TREATY SHOPPING: LAW AND PRACTICE IN THE GLOBAL BUSINESS LAW

There is a strong relationship between foreign investment and economic growth. Larger inflows of foreign investments are needed for the country to achieve a sustainable high trajectory of economic growth.[1]

Post Second World War, the countries were trying to reconstruct themselves, financially and commercially. Commercially the nations, especially the ones that had lost opted to increase trading activities and investments with other countries of the world. For this purpose they required regulatory institutions and rules governing the same. Therefore, the Bretton Woods Conference was held. The Bretton Woods Conference aimed at giving effect to three institutions for commercial and financial development across nations after the Second World War. These three institutions were the International Trade Organization (ITO), The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD). Out of the three aforementioned, only two, which were the IMF and IBRD, came into existence. However for the purposes of functioning of the ITO, the Havana Charter of 1948 was formulated which contained the rules relating to international trade and investment.[2] Although the Havana Charter could not see the light of the day, the General Agreement on Tariffs and Trade (GATT) was formulated at a later point of time which was a truncated version of the Havana Charter.[3] In the year 1994, when the World Trade Organisation was established, it was in the Agreement establishing the World Trade Organisation wherein GATT was enlisted in Annex 1A.

The World Trade Organisation and the agreements enlisted in the Agreement establishing the World Trade Organisation did not dedicate any specific agreements or rules relating to investment exclusively. Only matters relating to trade and validity of various tariff barriers of countries signatory to GATT was being supervised by the WTO. Investment related measures found mention in GATS, TRIMS, TRIPS and the Plurilateral Trade Agreement regarding Agreement on Government Procurement.

The aforementioned framework focused mostly on trade with sparing discussion on investments. But the need of the nations, especially the capital exporting nations, was to invest profitably in other nations of the world with adequate protection for the same. Such need came to be addressed through the agreements that nations then entered among themselves.

The Bilateral Investment Treaties (BITs) are a kind of such agreements and eventually became the most important source of international investment law. Everyday more and more BITs are being concluded between nations, be it between developed and developing nations or between developing and other developing nations.[4] Among other things, a BIT provides protection to the investment of investors from one of the contracting states in the other contracting state.[5] However, such investments and investors have to be within the scope of definition in the specific BITs in order to avail of the protection. The BITs also have detailed substantive provisions relating to protection of investments and investors. Typically these contain: a provision on admission of investments, a guarantee of fair and equitable treatment, a guarantee of full protection and security, a guarantee against arbitrary and discriminatory treatment, a guarantee of national treatment and a guarantee of most-favoured nation treatment, guarantees in cases of expropriation, and guarantees concerning free transfer of payment.[6] Therefore conventionally a BIT can be said to be a treaty between two countries that is aimed at protecting investments made by both countries.[7]

Although empirically there seems to be a lack of evidence as to a direct relation between bilateral investment treaties and the rate of foreign direct investments[8], it cannot however be ruled out that apart from attractive tax regimes, an investor also seeks to be protected with a standard of protection guaranteed by the host country such that the domestic laws of the host countries do not lead to an investor losing his investments altogether therein for reasons relating to expropriation by the host state or denial of adequate compensation to the investor as a consequence of such expropriation. However the cornerstone of such standard of treatment remains in the provisions that allow an individual investor to bring cases against host states if the latter’s sovereign regulatory measures are not consistent with the BIT.[9]

Therefore, a bilateral investment treaty imposes conditions on the regulatory behaviour of the host state and thus, limits interference with the rights of the foreign investor.[10]

Every nation has its own model Bilateral Investment Treaty which is then negotiated with the other contracting nations and clauses are framed. In the drafting of a bilateral investment treaty, a clause that is often used by most countries is that of this most-favoured-nation treatment. The most-favoured-nation clause (MFNC) is a clause that finds mention in Article I of GATT[11] has traditionally been the foundation of the WTO system for reciprocal facilitation of trade.[12] After the Havana Charter back in 1948[13], however, the concept was borrowed and the clause became popular in international investment agreements. These days, an international investment agreement seldom exists without the inclusion of the “most-favoured-nation clause”. Although it is offered on specific treaties, its operation largely depends on the identification of standards of treatment in other treaties so that the best standard offered could be determined. That best standard would then be afforded to the foreign investor through the operation of the most-favoured-nation standard of treatment.[14]

Article I of General Agreement on Tariffs and Trade lays down General Most Favoured Nation Treatment (most-favoured-nation clause). It lays down that:

  1. With respect to customs duties and charges of any kind imposed on or in connection with importation or exportation or imposed on the international transfer of payments for imports or exports, and with respect to the method of levying such duties and charges, and with respect to all rules and formalities in connection with importation and exportation, and with respect to all matters referred to in paragraphs 2 and 4 of Article III,* any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties.[15]

The most-favoured-nation clause (MFNC) is a clause that finds mention in Article I of GATT[16] has traditionally been the foundation of the WTO system for reciprocal facilitation of trade. After the Havana Charter back in 1948[17], however, the concept was borrowed and the clause became popular in international investment agreements. These days, an international investment agreement seldom exists without the inclusion of the “most-favoured-nation clause”.  There is a wide variety of standards of treatment provided in the bilateral investment treaties, meted out by host nations to their investing nations. These include national treatment, a fair and equitable standard of treatment, an international minimum standard of treatment and full protection and security.

