THE STATE OF NECESSITY DEFENSE: A BURDEN, NOT A BLESSING TO THE INTERNATIONAL INVESTMENT ARBITRATION SYSTEM

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1 THE STATE OF NECESSITY DEFENSE: A BURDEN, NOT A BLESSING TO THE INTERNATIONAL INVESTMENT ARBITRATION SYSTEM Kelley Chubb* I. INTRODUCTION The word crisis is used too frequently in the media today. Recently, the United States and much of the developed world faced a series of crises, including the housing market, contraception, student loans, healthcare mandates, and the explosion of the national debt. 1 In the field of international investment law, however, the word crisis is frequently used to raise the state of necessity or necessity defense for breaching bilateral investment treaties. 2 From , Argentina was in a state of economic, political, and social crisis. 3 The Argentinean government passed controversial legislation to prevent a regime collapse. 4 Despite the * Symposium Editor, Cardozo Journal of Conflict Resolution; B.A., 2010, University of Maryland; J.D. Candidate, 2013, Benjamin N. Cardozo School of Law. I thank my parents Lori Carter and John Chubb for their love and support, and my family and friends for their patience and guidance. 1 See Kathleen Madigan, Despite Gains, Housing Still Faces Problems, WALL ST. J. Feb. 16, 2012, KEYWORDS=housing+market; Erik Eckholm, Both Sides Eager to Take Birth Control Coverage to Voters, N.Y. TIMES, Feb. 15, 2012, Martha C. White, Is the Student Loan Crisis Worse that We Thought?, TIME MAGAZINE, Nov. 29, 2011, com/2012/11/29/is-the-student-loan-debt-crisis-worse-than-we-thought/; Kathy Kristof, Health Care Mandate is Tax, More Taxes Coming, CBS NEWS, June 28, 2012, _ /health-care-mandate-is-a-tax-more-taxes-coming/; Matthew Dalton & Stephen Fidler, Europe Faces Larger Bill for Greece, WALL ST. J. Feb. 18, 2012, wsj.com/article/sb html?mod=wsj_economy_ LeftTopHighlights. 2 See generally CMS Gas Transmission Co. v. Argentine Republic, ICSID Case No. ARB/ 01/8, Award, (May 12, 2005); LG&E Energy Corp. v. Argentine Republic, ICSID Case No. ARB/02/1, Decision on Liability (Oct. 3, 2006), 226; Cont l Cas. Co. v. Argentina, ICSID Case. No. ARB/03/9, Award (Sept. 5, 2008). 3 See Timeline: Argentina s Economic Crisis, THE GUARDIAN, world/2001/dec/20/argentina1. 4 See Alex Martinez, Invoking State Defenses in Investment Treaty Arbitration, in THE BACKLASH AGAINST INVESTMENT ARBITRATION 315, 319 (Michael Waibel et al. eds., 2010). 531

2 532 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 government s best intentions, the economy suffered and the government became severely unpopular. The citizens protested. 5 Many foreign investors who were harmed by the government s actions raised their claims before arbitration panels. 6 In most of these cases, Argentina raised the necessity defense to justify its breach of the bilateral investment treaties. 7 Many of the arbitration panels inconsistently interpreted and applied Argentina s necessity defense, by stirring much debate. Before the development of these cases, economic emergencies were not prevalent in investment law or investment arbitration. 8 The financial crisis in Argentina highlighted concerns regarding the obligations of the host nation versus the obligations of foreign investors. Traditionally, international investment arbitrations resolve disputes involving foreign investors and host states arising directly from an alleged breach of an international investment treaty. 9 The legal framework of international investment arbitration is derived from the International Center for Settlement of Investment Disputes Convention ( ICSID Convention ), bilateral and multilateral investment treaties, and rules of arbitral institutions. 10 Despite the popularity of investment arbitration, it has been criticized in recent years for several reasons most importantly: (1) the rigid view of contracts that panels take, (2) arbitral panels blind eye corruption or incompetency in the original negotiations, and (3) the inconsistency of arbitral decisions. 11 The application of the necessity defense to the arbitral cases arising from the financial crisis in Argentina resulted in several contradictory decisions. 12 These contradictory conclusions created significant confusion regarding the necessity defense. Three specific cases involving Argentina include: CMS, LG&E, and Conti- 5 See supra note 3. 6 See William W. Burke-White, The Argentine Financial Crisis: State Liability under BITs and the Legitimacy of the ICSID System in The Backlash Against Investment Arbitration 407, 407 (Michael Waibel et al. eds., 2010) (stating that as many as forty cases were initiated by foreign investors in response to the 2002 financial crisis and the government response). 7 See supra note 2. 8 August Reinisch, Necessity in Investment Arbitration, 41 NETH. Y.B. INT L LAW 137, 145 (2010). 9 RUDOLF DOLZER & CHRISTOPH SCHREUER, PRINCIPLES OF INTERNATIONAL INVESTMENT LAW 1-25 (2008). 10 Id. at Louis T. Wells, Backlash to Investment Arbitration: Three Causes, in THE BACKLASH AGAINST INVESTMENT ARBITRATION 341, (Michael Waibel et al. eds., 2010). 12 See generally supra note 2.

