A Canadian mining company is seeking $77 million from the government of El Salvador in one of the first disputes to be arbitrated under the Dominican Republic and Central America Free Trade Agreement (DR-CAFTA).

Vancouver-based Pacific Rim Mining Corp. was issued exploratory permits to develop the El Dorado mine, which the company estimates will yield about half a billion dollars of high-grade gold. El Salvador, however, never issued the final exploitation permit required to begin extraction activities. Pacific Rim believes the decision was politicallyinfluenced, is not in accordance with El Salvador’s laws and is seeking compensation for the money it claims it lost waiting for the permit to issue.

El Salvador’s Environmental Ministry never ruled on the applications for the El Dorado mine, located in the water-poor Cabañas district, on the grounds that an environmental impact assessment was not up to snuff. According to activist groups, even the exploratory drilling caused local wells to go dry. Concerns about potential contamination from the cyanide-intensive mining process also abound.

The dispute is a tangled web of national politics, high-stakes investment, environmental issues and foreign treaty rights. It features complex procedural and substantive issues, and it could have far-reaching significance for companies that do business in Central America.

Neutral Process

Arbitration provisions are a central feature of DR-CAFTA. The dispute is proceeding before a tribunal at the International Centre for Settlement of Investment Disputes (ICSID), an arm of the World Bank Group founded in 1966 to resolve exactly this sort of investor-host country conflict. 

The body was seldom used until the 1990s, when the North American Free Trade Agreement kicked off a proliferation of multilateral trade agreements. Caseloads grew rapidly in the last decade, says Jeffrey W. Sarles, a partner at Mayer Brown whose practice includes ICSID arbitrations. 

“Until this treaty came into effect, the only real venue that the mining company would have had is the El Salvadoran courts,” he says. “That’s not a very palatable option for a foreign company.” 

In the ICSID system, each party chooses one arbitrator. Those two, in turn, pick the third arbitrator, who serves as the head of the tribunal. Critics contend that the forum is inherently business-friendly, but Sarles, who is not involved in the El Salvador case, says the ICSID arbitration method ensures neutrality and is a positive development for all sides. 

“It’s not only good for foreign investors, like this mining company, but also for the host countries like El Salvador because they’re more likely to attract foreign investment if the investor knows that in the event of a dispute, there’s a neutral tribunal to resolve it,” he says.

Although the tribunal’s decision applies only to the concerned parties and does not set a formal precedent, the case is being closely followed because it may show how ICSID tribunals are inclined to handle some of the thornier aspects of DR-CAFTA, such as the perception of venue-shopping.

Onshore Move

Perhaps the most glaring aspect of the case is the simple fact that Pacific Rim is a Canadian company, and Canada is not a signatory of DR-CAFTA. The company brought the dispute through a U.S. subsidiary, Pac Rim, which was based in the Cayman Islands until relocating to Nevada in 2007. 

The company claims the El Dorado operation was largely financed in the U.S., and that it has strong business ties in Nevada going back more than a decade. A central pillar of El Salvador’s argument, however, is that the move is more than coincidence.

“It definitely gives one the impression of forum-shopping, especially in a case like this, where the Canadian parent would have no other outlet to bring the dispute than the courts in El Salvador,” says Edward T. Hayes, Partner at Leake & Andersson LLP and co-chair of the International Law Practice Group of ALFA International. “That places this arbitration in a very awkward position from the get-go.”

Of course it’s not unusual for companies to structure investments through foreign subsidiaries to take advantage of treaties, but if nationality is expressly transferred on a deal-by-deal basis, it essentially undermines the very concept of international trade negotiation.

“One of the goals of free-trade agreements is to diminish barriers to having a business presence in another country,” Hayes says. “But generally speaking, you must have some type of substantial business activity in the country to pass the smell test. You have to draw the line somewhere, or you’re talking about gaming the system. It’s going to be very interesting to see how the panel deals with this issue.”

Measure for Measure

Another knotty issue the tribunal faces is the question of whether denial of the exploitation permit constitutes a governmental measure. (A measure in this context is a policy or action, such as tariff, intended to protect national trade interests.) 

“The treaty says that in order for there to be a claim, it has to be with respect to a governmental measure,” Sarles says. “So is the failure to issue something a measure or not? Usually a measure is an affirmative act that violates a provision of the treaty because it’s not fair and equitable or it expropriates property.” 

Central to that issue is the question of how much risk—in this case, environmental risk—the sovereign is entitled to accept or reject in such investments, and whether it is using that risk as a smokescreen for trade protection.

“If I were one of the arbitrators, one of the things I’d ask is whether this is really a disguised or arbitrary limitation on trade, or a legitimate environmental concern,” Hayes says. 

In the absence of global environmental standards for gold mining, that question will likely be fiercely contested—and it won’t be resolved any time soon. The case is expected to be an especially long one. Initially filed in 2009, the dispute is currently awaiting decisions on a round of preliminary hearings. It will then proceed to the merits, which could take another two to three years.