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They were two oddly matched men who hoped to make history — and a fortune. Instead, they made new law. In the Soviet era, Vladimir Zelezny was a minor Czech television screenwriter with anticommunist leanings. During the Velvet Revolution, he emerged as the spokesman for Vaclav Havel’s party. He showed up on Ronald Lauder’s doorstep in 1993 with $400 to his name and a penchant for exaggeration. He presented himself as a dissident hero who had broadcast “freedom messages” during the 1968 Communist invasion. But in the recollection of the newscaster who led the resistance at the Czech TV studios, “Zelezny, a young boy with big ears, sort of ran around here with some boxes.” Ronald Lauder was a billionaire perfume heir who yearned to make a name for himself on his own terms. He succeeded at philanthropy — his eponymous foundation does good works in eastern Europe. But he failed at politics, losing the Republican primary for mayor of New York to Rudolph Giuliani in 1989, and earned only a mixed record as a high-risk investor. In 1993 Lauder set out to become a Mitteleuropean media mogul. He put one of his first TV stations in Prague and tapped Zelezny to run it. From the beginning, their station, TV-Nova, dominated the Czech market, using a formula of tabloid news, “Baywatch” reruns and Zelezny’s cult of personality. Its trademark program is a reverse striptease act, a nightly weather forecast featuring a fully naked volunteer, who dresses for the next day’s weather to the accompaniment of seductive music. In 1999, after a complex series of corporate maneuvers, Lauder found himself stripped of his television license. Lauder blamed both Zelezny, who wound up controlling the valuable license, and Czech regulators, whom he accused of aiding Zelezny in his intrigues. Attempts by Lauder to remedy the situation through the Czech courts went nowhere. Convinced that he had been cheated, Lauder resolved to win compensation. His company ran a full-page ad in The New York Times with highlighted text reading, “Czech government woos foreign investors … but then abuses them.” Lauder or his company filed three arbitration actions, one against Zelezny and two against the Czech Republic, each claiming sums in the vicinity of $500 million. Lauder needed all three tries, but he made the last one count. In the first arbitration, Zelezny was found personally liable for $23 million in damages. Lauder’s company filed collection suits in national courts around the world. But in a decision that may be a first for the Southern District of New York, Lauder’s company was able to attach only a Citibank account, belonging to Zelezny, in the amount of 5 cents. The other two arbitrations were brought against the Czech Republic — one in London by Lauder personally and the other in Stockholm by Lauder’s company. Both claimed that the Czechs had violated their bilateral investment treaties. Contradictory decisions came down in September. The Czechs won in London; Lauder won in Stockholm. The Czechs have launched a long-shot challenge to the Stockholm arbitration in the Swedish national courts, and in the second phase of the Stockholm arbitration, they will try to persuade the panel that Lauder’s damages demand is too high. But chances are that after the appellate shouting stops, the Czech Republic will cut a check for about half a billion dollars plus interest. That’s 10 billion nickels. It’s Lauder’s claim against the Czech Republic that makes this episode especially noteworthy. In effect Lauder argues that the Czech government expropriated his property, not by force of arms but with a pencil. Indeed, the Stockholm arbitration panel held that state expropriation takes place when an investor merely loses his property as the result of “covert or incidental … inaction” by the state, even if the state does not benefit. To be precise, the panel held that the Czechs had violated five related requirements of their investment treaty with the U.S.: the obligation of fair and equitable treatment; the obligation not to impair investments by unreasonable or discriminatory measures; the obligation of full security and protection; the obligation to treat foreign investments in conformity with the principles of international law; and the obligation not to deprive the claimant of his investment. The fact that the Czechs did not have a direct relationship with Lauder was not a defense. While trade treaties get all the press, the world’s nations have now signed about 2,000 bilateral investment treaties, mostly in the past decade. Investor protection provisions, such as those the Czechs violated, are standard. These guarantees were first drafted to help, for example, a Western oil company in the event that its joint venture with a Third World state was seized by an unfriendly government. But