Gramercy v Peru:¹  Vintage Sovereign Land Bonds Protected by a New-Generation International Investment Agreement

I. INTRODUCTION

Land reform programmes may lead to complex and sensitive investment disputes.³ A unique characteristic of Gramercy v Peru to be discussed in this case comment is that the dispute can be traced back to compensation paid to landowners subject to such a land reform. Issues became complicated by the fact that the compensation was made by the issuance of bond instruments, a form of assets which are tradable by nature and can therefore be purchased and owned by investors who have little or no engagement with the original land reform programme.

In an award dated 6 December 2022, the majority of the Tribunal in Gramercy v Peru found that Peru had breached its obligations towards investors under the United States–Peru Trade Promotion Agreement (TPA),⁴ on the ground that it imposed an arbitrary method for the revaluation and payment of the sovereign bonds held by Gramercy, a Delaware-registered hedge fund and its Peruvian subsidiary. Yet, a dissenting arbitrator opined that the Tribunal had no jurisdiction to entertain the dispute at hand on the ground that the Claimants’ bondholding did not constitute an investment protected under the TPA or that the Claimants committed an abuse of process.

The Award is notable as it upheld that the sovereign bonds, which were originally issued as compensation for local land expropriations but were subsequently purchased and held by foreign investors, constituted a protected investment. The majority of the Tribunal so determined by interpreting—presumably for the first time—the ‘new-generation’ TPA that contains an annex titled ‘Public Debt’, providing a detailed but nuanced definition of investment protected under the TPA. As such, the Award prompts observers to draw comparisons with previous sovereign bond cases in which arbitral tribunals arrived at opposite conclusions.

This case comment primarily focuses on salient jurisdictional and other preliminary issues on which arbitrators held divergent opinions. It commences with a review of the factual background of the dispute (Section II) before addressing whether the sovereign bonds issued by Peru constituted a protected investment (Section III) and whether the Claimants committed an abuse of process (Section IV). It then briefly discusses the Claimants’ main claim on merits (Section V) before offering concluding remarks (Section VI).

II. FACTUAL BACKGROUND

The dispute concerns Gramercy’s holding in Peruvian agrarian land reform bonds (‘Bonos Agrarios’), which were originally issued in the 1970s as a deferred payment to landowners in compensation for the land expropriations implemented by the then military Peruvian government of Juan Velasco Alvarado. Under these bonds, bondholders had the right to claim from the government an annual payment comprising part of the principal—which represented the value of the expropriated land—and the interest accrued, for a period between 20 and 30 years. However, owing to the hyperinflation that Peru experienced during the 1970s and 1980s, the real value of the Bonos Agrarios was gradually reduced to nil, and bondholders stopped claiming the annual payments and simply retained and stored the paper securities.⁵

The Peruvian Congress and government were engaged in discussions regarding the appropriate methodology to update the value of the Bonos Agrarios. In 1996, Congress promulgated the law establishing that any outstanding bonds would be paid according to their face value, which was practically nil because of the hyperinflation. The constitutionality of the law was subsequently challenged and, in 2001, the Peruvian Constitutional Tribunal declared the payment regime under the law unconstitutional partly because it breached a general principle of Peruvian law that protects the value of debt against fluctuations caused by inflation or deflation. However, neither the Constitutional Tribunal nor the general principle provided any further guidance on how the revaluation was to be made.⁶

In 2013, the Constitutional Tribunal issued a decision establishing that the Bonos Agrarios should be revalued by applying a dollarisation methodology, instead of a method based on Peru’s consumer price index (CPI), the application of which the Claimants had expected. Complying with the instruction by the Constitutional Tribunal to arrange the modalities, the Ministry of Economy and Finance (MEF) successively issued three decrees, which contained various formulas for the calculation of the parity exchange rate as amended and as corrected. Notwithstanding, on 19 August 2017, the MEF further issued a fourth decree (DS 242/2017), derogating the three preceding decrees, and introduced a completely new set of formulas which were particularly impugned by the Claimants in their main claim.⁷ No cogent explanation was found in the case file as to the introduction of the new formulas.⁸

