1150_2004_mtd_v._chile_-_summary

					                             DAMAGES IN INVESTOR-STATE ARBITRAL AWARDS: A REVIEW

                                                       Case summary

                MTD Equity Sdn. Bhd. and MTD Chile S.A.
                          v Republic of Chile
                            (MTD v. Chile)
Year of the award: 2004
Forum: ICSID
Applicable investment treaty: Chile - Malaysia BIT (1992)

Arbitrators                                                        Timeline of the dispute
Mr. Andres Rigo Sureda – President                                 26 June 2001 - request for arbitration
Mr. Marc Lalonde                                                   29 January 2003 - arbitral tribunal
Mr. Rodrigo Oreamuno Blanco                                        constituted
                                                                   25 May 2004 - arbitral award
                                                                   30 Dec 2004 - request by Chile for
                                                                   annulment of the award (not yet decided).


                                                   Table of Contents
I. Executive Summary ....................................................................................................... 2
II. Factual Background and Claims of the Investor .......................................................... 2
III. Findings on Merits ...................................................................................................... 3
   A. Fair and Equitable Treatment (FET) ......................................................................... 3
   B. Other Claims ............................................................................................................. 4
IV. Finding on Damages ................................................................................................... 4
   A. Law applicable to the determination of damages ..................................................... 4
   B. Standard of Compensation ........................................................................................ 4
   C. Causation/Attribution of Damage ............................................................................. 4
   D. Heads of Damages and Valuation ............................................................................. 5
     1. Investment (expenditures) and financial costs ....................................................... 5
     2. Deduction of the residual value of investment ....................................................... 5
     3. 50% reduction due to attribution of business risk .................................................. 5
   E. Interest ....................................................................................................................... 6
   F. Costs .......................................................................................................................... 6
V. Implications / Initial Analysis ...................................................................................... 6
VI. List of Commentaries to the Case ............................................................................... 7
   Table 1. Issues discussed in the award .......................................................................... 8
   Table 2. Relevant quotes from the award ...................................................................... 8




                                                                                                                                      1
I. Executive Summary
A Malaysian investment company and its Chilean subsidiary (collectively “MTD”),
initiated arbitral proceedings pursuant to the Chile - Malaysia BIT after they failed to
realize an investment project of developing a satellite city in the Chilean municipality of
Pirque.

The land which was secured by the Claimants for this project had originally been
earmarked for agricultural use, and needed to be rezoned before MTD could embark on
building the above mentioned city. The Chilean Government had previously assured
MTD that rezoning of the land would be achieved promptly. The Foreign Investment
Commission (FIC), a Chilean government body had also signed a contract approving
said investment, which did not, however, contain an approval of relevant rezoning, but
only a general approval to invest in Chile. The Claimants subsequently invested US$17
million into the project.

In 1997 the Claimants learned that the governmental agency responsible for rezoning
would not rezone the land owned by MTD on the grounds that it would be inconvenient
and contrary to Chilean law.

MTD initiated ICSID arbitration under the Chile - Malaysia BIT, alleging several
violations of the BIT by Chile and requesting compensation for the damage they had
sustained. The Tribunal dismissed most of MTD’s claims (on expropriation,
unreasonable and discriminatory measures, and obligations under foreign investment
contracts) but found that Chile had breached its fair and equitable treatment (FET)
obligation by creating and encouraging strong expectations that the project would be
implemented in the specified proposed location.

The Tribunal awarded damages on the basis of expenditures made by the Claimants in
relation to their investment reduced by the residual value of the investment. The
resulting amount was further reduced by 50%, as the Tribunal decided that part of the
Claimants’ loss had to be attributed to MTD's own failure to exercise business acumen
and diligence in purchasing the site. In total, the award amounted to approx. US$ 5.9
million plus compound interest at the LIBOR rate from the date of the beach until the
date of payment.

Chile has recently requested an annulment of this award; ICSID annulment proceedings
are pending.



II. Factual Background and Claims of the Investor
MTD Equity Sdn. Bhd (“MTD Equity”), a Malaysian company, and MTD Chile S.A.
(“MTD Chile”), its Chilean subsidiary, (collectively “MTD”) brought a claim against
Chile after failing to realize their building project in the Chilean district of Pirque.

In order to develop a satellite city in Pirque, in 1996 MTD set up a Chilean joint
venture, El Principal Inversiones S.A. (“EPSA”). MTD held 49% of shares in EPSA;
Mr. Fontaine, the owner of the land that was to be used for the project, was given, as
                                                                                         2
consideration for the land, 51% of EPSA shares. The land at issue was earmarked for
agricultural use, and MTD needed it to be rezoned in order to carry out the project.