3 2013] THE STATE OF NECESSITY DEFENSE 533 nental Causality. 13 In CMS and the similar subsequent cases including Enron, Sempra, BG Group and National Grid the panel held that the financial crisis did not excuse Argentina its obligations under the investment treaty. 14 While on the other hand, the LG&E and Continental Causality cases held that the financial crisis, and the civil unrest that followed, was sufficient to constitute a state of necessity and excused Argentina from its treaty obligations. 15 This Note discusses how the necessity defense, in the context of the Argentinian financial crisis arbitrations, has undermined the legitimacy of the international investment arbitration system. 16 A discussion of the Argentinean cases listed above reveals that its application is inconsistent. A successful claim for necessity requires the following factors: (1) an essential interest must be at stake, (2) that interest must be threatened by grave and imminent peril, (3) the wrongful conduct must be the only method to protect the threatened interest, and (4) the offending government must have considered a balance of interests and must not have contributed to the situation. 17 Part II discusses the development of international investment law as a body of law that regulates legal rights between host-states and foreign investors. 18 It then analyzes early necessity defense cases in Argentina and reveals how inconsistent interpretation and application of the defense caused great confusion. 19 This sets the stage for further discussion regarding the legitimacy of the state of necessity defense. Part III analyzes the reasoning of two arbitral tribunals where the panel upheld Argentina s use of the state of necessity defense. 20 It reveals the complicated process of applying the necessity defense under two different sources of law: (1) the provisions available in the bilateral investment treaty (BITs), and (2) the customary international law of necessity. 21 Here, the panels focused 13 Id. 14 See Reinisch, supra note 8, at 139. See also Enron Corp. Ponderosa Asset, L.P. v. Argentine Republic, ICSID Case No. ARB/01/3, Award (May 22, 2007), 337; Sempra Energy Int l v. Argentine Republic, ICSID Case No. ARB/02/16, Award 391 (Sept. 28, 2007). 15 Id. 16 See generally Wells, supra note See Articles on Responsibility of States for Internationally Wrongful Acts, G.A. Res. 56/ 83, Annex art. 25, U.N. Doc. A/56/49 (Vol. I)/Corr.4, (Dec. 12, 2001). 18 See Burke-White, supra note 6, at See Dolzer, supra note LG&E Decision on Liability, supra note 2; Cont l Award, supra note See Martinez, supra note 4.

4 534 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 on the severity of the financial crisis supporting the decision to allow Argentina s claim of necessity and avoidance of its treaty obligations. 22 In contrast, Part III analyzes the reasoning of three arbitral tribunals where the panel denied Argentina s claim of necessity. 23 Additionally, Part III discusses the most significant problems of the necessity defense, which include, (a) conflicts between the application of necessity under the provisions in the actual treaty and the customary international law, (b) the inconsistency in results from the same emergency situation in Argentina, and (c) the temporal limitation of the defense generally. 24 Finally, Part III presents potential solutions for the inconsistency problems of the necessity defense within international treaty arbitration system. These options include: (a) clarifying the legal jurisprudence by establishing a hierarchical referral system, (b) establishing multilateral agreements regulating the foreign investment system, (c) developing an appellate process for international treaty arbitration generally, and (d) encouraging the use of alternative state defenses. 25 Ultimately, Part IV concludes by inviting increased discussion regarding the necessity defense and the adoption of new procedures for its application. This discussion is essential to maintaining the respect and legitimacy of the international investment arbitration system. II. BACKGROUND A. The Development of International Investment Law Foreign investment emerged following World War II. Its greatest expansion of bilateral investment treaties (BITs), however, occurred during the 1990s. 26 While no specific reason for this boom of BITs has been identified 27, the growth in popularity could be attributable to internet expansion or increased involve- 22 See generally Reinisch, supra note CMS Award, supra note 2; Enron, supra note 14; Sempra Energy Int l, supra note See generally Martinez, supra note 4, at See generally Wells, supra note 11; Martinez, supra note See Recent Actions Regarding Treaties to which the United States is not a Party, 36 I.L.M. 1404, (1997). See also RUDOLF DOLZER & MARGRETE STEVENS, BILATERAL INVEST- MENT TREATIES, 1-5 (1995). 27 See generally DOLZER & STEVENS, supra note 26 at 3-5.

5 2013] THE STATE OF NECESSITY DEFENSE 535 ment from the U.S. 28 Foreign investment represents long-term risk, therefore international investment law developed as an alternative to regulation through traditional trade agreements, which largely regulates short-term, definite transactions. 29 Many states use international investment treaties in the absence of a Treaty of Friendship 30 to regulate their relationships with foreign investors. 31 There are two types of investment treaties: (1) bilateral investment treaties (BITs). or (2) multilateral investment treaties. 32 The first BIT was adopted in 1959 between Germany and Pakistan. 33 Typically, such agreements involve a developed country and one less powerful developing country. 34 Much like the practice today, the formal BIT provisions were typically based on a treaty template supplied by the developed nation with minor adjustments to provisions. 35 Despite the unequal negotiating power inherent in BITs, the agreements provided mutually beneficial results. The developed country obtained additional legal protections for its investors and the developing country created a more attractive climate for foreign investors. 36 According to the U.S. Department of State, the basic purposes of a BIT are to protect American investment in foreign countries, promote a market-oriented policy, and support the development of international legal standards. 37 For the U.S., BITs are beneficial because they ensure that investors receive favorable treatment, establish clear limits on expropriation of investments, provide transferability, and give investors from both parties the right to submit an investment dispute to arbitration. 38 Most developed nations have similar reasons for continuing to form BITs with other devel- 28 Id. 29 DOLZER & SCHREUER, supra note Id. 31 A Treaty of Friendship is a generic document that governs several issues between closely tied nations. Id. 32 Id. 33 Id. 34 U.N. Conference on Trade and Dev., Bilateral Investment Treaties at 1-5 (2000), 35 See generally id. 36 Id. 37 U.S. DEP T OF STATE, BILATERAL INVESTMENT TREATIES AND RELATED AGREEMENTS, 38 Id.