In the meantime, between 2006 and 2008, Gramercy Peru Holdings LLC purchased 9656 Bonos Agrarios from their original Peruvian landowners or their heirs with a payment of US$33,222,630. In June 2016, the Claimants commenced arbitration proceedings, arguing that the measures successively adopted by Peru breached the assurances provided in the TPA.⁹

III. SOVEREIGN LAND BONDS AS INVESTMENT

Among the eight jurisdictional objections raised by Peru, the most notable was the contention that the Bonos Agrarios would not constitute a protected investment under the PTA. Peru emphasised that the bonds were issued in unique domestic historical circumstances as compensation for expropriated lands and not as vehicles for international investment or economic development. According to Peru, these features implied that the sovereign bonds at hand did not have the characteristics of an investment.¹⁰

The majority of the Tribunal rejected Peru’s contention and concluded that the Bonos Agrarios constituted a protected investment under the PTA. This finding rested primarily upon the wording of Article 10.28 of the PTA which explicitly recognises in its paragraph (c) that an investment may take the forms of ‘bonds, debentures, other debt instruments, and loans’.¹¹ The Bonos Agrarios fell within the term ‘bonds’, which conveys ‘the idea of a financial operation, where an entity issues, to the bearer or in favor of certain identified individuals, a series of numbered, transferable securities with attached sub-securities (normally known as coupons), which formalize a long-term interest-bearing debt’.¹² The claimed unique historical circumstances in which the land bonds were issued ‘[did] not detract from their character as bonds’.¹³

This reading was reinforced by the contextual interpretation based on Annex 10-F of the TPA titled ‘Public Debt’,¹⁴ which recognises ‘that the purchase of debt issued by a Party entails commercial risk’ but goes further to provide ‘specific rules for the protection of investors who hold public debt, including certain situations where the Republic of Peru has undertaken a general restructuring of its public debt’.¹⁵ The only exception to this rule is provided in footnote 13 of the TPA, according to which ‘[l]oans issued by one Party to another Party are not investments’. In the view of the majority, ‘this exclusion reinforces, a contrario sensu, that loans issued by a State Party (including those formalized in bonds) which are held by private investors of the other State Party, must be considered as protected investments’.¹⁶

The majority of the Tribunal then examined whether the Bonos Agrarios has the intrinsic ‘characteristics of an investment’, one of the ‘quaestiones vexatae’ of investment arbitration. In doing so, the majority identified six characteristics that are typical of an investment under the TPA: commitment of capital or other resources; duration; assumption of risk; expectation of gain or profit; non-commercial character in the sense that debt resulting from financial lending transactions is more likely to be an investment than that resulting from the sale of goods and services; and securitisation in the sense that debt formalised in securities like bonds or notes is more likely to be an investment than debt formalised simply in contract.¹⁷ While the dissenting arbitrator Brigitte Stern described this presentation as ‘quite exotic’,¹⁸ all the characteristics, including relatively uncommon elements such as securitisation, are derived from the text of the TPA itself.¹⁹

While the majority eventually concluded that the Bonos Agrarios met all these six characteristics of investment,²⁰ the elements of commitment and risk deserve further discussion, since Stern failed to see the presence of these elements in the bonds. As far as the commitment of capital is concerned, Stern considered that it shall be made ‘in furtherance to an economic venture’, linked with ‘a process of creation of value’, as distinguished from a process of exchange of value.²¹ This is in line with what the majority of the Tribunal in Poštová banka v Greece—Stern formed part of it—stated as obiter dictum.²² Yet, the majority in the Gramercy Tribunal did not take this approach, because the language of TPA does not require an investor to perform an entrepreneurial or economic activity; what is required instead is that an activity is performed in ‘the expectation of gain or profit’, a concept that is much wider.²³

As to the element of risk, Stern distinguished ‘a risk inherent in the investment operation in its surrounding’ depending on the success or failure of the business operation and ‘risks coming from outside the investment operation’, which do not qualify as investment risks. For Stern, the risk of Gramercy’s bondholding came from the application and modifications of the Peruvian legal framework and not from the economic operation.²⁴ Again, this was also in line with the majority in the Poštová banka Tribunal.²⁵ The majority in the Gramercy Tribunal, for its part, put emphasis on the language of Annex 10-F of the TPA enabling foreign creditors to submit to arbitration the default or non-payment of sovereign debt and obtain compensation in limited circumstances, thereby acknowledging that bondholding, the risk of which is ‘effectively contractual’, still constitutes an investment.²⁶