After concluding a foreign investment contract with Chile’s Foreign Investment
Commission (FIC) in 1997 for the development of a real estate project consisting of the
“construction of a self-sufficient satellite city with houses, apartments, schools,
hospitals, commerce, services, etc.”, MTD invested US$ 8.4 million as its capital
contribution in EPSA and US$ 8.7 million to buy 51% of EPSA shares from Mr.
Fontaine. It did so despite the fact that the land had still not been rezoned. The above-
mentioned contract with FIC contained approval of the investment, but no rezoning
approval.

In 1997, the Mayor of Pirque formally endorsed the project by a letter. However, the
Claimants learned later the same year that the governmental agency responsible for
rezoning would not rezone the land in question, on the grounds that this would be
inconsistent with Chile's urban development and environmental policies. On 4
November 1998 Minister Henrique of the Ministry of Housing and Urban Development
officially informed MTD that to the land was not going to be rezoned.

MTD alleged that the actions of the Respondent had breached the following obligations
under Chile-Malaysia BIT:

   To provide fair and equitable treatment;
   To respect obligations under the foreign investment contracts (“umbrella clause”);
   To abstain from unreasonable and discriminatory measures;
   Not to expropriate without compensation.

According to the Claimants, the measure at issue (refusal to rezone the land) led to a
substantial loss of the value of the initial investment and left MTD with ownership of
land without being able to recoup what had been invested in the project. MTD claimed
compensation for the full value of the investment, calculated on the basis of actual
expenditures (the amount not specified in the award) plus compound interest and costs.

Chile denied the alleged violations.


III. Findings on Merits

       A. Fair and Equitable Treatment (FET)

The key question for the Tribunal was whether Chile’s obligation to rezone the land
following the approval by FIC of the foreign investment was part of its duty to provide
FET, even though the Chile - Malaysia BIT did not contain such a provision. (Para.103)

The Tribunal examined relevant provisions of Chile’s BITs with Croatia and Denmark.
Both included an obligation to award necessary permits subsequent to approval of an
investment. The Tribunal accepted that, by virtue of the Treaty’s MFN clause, such
obligations were part of the FET standard under the Chile-Malaysia-BIT. (Paras.103,
104)
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The Tribunal concluded that approval of an investment by the FIC for a project that was
against the urban policy of the government was a breach of the FET obligation by Chile.
(Paras.163, 166)


       B. Other Claims
The Tribunal dismissed MTD’s claims relating to expropriation, unreasonable and
discriminatory measures, and obligations under foreign investment contracts (“umbrella
clause”).


IV. Finding on Damages

       A. Law applicable to the determination of damages
In relation to the merits of the case, the Tribunal decided that the Chile - Malaysia BIT
and international law should be applied. (Paras.86-87) The same held true in relation to
the award of damages.


       B. Standard of Compensation
The Chile - Malaysia BIT contained a provision prescribing a specific standard of
compensation only for expropriation - “prompt, adequate and effective” (Article 4(c)) –
but not in relation to other BIT breaches. The Tribunal adopted the classic standard
formulated by the PCIJ in the Chorzow Factory case - compensation should “wipe out
all the consequences of the illegal act and re-establish the situation which would, in all
probability, have existed if that act had not been committed.” (Para.238)


       C. Causation/Attribution of Damage
Chile contended that the Claimants failed to prove the causal link between the alleged
losses and the breach. This was dismissed by the Tribunal without any further
discussion of the matter. (Para.216) However, the Tribunal held that Chilean
responsibility was limited to the consequences of its own actions to the extent they had
breached the obligation to treat the Claimants fairly and equitably.

