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BBL Summary (July 6, 2006)

Foreign Investment Protection Under International Treaties

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Speaker Daniel M. PRICE
Partner, Sidley Austin LLP
Andrew W. SHOYER
Partner, Sidley Austin LLP
Commentator KOTERA Akira
Former Faculty Fellow, RIETI
Professor, Graduate School of Arts and Sciences, The University of Tokyo
Moderator MATSUMOTO Kayo
Fellow, RIETI
Materials Handouts [PDF: 92.3KB]

Transcript

Daniel M. Price

Increasingly, global companies are looking at the world from two different perspectives. The first is the domestic law of the countries in which they operate, and the second is the international rules that sit atop domestic legislation and inform local and national legislatures of how legislation must be made consistent. As companies plan investments and seek to resolve regulatory problems, they are increasingly looking to these international rules, which are found in the World Trade Organization (WTO), in free trade agreements (FTAs), and in bilateral investment treaties (BITs).

Japan has recently embarked on a program of negotiating economic partnership agreements and BITs, and just as other global companies are looking at these rules, so too are Japanese companies. People often assume that international trade rules have to do only with tariffs, but these international rules relate not only to import and export of goods but to financial and professional services; the conditions and treatment of foreign direct investment and portfolio investment; intellectual property; and technical, health and safety standards. They affect all exercise of national and sub-national governmental authority, whether it is taxation, environmental regulation, government procurement, or the actions of local courts.

I will discuss BITs and investment chapters of FTAs, and then my colleague Andy Shoyer will address the WTO agreements and draw contrasts between the way investment agreements work and may be used and how the WTO system works.

Japan has negotiated BITs with 11 nations, a relatively small number. The signal feature of these agreements is that they protect investors against government action, whether at the national level or sub-national level. In contrast to WTO rules, these treaties provide a direct right of action by the investor against the host government that is enforceable through arbitration in a neutral, independent forum. If a global company has a dispute with a host government, it need not resolve the dispute in local courts as long as it enjoys the benefits of a BIT.

Initially, BITs were conceived of as agreements between capital-exporting countries and capital-importing countries. That is no longer the case. We now see BITs concluded between countries that we think of as principally capital importers. The proliferation of these treaties, and the fact that they no longer fit the classic north-south paradigm, is a strong indication of the benefits countries see in them.

The definition of investment is quite broad, covering everything traditionally thought of as a property right, both tangible and intangible, all forms of ownership interests in an enterprise, as well as rights arising from contracts. As I understand China is of particular interest to this group, I would note that, currently, the two strongest treaties with China are with the Netherlands and Germany. The older generation of BITs with China does not permit investor-state arbitration on questions of liability, only on questions of damage. By contrast, the treaty with Germany has very broad investor-state arbitration protection. Thus, as Japanese companies start thinking about investing in China, they should give consideration to doing so through a German affiliate for which BITs protect direct and indirect ownership.

BITs offer five basic protections; the same is true of investment chapters of FTAs. First is "non-discriminatory treatment," a promise that the host state will treat foreign investments no less favorably than an investment owned by its nationals and will accord the investor most-favored-nation (MFN) treatment. Under a BIT, a state wishing to take an exception to non-discriminatory treatment must negotiate it and inscribe it in an annex. It is important that the investor actually read the treaty, because the host government is not going to educate the investor about the restrictions imposed in the treaty.

The second almost universal provision of BITs is a guarantee of "fair and equitable treatment" that seeks to establish an absolute, non-relative international law standard. National treatment is a relative standard; fair and equitable treatment means that no matter how a state treats its own nationals, it must treat the foreign investor in accordance with certain basic standards; for example, it must provide due process and cannot engage in arbitrary conduct that interferes with the investment. Along with the third promise of "full protection and security," and the fourth of "treatment in accordance with international law," these provisions set a standard of treatment that can be particularly important when investing in countries with less-developed legal systems. The fifth promise is an elaboration of the second and fourth, stipulating that the host government may not impair the management or use of the investment through unreasonable or discriminatory measures. What is unreasonable and discriminatory? While the cases and commentators provide some guidance, it is the investor-state arbitration tribunal in the specific case which decides that. The language employed by investment treaties is necessarily broad, because these instruments cannot foresee every factual situation.