In sum, both the overall presentation of the characteristics of investment and the application of the respective elements were anchored in the language of the TPA. Counterarguments based on arbitral jurisprudence regarding Article 25 of the ICSID Convention²⁷ might have been relevant but fell short of overriding the tailored and nuanced wording of Article 10.28 and Annex 10-F.

Arbitral jurisprudence consistently emphasises the difference in the language of the applicable treaties in distinguishing the case at hand from the previous findings. The Poštová banka Tribunal deemed the language in the Slovakia–Greece bilateral investment treaty (BIT) to be ‘significantly different’ from that of the Argentina–Italy BIT,²⁸ which had led the tribunals in Abaclat v Argentina and Ambiente Ufficio v Argentina to conclude that Argentine sovereign bonds were covered by the broadly worded terms in the list of investments.²⁹ Among others, the broad term ‘obligaciones’ in the Spanish version or ‘obligazioni’ in the Italian version of the Argentina–Italy BIT, an equivalent term of which was not found in the Slovakia–Greece BIT, was construed as meaning ‘obligations’ or even ‘bonds’.³⁰ In the same vein, the Tribunal in Gramercy v Peru focused on the language of the US–Peru TPA referring explicitly to bonds to distinguish the case at hand from Poštová banka v Greece.³¹ Arriving at an opposite conclusion is of no surprise insofar as it is reached in accordance with the rules of treaty interpretation.

IV. ALLEGED ABUSE OF PROCESS

As a subsidiary contention, Peru argued that the Claimants were committing an abuse of process. According to Peru, Gramercy made its investment not in order to engage in national economic activity, but with the unique goal of transforming a pre-existing domestic dispute into an international dispute subject to investment arbitration.³² The dissenting arbitrator Stern was largely convinced by Peru’s argument.³³

The majority of the Tribunal, recognising in principle that treaty claims may be dismissed on an abuse ground,³⁴ disagreed with all the four grounds invoked by Peru. First, while an investment made with the sole purpose of raising a domestic dispute to the level of an international dispute is abusive—as was the case in Phoenix v Czech Republic presided over by Stern³⁵—Gramercy purchased the Bonos Agrarios because the Peruvian legal system guaranteed that the securities would be fully paid with readjustment for inflation; it was only after impugned measures had been adopted, and when the recourse to local proceedings proved unsatisfactory, that the Claimants decided to initiate arbitration proceedings.³⁶

Second, the subject matter of the present investment dispute was different from the historical dispute regarding the proper valuation of the Bonos Agrarios, which concerned ‘a purely domestic legal issue’ that had been settled by the Constitutional Tribunal in 2001.³⁷ According to the majority:

[w]hat was at issue between the 1980s and 2001, was whether the face value of the Bonos had to be revalued to off-set the devastating effects of hyperinflation; whereas what the Tribunal has to adjudicate here is … whether the [series of Peruvian decrees] are so arbitrary as to constitute an international delinquency of the Peruvian Republic.³⁸

After summarily rejecting Peru’s third argument that it was foreseeable for Gramercy at the time of investment that Peru would implement further measures,³⁹ the majority of the Tribunal finally concluded that an allegedly excessive lobbying and public relations campaign conducted by Gramercy against Peru was not a cause capable of turning otherwise admissible claims into inadmissible claims. The fact of the Claimants’ purchase of additional bonds while the arbitral proceedings were ongoing could not render their claims inadmissible, despite causing bewilderment to Peru.⁴⁰

Arbitral jurisprudence ‘revolving around the concept of foreseeability’⁴¹ has been the object of scholarly criticism because of its subjectivity or of its narrowly confined scope of analysis.⁴² In contrast to this, while being prompted by the Respondent’s contentions, the Tribunal in Gramercy v Peru analysed a wide range of circumstances underpinning the abuse of process arguments, and the element of foreseeability was only one of them. Insofar as the Respondent acknowledged and assumed the relevance of foreseeability in its objection based on abuse of process,⁴³ the Tribunal had no reason to ignore that element before rejecting the Respondent’s objection in its entirety. As such, while being short of articulating an analytical framework in general terms, Gramercy v Peru may provide guidance in future cases in which foreseeability and the other elements could simultaneously be relevant in vindicating or rejecting an abuse of process objection.