6 536 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 oping nations. 39 Ultimately, these documents are written and signed to protect domestic citizens that invest in foreign countries. 40 B. The Complexity of International Investment Arbitration While arbitration is now widely accepted as a method of dispute resolution, 41 this has not always been the case. Most parties utilize arbitration to ensure party autonomy, fair and impartial proceedings, and avoidance of unnecessary delays or expenses. 42 Further, the arbitration provides interested parties with more privacy, flexibility, neutrality, and equality than sometimes enjoyed in a court system. 43 Arbitration also establishes the option to choose the panel members, potential appellate courts, and scope of the award. 44 The interested parties regulate the arbitration process by executing a contract that determines the choice of law, venue, procedure, and tribunal. 45 Despite the advantages listed above, arbitration has some disadvantages, including expense, delay, no joinder or consolidation, and the risk of lower-quality decision making. 46 Arbitral panels are flexible but they also lack consistency and authority. 47 These problems are extremely relevant to disputes that arise under international investment treaties. A key organization in the development of international investment arbitration is the International Centre for the Settlement of Investment Disputes (ICSID). 48 ICSID was established under the 39 Similarly, the U.K. Ministry of Foreign and Commonwealth Affairs states that a treaty is used to create rights and obligations in international law. MINISTRY OF FOREIGN & COMMON- WEALTH OFFICE, Treaties and MOUs: Guidance on Practice and Procedures (Apr. 2000, rev d 2004), / /treatiesmousguidance. 40 Id. 41 See Loukas Mistelis, International Arbitration Corporate Attitudes and Practices, 12 Perceptions Tested: Myths, Data and Analysis, Empirical Research Report, 15 AM. REV. INT L ARB (2004), 42 See generally THE LEADING ARBITRATORS GUIDE TO INTERNATIONAL ARBITRATION (Lawrence W. Newman & Richard D. Hill, 2d. ed., 2008). 43 Id. 44 Id. See also United Nations Conference on Trade and Development (UNCTAD), Dispute Settlement: Selecting and Appropriate Forum, (2003), 232add1_en.pdf. 45 See supra note See generally UNCTAD, supra note 44, at Id. 48 Lucy Reed, Jan Paulsson & Nigel Blackaby, Introduction to ICSID, in GUIDE TO ICSID ARBITRATION 1-7 (2004).

7 2013] THE STATE OF NECESSITY DEFENSE ICSID Convention. 49 The driving force behind the formation of ICSID was that creating a dispute resolution system was more beneficial for foreign investors than trying to create one set of rules that governed all international investment. 50 Today, all 143 signatories to the ICSID Convention have the power to bring claims against host-states that allegedly violate the terms of the BIT. 51 Similarly, all signatories to the ICSID Convention are considered a contracting state with regard to disputes brought to arbitration. 52 The current ICSID arbitration rules provide a comprehensive procedural system for bringing an arbitral claim. In order for IC- SID arbitration to be initiated, three criteria must be fulfilled: (1) the parties must have consented to their dispute being submitted to ICSID arbitration, (2) the dispute is between a contracting state and a national of another contracting state, and, (3) the dispute must be a legal dispute arising directly out of an investment. 53 Foreign nations involved in BITs consent to arbitration to avoid the bias of one domestic court weighing into the dispute resolution. 54 Once arbitration commences, parties most frequently argue over such issues as, choice of applicable law, substantive rights afforded to investors, and enforcement of rights under the BIT. 55 C. State Defenses in International Investment Arbitration Foreign states involved in disputes regarding a breached investment treaty may claim several defenses, such as force majeure, public policy violation due to bribery, legitimate exercise of sovereignty, and necessity. 56 A state may raise the force majeure defense if it was coerced or compelled by external events outside the 49 Id. At this convention, a scholar named Aron Broches recognized that it would be more productive to strive for a multilateral agreement on a process for independent resolution of individual investment disputes rather than on actual substantive standards. 50 See id. 51 See Burke-White, supra note 6, at The term contracting state is frequently referenced within international investment laws and commentaries. See List of Contracting States and Other Signatories of the Convention, ICSID/3 (July 25, 2012), DocRH&actionVal=ContractingStates&ReqFrom=Main. 53 See Burke-White, supra note 6, at Id. 55 See Wells, supra note 11, at Martinez, supra note 4, at 315.

