Developments in Arbitration in Europe and the Active Use of Arbitration by Japanese Companies

International arbitration is of great and growing interest to governments, as well as to any company that might think of investing abroad.

I represented Nomura in its claim against the Czech Republic, which is to date the only case under any investment agreement involving a Japanese company. The case was a success. That should be proof enough that investment agreements are not theoretical instruments, but are real tools that can be used to obtain real results in the case of inappropriate action by government. It is a lesson for governments, and they should look to adapt their own behavior accordingly.

International investment agreement (IIA) is a term that covers a number of different instruments. The most common instrument is the bilateral investment treaty (BIT), but there are many multilateral agreements, and other forms of bilateral agreement called, variously, free trade agreements (FTAs), or, particularly in Japan, economic partnership agreements (EPAs). Those tend to cover much more than pure investor protection: they cover all of the rules that are to be applied in trade between countries, and contain a chapter that will deal with the protection of investments made pursuant to the agreement. The best known multilateral investment agreements are the Association of Southeast Asian Nations (ASEAN), the North American Free Trade Agreement (NAFTA), and the Energy Charter Treaty (ECT). The ECT is a wide-ranging treaty; Japan is a member, but only investment in the energy field is covered. Then there are FTAs that are similar to NAFTA, but are bilateral in nature.

The many ways in which investors have successfully used investment treaties can be summarized in groups: changes in regulatory regimes; changes in tax regimes; denial or withdrawal of permits; the absence of transparency in administrative processes; the taking of an investment (expropriation or nationalization); and denial of justice.

What would a change in a local regulatory regime be? An investor might make a claim if a change in environmental regulation meant that he were no longer able to market, for example, an additive in fuel that he manufactures.

Changes in tax regimes can cover a multitude of different problems that investors might face. It might be as simple as a windfall tax, or it might be something more structural and fundamental. There is not a definitive list specifying what kinds of taxes might give rise to a claim. Again, one needs to caution investors that every treaty is different and some treaties specifically exclude tax from the scope of their operations.

It may seem obvious that denial of permits would lead to a claim, but even the denial of the renewal of a permit can give rise to a claim. A number of claims have been brought by companies that deal with waste disposal, for example. They need to have a permit, that permit is given, and the permit is later withdrawn: that can give rise to a claim.

Transparency in a local administrative process is also a difficult area. If you cannot see the decision going through the various stages, then that could give rise to a claim, usually combined with the investor claiming that his legitimate expectations were not met by the state's administrative processes.

The outright or effective taking of an investment seems clear enough: nationalizing a factory would be an expropriation that would give rise to a claim. Expropriation is itself broadly-defined: it can be direct or indirect. Indirect expropriation is itself a controversial concept. If you tie it in with changes in regulatory regimes, the situation may be sufficiently drastic that you can no longer function at all, so you have effectively lost your investment. This runs up against the government's sovereign right to regulate. Where do you draw the line between the government's right to regulate to protect its citizens and the environment, and the rights of an investor to be able to continue with the investment? Very often these cases depend on deciding what is legitimate, and what is not. A very important case in the NAFTA context was brought by a Canadian company called Methanex against the U.S. government. States have to have regard to the need to be non-discriminatory: they must not use regulation as an excuse for protectionism. At the same time, the regulation must be genuinely for a public purpose, because if it is not for the good of the community as a whole, there might still be a right to compensation. States have to act within tightly drawn parameters, but if they do, investors have no grounds for complaint that their investment has been effectively removed by the state's acts.

Regarding the issue of denial of justice, one has to remember that courts are an arm of the state, which bears international responsibility for the acts of its courts. If the courts take a particular decision, the state is still responsible for compensation if there has been a breach of the treaty. But denial of justice is not an appeal. The court has an absolute right to get things wrong. Just being wrong is not a denial of justice, in international law terms. A denial of justice might be refusing to follow the appropriate procedures; not giving a fair hearing; taking an inordinate length of time to get to a final decision; or improperly refusing a right of appeal.

In the Nomura case, the real issue was discrimination: the treatment of an investment made by a foreign investor in a way that was different to the treatment given to other investments that were on all major levels comparable.

What are the substantive rights under the treaties? The most important is the most nebulous, "fair and equitable treatment," which means no discrimination: the protection of the legitimate, reasonable expectations of an investor. Nearly every case will include a claim for unfair and inequitable treatment. It is the catchall right that should cover lots of instances of inappropriate action by a state.

