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The International Centre for Settlement of Investment Disputes (ICSID), an institution of the World Bank, plays an important role in international arbitration. It intervenes in disputes between investors and states, typically based on bilateral or multilateral investment protection agreements.
The importance of ICSID, founded in 1965, has grown considerably since the mid-1990s. The institution handles an increasing number of cases, some involving high monetary stakes. At the same time, international arbitration faced growing criticism. Bolivia and Venezuela have withdrawn from ICSID, and Honduras declared its withdrawal in 2024 (though this has not yet taken effect). Ecuador, India, Indonesia, and South Africa have also withdrawn from the bilateral investment protection agreements on which the arbitration is based.
In the case of Honduras, ICSID arbitration procedures are governed by the Dominican Republic–Central America–United States Free Trade Agreement (DR-CAFTA).
On one hand, arbitration procedures offer foreign investors protection that goes beyond the mechanisms of national and international law, potentially stimulating economic growth.
On the other hand, such investment protection agreements can severely limit national governments’ decision-making options and capacities. In addition, they may create politically undesirable and democratically unlegitimized dependencies on foreign companies. This raises the question of whether ICSID and its arbitration procedures can truly strike a balance in this tense relationship in line with the principles of international law, in particular with human rights protection standards.
Due to its extreme configuration, the controversial case of the Employment and Economic Development Zones (ZEDEs) established in Honduras may become a litmus test for the legal and ethical quality of international arbitration.
ZEDEs are a far-reaching form of special economic zones. Also known as charter cities or free private cities, these zones are micro-jurisdictions virtually detached from the national territory based on contracts between the state and the operators. ZEDEs regulate their affairs, including legislation and jurisdiction, in a manner that is essentially independent from national and international law. There are no transparent accountability standards.
As a result, these special zones were extremely controversial from the beginning, both legally and politically. In 2011, the Honduran Supreme Court declared the ZEDEs (then known as Regiones Especiales de Desarrollo – RED) unconstitutional. Specifically, it assessed violation of the country’s territorial integrity warranted by the constitution. Following a politically induced change of judges, in 2013 the new Supreme Court approved the ZEDEs. Furthermore, the National Congress amended the Honduran Constitution in favor of ZEDEs at the request of the then-government.
The new Honduran government, in power since 2022, wants to abolish the ZEDEs. The new National Congress approved this decision in 2022. However, the constitutionally required confirmation of this parliamentary resolution in the following session did not materialize. The newly appointed Supreme Court declared the ZEDEs unconstitutional again in 2024 by a narrow majority decision.
Human rights organizations, indigenous groups and other civil society organizations have vigorously protested against the ZEDEs from the beginning. Prominent academics and representatives from the United Nations have also expressed their opposition. During its 191st Session, the Inter-American Commission on Human Rights held a hearing on the “Impact of Special Economic Zones and Low Financial Transparency Jurisdictions on Fiscal Justice and Climate Change”.
Allegations have been made regarding violations of national and international law, particularly environmental, labor, administrative, and civil law, as well as the violations of human rights and indigenous rights. Critics compare the ZEDEs to a modern version of the historical plantations in the so-called banana republics, which U.S. companies exploited at will in the 20th century. There are also concerns that the ZEDEs may become ideal locations for money laundering by organized crime. Lastly, there are claims that Honduran policymakers have been bribed by the operators of the ZEDEs from the outset.
Despite these serious accusations, operators have created three ZEDEs in Honduran territory (Próspera on the island of Roatán, Morazán in Choloma and Orquídea near San Marcos de Colón) with the support of the previous government. Contrary to the declared will of the current government, the corresponding resolution of the National Congress, and despite ongoing protests from civil society, the operators have continued to develop these ZEDEs.
The operators of ZEDE Próspera have initiated arbitration proceedings against Honduras at ICSID, seeking compensation of US$10.775 million, mainly for lost profits–, i.e., the expected profit that cannot be realized due to the Honduran government’s decision to repeal the ZEDEs. This amount corresponds to approximately two-thirds of Honduras’ national budget. The basis for this claim would lie in 50-year guarantee contracts concluded with the previous Honduran government under the ZEDE legislation at the time.
The question arises as to which aspects the arbitral tribunal will examine in this case: Will it merely determine whether the conditions for compensation set forth in the aforementioned guarantee contracts are met? Or will the tribunal also examine constitutional aspects and the compatibility of the ZEDEs with Honduras’ international obligations, particularly regarding environmental law, human rights and the rights of indigenous peoples?
Will it examine whether the decision of the new Honduran government and the recent Supreme Court decision have eliminated the legal basis for activities related to the ZEDEs? Was it possible for the operator to have good faith about the legality of the ZEDEs under the unclear legal situation and significant protests? Did the operator violate Honduran law by constructing an eight-story building on the island of Roatán–where high-rise buildings are not permitted–and through its investments in creating a cryptocurrency and conducting genetic therapies and experiments? Is the claim for damages so excessive as to exert extortionate pressure and therefore contrary to good faith?
A national or international court would have to examine all these aspects, which go far beyond the clauses of the guarantee agreement between Honduras and the operator. The question arises as to how the arbitral tribunal will address this complex legal issue. Is it sufficiently qualified to examine the relevant legal issues, and is it authorized to do so under ICSID regulations?
Given that the potential legal violations and possible criminal implications are as numerous as they are serious, the ZEDEs case could become a litmus test for assessing the capacity and limits of international arbitration. Beyond the final decision, this case should prompt a critical analysis of whether private arbitration bodies should be authorized to decide on fundamental and constitutionally significant legal disputes between companies and sovereign states.
Photo credits: AP Photo/Elmer Martínez, file.