8 538 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 state s control. 57 Alternatively, a state may annul the agreement completely if it was encouraged to sign the agreement through bribery. 58 The legitimate exercise of sovereignty defense excuses some acts of a state because they are representative of the people as a whole. 59 Finally, a state may attempt to excuse conduct constituting a breach because exceptional circumstances necessitated such conduct. 60 The necessity defense applies to many different types of situations, including military, humanitarian, environmental, and economic necessity. 61 While the use and success of these defenses are rare, the necessity defense is the most complex and inconsistent defense, which fuels skepticism about the effectiveness of international investment arbitration overall. 62 The doctrinal source of the necessity defense is Article 25 of the Articles on Responsibility for Internationally Wrongful Acts ( Articles on State Responsibility ). 63 The Draft Articles on State Responsibility were finalized by the United Nations International Law Commission ( ILC ) in August 2001, and formally adopted by the U.N. in December of the same year. 64 The ILC was created under the U.N. s limited power to study the international laws and make recommendations for member states. 65 Based on this power, the U.N. created the ILC in 1947 as a permanent institution for the 57 Id. at This principle is enumerated under the Articles on Responsibility, supra note 16, at art Id. at 326. An International NGO defines bribery as payment to receive preferential treatment. Frequently Asked Questions About Corruption, TRANSPARENCY INT L (June 30, 2012), org/news_room/faq/corruption_faq. 59 Andrew Reding, U.S. Must Not Handicap Artistide, NEWSDAY, (Sept. 22, 1994), available at Not%20Handicap%20Aristide.pdf. Currently, this defense has not been invoked in arbitration. Id. at Martinez, supra note 4, at See generally Sarah F. Hill, The Necessity Defense and the Emerging Arbitral Conflict in Its Application to the U.S.-Argentina Bilateral Investment Treaty, 13 L. & BUS. REV. AM. 547, (2007). 62 Id. 63 Articles on State Responsibility, supra note 17, Art Text adopted by the Commission at its fifty-third session, in 2001, and submitted to the General Assembly as a part of the Commission s report covering the work of that session. The Report, which also contains commentaries on the draft articles, appears in 2 Y.B. Int l L. Comm n. 65 U.N. Charter art.12, para. 1, available at html (last visited Mar. 18, 2012). ( The General Assembly shall initiate studies and make recommendations for the purpose of: (a) encouraging the progressive development of international law and its codification. ).

9 2013] THE STATE OF NECESSITY DEFENSE 539 codification and progressive development of international law. 66 The rules created by the ILC are sent to the U.N. and distributed to member states for their comments, reservations and suggestions. 67 As a result, the rules drafted by the ILC typically represent public customary international law that the international community is encouraged to follow out of international tradition. 68 Customary international law is not codified like international treaties, but rather derives from practice or custom. 69 Article 25, which is generally accepted as customary international law, 70 states the requirements of the necessity defense as follows: Necessity may not be invoked by a State as a ground for precluding the wrongfulness of an act not in conformity with an international obligation of that State unless the act: (a) is the only means for the State to safeguard an essential interest against a grave and imminent peril and; (b) does not seriously impair an essential interest of the State or States towards which the obligation exists, or of the international community as a whole. 71 In any case, necessity may not be invoked by a State as a ground for precluding wrongfulness if: (a) the international obligation in question excludes the possibility of invoking necessity; or (b) the State has contributed to the situation of necessity. 72 There are some important distinctions to note when discussing the application and validity of the necessity defense. First, the ILC commentary cautions that the necessity defense should only be used in exceptional cases, subject to strict limitations in order to prevent abuse 73 and it should only apply when there is an irreconcilable conflict between an essential interest... and an obligation 66 Statute of the International Law Commission, G.A. Res.174(II), Art. 1, 1 (Nov. 21, 1947). This section establishes the purpose of the ILC. Id. See also Jeffrey S. Morton, THE INTERNATIONAL LAW COMMISSION OF THE UNITED NATIONS 1-5 (2000). 67 Morton, supra note 66, at See id. 69 See Restatement (Third) of the Foreign Relations Law of the United States 102(2) (1986). See also Jack Landman Goldsmith & Eric A. Posner, A Theory of Customary International Law,1 (U. of Chicago, Law and Economics Working Paper, 2d. Series, Paper No. 63, 1998) available at 70 Draft Articles on Responsibility of States for Internationally Wrongful Acts with Commentaries, U.N. Art. 25 at (2008) [hereinafter Draft Articles Commentary], treaty.un.org/ilc/texts/instruments/english/commentaries/9_6_2001.pdf. See generally DOLZER & SCHREUER, supra note Draft Articles Commentary, supra note Id. 73 Martinez, supra note 4, at