Now, there is a very important debate among international lawyers as to what standard the state's conduct must meet. There are those in government who will argue this is a minimum standard. Most tribunals consider that fair and equitable treatment is an evolving standard: it has to take account of the expectations of investors today.

Many countries argue that it is unfair that foreign investors should get better treatment than their own nationals. This is called the Calvo Doctrine, but is not accepted generally as a matter of international law, because in many countries the nationals of that country are treated very badly, and would not satisfy the minimum standard that is recognized by international law. But that debate continues.

Regarding expropriation and the measure of damages, the investor should be entitled to the fair market value of the investment, rather than the amount of the investment.

Most favored nation (MFN) treatment is essentially that the state promises that an investor will be treated no worse than and at least as well as nationals, and nationals of third states. The umbrella clause guarantees that the state will observe other commitments it has entered into with the investor.

What considerations do investors take into account in structuring their investments? What is the role of political risk insurance? What are the benefits of having the protection of an IIA? If the treaty gives you the choice, should you take the route of arbitration under International Centre for the Settlement of Investment Disputes (ICSID) rules? Finally, do Japan's own IIAs help Japanese investors?

An investor might want to take account of a treaty that would protect investments, but there might not be one, so they might make an investment through a country that does benefit from such a treaty. The Nomura case is a case in point: a Japanese company has an indirect investment in a bank in the Czech Republic, where there is no treaty protecting Japanese investors. The investment was made through a special-purpose vehicle incorporated in the Netherlands, allowing Nomura to take advantage of the Netherlands-Czech Republic treaty. Nomura won, despite the arguments that the investment should not be counted as a Dutch investment because it was only through a shell company. This is, again, a controversial issue. But the treaty will define who is an investor and who is not.

There are concerns about "forum shopping." Some consider it improper for investors to be able to choose to bring such a claim by routing their investment through a third country. But countries can easily avoid that by stipulating in their treaty that the company has to have a real economic interest in the company in which it is incorporated. Some treaties say that, but if they do not, then a claim is unlikely to be thrown out.

Nearly all IIAs require that investments be made in compliance with the laws of the host state. What happens if the host state abuses its own legal system in order to argue that the investment is not made in accordance with local law? An example was the allegations made against Shell and its Japanese partners Mitsui and Mitsubishi in relation to the gas field development on Sakhalin. The allegation was that the development was not made in accordance with environmental regulations, and it was alleged by the investors that the state was selectively applying those laws. An interesting question for a tribunal would be whether or not that would mean that this was not in accordance with local law.

Investors most certainly take advantage of treaties by structuring their investments. I do not think that large companies are less likely to bring claims. If the investment is big enough, then companies will certainly take the risk. In any event, there are companies that are insured.

What are the pros and cons of having the protection of an IIA? Arbitration can obviously cause damage to long-term relationships with the host state: you do not want to ruin your relationship over 25 or 30 years by bringing a case. You might also worry that if you do bring a case to protect your rights you might be excluded from the next big government contract. On the other hand, if you have no option but to bring the case, then the simple ability to bring the case can significantly strengthen your hand when negotiating with the government. The simple existence of a right can be of great value to an investor, even if it is no more than keeping a government neutral.

Is ICSID the best route? Most treaties provide an investor with a choice of forum. They can use arbitration, or they can bring litigation in the national courts of the host state, though the latter is the one thing they want to avoid. Treaties also usually give options as to the kinds of arbitration that can be undertaken. ICSID, a sister company to the World Bank, is dedicated to investment treaty arbitration. There is no relationship at all between the likelihood of a state to pay and whether the award against it is an ICSID award, a United Nations Commission on International Trade Law (UNCITRAL) rules award, or a Stockholm Chamber of Commerce (SCC) award. A state will pay or it will not. No supranational body can bring any pressure to bear.

What are the pros and cons of ICSID? On the negative side, it is slow; it contains a definition of investment that has been interpreted by tribunals in a restrictive manner; there are restrictive rules about nationality; and there is no advantage in enforcement. On the other hand, every ICSID case is publicly known, which an UNCITRAL case might not be: states often want to keep these cases quiet so that other investors are not put off by the existence of claims against the state. It is not an obvious decision, however, that ICSID is the way to go.