V. ARBITRARY MODIFICATION OF THE EXCHANGE RATE

The Claimants’ ‘main claim’ was that revaluation methodologies developed by the MEF constituted arbitrary measures in violation of the minimum standard of treatment of aliens enshrined in Article 10.5 of the TPA. While the Claimants also submitted a number of ‘ancillary claims’, the Tribunal eventually dismissed all these claims and upheld only several aspects of the ‘main claim’, as explained below.

The Tribunal acknowledged that the threshold for proving that State conduct is arbitrary is high but concluded that this threshold was met in the present case, mainly in light of the claims involving DS 242/2017. According to the Tribunal, one of the most surprising elements was that DS 242/2017 completely jettisoned the base period previously utilised by Peru for the calculation of the parity exchange rate. In place of a previously used 63-year base period, stretching from 1950 to 2013, the MEF decided to adopt the base period of one single month, and selected January 1969.⁴⁴ Yet, that January 1969 coincided with the beginning of the Agrarian Reform was not a ‘cogent explanation’, given that the land bonds were issued between 1970 and 1980.⁴⁵ Thus, the real reason to deeply modify the revaluation methodology was to artificially increase the parity exchange rate, so as to reduce the financial burden of debt by the government to bondholders.⁴⁶ Given the calculation of financial experts, the Tribunal estimated that the use of the new exchange rate under DS 242/2017 reduced the amount that Peru owed to Gramercy by US$40.7 million.⁴⁷ The arbitrariness of the revaluation methodology was compounded because the higher parity exchange rate under DS 242/2017 was used only when converting into US$; to convert the US$ amount back to soles, the lower market exchange rate at the date of revaluation was applicable.⁴⁸

Having concluded that Peru had breached Article 10.5 of the TPA by imposing an arbitrary method for the revaluation and payment of the Bonos Agrarios, the Tribunal ordered Peru to pay Gramercy US$33,222,630,⁴⁹ the amount actually paid by the Claimants to purchase the land bonds,⁵⁰ plus interest at a rate of 7.22 per cent per annum which, according to the Tribunal, ‘represents the average real return on debt in Peru and the fair remuneration to which Gramercy is entitled’.⁵¹

The Tribunal’s focus on the lack of any ‘cogent explanation’ by Peru as to the radical change in its calculation methodology⁵² was anchored in the concept of arbitrariness that included the lack of reasons.⁵³ It followed from this construction that, while upholding Peru’s breach of its obligations under the TPA, ‘[i]nvestment arbitration tribunals are not called to adjudicate appeals against measures adopted by States’.⁵⁴ By emphasising that its task of focusing on reason and explanation—or lacking thereof—was something short of a substantive review of measures at hand, the Tribunal paid, albeit implicitly, deference to the Respondent working on the settlement of its debt revaluation dispute. Gramercy v Peru was the first occasion where the merit of an investment dispute involving sovereign bonds was decided against the backdrop of deference or an equivalent framework, an approach that has already become part of investment arbitration practice.⁵⁵

Notwithstanding the upholding of a treaty breach, the Tribunal’s calculation of compensation based on ‘the price actually paid by Claimants when they bought the Bonos’⁵⁶ was far short of the massive amount of damages claimed by the hedge fund with reference to a CPI-linked revaluation method. This is broadly in line with the relevant case law of the European Court of Human Rights involving Greek bondholders, in which the fair market value of bonds in lieu of its nominal values as advanced by the bondholders was considered when it came to the proportionality analysis of the measures in question.⁵⁷ Insofar as the profit gained by the hedge fund was confined to the accrued interest on the fixed amount of compensation,⁵⁸  Gramercy v Peru desisted from transforming investment arbitration into an attractive venue for speculative hedge funds investing in distressed sovereign debt.