10 540 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 of the State. 74 Second, the ILC commentary also emphasizes that this strict limitation distinguishes the necessity defense from the other defenses available to states in investment treaty arbitration. 75 For example, the use of the necessity defense does not depend on prior conduct, involuntary conduct or the threat of personal injury to government officials. 76 Third, the arbitral panels frequently turn to two sources of authority when analyzing the validity of the necessity defense: (1) customary international law, and (2) investment treaty provisions. 77 The Articles on State Responsibility were intended to codify the existing customary international law. 78 Yet, contracting states reserve the right to draft the BITs to include a provision that allows the use of necessity to defend wrongful state action. 79 Today both customary practice of excusing treaty obligations due to necessity and Article 25 stem from several early international cases. 80 The holdings from these cases establish a questionable foundation of inconsistency and confusion for the modern necessity defense. First, the Russian Indemnity case was the first to consider the necessity defense as a defense to an alleged breach of treaty obligations. 81 The judgment also served as a central reference during the drafting of Article The conflict there resulted from a treaty that ended military conflict in exchange for the Ottoman Empire s 74 Draft Articles Commentary, supra note 70, at Id. 76 Id. Concepts like consent (art. 20), self-defense (art. 21) or countermeasures (art. 22) are dependent on prior conduct of the injured State. The force majeure defense is dependent on involuntary or coerced conduct of the injured State. The distress defense is applicable in situations where the lives of individuals in the charge of the State official are in danger. 77 See Draft Articles Commentary, supra note 70, at See also Office of the United States Trade Representative, Treaty Between the United States of American and the Oriental Republic of Uruguay Concerning the Encouragement and Reciprocal Protection of Investment, 8, See generally Martinez, supra note Draft Articles Commentary, supra note 70, at See Cont l Award, supra note 2. For example, a previous BIT between the U.S. and Argentina contained the following language, the [t]reaty shall not preclude the application by either Party of measures necessary for the maintenance of public order, the fulfillment of its obligations with respect to the maintenance or the restoration of international peace or security, or the protection of its own essential security interests. 80 See Affaire de l Indemnite Russe, 7 AM. J. INT L L. 178 (1913), available at Societe Commerciale de Beligique, 1939, Permanent Ct. of Int l Justice (PCIJ) A./B. No. 78 at 160; Case Concerning the Gabèíkovo-Nagymaros Project, I.C.J. Reports 7, 2-40 (1997), Judgment (Sept. 25, 1997). 81 Russian Indemnity, supra note See Articles on State Responsibility supra note 17, at Art. 25.

11 2013] THE STATE OF NECESSITY DEFENSE 541 payment of 350,000 Turkish pounds to Russia. 83 However, the Ottoman Empire took nearly twenty years to pay the principal. This delay forced Russia to initiate arbitration in order to recover the interest payments due. 84 Ultimately, the arbitral tribunal decided that the Ottoman Empire was not liable for the interest and was excused from its treaty obligations because the very existence 85 of the Ottoman state was threatened by bankruptcy. In addition, the tribunal s discussion of circumstances that imperil the existence of state 86 set the evidentiary foundation for the state of necessity defense as grave and imminent peril. 87 Second, Société Commerciale de Belgique (SCdB) represents another early necessity defense case. The issue there was whether the Greek government could avoid, mitigate or defer its debt by citing the necessity defense. 88 In contrast to Russian Indemnity, the arbitral tribunal here ordered the Greek government to repay its debt to a French railway company, despite the Greek government s poor financial situation. 89 The arbitral tribunal did emphasize the importance of the need to balance all interests, 90 by stating, the legitimate interests of the company, the ability of Greece to pay and the traditional friendship between the two countries should be balanced. 91 However, the tribunal eventually held that the duty to meet treaty obligations outweighed the severity of high national debt. 92 Finally, and most significantly, the necessity defense was discussed by the International Court of Justice (ICJ) in the Case Concerning the Gabèikovo-Nagymaros Project ( GN-Project ). 93 The ICJ reviewed the necessity defense based on its formal elements as stated in the Articles on State Responsibility. 94 This dispute resulted from a treaty signed by Hungary and the Czechoslovak People s Republic ( Czechoslovakia ) that governed the construction 83 Russian Indemnity, supra note 80, at Id. at Id. at 193. Stated more simply, Turkey s (formerly Ottoman Empire) necessity claim was successful because meeting the treaty obligation would truly threaten the existence of Turkey as a state. 86 Id. 87 Draft Articles Commentary, supra note 70, at 80 Art Belgium v. Greece, supra note Id. at Id. at Belgium v. Greece, supra note 80, at Id. at GN-Project, supra note Id.

12 542 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 and operation of the Gabèíkovo-Nagymaros system of locks on the Danube River 95 as a joint investment. 96 After the treaty was signed, Hungary abruptly postponed the venture and completely disregarded its obligations under the original 1977 Treaty. 97 During arbitration, Hungary raised the necessity defense due to environmental necessity. 98 Hungary argued that they were unable to perform because of substantial political and economic change, which fueled public concern over the environmental dangers of the project. 99 The people were specifically outraged about the expansion of a planned reservoir which increased the ecological dangers of discharge, artificial flooding, creation of stagnant water, degradation of water quality, and eutrophication. 100 In response, Czechoslovakia argued that the necessity defense was not applicable because it was unclear whether there was actually an ecological risk according to the strict requirements of Article Ultimately, the court agreed. 102 GN-Project provides valuable discussion on the application of the necessity defense. The ICJ concluded that Hungary s environmental situation could constitute grave peril. However, the danger was not imminent enough to completely disregard Hungary s treaty obligations; there were other methods to deal with the situation. 103 Although the ICJ recognized the legitimacy of the necessity defense, it noted that the defense is a very narrow concept; necessity does not terminate a treaty, but absolves state responsibility only in extreme situations. 104 Most importantly, the ICJ added that as soon as the state of necessity ceases to exist, the duty to 95 Id. at Id. 97 See Martinez, supra note 4, at Id. 99 Id. 100 GN-Project, supra note 80, at Eutrophication is [t]he process by which a body of water acquires a high concentration of nutrients, especially phosphates and nitrates. These typically promote excessive growth of algae. As the algae die and decompose, high levels of organic matter and the decomposing organisms deplete the water of available oxygen, causing the death of other organisms, such as fish. Eutrophication is a natural, slow-aging process for a water body, but human activity greatly speeds up the process. United States Geological Services, Definition of Eutrophication, (last visited Mar. 18, 2012). 101 See Martinez, supra note 4, at See GN-Project, supra note 80, at See Martinez, supra note 4, at 319. In fact, the possibility of alternative solutions was given particular weight by the ICJ. 104 See GN-Project, supra note 80, 101.