Regarding practical considerations in starting arbitration under an IIA, every treaty requires that you try to negotiate first. States do not want to negotiate very seriously. It is very difficult for states to settle a case, because they can be criticized for a settlement.

There can be up to three stages in arbitration. First, a challenge by the state to jurisdiction, followed by the merits of the claim, then, nearly always, if the state loses, it challenges the award. States feel obliged to use every means they can to save taxpayers' money. It is not uncommon for these cases to take five years.

Regarding enforcement, there is to date almost universal compliance with arbitral awards. It is in the interests of the state to pay up because that shows that the state is a reliable partner for future investment. Failure to comply with an award would itself be a breach of the treaty, so the investor could bring another claim. Enforcement against the assets of a state can be very difficult, because the state benefits from sovereign immunity from execution, but you can enforce against commercial assets of the state abroad. If your state has assets abroad then it is in your interests, as the state, to pay up.

Do IIAs encourage foreign direct investment (FDI)? Investors do consider the existence of treaties when making an investment. If you make an investment without the protection of a treaty, shareholders may be cross in the future.

There is nonetheless enormous criticism of the investment treaty arbitration system. Some call it the "law of greed," saying it detracts from the ability of a state to regulate, and is anti-democratic. Some argue it is contrary to sustainable development, because it encourages claims against poor counties. There is an argument that it does not encourage good governance in the host states, but rather creates an enclave of justice, where only foreign investors get justice, and that the courts of the host state never improve. These are purely political arguments, and are all wrong. The state needs to look at whether the regime encourages the creation of investment, wealth, and jobs. The fact that there are now 2,500 treaties seems to me to be the final answer to criticism.

Japan has very few investment treaties, though more are being negotiated. Not one of Japan's own treaties has yet been used by an investor. Japan's treaty with one of its big foreign partners, China, is a very old-fashioned treaty, and does not give companies the right to bring arbitration against the state, except for the amount of damages for expropriation.

So, what can Japanese companies do? Either they can structure their investments through a third country, or they can use the MFN clause. If the third state has a right of arbitration against the host state, can the Japanese investor use that right through his MFN clause? Some tribunals have said yes, and some have said no. It seems to be dependent on the wording of the MFN clause. It is strongly arguable that Japanese investors could take advantage of more favorable dispute resolution provisions in more modern treaties.

Let us not forget that treaties work both ways: Japan is an exporter of capital, but also an importer. States that are mainly capital-exporting are also, sometimes, the subject of claims. As for the number of cases in this region, there have been 20 or 25 cases, none of which have been brought against China. I think there will be more soon.

Comments:

Akira KOTERA

What is the essence of investment treaty arbitration? The change of BIT functions is composed of two factors. The first one is the substantial norm aspect. The second is an implementation aspect.

For the substantial norm aspect the main points are related to expropriation. What is indirect expropriation, or fair and equitable treatment, or an MFN clause, or national treatment? The meanings have been determined in arbitrations, but they have frequently been beyond the expectations of the contracting parties when they concluded the BITs. This is a little bit of a scandal. The main point is how to reconcile the expectation of investors and the regulatory interest of host states.

Regarding the implementation aspect, before the 1990s arbitration was not so popular. But after 2000, the number of investment arbitrations has been increasing and the implementation of BITs was in the hands of the investors. Before 2000, the implementation was done between governments. This is a revolutionary change. How should this change be evaluated?

Who are the true profit-takers: giant enterprises or medium-sized companies? For small and medium projects, investment insurance is reasonable, but for big projects, such as the development of natural resources and the management of infrastructure, BITs are very suitable. In this case, BITs are efficient and economical tools for risk-hedging. A determining factor in deciding how to hedge investment risk is whether the insurance premium is cheaper than the cost incurred from the possible utilization of BITs.

Q: Dr. Turner, you briefly mentioned the ECT. An argument could be made that the fact that Japan is a party to the ECT could reduce the necessity of the Japanese government to conclude BITs with energy-exporting countries. What additional merits are there in concluding BITs with countries party to the ECT?

A: If you are doing business in the energy sector and have ECT protection, there is no need for any further treaty protection. The investment provisions of the ECT are as wide as any BIT, and the dispute resolution provision gives you a greater choice of arbitration. If you are covered by the ECT then you need no more, but that does not let the government off the hook in negotiating other BITs that cover a whole range of investment that would help financial investors or car manufacturers, for example.