VI. CONCLUSION: REOPENING PANDORA’S BOX?

Gramercy v Peru marked the first opportunity to interpret and apply a ‘Public Debt’ annex attached to an international investment agreement—and Peru is among countries that have been actively adopting such an instrument⁵⁹—providing a detailed but nuanced coverage of bonds within the definition of investment. The tailored language of the TPA led the Tribunal to distinguish the case at hand from previous jurisprudence involving sovereign bonds.⁶⁰

The consequences of this ‘reopening’ of Pandora’s box⁶¹ are not necessarily far-fetched: the ordered amount of compensation was the amount actually paid by the Claimants to purchase the bonds, thereby not fuelling an incentive to involve sovereign distressed debt recovery business. Moreover, the Respondent’s financial policy leeway remained intact insofar as no decision was rendered as to the Claimants’ alleged legitimate expectations to use a CPI-linked revaluation method.⁶² What was decisive in upholding the arbitrariness of DS 242/2017 was the lack of any cogent explanation or justification as to the modification of the applicable formulas, demanding the Respondent merely to discharge its argumentative burden. As such, only a modest disciplinary or regulatory effect of investment treaty-based tribunals on States struggling to resolve financial vexation is identified.⁶³

Footnotes

3

See eg Bernhard Friedrich Arnd Rüdiger von Pezold and others v Republic of Zimbabwe, ICSID Case No ARB/10/15, Award (28 July 2015).

4

United States–Peru Trade Promotion Agreement (signed 12 April 2006, entered into force 1 February 2009) (TPA). The Award refers to the TPA as the ‘FTA’ or ‘Treaty’.

5

Gramercy v Peru, Award (n 1) paras 112–22.

6

ibid paras 123–27.

7

See Section V.

8

Gramercy v Peru, Award (n 1) paras 137–42, 703–05, 800–02.

9

ibid paras 115, 135–36, 141.

10

ibid paras 149–50.

11

ibid para 187.

12

ibid paras 188–89.

13

ibid para 197.

14

Paragraph 1 of Annex 10-F of the TPA provides:

The Parties recognize that the purchase of debt issued by a Party entails commercial risk. For greater certainty, no award may be made in favor of a claimant for a claim under Article 10.16.1(a)(i)(A) or Article 10.16.1(b)(i)(A) with respect to default or non-payment of debt issued by a Party unless the claimant meets its burden of proving that such default or non-payment constitutes an uncompensated expropriation for purposes of Article 10.7.1 or a breach of any other obligation under Section A.

15

Gramercy v Peru, Award (n 1) para 209.

16

ibid para 209.

17

ibid paras 216–37.

18

Gramercy Funds Management LLC and Gramercy Peru Holdings LLC v Republic of Peru, ICSID Case No UNCT/18/2, Dissenting Opinion of Professor Brigitte Stern (6 December 2022) para 107.

19

Gramercy v Peru, Award (n 1) para 228, fn 120; the chapeau of Article 10.28 provides:

investment means every asset that an investor owns or controls, directly or indirectly, that has the characteristics of an investment, including such characteristics as the commitment of capital or other resources, the expectation of gain or profit, or the assumption of risk.

Also, footnote 12 of the TPA Investment Chapter explains:

Some forms of debt, such as bonds, debentures, and long-term notes, are more likely to have the characteristics of an investment, while other forms of debt, such as claims to payment that are immediately due and result from the sale of goods or services, are less likely to have such characteristics.

20

Gramercy v Peru, Award (n 1) paras 228, 263.

21

Gramercy v Peru, Dissenting Opinion (n 18) para 91.

22

Poštová banka, AS and Istrokapital SE v Hellenic Republic, ICSID Case No ARB/13/8, Award (9 April 2015) para 361.

23

Gramercy v Peru, Award (n 1) para 225.

24

Gramercy v Peru, Dissenting Opinion (n 18) para 94.

25

Poštová banka v Greece (n 22) paras 367–70.

26

Gramercy v Peru, Award (n 1) paras 231–34.