13 2013] THE STATE OF NECESSITY DEFENSE 543 comply with treaty obligations revives. 105 The standard for invoking the necessity defense is real danger concerning an essential interest of the state in question. 106 What constitutes an essential interest depends on the circumstances of the state in current situation. 107 Finally, the ICJ limited necessity to situations involving grave danger to the existence of the state itself, to its political or economic survival, the maintenance of conditions in which its essential services can function, the keeping of its internal peace, the survival of part of its population, the ecological preservation of all or some of its territory. 108 Ultimately, the ICJ denied Hungary s state of necessity defense. 109 However, investment treaty tribunals continue to discuss the necessity defense and its proper application remains unclear. In fact, much of this analysis is based on the same financial crisis and Argentina s response to that crisis in D. A Case Study: The Argentine Financial Crisis Near the end of 2001, a severe financial crisis occurred in Argentina. 111 The crisis was fueled by the collapse of the currency regime. The Argentine peso lost forty percent of its value in just one day. 112 As a result, the value of Argentine salaries was almost cut in half and many people were laid off. 113 In an attempt to stabilize the economy and curb public disapproval, the Argentinian government made several changes. First, the government terminated the currency board, which valued the peso based on the U.S. dollar. 114 Second, the government passed the pesification of all finan- 105 Id. 106 GN-Project, supra note 80, at See also Y.B. of the Int l Law Comm n, 1980, vol. II, ch. 3, p. 39, GN-Project, supra note 80, at Y.B. of the Int l Law Comm n, 1980, vol. II, pt. 2, p. 35, See GN-Project, supra note 80, at See THE GUARDIAN TIMELINE, supra note Paul Blustein, AND THE MONEY KEPT ROLLING IN (AND OUT): WALL STREET, THE IMF AND THE BANKRUPTING OF ARGENTINA (2005). 112 Burke-White, supra note 6, at Argentina s Collapse: A Decline without Parallel, THE ECONOMIST, Mar. 2-8, 2002, at 26. The financial situation was drastic, income per person in dollar terms... shrunk from around $7,000 to just $3, [and] unemployment [rose] to perhaps 25%. 114 See Burke-White, supra note 6, at 409. See generally Law No , Jan. 6, 2002, [LXII-A] A.D.L.A. 44 (Arg.).

14 544 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 cial obligations. 115 Finally, the government also froze all bank accounts through a process known collectively as the Corralito. 116 While these measures did help stabilize the economy and restore public support for the government, many foreign investors faced serious losses and to turned to their BITs for legal protection. 117 Most BITs resolve disputes through arbitration. 118 Consequently, Argentina quickly became a party to approximately 43 ICSID arbitrations. 119 In an effort to preclude liability for the alleged breach of the BITs, Argentina raised two key arguments: the non-precluded measures provisions ( NPM provisions ), and the necessity defense. 120 As discussed above, several arbitral tribunals inconsistently determined the strength of Argentina s necessity defense. The following discussion explores how the aforementioned inconsistencies are detrimental to the international investment arbitration system. III. DISCUSSION In the case of the Argentinian financial crisis, arbitral panels are divided on whether the circumstances warrant the protection of the necessity defense. This section will examine the arbitration awards from two cases that upheld the necessity defense: LG&E Energy Corp. v. Argentina Republic; and, Continental Casualty Company v. Argentine Republic. 121 Later, this section will examine the arbitration award from CMS v Argentina where the panel denied Argentina s claim for necessity Id. Pesification occurs when the government forced banks to convert their dollar-denominated accounts and debts to pesos. Argentina Glossary of Financial Terms and Acronyms, U.S. Embassy Buenos Aires Asymetrical Pesification (Sept. 2003), gov/uploads/images/oeoj8xp9bupc9rb8lsvidg/wwwfecn2.pdf 116 See Burke-White, supra note 6, at , (citing Decree No. 1570, Dec. 3, 2001, B.O. 1, For reference to the measures as the Corralito, See THE GUARDIAN TIMELINE, supra note See Burke-White, supra note 6, at Id. 119 Id. at 410. Argentina s potential liability for the current pending cases could be more than US $8 billion, with some speculating that Argentina s total liability for the crisis legislation reaching US $80 billion. 120 Id. 121 See LG&E Decision on Liability, supra note 2; Cont l Cas.Award, supra note See CMS Award, supra note 2.

