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Dispute Resolution In Colombia Compared to Brazil And Mexico

October 13, 2009

When businesses assess emerging market economies, how important are dispute resolution systems?

Each of Brazil, Colombia, and Mexico has been enjoying substantial economic growth over the last several years. Each also faces very negative worldwide perceptions about corruption in their legal systems.

The Latin America Venture Capital Association reports on the 2009 LAVCA Scorecard on “perceived corruption.” Brazil ranks very highly overall (75 out of 100 points in 2009 as in 2008), but received only 1 out of a possible 4 points for perceived corruption. Mexico’s overall score is 58 (as in 2008), but again, it received only 1 out of a possible 4 points for perceived corruption. Colombia’s overall score is a much-improved 57 (up four points from 2008, moving from sixth to fifth position), but, again, 1 out of 4 possible points for perceived corruption. 

The same LAVCA scorecard provides a rough basis of comparison for “strength of the judicial system,” and in each country the score was 2 out of 4 points.

Overall, these low ratings suggest that investors face either real or at least stigmatic hurdles in the important arena of judicial dispute resolution.

When it comes to bankruptcy procedures, LAVCA scores Brazil 3 out of 4 points, Colombia 2 out of 4 points, and Mexico 1 out of 4 points.

Closely related to enforcement issues are the protection of minority shareholders and corporate governance requirements, which are scored 3 out of 4 in all three countries  Also related are rankings on intellectual property protection, which is scored 2 out of 4 in all three countries.

LAVCA reports overall on the strengths and “challenges” that stand out in each economy.  For Brazil, its strengths include protection of majority shareholders rights and bankruptcy procedures, areas in which there has been progress over the last several years, while its challenges are the protection of IP (“further progress could be made”) and in perceived corruption (“serious challenge”). 

Colombia’s strengths include improved minority shareholders rights and corporate governance, while among its challenges are perceived corruption and the weakness of the local judicial system (“still roadblocks”). 

Mexico’s strengths include corporate governance, protection of minority rights (“though there remains room for improvement in each”), while its “challenges” include the judicial system, control of corruption, and modernization of bankruptcy laws.

Another way of looking at some of the same issues is The World Bank 2010 Doing Business report (link is to Colombia page).  Among the factors measured concerning the effectiveness of local dispute resolution systems are:

  • “protecting investors” – liability for self-dealing (Extent of Director Liability Index), shareholders’ ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index) and Strength of Investor Protection Index. The indexes vary between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection),
  • “enforcing contracts” (determined by following the evolution of a payment dispute and tracking the time, cost, and number of procedures involved from the moment a plaintiff files the lawsuit until actual payment), and
  • “closing a business” (time and cost required to resolve bankruptcies.

Breaking these measures down as they relate to dispute resolution issues, the data show wide variability within each country and comparing among the three countries:

World Bank Doing Business Rating Category Brazil  Colombia  Mexico  Lat. Am./ Caribbean OECD Avg.
Protecting Investors (Worldwide rank 2010) 73 5 41
Protecting investors overall[1] 5.3 8.3 6.0 5.1 5.8
– director liability 7 8 5 5.3 5.0
– ease of shareholder suits 3 9 5 6.0 6.6
Enforcing Contracts (worldwide rank 2010) 100 152 81
– procedures (number) 45 34 38 39.7 30.6
– time (days) 616 1346 415 707 462.4
– cost (% claim) 16.5 52.6 32.0 31.3 19
Closing Business (worldwide rank) 131 32 24
– time (years) 4.0 3.0 1.8 3.3 1.7
– cost (% of estate) 12 1 18 15.9 8.4
– recovery rate 17.1 52.8 64.2 26.8 68.6
Avg. Combined Rankings[2] 101 63 49

In terms of worldwide rankings, blending the three categories, Brazil’s average is lowest (no. 101), Colombia’s is in the middle (no. 63), and Mexico’s is highest (no. 49).  Mexico outranks Colombia but not by as much as both outrank Brazil. There are fairly wide disparities between the rankings within each country, Brazil ranks 73rd for protecting investors, 100th for enforcing contracts, and 131st for closing a business. Colombia ranks a stunning 5th for protecting investors, and a quite respectable 32nd for closing a business, but 152nd for enforcing contracts. And, it is worth noting, Mexico ranks 41st for protecting investors, 81st for enforcing contracts, and a very strong 24th for closing businesses.

How useful are these comparisons?  Colombia for example compares very favorably to the world, to Latin America, and to the OECD on protecting investors, and Colombia compares favorably to Latin America and the Caribbean on closing businesses, with rankings that are fairly high. Colombia’s bankruptcy procedures for closing a business are considerably better-ranked than the LAVCA Scorecard ranks them.  But the data point for costs and delays in enforcing contracts sends Colombia’s ranks down considerably (rank no. 152 vs. no. 5 and 32, respectively, in the other categories). It is a real outlier.

The methodology the World Bank used (Djankov et al) for measuring contract enforcement relies entirely upon a hypothetical court process, however, and it does not measure private arbitration in any way.  This is a serious weakness for any country, like the three in this study, where the norm in the economy for commercial disputes resolution is commercial arbitration.  For enforcing contracts in courts, all three countries received very low rankings.

Arbitration is very robust in each of the three countries (see this site’s post about arbitration in Colombia).   Indeed, it not only provides a superior alternative to the poorly-rated court systems, but it may provide superior alternatives to courts in general, even in more advanced economies, for reasons of expertise and availability of the decision-maker, and privacy in private commercial matters. It is also flexible, to the extent that foreign arbitration may be perceived by international players at a minimum as a confidence-building measure, and to the extent that foreign arbitration is on a par with local arbitration.

Thus, the already positive signs for the Colombian dispute resolution system in terms of investor protection, corporate governance, and bankruptcy procedures should not be discounted because of the weak local court system for enforcing contracts – unless and until the strong local system for arbitration and recognition of foreign arbitration is tested and factored into the analysis.

[1]               Scores awarded are out of a possible 10 points.

[2]               Calculated from the World Bank data by summing the three rankings, dividing by three and rounding.

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