27

Convention on the Settlement of Investment Disputes between States and Nationals of Other States (opened for signature 18 March 1965, entered into force 14 October 1966) (ICSID Convention).

28

Poštová banka v Greece (n 22) paras 303–04; for a critical analysis of the award, see Kei Nakajima, ‘Parallel Universes of Investment Protection? A Divergent Finding on the Definition of Investment in the ICSID Arbitration on Greek Sovereign Debts’ (2017) 15 LPICT 471, 479–87.

29

Abaclat and others v Argentine Republic, ICSID Case No ARB/07/05, Decision on Jurisdiction and Admissibility (4 August 2011) paras 354–61; Ambiente Ufficio SpA and others v Argentine Republic, ICSID Case No ARB/08/9, Decision on Jurisdiction and Admissibility (8 February 2013) paras 488–95.

30

Poštová banka v Greece (n 22) paras 298–303.

31

Gramercy v Peru, Award (n 1) para 272.

32

ibid paras 280–87.

33

Gramercy v Peru, Dissenting Opinion (n 18) paras 5–69.

34

Gramercy v Peru, Award (n 1) paras 355–57.

35

Phoenix Action, Ltd v Czech Republic, ICSID Case No ARB/06/5, Award (15 April 2009) para 93.

36

Gramercy v Peru, Award (n 1) paras 366–71.

37

ibid paras 383–90.

38

ibid para 393.

39

ibid paras 425–35.

40

ibid para 440.

41

Philip Morris Asia Limited v Commonwealth of Australia, UNCITRAL, PCA Case No 2012-12, Award on Jurisdiction and Admissibility (17 December 2015) para 554.

42

Duncan Watson and Tom Brebner, ‘Nationality Planning and Abuse of Process: A Coherent Framework’ (2018) 33 ICSID Rev—FILJ 302, 318; Yuka Fukunaga, ‘Abuse of Process under International Law and Investment Arbitration’ (2018) 33 ICSID Rev—FILJ 181, 200.

43

Gramercy Funds Management LLC and Gramercy Peru Holdings LLC v Republic of Peru, ICSID Case No UNCT/18/2, Post-Hearing Brief on Jurisdiction of the Republic of Peru (1 July 2020) para 62.

44

Gramercy v Peru, Award (n 1) para 866.

45

ibid para 876.

46

ibid paras 878, 880.

47

ibid para 882.

48

ibid para 893.

49

ibid para 1396(iv).

50

ibid paras 1315–18.

51

ibid para 1324.

52

ibid paras 863, 875, 989.

53

ibid para 832.

54

ibid para 838.

55

Kei Nakajima, The International Law of Sovereign Debt Dispute Settlement (CUP 2022) 52, 239–45.

56

Gramercy v Peru, Award (n 1) paras 1315–16.

57

Mamatas and others v Greece App nos 63066/14, 64297/14 and 66106/14 (ECtHR, 21 July 2016) para 112; see Nakajima (n 55) 249.

58

Gramercy v Peru, Award (n 1) para 1339.

59

Kei Nakajima, ‘An Elusive Safeguard with Loopholes: Sovereign Debt and Its “Negotiated Restructuring” in International Investment Agreements in the Age of Global Financial Crisis’ (2018) 1 TDM 1, 16–17.

60

See Section III.

61

cf Michael Waibel, ‘Opening Pandora’s Box: Sovereign Bonds in International Arbitration’ (2007) 101 AJIL 711, 759; Sebastian Grund, Sovereign Debt Restructuring and the Law: The Holdout Creditor Problem in Argentina and Greece (Routledge 2023) 120–21 (discussing a ‘closing Pandora’s box’).

62

Gramercy v Peru, Award (n 1) para 1216.

63

Nakajima (n 55) 52, 243–45.

Author notes

1

Gramercy Funds Management LLC and Gramercy Peru Holdings LLC v Republic of Peru, ICSID Case No UNCT/18/2, Final Award (6 December 2022) (Prof Juan Fernández-Armesto, President; Mr Stephen L Drymer; Prof Brigitte Stern).

2

Associate Professor of International Law, University of Tokyo, Japan. Email: [email protected].