Nobody expects the Spanish arbitration

Jay Newman was a senior portfolio manager at Elliott Management and is author of the finance thriller Undermoney. Richard Carty was managing director of Morgan Stanley Principal Strategies and CEO of Bonanza Creek Energy.

No one blinks when Argentina, Venezuela, and India default on debts or refuse to honor arbitration awards. The shocker is that Spain — egged on by the European Union itself — has become an incorrigible deadbeat.

Spain is second only to Venezuela in the number of defaults on arbitration awards. Foreign investors now need to re-think whether Spain, and the European Union more broadly, are safe places to invest. If nothing changes, Ursula von der Leyen’s recent promise to fast-track EU funding for the energy transition may come a cropper.

This story, like many, begins with good intentions. In 1994, 50 countries ratified the Energy Charter Treaty, a multilateral framework to promote open, competitive markets for energy. The scheme was intended to incentivise private investment in renewable energy infrastructure – wind farms, hydroelectric, solar, pipelines, electricity grids, geothermal, and biomass. In 2008, Spain began offering feed-in tariff incentives to encourage investment. Investors pumped billions into the Spanish economy. What could be cozier than investing in a developed country on attractive returns: doing well by doing good?

The honeymoon was short-lived. In 2012, Spain reneged on its promises to investors, unilaterally cutting promised rates, bankrupting state-of-the-art photovoltaic, solar and wind power projects that had been entered into in good faith.

With no alternative, investors invoked the arbitration provisions of the ECT. Fifty-one arbitration cases have been brought against the Spain, most before the World Bank’s International Centre for Settlement of Investment Disputes. Total damage claims amount to roughly €8bn. Spain has successfully defended some cases and lost most: as of mid-2022, 27 have been resolved; Spain won six; final awards having been granted in 21.

Just this week a UK court threw out a bid by the European Commission to intervene in a legal battle between Spain and two investors in a solar project. The World Bank’s arbitration tribunal had awarded the pair €101mn, which Spain wants to set aside and the commission says may constitute illegal state aid.

One of the dark underbellies of international investing is that arbitration is a false promise. Touted as the efficient, less-expensive alternative to conventional lawsuits, arbitration has become its own morass: cases are notoriously time-consuming, and complicated to bring to resolution. With arcane rules and traps for the unwary, most investors have discovered that the process is brutally expensive. Cases drag on for years, and are subject to appeal and applications for annulment.

Worse, if a sovereign debtor digs in its heels, a creditor faces legal actions in multiple jurisdictions. Enforcement against a determined sovereign can double costs and time.

It’s almost unheard of for developed countries to refuse to honor ICSID awards, which makes Spain’s stance more remarkable. Arbitration can be a rough game, and that’s how Spain plays it.

More surprising is Spain’s willingness to push the process to such extreme lengths that the entire arbitration framework could crumble. Its intransigence has added several novel gambits to the deadbeats’ playbook:

• My-Ball-My-Rules: Just to make a rhetorical point, Spain has withdrawn from the ECT and urges all members of the European Union to do the same. No matter that a 20-year tail of contractual commitments will keep wagging. Spain, of course, isn’t alone in finding Bi-lateral Investment Treaties inconvenient: since 2016, India has withdrawn from 76. Good luck convincing potential investors that the absence of treaty protections makes Spain, or India, more attractive destinations for investment.

• Daddy-He-Hit-Me: For investors, the most far-reaching gambit has been Spain’s request that the Court of Justice of the European Union erect a legal shield. Ever obliging, the CJEU has determined that the enforcement of arbitration awards intra-EU is inconsistent with “the preservation of the autonomy and specific character of EU law.” No lesser authority than the Advocate General, Maciej Szpunar, opines that contractual rights to money arising out of purely commercial transactions don’t consitute investments. Translation: at a minimum, investors from EU states can be prevented from enforcing awards against other member states. All of which makes the prospects for enforcement of arbitration awards — by anyone — against EU member states completely unclear. To get the message out, the European Commission has published a handbook laying out the best ways for states to frustrate the enforcement of awards.

• Stop-the-World-Spinning: Spain has asked Luxembourg courts for a worldwide injunction prohibiting enforcement of arbitral awards. It claims extraordinary relief is warranted by the claimants “abuse of law.” Ironically, enforcement of arbitration awards is governed by international treaties signed by scores of nations, including Spain and Luxembourg. Those create a uniform framework for enforcement. In effect, Spain asks not only that Luxembourg courts cast aside a well-established framework, but that they order courts in other countries to violate their own treaty obligations. 

Sovereign investing is perilous, Mostly, misbehavior is self-limited: feckless sovereigns generally hurt only themselves. Argentina’s repeated defaults have made it unbankable. India’s abuse of international investors could scare away foreign entrepreneurs for a generation.

The conflagration that Spain has ignited threatens something quite different. Spain’s withdrawal from treaties is a sovereign prerogative: no one should care except Spaniards. What matters more is the perception that the European Union and its Court of Justice have become fundamentally hostile to investors — evincing a willingness to relieve member states of their obligations to pay completely forseeable damages caused by their own actions.

In reality, actions by the EU and the CJEU hurt their own credibility, but don’t end Spain’s pain. Arbitration awards don’t evaporate. Holders will seek enforcement outside the EU. Foreign courts will pass their own judgments on the legitimacy of the CJEU itself. That kind of a legal mischief takes a decade of expensive court battles to sort.

Meanwhile, Spain will suffer. Messy and intrusive litigation will follow as creditors seize assets and obstruct access to capital markets. Spain’s creditworthiness will be downgraded and challenge any notion of Spain as a reliable destination for investment — echoing an historical pattern of confiscation that harkens back to Charles III.

Most surprising: Spain’s liability amounts to less than a quarter of a percent of its GDP.

A better approach would be for the European Union to rethink its defence of the oppressive exercise of sovereign prerogatives–and for Spain to accept responsibility and find a commercial solution. Stranger things have happened.