Many treaties contain an "umbrella" clause, a provision requiring the host government to honor contractual obligations entered into with the foreign investor. The effect of an umbrella clause is to transform the contractual obligation into a treaty obligation. The purpose is quite clear. In the instance of a contract between an investor and the host government, the host government has at its disposal both the usual tools and rights of a commercial actor and the entire apparatus of the regulatory state and the legislature. The umbrella clause ensures that the sovereign does not act to effect a breach or repudiation of contract. Even in the absence of an umbrella clause, fair and equitable treatment has been interpreted to incorporate the customary international law notion of pacta sunt servanda, and has been interpreted by tribunals to protect the legitimate expectations of the investor. A number of commentators, and at least one tribunal so far, have said that this requires observation of contracts.

One of the most important features of these BITs is the protection against expropriation. By its terms, the expropriation article recognizes the right of a state to nationalize or expropriate, but says that when the state does so, the expropriation must be for a public purpose, done on a nondiscriminatory basis and accompanied by compensation equal to the market value of the investment that was taken. The expropriation article does not apply only to outright takings or nationalization, but also to the repudiation or arbitrary termination of a concession agreement. It also applies to regulatory actions that effect a taking; that is, where such actions are in effect simply substantial impairment or destruction of property rights by another name. It applies to so-called creeping expropriation, which occurs a little bit at a time, and the cumulative effect of which is tantamount to an expropriation.

There are two additional provisions that are quite important. The first has to do with financial transfers. Investment agreements typically ensure that repatriation of capital in the form of dividends or profits and the ability to obtain foreign exchange at a standard rate for the purpose of making principal and interest payments are unimpeded by exchange controls. It ensures that the lifeblood of the investment, the capital flow going in and out, is not impeded by government action.

The final protection is a prohibition of so-called performance requirements, as in the WTO agreement on Trade Related Investment Measures (TRIM). Performance requirements sometimes imposed by countries may require, for example, a minimum percentage of local content in the production of goods, or stipulate that foreign currency needs must be satisfied through export earnings. Such performance requirements are prohibited under these investment chapters. I said at the outset that it is important for investors to read treaties; here is a prime example. Investors often agree in a document to accept these performance requirements, even though under the relevant international agreement the host state is not permitted to establish them as a requirement. Investors must read these agreements in order to gain the benefit of their protections.

There has been a recent increase in the number of cases filed, most of which are heard under the World Bank's International Centre for Settlement of Investment Disputes (ICSID) rules, or under the United Nations Commission on International Trade Law (UNCITRAL) rules. The difference is that while under ICSID there is a secretariat that will administer arbitration, under UNCITRAL it is necessary for the parties to establish a secretariat or designate an appointing authority for certain gap-filling or arbitrator appointment exercises.

What are some common contexts of disputes? One is privatization. There is a famous case involving Nomura Securities and the Czech Republic. Nomura participated in the privatization of the Czech financial sector, and then the Czech Republic allegedly adopted rules favoring certain banks, but not the financial institution in which Nomura invested, so a claim was brought by Nomura under the Dutch-Czech bid.

Creeping expropriation may be seen under long-term contracts or concession agreements or infrastructure agreements where there are a series of government failures to act as required under the investment agreement. There could be a series of defaults by the host government that collectively render an investment worthless.

Other disputes revolve around repudiation or wrongful termination of contracts or discrimination either by law or de facto, where on its face the measure does not look like it is discriminatory, but in fact is. One example is where a measure disrupts competition between a foreign investor and its domestic competitors. A tax or measure that is not nationality-based may look neutral on its face, but may still have the effect of significantly favoring the local industry at the expense of the foreign investor.

The final dispute category is regulatory measures that can arbitrarily impair the value of an investment. Typically there will be some form of discrimination associated with these regulatory measures. It might look neutral, but when you examine it you will find that it likely will disproportionately affect the foreign-invested sector.

Many of these cases settle after the jurisdictional phase, or even in advance of being filed.

A word on procedure. If the investor chooses the ICSID system, it is really a self-contained world with no role for judicial review. Under the ICSID convention, each party to accord the award the same status it accords the judgment of its highest courts. It is subject only to annulment procedures under the convention. If an investor opts for UNCITRAL arbitration, it will find itself under the New York Convention, where awards are subject to judicial review in two locations: either in the jurisdiction where the award is rendered or the jurisdiction where enforcement is sought.

Let me stop here and turn to my colleague.

Andrew W. Shoyer

I want to help put in context the tools that Dan Price discussed under investment agreements with the tools that are available for solving commercial problems under more familiar international trade agreements, including the WTO.