in the mid-’80s, investors with no state contracts began to invoke the provisions. Investors also claimed state compensation for investment losses resulting from more subtle state action — takings effected by reckless regulators or undisciplined courts. International lawyers now have within reach something domestic lawyers can only dream of: a law of regulatory takings. Jan Paulsson of the Paris office of Freshfields Bruckhaus Deringer spotted the trend in a 1995 article, “Arbitration Without Privity.” He foresaw “an epochal extension of compulsory arbitral jurisdiction over states at the behest of private litigants.” Still, he wrote, at that time it was “too early to tell whether this new field of international arbitration would fundamentally alter practice or remain a marginal feature.” Today, cases like Lauder’s are fundamentally altering practice. Between June 1996 and June 2001, the docket exploded at the International Centre for Settlement of Investment Disputes, with 34 cases filed under investment treaties. (During the 30 years preceding, ICSID heard only 32 cases of any type.) That doesn’t count cases, like Lauder’s, that were heard by other tribunals. Nor does it include some of the most startling investor-state cases of all — those filed under the North American Free Trade Agreement. Although NAFTA is a trilateral trade and investment treaty, its Chapter 11 contains the same investment protections that bilateral investment treaties do. As of last June, 13 major NAFTA cases had been brought by foreign investors. ICSID panels heard some of the cases, while others were convened under rules borrowed from the United Nations Commission on International Trade Law. To the surprise of many, the investment provisions are being used against rich nations, with five cases filed against Canada and four against the United States. Early arbitral opinions have been friendly to investors, leading Canada and Mexico to each settle a case for more than $15 million. Next up is the first decision on the merits in a case filed against the U.S. With NAFTA as the centerpiece, investment treaty arbitration has been the subject of three major conferences in the past 18 months. David Rivkin of Debevoise & Plimpton, chair of the International Bar Association’s arbitration committee, calls it the fastest-growing segment of the field, representing up to 20 percent of his firm’s international practice. Today’s arbitration hot spots, he notes, are yesterday’s investment hot spots. That means telecom (think Lauder) and Latin America (think NAFTA). With such high stakes, fees have been high. Lawyers close to the Lauder case estimate that billings now exceed $10 million and the appeals are still running. In an article published in the IBA arbitration committee newsletter in June 2001, Barton Legum, who heads the U.S. State Department office that defends against investor-state claims, wrote that these claims are inherently radical. States that sue other states are inhibited by the knowledge that a nasty new precedent can bite back at them. Private parties are free to test the outer limits of international law. Lawyers for states, like Jeremy Carver and Audley Sheppard of Clifford Chance, who represent the Czechs, find the trend alarming. As Carver put it: “Investment treaties are not insurance policies that can be called in whenever an investor loses money.” That wishful statement was made during the halcyon 10 days between the London Lauder award, which Carver won, and the Stockholm Lauder award, which he lost. After Stockholm, Carver and Sheppard say, it’s hard to know how to advise their state clients regarding investment treaty liability. Sheppard calls the Stockholm Lauder decision the “high-water mark of state responsibility under investment treaties.” Lauder’s Prague Spring began in April 1993, when a company he controlled, ultimately called Central European Media Enterprises (CME), launched a Czech TV station. CME invested $10 million. To appease nationalist sentiment, CME set up a shell corporation, CNTS, to operate the station. At the same time, a locally owned firm, CET-21, was created to hold the license, on the understanding that it would give CNTS exclusive rights to the license. Lauder agreed that Zelezny would run both the operating shell (CNTS) and the license holder (CET-21). He was also given an ownership interest in CNTS. The Czech Media Council granted the license and approved the structure. Thanks to Zelezny’s gifts as a showman, TV-Nova was a hit. In some time slots, it attracted 70 percent of the audience. Eventually it generated $30 million a year in operating profits, and claimed a value of half a billion dollars. In July 1996 the media council brought regulatory proceedings against Lauder’s operating company for “broadcasting without authorization.” Under pressure from the media council — an arm of the Czech government — CNTS and CET-21 weakened their contract. Going forward, CET-21 would contribute only know-how; there was no mention of exclusive rights to use the broadcast license. The media council soon dropped its proceedings. No other immediate consequence followed, and Zelezny continued to run both companies. Still, Lauder’s position was precarious. In August 1997 Zelezny persuaded CME to buy his 6 percent share of CNTS for $23 million. Zelezny’s and Lauder’s interests began to diverge. But Lauder tried to protect himself by providing in the buyout agreement that if Zelezny ever competed with CNTS, the sale would be reversed. On March 3, 1999, Zelezny asked the media council to declare that the relationship between the license holder and the operating company must be nonexclusive. On March 15, the media council issued a letter taking that position, using almost the same words that Zelezny had used. Believing that he was under attack, Lauder fired Zelezny from CNTS, the operating shell. On Aug. 4, Zelezny, who still ran CET-21 (the license holder), asked CNTS to share some technical data, known as the daily work log. CNTS refused. The next day, CET-21 terminated its contract with CNTS and proceeded to transfer the TV-Nova signal to a new operating company controlled by Zelezny. Just like that, Lauder’s investment was worthless. To fight back, the Lauder interests retained John Kiernan and Mark Friedman of Debevoise & Plimpton. The attorneys filed for three arbitrations. The first ended in a partial win in February 2001. The award enforced Zelezny’s noncompete agreement and ordered a reversal of the $23 million sale. The arbitration panel sat in Amsterdam, and Zelezny was represented by the local office of Freshfields Bruckhaus Deringer. Over the next two months, Debevoise argued two broader investment treaty claims against the Czech Republic, represented in both cases by Clifford Chance. Lauder sought to consolidate the two cases in London, but the Czechs rejected that bid. Their reason? Two different bilateral treaties were at stake. Lauder had filed both as an American (in London) and on behalf of his Dutch-incorporated company (in Stockholm). The Czechs won their point, rejecting consolidation, but lost the war. The London panel included Bohuslav Klein (named by the Czechs) and American elder statesman Lloyd Cutler (named by Debevoise). The panel was chaired by Robert Briner of Switzerland, who also chairs the International Chamber of Commerce Court of Arbitration. The Stockholm panel consisted of Jaroslav Handl of the Czech Republic and Stephen Schwebel, who had retired in 2000 as president of the World Court in The Hague. The panel was chaired by Wolfgang Kuhn of Germany, who has also served as chair of the IBA arbitration committee. In their September awards, the London panel and the majority of the Stockholm panel read the facts of the case very differently. In the view of the London panel, Lauder had his eyes wide open when he set up a risky corporate structure. The positions taken by the broadcast regulators, while sometimes questionable, were not consequential, and none constituted “a measure or action” that was tantamount to expropriation under the investment treaty. In this view, there was only one legal cause for CET-21′s termination of its contract with CNTS on Aug. 5, 1999: namely, CNTS’s refusal to share broadcasting data the day before. Schwebel and Kuhn, who formed the majority in Stockholm, perceived a longer-term plan at work. They derided the “nondelivery of the daily work log for one(!) day” as a pretext for terminating the agreement — punctuating their opinion with indignation. Clearly, they wrote, Zelezny was looking to attack, and CNTS was vulnerable because the agency had undermined the licensing deal that was the basis for Lauder’s investment. Indeed, the Stockholm majority recounted the facts in conspiratorial terms: “The media council was obviously working hand-in-hand with Dr. Zelezny. … [It] actively support[ed] Dr. Zelezny, who clearly and openly violated his duties as CEO of CNTS. This unconcealed violation … must be assessed as a serious criminal offense in any functioning judicial system.” Not only did the Czech courts wink at Zelezny’s malfeasance, they “permitted a $500 million … investment to be destroyed by the purported nondelivery of a one-day day-log under [a weak contract which was] imposed on the investor by the media council.” The dissenting Czech arbitrator in Stockholm, Handl, seemed to take all of this Czech-bashing personally. Handl wrote of his colleagues, Kuhn and Schwebel: “The basis of their decision was, and this was their only target, to condemn the Czech Republic.” Later he added that the two arbitrators “tried to create around the tribunal a nimbus of superiority [over] any state body of the Czech