Honduras Threatens ICSID Withdrawal Over $11 Billion ‘Neo-Colonial’ Special Economic Zone Claim

Honduras is facing the possibility of withdrawing from the World Bank’s International Centre for Settlement of Investment Disputes (ICSID) due to an $11 billion claim made by Honduras Prospera, a US-based company. The company argues that ICSID has breached “law and procedure” in its handling of the case.

In 2022, the Honduran government repealed a 2013 law that had allowed the US company to establish a charter city in a special economic zone (SEZ) in 2021. The $11 billion claim for damages by Prospera amounts to roughly two-thirds of Honduras’s annual budget. The company has been described as “neo-medieval and neo-colonial” by The Atlantic, while Bloomberg has referred to it as “a mini startup nation with its own set of laws.”

This case highlights significant issues with both SEZs and investor-state dispute settlement (ISDS) arbitration panels like ICSID. The situation raises critical questions about national sovereignty and effective democratic oversight over economic governance in the Global South.

Honduras Pushes Back Against SEZs

Honduras has been promoting its Special Economic Zones (SEZs) as a means to stimulate investment and improve economic governance. However, the establishment of these zones has been met with resistance from various stakeholders, who fear the zones could undermine national sovereignty and democratic oversight.

One of the most controversial SEZs in Honduras is Prospera, which was established in 2021 and has been described as a “crypto-libertarian paradise.” The model Prospera followed was based on former World Bank Chief Economist Paul Romer’s idea that foreign-run ‘charter cities’ could help poor countries grow rich. However, Prospera’s neighbors in Honduras have expressed concerns that the zone could expropriate their land and expand beyond its current borders.

The Honduran SEZ law that permitted the establishment of Prospera was initially ruled unconstitutional by the Supreme Court in 2012. However, the law was later reversed after several Supreme Court Justices were replaced and the constitution changed. This has led to accusations that the government is undermining national sovereignty by allowing foreign corporations to operate under their own civil code and administration.

Critics of SEZs argue that they are incompatible with democratic oversight and policy space, and that they often prioritize the interests of corporations over those of workers, consumers, and small businesses. Furthermore, there is little evidence that SEZs are capable of supercharging national economies, with studies showing that they only provide an initial growth spurt before reverting to the growth rate of the rest of the economy.

The establishment of SEZs in Honduras has also raised concerns about the country becoming a tax haven and the potential for large corporations to exploit the policy asymmetries created by these zones. This has led to calls for the repeal of the 2013 law that allowed for the establishment of SEZs and for greater democratic oversight of foreign investment in the country.

In conclusion, while SEZs may offer some benefits in terms of stimulating investment, their potential negative impact on national sovereignty and democratic oversight cannot be ignored. As such, it is important for Honduras to carefully consider the long-term implications of these zones and to ensure that they are compatible with the country’s constitution and economic development goals.

ISDS: Pervasive, difficult to escape and of no discernible benefit

Despite the increasing prevalence of investor-state dispute settlement (ISDS) clauses in trade and investment agreements, there is little evidence to suggest that such agreements actually stimulate investment or provide any benefits to host countries. In fact, a 2018 study by the Columbia on Sustainable Investment (CCSI) found that the expected benefits of such agreements have not materialized, while the costs have been unexpectedly high. Similarly, a 2020 meta-analysis by researchers Jozef Brada et al concluded that the effect of international investment agreements is so small as to be considered zero.

Moreover, civil society has long criticized the International Centre for Settlement of Investment Disputes (ICSID), which administers ISDS cases, as “seriously flawed” with a perceived bias against states. UN special rapporteurs have also been highly critical of ISDS clauses, arguing that they constrain the policy space available to states to act in the interests of their people.

Despite these criticisms, ISDS clauses remain pervasive and difficult to escape. In the case of Honduras, for example, even if the country were to withdraw from ICSID over a specific claim, it would still have to defend that claim and any others filed within six months of formal withdrawal notification. Additionally, Honduras could be subject to further cases through bilateral investment treaties that refer arbitration to ICSID.

The power relationships in investment treaties are often inherently asymmetrical, with investors from Global North states more likely to win their claims. Large corporations have been accused of weaponizing ISDS clauses to benefit their own interests at the expense of workers, consumers, and small businesses globally. These agreements also undermine the ability of Global South states to govern, reducing the policy space available to them and increasing the cost of regulating their own economies. This problem is particularly acute for states navigating the green economic transformation.

As discussions on reform of international development finance progress, concerns about the impact of ISDS clauses are likely to become even more salient. The World Bank’s Evolution Roadmap explicitly refers to increased support for ICSID as efforts are made to mobilize more private capital. However, it is important to consider the potential costs and benefits of such support, particularly in light of the criticisms and concerns raised by civil society and UN special rapporteurs.

Can ISDS be Challenged?

The growing opposition to ISDS has led to questions about whether the system can be challenged. In 2020, US President Joe Biden pledged to exclude ISDS clauses from future trade deals. US Senators and members of Congress have also requested the US administration to investigate options to eliminate ISDS liability from existing trade and investment agreements. The EU Court of Justice has issued rulings that ISDS clauses between members of the bloc are incompatible with EU law, but national courts and ICSID have pushed back, leaving the issue unresolved.

Despite this opposition, the web of international treaties and obligations containing ISDS clauses means that dismantling the system of protection for international investments will be difficult. Thousands of investment treaties and ICSID itself embody the system, making it difficult to course-correct in a fragmented and often conflicted international investment law regime that lacks meaningful checks and balances, as noted by the CCSI.

However, this leaves countries vulnerable to costly claims. Honduras is facing a budget-busting $11 billion claim for reasserting its sovereignty over a foreign enclave that a previous government sanctioned on its soil. As the opposition to ISDS continues to grow, it remains to be seen how the system will evolve and whether it will continue to be a part of trade and investment agreements in the future.