Companies have tools available to solve problems using treaty protections from trade agreements, just as they have tools available under investment treaties. With the availability of investor-state dispute settlement under investment treaties, there is a much more direct capacity for companies to invoke these treaty protections, because they themselves have the ability to initiate and arbitrate disputes. However, the treaty protections available under trade agreements are also very powerful. Even though formal enforcement of trade agreement protections requires the intervention of the government, companies and trade associations have access to these protections, and are using them to increase their leverage with regulators and help to resolve problems.

Nike has made use of WTO protections. They asked Dan Price and his colleagues to generate arguments under the WTO to demonstrate that the restrictions Argentina had imposed against an onslaught of inexpensive footwear exported from Asian countries were inconsistent with its WTO obligations. They took their legal brief to Indonesia, which as a producing country had a certain amount of credibility; to the United States, because Nike is a U.S.-based company; and to the EU, which had a very different interest. The EU viewed abuse of safeguards as a significant problem, because the further you push a country to make aggressive tariff cuts, the more incentive there is to cheat. The EU wanted strong test cases that could serve as precedents; it pursued and ultimately won this Nike case. Nike then took the WTO brief to a local counsel in Argentina, and asked them to file suit against the government in order to put as much pressure on Argentina as possible from as many different points as possible. Even though these remedies are quite different from the protections of investment treaties, they provide powerful tools.

Dr. Kotera

As Mr. Price has said, it is not correct to think that no Japanese company understands or has used this system. Nomura Securities' case against the Czech government is a very typical investment arbitration case for two reasons. Firstly, the issues under consideration were (1) expropriation and (2) the obligation of fair and equitable treatment. Secondly, the arbitration panel recognized the violation of fair and equitable treatment, but not of expropriation, a typical outcome. Such cases are not widely known, but the number of claims of Japanese companies that have been settled because of the existence of an arbitration clause far outweighs the number of claims that have actually been brought to arbitration.

One question often posed to me when I give lectures on this topic regards enforcement mechanisms. Mr. Price explained the ICSID mechanisms, but many corporations use other forums, like the International Chamber of Commerce (ICC) or the Stockholm arbitration panel. Many lawyers would like to know whether such arrears can be enforced in a national enforcement system. If they are recognized as arbitrable, how can corporations overcome a state's immunity claim on executions?

Another question is from the viewpoint of the government, or persons involved in economic partnership agreement (EPA) negotiations. Understanding the presence of the BITs, two alternatives come to mind. One common approach is to draft carefully the provisions of the BITs under negotiation, particularly the scope of the MFN treatment, so as to avoid future confusion. A second approach would be to stop negotiations, because multinational companies can make use of about 2,300 already-completed BITs by making their investments through an affiliate paper company in a country with favorable BITs. Do you think that this second alternative might concern the enforcement issues of bilateral investment arbitration?

Mr. Price

Let me start with the second question first: Why should the Japanese government negotiate BITs when there are all of these BITs out there that Japanese companies may use? There are two answers. One is that certain BITs have "anti-shell" provisions. The second is, from the perspective of the Japanese government, why would it want to force its companies to engage in non-economic behavior? One reason the United States negotiated NAFTA, for example, is that it saw the treaty network as a benefit to attract investment into the U.S., as well as protecting the interests of its investors. A government must balance its offensive and defensive interests, but for significant outbound investors, the interest of protecting its global companies and contributing to the development of rule of law hugely outweighs the incremental risk that those countries will be named as a defendant in an investment arbitration case.

The issue of sovereign immunity is a very significant one that arises principally outside of the ICSID system. If you have an ICSID award and are under the ICSID convention, there is a treaty obligation to honor the pecuniary obligations of that award, and breach of that obligation constitutes a separate breach addressable either under the treaty or state-to-state before the International Court of Justice. If an investor chooses a non-ICSID mechanism, such as the London Court of International Arbitration (LCIA), Stockholm, ICC, or the Japan Commercial Arbitration Association (JCAA), then the question becomes: what if the state does not honor the award? I am not aware of any coherent body of law definitively addressing the question of whether consent to treaty arbitration coupled with the treaty obligation to honor the award together constitute a waiver of immunity from execution. However, governments' compliance with arbitral awards under BITs is excellent, because if a state fails to honor a treaty-based award, it can affect its credit rating.

Comments, Questions and Answers

Q: How effective do you think political risk insurance for enforcement of awards is? Also, the European Convention on Human Rights states in Article One of Protocol One that arbitral awards are considered property, and companies are entitled to the protection of that property. Thus, companies could add pressure on countries to comply by bringing a claim under the European Convention.

