related deaths.

Here's what Philip Morris wanted the arbitrators to do:
The Claimant, in its Statement of Claim, requests that the Tribunal:
(1) order Respondent to withdraw the [Plain Packaging] [M]easures or refrain from applying them against Claimant’s investments; or in the alternative
(2) award damages of at least [USD] 4,160 million, plus compound interest...
For clarity: Philip Morris wanted either the equivalent of a permanent injunction barring Australia from implementing the plain-packaging regulations or $4,160,000,000 in damages. And costs, legal fees, expenses, and a pony. (OK, I made the last one up, but the rest is real.)

Here's how the arbitrators responded to Philip Morris' request:
[T]he Tribunal cannot but conclude that the initiation of this arbitration constitutes an abuse of rights, as the corporate restructuring by which the Claimant acquired the Australian subsidiaries occurred at a time when there was a reasonable prospect that the dispute would materialise and as it was carried out for the principal, if not sole, purpose of gaining Treaty protection. Accordingly, the claims raised in this arbitration are inadmissible and the Tribunal is precluded from exercising jurisdiction over this dispute.

The tribunal held that changing the ownership of an investment through corporate restructuring just so that you can invoke treaty protections for an investment that wouldn't otherwise be covered isn't a legitimate technique.

Here's why this result is so important:

1: Had the case gone the other way, plain-packaging efforts would have suffered globally.

There are lots and lots of treaties out there that contain the kind of investor-state dispute resolution procedures that Philip Morris was trying to use to challenge the Australian plain packaging regulations. There are so many such treaties, and the record keeping is so poor, that the exact number that are in force is not actually clear to anybody.  I've seen estimates ranging from around 2,500 to nearly 4,000. Even if the number is closer to the low-end estimate (which I suspect is the case), that's still a hell of a lot of different treaties.

If the court had ruled that the "restructure to take last-minute advantage of a treaty" strategy that Philip Morris engaged in was legitimate, it would have been an "open the floodgates" moment. First, you can bet your ass that Philip Morris  would use this strategy anywhere else that plain packaging in being considered, provided the strategy is at all feasible. Second, you can bet that the other major players in the tobacco industry would follow suit. It would have been a massive setback for anti-tobacco efforts around the world.

2: Had the case gone the other way, the effects would have been felt beyond the tobacco industry. 

There were multiple grounds to the investment challenge that Philip Morris brought, but the one that was (IMO) most likely to succeed was the expropriation claim. In American legal terms, this is something that's broadly similar to what's known as an "inverse condemnation" claim, where someone brings a suit claiming that government actions have "taken" their property, and that they are due compensation as a result.

In the US, it's fairly difficult for a regulatory action that applies to everyone to meet the threshold where compensation is required.  In America, a law or regulation must deprive the property owner of "all economically beneficial use" before it clearly becomes the kind of taking of property that requires compensation. That's not necessarily true in investment treaty cases. The exact point where compensation is required when a regulation affects the value of a treaty-protected investment is not crystal clear, but it's probably not quite at that point.

There are a lot of kinds of regulation that can affect the value of a foreign investment. The range of regulations that can reduce the value of foreign investments includes public health measures like the plain packaging tobacco regulations that Philip Morris was attacking, but it can also include emissions lowering regulations, changes to patent rights, and possibly even basic workers' rights laws. Granted, not every company has the resources to engage in what's known in the trade as "nationality planning," but had the ruling in this case gone the other way, it would be reasonable to expect that the tactic would become much more common.

3: Had the case gone the other way, the effects could have been felt in most of the world. 

As I mentioned earlier, there are lots and lots of investment treaties out there. In fact, the vast majority of the world's population lives in a country that is a party to at least one currently in force Bilateral Investment Treaty that permits investor-state arbitration.

For perspective, about 5% of the world lives in a place that falls within the jurisdiction of the Supreme Court of the United States. By my best estimate, 97% of the world's population lives in a country that is a party to at least one currently in force bilateral investment treaty that provides for investor-state dispute resolution. Any arbitral tribunal that's faced with similar facts to those in this case - an investor restructuring ownership to take advantage of a treaty - is almost certainly going to at least consider the approach taken in this case. Most tribunals, I suspect, will follow this approach.

Here's why this is an area of law to watch:

1: This case won't necessarily put an end to Philip Morris-type restructuring methods. Investment tribunals are established on a case-by-case basis, and there is no binding precedent in this area of law - so it would be theoretically possible for Philip Morris to take similar measures in another country, initiate arbitration before a different tribunal, and have that tribunal reach the opposite conclusion. However, investment arbitration tribunals pay a lot of attention to the rulings of other investment arbitration tribunals in similar cases. So while this case isn't binding law, it does make it that much riskier for anyone else to try the tactics that Philip Morris used here. That's particularly true given the costs of both restructuring and investment arbitration.

2: Love it or hate it (and I don't actually hate it), investor-state dispute resolution is not going anywhere anytime soon. That ship sailed so long ago that you'd have to go to the horizon to get a glimpse of the ship sailing over the next horizon. Not only are there thousands of treaties that provide avenues into ISDS, most of these treaties contain lengthy sunset clauses - even if the treaties are terminated tomorrow, investments remain protected for years (and sometimes decades).

3: Like any legal system, IDSD is not an absolute evil. Countries do sometimes treat foreign investors unfairly or unjustly; ISDS provides a legal remedy for the investor that's not dependent on the whims of the host state. There are cases where ISDS is being used abusively by a company looking to be compensated for losses that would be ordinary business risks in other contexts, but there are also cases where countries take advantage of corporations, seize property for political gain, and otherwise act in bad faith.

Take-home point:

Investor-state arbitration cases need to get a lot more public attention than they usually receive. I hope I've made the case for that by now. This was a ruling by a three-member arbitral tribunal, the members of which are not full-time judges. It was not a ruling of any national or international court system. Despite this, it's potential effects were wide-reaching enough to potentially affect public health, environmental, and human rights regulation in countries occupied by 97% of the world's population.

Case Citation:
Philip Morris Asia Ltd. v. Commw. of Austrl., Perm. Ct. Arb. Case No. 2012-12, Award on Jurisdiction and Admissibility (Dec. 17, 2015), http://www.pcacases.com/web/sendAttach/1711
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