15 2013] THE STATE OF NECESSITY DEFENSE 545 A. ICSID Cases that Upheld the Necessity Defense The necessity defense succeeded in two cases connected to the 2001 Argentine financial crisis: LG&E v. Argentina 123 and Continental Causality v. Argentina. 124 However, these cases represent the minority position. In LG&E v. Argentina, the foreign investor claimant, LG&E, held shares in three Argentinian gas distribution companies. 125 Argentina enacted emergency legislation that allow itself to suspend and later renegotiate the treaty. 126 When the government failed to reinstate the legal protection suspended by the legislation, LG&E filed a request for ICSID arbitration in December 2001 seeking compensation for its losses. 127 Argentina raised the necessity defense to excuse their potential liability for the $250 million plus interest and cost. 128 Based on the BIT, Argentina could raise the necessity defense through a treaty provision or the customary international law as codified in Article The tribunal excused Argentina s liability by holding that Argentina was in a crisis from December 2001 to April 2003 and that necessity required the government act in ways that would maintain public order and protect its essential security interests. 130 The tribunal s analysis first discussed Article XI of the U.S.- Argentina BIT, which stated, [t]his treaty shall not preclude the application by either Party of measures necessary for the maintenance of public order, the fulfillment of its obligations with respect to maintenance or the restoration of international peace or security, or the protection of its own essential security interests. 131 Based on this provision, tribunal broke down its analysis into two parts: (1) whether the situation was extreme enough to necessitate protection by Article XI and (2) whether the government s actions were necessary to protect its essential interests. 132 Primarily, the tribunal found the situation to be extreme based on the existence of serious public disorder. There were fatal shootings, closure of 123 LG&E Decision on Liability, supra note 2, at Cont l Cas. Award, supra note LG&E Decision on Liability, supra note 2, at See Martinez, supra note 4, at LG&E Decision on Liability, supra note 2, Martinez, supra note 4, at Id. 130 LG&E Decision on Liability, supra note 2, Martinez, supra note 4, at LG&E Decision on Liability, supra note 2, at 205.

16 546 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 public transportation, public riots and other economic problems that produced a harmful combination of events warranting protection under Article XI. 133 Therefore, the situation compelled protection under Article XI. 134 Subsequently, the tribunal created a broad standard for what constitutes a crisis. For instance, tribunal rejected military action as a prerequisite to a crisis and held that Article XI extended crisis situations beyond those that result in military action. 135 Here, the situation in Argentina required the government to make immediate and decisive action to restore order. 136 Therefore, from December 1, 2001 to January 26, 2003, the tribunal accepted that Argentina was in political, economic and social crisis. 137 Under this conclusion, Argentina was excused from liability for breaching the BIT during the crisis period under Article XI. 138 The tribunal did not explain its reasons for arriving at this conclusion, but rather focused on the totality of the circumstances to determine that the situation was grave enough to justify the government action as necessary. Finally, the tribunal engaged in a separate inquiry of the necessity defense under Article 25 and customary international law. 139 The key question was whether Argentina contributed to the state of necessity. 140 The tribunal held that LG&E failed to prove Argentina contributed to the crisis. 141 However, the panel was silent on exactly what factors LG&E failed to prove. In fact, the tribunal only mentioned Argentina s intent to slow the damaging effects of the crisis. 142 Ultimately, the panel held that Argentina was exempted from its liability under both Article XI of the BIT and Article 25 of the Articles of State Responsibility. Similarly, the panel in Continental Casualty applied similar reasoning in excusing Argentina s liability under Article XI and Article 25. However, it observed an important distinction between the two provisions: 143 Non-precluded measure provisions, like Ar- 133 See id. at Id. at See id. at Id. 137 Id. at See id. at Martinez, supra note 4, at LG&E Decision on Liability, supra note 2, at Id. 142 Id. at See Martinez, supra note 4, at

17 2013] THE STATE OF NECESSITY DEFENSE 547 ticle XI, only apply to actions that are outside the scope of the BIT and are not in breach of the relevant BIT provision, while Article 25 precludes liability for breach of treaty obligation. 144 In Continental Casualty, Argentina passed emergency legislation, which froze bank accounts across the country and, as a result, the Continental Casualty was unable to access its investments. 145 Therefore, Continental Casualty could not access its investments in Argentina and suffered significant loss. 146 The panel concluded that Argentina was excused from liability under the state of necessity defense, and further concluded that the NPM provision and Article 25 apply to different situations. 147 B. ICSID Cases that Denied the Necessity Defense CMS v. Argentina represents one case, in a long line of cases, against Argentina in response to the financial crisis and related emergency legislation. Here, foreign investors claimed that Argentina s response to the financial crisis harmed their 25% stake in an Argentinean national gas transportation company. 148 Argentina pleaded the necessity defense, but the tribunal held necessity did not excuse Argentina from its obligations. 149 Argentina was not excused from its treaty obligations, despite contrary precedent involving the same emergency situation and government response as discussed in LG&E. 150 In the arbitral award, the panel acknowledged that the financial crisis in Argentina was difficult and warranted government action to prevent a worsening of the situation or total economic collapse. 151 However, the tribunal determined that use of harmful emergency legislation may not have been the only way for Argentina to safeguard its interests. 152 In its analysis, the arbitral panel cited the ILC s comment to the effect that the plea of necessity is excluded if there are other (otherwise lawful) means available, even if they may be more costly or less convenient as a 144 Id. at See Cont l Award, at Id. 147 See Cont l Cas. Award, supra note 2, at See Martinez, supra note 4, at See id. at 323. See generally CMS Award, supra note 2, at See Martinez, supra note 4, at See CMS Award, supra note 2, at Id.at