Q: How would you evaluate the effectiveness of BITs against Russia and China?

A: There have been several claims against Russia. The biggest claim is YUKOS, brought under the ECT. The issue with Russia is that Russia has not ratified the ECT, but it has a provisional application. There are two big issues. The first is whether provisional application includes the dispute resolution mechanism of the ECT. The second is whether Russia applies, or applied at the time this course of action accrued, the ECT provisionally, because there is the issue of the presentation of the Treaty to the Russian Parliament for ratification, and the question of whether or not that Treaty is still actually under provisional application under Russian constitutional and investment law.

No claim at all has been brought against China, but the Chinese government is concerned about claims being brought. They conduct themselves with that possibility in mind. It means that they take seriously the possibility that investors can bring claims. China has over 100 BITs: nearly all of them are Soviet-era BITs, but because China has signed at least four modern-style treaties, they take this very seriously. That is enormously important. It might not give rise to claims, but it might stop the Chinese state from behaving in such a way as to give rise to claims. That does not mean that countries should not seek to renegotiate their treaties with China. I think there will be claims against China, and, also, the threat of claims being used to achieve the commercial ends of the investors.

Q: Does bringing a case against a government usually mean that the investors will have to leave the country forever?

A: This is all part of the great commercial negotiation each time. You weigh up what the interests are and you decide whether you would be better served by negotiating and reaching whatever agreement you can or whether you would be better served by gambling on arbitration. It is certainly the case that a number of companies have taken the view in Venezuela and elsewhere that they can still make enough money under the new terms on offer to make it worthwhile continuing. What we do not know is the extent to which the existence of the threat of a claim improves those terms. It is also clear that there would be a point at which the terms on offer would not be acceptable, and then there is a treaty claim. But it might not be out forever, it might be out for the next five years.

Q: UNCITRAL is discussing the change of rules. What movement do you see?

A: The UNCITRAL rules are very out of date. They do not work very well. They are not appropriate in an investment treaty context in many ways. Nonetheless, they have been used, and very successfully. They need to be reformed, and I hope they will be. I hope they will take particular account of their use in investment treaty cases.

Q: What do you think about the investment authorization clause?

A: As to the idea that changes in the regulation can automatically give rise to a claim, it is almost like incorporating a stabilization clause into the treaty. In practice, significant changes in regulation that have an effect on the investment but not elsewhere would still, even under normal BITs, give rise to a claim. I am not sure how much more this would add, but investors would be very happy with it. I cannot see states ever agreeing to any investor being given the benefit of an automatic full stabilization clause. It is a very special right given to big investors in huge, long-term, capital-intensive projects. I would be very surprised to see a state accept it.

Q: My question is about transparency in international arbitration. Most of the cases are closed to the public, and sometimes we do not even know the existence of the cases. On the other hand, there is a tendency to open up investor-state arbitration, such as the amendment of the ICSID arbitration rules. What do you think about these tendencies? How do you see the investor-state arbitrations: is this a new hybrid type?

A: The last part of your question is quite right: this is a hybrid arbitration. It is non-subjects of international law being able to bring claims against subjects of international law, under international law. It has never been seen before. These claims have always been dealt with by way of mixed commissions or by diplomatic protection claims being brought in the past. It is new and developing, and everyone is feeling their way toward a satisfactory definition of what this kind of arbitration is, in contradistinction to an ordinary commercial arbitration. They are not the same. For a start, they are under international law. Secondly, they involve state responsibility. Thirdly, the result of that is public and taxpayer interest in them. Therefore a middle ground has to be found.

When acting in UNCITRAL arbitrations, it is the state that wants secrecy. The investor would rather it be publicized, so that the state feels under pressure.

Investment arbitration creates real jurisprudence: it is beginning to be a homogenous body of jurisprudence that can even create international law. It is no longer acceptable to think this is just a purely private case which has no implication beyond its four corners. I do not know where it will end up, but it will not stay where it is now.

Q: What is the relationship between China and the United States in this field?

A: None. There is no investor protection treaty between China and the United States.

A: (Dr. Kotera) I will make some brief comments. The Chinese government proposed concluding a BIT with the U.S. in the early 1990s, but the U.S. claimed that the BIT should be of a very high standard including the securing of national treatment. The Chinese government refused to accept the U.S. demands, so ultimately the proposals were in vain and there have been no agreements between the two countries.