A new ruling by an arbitration panel at the World Bank has given a fresh twist to a long-running debate about the best way for international arbitrators to confront the scourge of corruption.

Each year, the World Bank's International Centre for Investment Disputes (ICSID) sees dozens of new arbitration lawsuits filed by foreign investors against their host countries. These cases typically involve allegations that the host country has expropriated an investment, or that domestic regulators trampled upon contractual commitments.

In recent years, governments have begun to turn the tables on foreign investors, attempting to derail investor arbitration claims by showing that the investors had themselves engaged in wrongdoing: by paying bribes to obtain or sustain their investments.

In a number of arbitration cases, arbitrators have dismissed hundred-million-dollar lawsuits against states because the investors were – on closer scrutiny – discovered to have unclean hands.

Righting a wrong 

Many have cheered this tough anti-corruption posture on the part of arbitrators. However, one awkward consequence has been that countries get to walk away from lawsuits completely unscathed – even if they've behaved appallingly towards the relevant investors.

Somewhat oddly, countries such as Uzbekistan and Kenya, which perform dismally in global surveys of 'corruption perception' and good governance, have been able to duck liability for mistreatment of foreign investors. At the same time, much better governed countries such as Canada have been held liable for harming foreign investors.

In countries where bribery is endemic, it appears that those governments can readily unearth evidence of 'wrong-doing', and then use it against investors who try to sue the government for breach of contract or expropriation. There has been growing grumbling in the legal world about the irony of some countries seeming to benefit from their own widescale corruption.

The pushback begins 

Recently, a tribunal at the Washington-based ICSID tried to push back against this irony. The arbitrators were hearing a case brought by Indian investors in Uzbekistan's textiles sector. The investor, the Spentex group, alleged that local authorities had failed to keep various promises, including in relation to preferential tax rates, and that the project went into liquidation as a result. Accusing Uzbekistan of breaching legal commitments, the investors sought more than $130m in compensation.

However, as the arbitration process unfolded, Uzbekistan unearthed evidence that the investors had paid many millions of dollars to 'consultants' on the eve of a crucial public tender. The arbitrators noted that these consulting arrangements had been hidden by the claimant, and that very little work appeared to have been done in return for the vast payments. Ultimately, the tribunal was persuaded that the investment had been obtained through corruption, and thus the investor's lawsuit should be dismissed.

In an earlier era, this would have been the end of the story. But two of the three arbitrators stressed that it takes 'two to tango', and they argued that Uzbekistan should not be permitted to walk away scot free since its officials appeared to have benefited from the bribery in this case. Thus, the two arbitrators – with the third tribunal member dissenting – found a novel way to put pressure on the country to make an $8m donation to a UN anti-corruption project.

Strictly speaking, arbitrators in these cases lack the power to 'punish' governments, or to pressure them to perform such 'good deeds'. So, the arbitrators had to get creative. They realised that they enjoyed some discretion to decide which party should cover the legal bills of the arbitration process – which can run into the tens of millions of dollars in large arbitrations. In this case, the arbitrators warned that they would make Uzbekistan reimburse the investor for most of its $17m legal bills, unless the government agreed to pay a lesser sum ($8m) to support the UN's anti-corruption work. Using this spectre of an adverse costs ruling, the arbitrators were able to pressure Uzbekistan into paying this lesser sum to the UN.

Greater discretion 

Of greater interest, the arbitrators' ruling also laid out a blueprint for international trade negotiators to craft future treaties that would give arbitrators even greater discretion to sanction governments for their own complicity in corrupt FDI ventures. In particular, the arbitrators proposed that new treaties applicable to FDI should be drafted so that future arbitrators could dictate that the entire compensation sought in a case – in the Uzbekistan case, this amounted to $130m – could be passed on to the UN or other global corruption fighters.

In other words, if a host country was found to have mistreated a foreign investor, but the investor was itself guilty of corruption, then the amounts at issue would go to neither party in the arbitration, but would be directed instead to worthy third parties.

This is a radical solution, which may or may not be adopted in future international treaties. However, the arbitrators clearly directed their minds to finding a more equitable solution to the increasing problem of host countries using their own endemic corruption as a get-out-of-jail-free card when confronted with foreign investor lawsuits.

Luke Eric Peterson is the publisher of InvestmentArbitrationReporter.com, an online news and analysis service focused on investor-state arbitration cases.