Republic.” With all the opinions’ contradictions and complexities, it’s easy to lose sight of what went on in Prague. Jan Culik, a Czech media studies professor at the University of Glasgow, frames the issue with refreshing simplicity. Clearly, he says, the regulators sided with Zelezny. The mystery is “to what extent it was incompetence and to what extent it was corruption.” Lauder’s spokesmen hint at corruption, or at least improper influence. They stress that Zelezny wields the power of public opinion. Besides running the most popular television station, Zelezny is an on-air performer, with a popular weekly call-in show that he uses to support friendly public figures. None of this, in the view of Team Lauder, was lost on the Czech regulators. The Clifford Chance lawyers see the media council differently. In their view, council members were “intellectuals” who were disappointed in TV-Nova. They thought they were going to get “the best of the BBC” on their airwaves. Instead, they were fed a diet of Murdoch-style entertainment. The regulators, Sheppard says, “tried to regulate TV-Nova — perhaps rather ineptly.” In December, the Czechs appealed the Stockholm decision in the Swedish national courts. They see two main points of vulnerability. One is the quarrel between the majority dissenting arbitrators. Carver says that evidence of “straightforward bigotry” should undermine the judgment. The second is the inconsistency in the rulings between the London and Stockholm panels. “You should not be able to treaty-shop,” Carver says. In defense, Debevoise’s Kiernan says that the Stockholm majority was above reproach. “You don’t go after the integrity of guys like that,” he says. “It’s simply wrong to question their character.” CME’s chief executive, Fred Klinkhammer, says that if Lauder got two bites at the apple, that was the Czechs’ choice, since it was the Czechs who declined the chance to consolidate. From a policy standpoint, Carver says, Lauder’s case shows the need for a worldwide investment treaty. Such a treaty has been advocated by the Organization for Economic Cooperation and Development, but its development stalled in 1998 in the face of pressure from anti-globalization activists. Beyond the Swedish court challenge, Lauder faces a damages hearing and the challenges of collection. He still has not received about a million dollars in fees, which were due in September. Then there is the matter of the $23 million owed by Zelezny personally, and there the plot thickens, again. In addition to the usual ways of hiding assets, Kiernan says, Zelezny found an ingenious way to dodge collection of the award. Zelezny asserts that, soon after selling his CNTS shares to CME for $23 million, he signed a contract with the Astrona Foundation of Liechtenstein. He supposedly sold to Astrona the rights to his CNTS shares in the event that they were ever returned, based on the premise that those shares would still be valuable. However, when the CNTS shares were returned they were worthless. By this logic, Zelezny argues, he owes Astrona $23 million. In effect, he found a third-party claim against himself in the same amount as the award against him in favor of Lauder. Team Lauder was incredulous. “You think the day after you sell a share, you sign a contingent agreement to sell that same share?” asks Kiernan. Lauder’s lawyers complained to Czech prosecutors. In April 2001 they charged Zelezny and his personal attorney, Ales Rozehnal, with criminal fraud. In November both were detained for questioning. Rozehnal remains in custody. Zelezny was released, and a few days later, in a public show of support, received an audience with Vaclav Klaus, the Czech opposition leader who will stand for election as premier in June. Soon afterward, Klaus was reprimanded for meeting with Zelezny by President Vaclav Havel and the chief justice of the Czech Supreme Court. (A lawyer for Zelezny said he disagreed with this article’s characterization of the relationship among CME, CNTS, and CET-21 but declined to elaborate.) Zelezny may or may not pay a price for his actions, civil or criminal. But Lauder is determined that the Czech Republic will pay for them. “To me it’s simple,” says Debevoise’s Kiernan. “You signed the treaty, you pay. But if they want to go through the four stages of grief, so be it.” To listen to Lauder’s people, the Czechs may face more serious grief if they fail to honor the judgment. The Czech Republic has applied for membership in the European Union, but, insists CME’s chief Klinkhammer, “no sovereign state that refuses to honor its treaties is going to be admitted to the EU.” So, what started as a plan between two private citizens to brighten the gray screens of Czech television now threatens the geopolitical map of Europe. Jan Paulsson, you were right.

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