Lone Star: Investor-State Dispute Settlement and Korea’s (First) Experience (Part 1)

I apologize first and foremost for not writing during the past several weeks.

There was a family vacation. Then there were some deadlines for work. Last, but not least, I am running out of interesting topics to write.

That said, I still have a topic in my pocket that is not going to bore anyone. Its called an investor-state dispute settlement (“ISD”). Whereas dispute settlement in trade has been developed over a century, first through domestic antidumping laws as early as in 1904 (by Canada, interestingly!), dispute settlement between investors and the host states have only seriously begun in the late 90s. Canada has been at the front and centre of many of ISDs, as proliferation of ISD began under the investment chapter of NAFTA (Chapter 11). On the other hand, Korea has zero ISD experience to this date, win or lose. That said, having signed FTAs with the US and the EU, and engaged in a number of comprehensive economic partnership agreements with a number of countries, including Canada, ISD is becoming ever more relevant in Korea’ future foreign relationship.

In fact, Korea is now facing the first ISD claim, by no other than Lone Star.

As many of you know, “Lone Star” has become the “L” word in Korea. It became a name that represents everything that is wrong with capitalist society. For conspiracy theorists, Lone Star represents imperialistic exploitation by the western societies.

What, or rather who, is Lone Star?

The story goes back to the “Asian Financial Crisis” of late 1990s (before the 2008 financial recession and the dot com bubble). As many of you already know, it was a financial crisis in the earthquake magnitude of 9.5 that swept all over Asia from Korea to Thailand. In Korea, the crisis was led by hugely indebted national champions, such as Hanbo, Kia, Daewoo, and even Hyundai and Samsung. When these companies began to show the signs of failure, and when the government’s ability to assist these companies looked challenging to the business community, there was a sudden loss of confidence and exodus of capital.

The crisis then spread quickly through the financial industry, as almost all of Korean financial institutions were intrinsically connected to the victims, the large, national champion corporations. All said and done, a crisis that started in a corner of an industry has turned into a national economic tsunami, which by 1998 was on course to engulf entire financial industry.

In a sense, the situation was analogous to a snow ball falling down in mountains. As companies’ performance worsened, banks that provided capital to these companies started suffer from non-performing loans, or NPLs. Since these banks were suffering, they tightened their purse. In turn, the tightened capital market further aggravated performance of the companies, which then in turn hurt the banks even more.

Korean Exchange Bank, or KEB, was a bank that was in the eye of this storm. As with many other Korean banks at the time, it was being hit by NPLs left and right. To let it sink was not an option, as it would, as described, only accelerate the downward cycle.

There was a viable option though – fresh investments from outside. It was hoped that the foreign investors would recognize the fundamental potentials of Korean economy. The population was highly educated and skilled; productivity was high; Korean government was implementing appropriate reform measures (which in retrospect has proven to be one of the most successful reform measures in the history of modern economy); and so on.

So here comes the superman to save the day for KEB: Lone Star. In September 2003, Lone Star invested and effectively bought 51% control of KEB. It appeared, at the time, that another disaster was prevented.

However, Lone Star was and has always been a private equity (“PE”), not a bank. It is not in the business of banking. Its business is to buy distressed companies like KEB at a low price and to sell them when the price is high. Those who are in finance industry would tell you that PE is a job that requires skill, experience, knowledge, and most importantly, gut for high-risk. On the other hand, campus activist types would tell you that it’s simply a scalping, except that you do it on a mega-scale.

Whichever stance you take, the fact is that Lone Star bought KEB in 2003 and has since tried to realize on its investment by selling it as early as in January of 2006, barely 2 years after the purchase. But its attempt was unsuccessful, as the government did not approve on the sale. The failed attempts repeated a number of times during 2006 to 2012. It is largely on the basis of these failed sales on which Lone Star alleges that the Korea government breached the obligations under the investment treaty.

In the next blog, I will describe the company’s characterization of the events during 2003 to 2012 and share my thoughts of these events with respect to the investment treaty at issue.

Categories: 2013

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