Price: The European Convention recognizes judgments and awards as property; it also recognizes property as a human right, and so a number of observers have seen what they considered to be the possible convergence of international investment treaty law and human rights law. Interestingly, human rights advocates tend to fall in the anti-globalization camp, whereas the investment treaty types are in the pro-globalization camp. Once again, we see the world as a circle and not a line.

With respect to political risk insurance, to my knowledge there is coverage for non-compliance with an arbitral award, and also for contract breach or repudiation. Anything an investor can do to increase the chances of compliance with the contractual undertakings initially, or with a resulting award, is certainly to its advantage.

C: With regard to Professor Kotera's second question, it is true that there are a lot of BITs, so Japanese companies can treaty-shop through third-country affiliates. However, the task for any government is to provide businesses with a predictable environment and the best legal framework, especially abroad.

Q: Which arbitration systems are most in use nowadays? Does most litigation go to ICSID, or UNCITRAL? ICSID may be more interesting for investors because it is final, whereas UNCITRAL leaves scope for judicial review.

Price: There is a growing number of investor-state cases that by definition are not ICSID because they are under Chapter 11 of NAFTA, and at the time it was negotiated, neither Mexico nor Canada were parties to ICSID. I prefer ICSID, because of its experienced secretariat and sophisticated appointing authority, because of the non-interaction with domestic courts, and also because they run a very efficient operation, whereas UNCITRAL is a set of rules, but otherwise ad hoc.

Q: What do you think of the U.S.-Australia FTA which does not have investor-state dispute settlement?

Price: I think it is hugely disappointing. I can only imagine that Australia and the United States said to each other, "We both have well-developed court systems; if investors have problems, they can go to the court system." My personal view is that it is an unfortunate precedent, and, if I am correct about the reason for the decision, that it is unfounded. The very reason for having dispute settlement outside the court system is the preservation of neutrality in the event that there is a highly political case.

Shoyer: The traditional view of these treaties is that they are between capital exporters and capital importers; developed countries and developing countries. At the bargaining table between the U.S. and Australia, from a political standpoint it seemed beneath both parties to have this protection. That view is no longer accurate; when you look at the kinds of protections that are available, we see this significant increase in BITs around the world that many are flowing between countries that are more similar in terms of levels of development.

Kotera: In my view it is very understandable. Investment arbitration was invented in place of national courts of developing states in which advanced countries lacked confidence. In addition to the U.S.-Australia FTA, the U.S.-Canada FTA also lacks arbitration systems, because BITs between advanced states do not require them. We must analyze whether the system of the advanced state is better suited than arbitration to handling disputes. We cannot think about such systems in categorical terms.

Price: I agree with that, but would only ask why, if Australia and the U.S. think that their court systems are so attractive to investors, they do not give the investors the choice of going either to courts or international arbitration? I suggest that one of their motivations was the desire not to be named as a respondent. I think that it is regrettable that the countries gave in to that defensive impulse.

Q: Many Japanese companies in China complain about the incompetence of local government. What is the best practice for companies to pursue BIT principles? How should companies deal with Chinese local government?

Kotera: Concerning BITs and China, investment arbitration is very useful. Even in claims against local governments, investors can bring a case against the central government. As Mr. Price said, recent BITs have a wide arbitration clause between investors and the Chinese government. Japan and China have an MFN clause, so the ICSID clause can be applied, or Japanese investors can invoke the Germany-China arbitration system through the MFN clause.

Price: I agree that the acts of government officials are as a matter of international law attributable to the central government. If an action breaches the treaty, Beijing is responsible. If there is a string of cases against Beijing for the acts of local officials, it will have to develop the mechanisms of control that exist in other complex states.

With respect to the scope of the MFN clause, Professor Kotera raised the Maffezini question, which addresses the scope of MFN status. Does it include only treatment? Or does it mean that procedural and dispute settlement clauses are also imported by virtue of the MFN clause? I think there are cases that go both ways. I do not think that we have definitive precedents, and it will continue to be worked out case by case.

Q: You mentioned elements such as the MFN performance requirement and the provision of protection of investment to be stipulated in the investment agreement. Which element is most important? Do you think that quality is the highest priority to be pursued, or the network?

Price: I speak now from my personal view. Many countries say at the beginning of negotiations that they will never accept investor-state, and maintain that position right up until the time comes to conclude the agreement. In my view, it is better to have no agreement than a low-standard agreement that puts you on an inevitably declining plane. As a negotiator, your last concession becomes the starting point of the next negotiation. It is in your interest to negotiate only high-standard agreements.

*This transcript was compiled by RIETI Editorial staff.

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