18 548 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 persuasive justification for concluding that necessity does not apply to this case. 153 The second condition is that the state cannot contribute to the situation of necessity. 154 Furthermore, the panel concluded that Argentina made substantial contributions to the state of necessity. 155 The financial crisis in Argentina was not a recent development, but had been festering since the late 1980s and grew out of complications arising from the government s emergency legislation. Therefore, the government had significantly contributed to the crisis and the emergency. 156 C. Problems with the State of Necessity Defense (i) Conflict Among the Sources of Law. Arbitral tribunals do not agree as to the appropriate source of law for the necessity defense. This uncertainty plays a major role in over-complicating the defense and ultimately weakening the authority of international investment panels. In the cases described above, arbitration panels referred to a combination of three different areas of the law, including: (1) NPM provisions, (2) customary international law as codified in Article 25, and (3) case law from other international non-governmental organizations. 157 The system s reliance on varying language and standards when applying one defense creates overly broad and confusing awards. This may discourage parties from turning to ICSID as an international arbitration institution. (ii) Inconsistent Interpretation of Rules. When tribunals interpret Article 25, they continually reach inconsistent results, even when the dispute is based on the same fact pattern. The inconsistent application of Article 25 and the resulting confusion ultimately undermines confidence in international investment arbitration institutions. Basically, Article 25 requires any state action to be necessary to avoid grave and imminent peril, regarding an essential inter- 153 Id. at Id. at See id. at Id. 157 See Martinez, supra note 4, at 322. See also Cont l Award, supra note 2, at There, the panel referred to case law of General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO) panels as a more reliable source of law than the customary international law. Id.

19 2013] THE STATE OF NECESSITY DEFENSE 549 est. 158 Most can agree that state action to avoid an economic crisis is necessary to avoid imminent peril regarding an essential interest. In Argentina, most tribunals agreed that the country suffered a drastic economic crisis. 159 However, based on the cases discussed above, the tribunals could not agree on whether Argentina faced grave and imminent peril or whether alternative actions were available to avoid further crisis. Firstly, there is confusion regarding the meaning of grave and imminent peril. For example, the Enron 160 and Sempra 161 tribunals found that the events in Argentina were controllable and manageable. Similarly, the CMS 162 tribunal found that the crisis was serious, but did not result in total economic or social collapse. The CMS 163, Sempra 164, and Enron 165 tribunals all concluded that Argentina was liable, despite the necessity defense, because less harmful options were available. On the other hand, the LG&E tribunal held that Argentina faced a grave threat to the state s very existence and emergency legislation did not contribute to the crisis. 166 Moreover, the actions taken by the government were the only methods of dealing with the crisis. 167 In short, it is unclear how or why a tribunal would conclude a government s action is sufficient; this confusion is problematic. Secondly, the necessity defense requires that the government action does not impair an essential interest of the state. This generally means that the government of the host-nation cannot act in necessity for one interest while blatantly harming another of its essential interests. 168 In CMS 169 and LG&E, 170 the panels held that action taken would not seriously impair other states rights. However, in Enron 171 and Sempra, 172 the panels concluded that the 158 Draft Articles Commentary, supra note 70, at 80. See Andrew Newcombe & Luis Paradell, LAW AND PRACTICE OF INVESTMENT TREATIES: STANDARDS OF TREATMENT 518 (2009). 159 See generally, LG&E Decision on Liability, supra note 2; See Cont l Award, supra note Enron Award, supra note 14, at See Sempra Award, supra note 14, at CMS Award, supra note 2, at See id. at See Sempra Award, supra note 14, at See Enron Award, supra note 14, at LG&E Decision on Liability, supra note 2, at Id. at See generally Martinez, supra note 2, at CMS Award, supra note 2, at LG&E Decision on Liability, supra note See Enron Award, supra note 14, at Sempra Award, supra note 14, at

20 550 CARDOZO J. OF CONFLICT RESOLUTION [Vol. 14:531 claimant s essential interests would be impaired by the operation of necessity. Commentators argue that these conflicting awards do not explain how article 25 should apply in the case of international investment agreements where rights are provided to non-contracting parties, namely private investors. 173 Thirdly, the necessity defense does not protect any state action that contributes to the situation generating necessity. Most of the decisions reviewed herein found that Argentina did contribute to the crisis and thus failed to meet this condition. For example, the CMS 174, Enron 175 and Sempra 176 tribunals held that even though the crisis had domestic and international roots, the Argentinean government made substantial contributions to the crisis. Commentators suggest that these results do not involve sufficient explanation on the degree of contribution required or what facts suggested contribution. 177 Similarly, there is concern as to the lack of explanation as to why the burden of proof shifts to the claimant. 178 On the other hand, the results of the LG&E award demonstrate that it is possible for the panel to conclude that the government action did not contribute to the crisis. 179 In conclusion, there are inconsistencies at almost every aspect of the legal interpretation of Article 25 and these inconsistences can potentially weaken the international arbitration system. (iii) Temporal Limitation. As stated in Article 27 of the ILC s Articles on State Responsibility, when the circumstances giving rise to the preclusion of wrongfulness no longer exist, the duty to comply with the treaty obligations revives. 180 The mentioned article provides: The innovation of a circumstance precluding wrongfulness in accordance with this chapter is without prejudice to: (a) compliance with the obligation in question, if and to the extent that the circumstance precluding wrongfulness no longer exists Effectively, this means when the circumstances giving rise to the preclusion of wrongfulness no longer exist, the duty to comply 173 Newcombe & Paradell, supra note 158, at Id. 175 Enron Award, supra note 14, at Sempra Award, supra note 14, at Newcombe & Paradell, supra note 158, at Id. 179 LG&E Decision on Liability, supra note See Draft Articles Commentary, supra note 70, at Draft Articles Commentary, supra note 70, at 85 Art. 27.