The Tribunal held that Chile would not be liable for bad business decisions of MTD
with regard to the relevant land purchase (MTD had purchased the land without legal
protection and proper investigation). Although the Tribunal did not use the term
“contributory fault”, it seemed to apply this concept. In the Tribunal’s view, MTD had
to accept some of the blame for to its lack of oversight, diligence and business
awareness. The Tribunal thus concluded that MTD itself should bear 50% of damages.
It did not give any indication on how that figure was reached. (Paras.167, 242, 246)




                                                                                        4
       D. Heads of Damages and Valuation

               1. Investment (expenditures) and financial costs

MTD claimed compensation for the expenditures it had made as well as financial costs
and expenses related to the investment. The Tribunal accepted the calculation of MTD’s
lost expenditure on the initial investment (capital contribution in EPSA, amount paid to
buy 51% of EPSA shares from Mr. Fontaine, additional working capital – in total
approx. US$ 17.3 million) after being satisfied that:
     The expenditures were made by the Claimants or on their behalf;
     The expenditures were made for purposes of the investment in Chile.
(Para.239)

However, the Tribunal limited the recoverable expenditures. Firstly, it decided that
project expenditures made prior to the execution of the first FIC contract on 18 March
1997 were not eligible for calculation of damages even if they could be considered part
of the investment. This was because the Claimants could have legitimate expectations in
relation to the project only after the FIC approval of their investment. Secondly, the
Tribunal excluded expenditures made after 4 November 1998 – the date on which
Minister Henríquez informed the Claimants in writing that the land would not be
rezoned. (Para.240)

The Tribunal accepted that MTD could recover financial costs related to the
investment. These costs of approx. US$ 3.9 million included primarily debt servicing
and bank guarantee fees. The Tribunal’s reasoning was that these financial costs were
part of the Claimants’ business decision on how to finance the investment and since the
Chilean breach of the FET standard also related to the Claimants’ decision to invest,
these expenditures were caused by the wrongful conduct of the Respondent. (Para.240)

On this basis the Tribunal estimated that the total investment expenditures amounted to
US$ 21.5 million. (Para.241)


               2. Deduction of the residual value of investment
The Tribunal decided to deduct the residual value of the investment (MTD’s
shareholding in EPSA). The Tribunal estimated this residual value on the basis of an
offer put forward by company partner Mr. Fontaine to buy MTD’s shares in EPSA.
The offer by Mr. Fontaine was $10,069,206. As only part of the offer was in cash, to
estimate the present value of the remainder, the Tribunal used the US dollar two-year
swap rate of 6 May 2004 for a two-year swap effective 21 May 2004 published by
Bloomberg. The cash value on a present value basis was assessed at approx. US$ 9.7
million. (Paras.244, 245)


               3. 50% reduction due to attribution of business risk

As explained above, the Tribunal held that MTD should be bear 50% of damages for
paying a price for the land without appropriate diligence and legal protection. (Para.246)


                                                                                        5
After deducting the residual value of the investment and reducing the remaining amount
by 50%, the Tribunal awarded MTD damages of approx. US$ 5.8 million.


       E. Interest
The Tribunal awarded compound interest based on the London Inter-bank Offered Rate
(LIBOR), running from 5 November 1998 until full payment of the damages awarded.
This date was chosen by the Tribunal as it was the date the violation had in fact
occurred i.e. the date on which the Chilean Minister informed MTD of its decision to
refuse their rezoning application. (Paras.247, 250)

The Tribunal considered that compound interest was “more in accordance with the
reality of financial transactions and a closer approximation to the actual value lost by an
investor.” (para.251, with reference to Santa Elena)


       F. Costs
The Tribunal concluded that neither party had succeeded fully in its allegations and
decided that each party would bear all its own expenses and fees related to this
proceeding and 50 % of the costs of ICSID and the Tribunal. (Para.252)



V. Implications / Initial Analysis

      Rules of public international law are applicable even though this is not a
       dispute between States.

      The investment at issue was a shareholding but, unlike in other cases, the
       Tribunal did not attempt to assess the value of the shareholding at the time
       preceding the breach, but awarded out-of-pocket and related expenses associated
       with the investment project. At the same time, the residual value of the
       investment (deducted from the award) was determined on the basis of the
       amount offered for MTD’s shareholding.

      To qualify for compensation, expenditures have to be made by the Claimant (or
       on its behalf) and relate to the investment.

      It is possible to recover financial costs incurred in relation to the decision on
       how to finance the investment, as long as it is associated with the investment.
       Such costs would include debt servicing, bank guarantee fees and other project-
       related expenses.

      Contributory fault? BITs are not insurance against risk and investors must
       exercise a certain degree of caution or diligence when investing in another
       country. If shown to be reckless in investing, a Tribunal would take this into
       account when awarding damages by reducing the amount of compensation
       proportionately.


                                                                                         6
      The Tribunal awarded compound interest. It justified this on the basis that
       compound interest was more in accordance with the reality of financial
       transactions and a closer approximation to the actual value lost by the investor.
       Does this mean that tribunals are more prone to award compound interest when
       compensating for out-of-pocket expenses, which have more to do with the
       reality of financial transactions (as opposed, e.g. to the value of investment as a
       going concern)?

