Money talks

In the past couple of years Central and Eastern Europe (CEE) has seen a further proliferation of investment arbitration disputes and a considerable increase of intra-regional commercial arbitration. A rise in the local elite’s economic power and sophistication, changes in standards of corporate governance and managers’ accountability, plus a few sudden reversals in governmental economic policies, are the main drivers.

Investment arbitration entered the CEE legal and political landscape in the mid-1990s. The first big cases were concluded shortly after 2000. Investors Ceskoslovenska Obchodni Banka and CME walked away with multimillion-dollar awards against Slovakia ;and ;the ;Czech ;Republic respectively. Since then virtually all CEE countries, including the regional giants Russia and Ukraine, have become involved in major investment arbitration cases.

This exposure made CEE countries aware that bilateral investment treaties (BITs) are much more than free-market equivalents of empty declarations of mutual friendship and economic assistance that were made in the times of communist economic organisation the Council for Mutual Economic Assistance (an Eastern Bloc equivalent of the European Economic Community). BITs give investors rights and the means to enforce them against host countries. Despite CEE countries’ scattered and generally unsuccessful efforts to renegotiate their BITs, or to argue that BITs between old and new EU member states were superseded upon the host countries’ EU accession, the volume of investment disputes is growing steadily.

Many recent claims come from sudden political and regulatory changes. Russia has to defend many investment arbitrations in connection with the fall of Yukos and the rearrangement of economic power in Russia’s natural resources and energy industries under Vladimir Putin’s presidency.

The Slovak example illustrates the potential importance of investment arbitration in the context of reforms of state-administered health and pension insurance systems planned in many CEE countries. The exact design of those reforms, especially the extent of involvement of private investors, is usually debated fiercely. When a thin majority passes a reform, private investors face a significant risk that a new legislation will attempt to reverse it, as happened in Slovakia. Investment arbitration may shield the investors against such adverse developments.

Those major cases also show the likely sources of investment arbitration in the coming years. The worldwide trend of sovereign states’ attempts to reaffirm public control over strategic sectors – most notably natural resources and energy – conflicts with the interests of foreign investors that entered those sectors under the generally more liberal climate of the 1990s. While the investors may ultimately prefer negotiated solutions, the possibility of turning to investment arbitration will increase significantly their bargaining power.

In 2007 the European Commission released a draft of an amendment to the current liberalisation directives that, subject to final approval, imposes a duty on EU member states to require effective separation of ownership of gas and electricity transmission networks from the ownership of respective supply and production businesses. Although the final form of this ‘ownership unbundling’ is still subject to political debate, in addition to obvious constitutional hurdles, it raises questions of availability of BIT (as well as Energy Charter Treaty) protection to foreign investors that acquired the CEE gas and electricity incumbents in the pre-liberalised environment.

The proliferation of intra-regional commercial arbitrations is another recent development. The new local economic elite traditionally preferred to settle their disputes through top-level negotiation. The increasing use of arbitration may be related to a continuing drift of executive power from the founders to professional managers, who prefer more transparent and objective methods of dispute resolution. Increased transparency is also required because of local financial and industrial groups’ involvement in US and European capital markets.

Many cases heard in regional arbitration hubs such as Moscow, Prague or Budapest are administered by the most respected arbitral institutions, such as the International Chamber of Commerce and the London Court of International Arbitration, rather than locally. A reason for such preference may be that local arbitrators’ impartiality sometimes raises serious concerns. Historically, the arbitration milieu in CEE has been quite small and interconnected. Most arbitrators also serve as counsel and it may be difficult to find an arbitrator without a conflict.

The move to arbitration administered by international institutions is understandable in the light of concerns often expressed regarding CEE judiciary – slow, low quality and open to corruption.

The reputation and reliability of local arbitral institutions will undoubtedly benefit from the gradual arrival of a new generation of locally based practitioners who combine region-specific knowledge with foreign, often common law, education and training. Local commercial arbitration hubs will continue their steady growth, which began with the arrival of foreign investment and the intensification of foreign trade in the 1990s.

Roman Prekop a partner and Rostislav Pekar is a local counsel, based respectively in the Bratislava and Prague offices of Squire Sanders & Dempsey