Whose money is it and should it matter? An essay on the Cost of Capital in International Arbitration
Published 18 April 2014
Mick Smith and Romans Vikis - contribution to 10th Anniversary Issue of TDM
This paper develops some of the themes from the author’s Guest Series on Third Party Funding on OGEMID. During that discussion, particularly on the use cost of capital in quantification of damages, it became clear that many of the concerns that legal practitioners exhibit about Third Party Funding stem from misconceptions about how to apply the cost of capital in general.
During the OGEMID exchanges the discussants appeared familiar with the concept of the cost of capital, but for present purposes we adopt the following as a definition: the cost of capital is the expected annualized return that an investor hopes to receive from an investment. It is not a guaranteed return; simply that which the investor hopes to achieve.
We believe that when the principle of full reparation is used to guide the award of compensation in investment treaty arbitration, the tribunal must think about the capital supplied from the moment of investment to the time of award. This necessitates considering pre-award interest in tandem with damages using a common approach to the cost of capital.
What was more uncertain during the OGEMID discussion was current legal thinking on how the cost of capital concept is or should be used. In particular, discussants seemed to (i) mix cost of capital measures particular to the claimant, with those applicable to the respondent, without any clear legal principle as to which rate is apposite. There also appeared to be little consensus on (ii) what is the correct time at which to measure the cost of capital. Similarly, there was disagreement as to (iii) what is the correct asset value to which the cost of capital should be applied. And lastly, little or no consensus as to (iv) whether the damages measure should attempt to wind the clock back from the date of award, or to assess value as at the current day. We examine the construction of the cost of capital below in section 2.1 and its application to these areas of uncertainty.
In truth, the cost of capital is crucial not just for the calculation of damages, but also and equally importantly, we will argue in this article that an appreciation of the relevant cost of capital at the key time is intimately bound with the core issue of causation, and provides arbitrators with a vital commercial marker when assessing liability on the facts. This is most easily seen in the context of creeping expropriation claims, and where the value of the relevant assets has been impacted by exogenous events such as the Global Financial Crisis of 2008-9.
To summarise, the central aim of this paper is to simplify some of the legal principles on which to assess damages, and in particular to remove the arbitrariness that seems to exist when choosing between historic investment costs and fair market value as the correct measure of damages.
M. Smith; R. Vikis; "Whose money is it and should it matter? An essay on the Cost of Capital in International Arbitration" TDM 4 (2013)