      Compound interest is frequently awarded by tribunals with justification that it is
       appropriate in expropriation cases. In this case compound interest was awarded
       in a non-expropriation case.




VI. List of Commentaries to the Case
Frug, G and Barron, D., International Local Government Law, The Urban Lawyer, Vol.
38, No. 1 winter 2006, pp 46-50.

Laird, I., Case Comment on the MTD v Chile case, Transnational Dispute Management,
Volume 1, No.4 October 2004.




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VIII. Annexes
Table 1. Issues discussed in the award


Issue                                       Indication
Applicable law                              Chile - Malaysian BIT and Public
                                            International Law
Measure at issue                            Refusal by Chile to rezone land owned by
                                            MTD despite previously approving of the
                                            investment project
Violations found                            Fair and Equitable treatment
Heads of damages
          Loss of capital value of assets Not discussed
          Out-of-pocket expenses          Compensated (eligible expenditure)
          Loss of profits                 Not discussed
          Incidental expenses/costs       Compensated (financial costs related to
                                          investment)
           Loss of customer         base, Not discussed
           goodwill, market
           Loss of opportunity              Not discussed

Causation                                   Chile’s responsibility limited to the
                                            consequences of its own actions. Chile not
                                            held liable for the bad business decisions of
                                            MTD (MTD - contributory fault?)
Standard of compensation                    Chorzow standard
Valuation approaches/criteria               The US dollar two-year swap rate was used
                                            to measure residual value of the investment
                                            i.e. Mr. Fontaine’s offer
Use of accounting standards                 Not discussed
Mitigation of damages                       Possibly. MTD had to bear 50% of
                                            damages which were incurred in part due to
                                            its own bad business decisions (see also
                                            causation)
Burden of proof                             Not discussed
Issues of evidence                          No
Amount of damages                           Exact claimed amount not indicated
                                            US$5.9 million awarded
Interest                                    Compound interest based on the LIBOR on
                                            5 November of each year since the date of
                                            breach (5 November 1998) until payment
Legal costs                                 Each party bears its own legal costs. Other
                                            costs split equally.


Table 2. Relevant quotes from the award


                                                                                            8
Issue                  Quotation from the arbitral award

                       "The BITs are not an insurance against business risk and the
Attribution       of   Tribunal considers that the Claimants should bear the
Damages                consequences of their own actions as experienced businessmen.
                       Their choice of partner, the acceptance of a land valuation based
                       on future assumptions without protecting themselves contractually
                       in case the assumptions would not materialize, including the
                       issuance of the required development permits, are risks that the
                       Claimants took irrespective of Chile’s actions". (Para 178).

                       “[MTD]...made decisions that increased their risks in the
                       transaction and for which they bear responsibility, regardless of
                       the treatment given by Chile to the Claimants. They accepted to
                       pay a price for the land with the Project without appropriate legal
                       protection.” (Para 242)

Eligible               “The Tribunal considers that the Claimants have proven that the
expenditures           expenditures related to the Project were made by them or on their
                       behalf and that they were made for purposes of the investment in
                       Chile.” (para.239)

Financial Costs        "The Tribunal considers the financial costs related to the
                       investment made to be part of a business decision on how to
                       finance the investment. As stated by the tribunal in Middle East
                       Cement and referred to by the parties in their allegations: “They
                       could be claimed, if it were shown that they were caused by
                       conduct of the Respondent which was in breach of the BIT.”
                       (Para. 240).
Interest rate          "This being an international tribunal assessing damages under a
                       bilateral investment treaty in an internationally traded currency
                       related to an international transaction, it would seem in keeping
                       with the nature of the dispute that the applicable rate of interest be
                       the annual LIBOR on November 5 of each year since November
                       5, 1998 until payment of the awarded amount of damages". (Para.
                       250)

                       "The Tribunal considers that compound interest is more in
Compound               accordance with the reality of financial transactions and a closer
interest               approximation to the actual value lost by an investor. As
                       expressed by the tribunal in Santa Elena:

                       “Where an owner of property has at some earlier time lost the value of his asset
                       but has not received the monetary equivalent that then became due to him, the
                       amount of compensation should reflect, at least in part, the additional sum that
                       his money would have earned, had it, and the income generated by it, been
                       reinvested each year at generally prevailing rates of interest.” (Para. 251)




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