In addition to the aforementioned, another standard of treatment that is enlisted in most treaties is that of the most-favoured-nation standard of treatment. Although it is offered on specific treaties, its applicability is mostly in importing standards of treatment in other treaties so that the best standard offered could be used by the investor to its benefit. That best standard would then be afforded to the foreign investor through the operation of the most-favoured-nation standard of treatment.[18]

Article II of the GATT lays down the national-treatment-clause. The most-favoured-nation clause combined with the National-Treatment provision, provides for an indirect standard of protection that attempts to provide an equal playing field between investors and therefore decreases the economic distortions in a host country.[19]

To further understand the interpretation of the most-favoured nation clause by arbitral tribunals certain cases can be referred to. One of the oft discussed cases is that of White Industries Australia Limited vs. Republic of India, 30th November, 2011 (final award). In 1989, an Australian mining company called White Industries, invested in India through a long-term contract with Coal India Ltd. for supply of equipment for development of coal mine in India. Eventually a dispute arose between the parties relating to bonus and penalty payments, wherein Coal India Limited contended that White Industries had violated contractual standards relating to quality of coal produced among other things. This dispute prompted White Industries to commence arbitral proceedings under the ICC Arbitration Rules, 1999. The ICC Tribunal by a majority decision awarded a hefty compensation in May, 2002 to be paid to White Industries by Coal India Ltd. Around the same time when White Industries sought to enforce the ICC Award in the New Delhi High Court, Coal India Ltd. sought to set aside the ICC Award under the Arbitration and Conciliation Act, 1996 before the Calcutta High Court. Since the aforementioned proceedings had significant delays, White Industries appealed to the Supreme Court, which in turn was even more long drawn. Eventually, in 2010, White Industries commenced arbitration proceedings against India under the India-Australia BIT of 1999 claiming inordinate delay in enforcement of award which allegedly resulted in breach of the provisions of fair and equitable treatment, expropriation, MFNC and free transfer of funds.[20]

The arbitration which was initiated by White Industries alleging violation of the India-Australia BIT was conducted as per the UNCITRAL Rules of Arbitration in Singapore by an ad-hoc Tribunal, wherein India contended that the mining contract entered into by White Industries and Coal India Limited did not fall within the definition of investment and therefore, India had not violated the provisions of the 1999 BIT. However, the Tribunal held the Government of India liable for violating the effective means standard of protection of asserting claims and enforcing rights under MFNC.

The Tribunal while interpreting the most-favoured nation clause favoured the contention by White Industries regarding the import of the effective means standard of protection from Article IV (5) of the India-Kuwait BIT. The Tribunal went on to interpret that for any “means” of asserting claims or enforcing rights to be effective, it must not be subject to indefinite or undue delay, as it amounts to denial of access to “means”. Therefore, since there was delay by Indian courts in redressing, through the most-favoured nation clause in the India-Australia BIT, effective means standard of protection was violated. The most-favoured nation clause presupposes that the nation to whom such a privilege has been conferred will not be treated any less favourably than other nations with whom the host country has trade relations with. Therefore in absence of any universal rules of interpretation of BITs as to the application of MFNC to substantive or procedural provisions, the MFNC was interpreted to import benefits from other BITs which were favourable to White Industries.

This was incidentally the first Investment Treaty Arbitration (ITA) tribunal award issued against India.[21] India lost the investment treaty dispute to an Australian company whereby they challenged the inordinate delay by Indian courts to enforce a foreign award. The ITA tribunal held India guilty of violating a provision even when the India-Australia BIT did not include such a duty for host states. However, the tribunal decided that White Industries could borrow the provision from the India-Kuwait BIT by relying on the MFN provision of the India-Australia BIT.[22]

This behaviour of claiming benefits by an investor from a treaty between the host nation and a third country in the garb of interpreting the MFNC is called as treaty shopping. Unfortunately, India was not the only country that fell victim to the practice of treaty-shopping. In the case of Maffezini vs. Spain[23] and Tza Yap Shum vs. Peru[24], the most-favoured-nation treatment clause was invoked in order to benefit from a better dispute-settlement provision from a treaty that was made by the respondent state with a third state. Incidentally the decision in Maffezini vs. Spain also went on to be confirmed in Ross-Invest vs. Russia (2007). However, a line of awards have raised questions on the reasoning in Maffezini on the ground that arbitration required a clear and unambiguous consent and not consent through construction of treaty terms.[25]

 

The arbitration in Emilio Agustin Maffezini vs. Kingdom of Spain[26] was conducted as per ICSID Rules of Procedure for Arbitration Proceedings. Maffezini had invoked the MFNC in the Argentina-Spain BIT in relation to the clause pertaining to dispute resolution that mandated the exhaustion of local remedies. In other words, the dispute resolution clause in the BIT required that a dispute between investor and State be referred to the courts of host state before it could be brought to international arbitration. When the arbitration was initiated before the ICSID Tribunal, Spain challenged ICSID jurisdiction and contended that as required by the BIT in question, the investor was to submit the claim to Spanish courts first. However, the investor here invoked the MFN clause and sought to go for the ICSID arbitration before exhaustion of remedies. This was upheld by the ICSID Tribunal, as the MFNC in Argentina-Spain BIT allowed the investor to invoke favourable provisions in Chile-Spain BIT where there was no requirement to seek local remedies prior to recourse to international arbitration. Such an arrangement in Chile-Spain BIT was favourable to the investor in Argentina-Spain BIT who sought for this international arbitration. Eventually the Tribunal deciding in favour of the investor found Spain liable for the breach of the BIT in question.

In BITs, usually an MFN Clause reads as follows:

In “all matters” subject to this Agreement, MFN treatment shall not be less favourable than that extended to investors of third country.

The Tribunal went on to decide that MFN clauses could even undermine dispute resolution clauses negotiated in treaties, if investors were permitted to rely on more favourable provisions granted in third party. Spain however countered by arguing that the reference in MFN Clause to “matters” in Arentina-Spain BIT referred only to substantive or material aspects of treatment granted such as regarding entry norms and national treatment, and could under no circumstance extend to procedural or jurisdictional question. Spain went on to argue that to bypass requirements of exhaustion of local remedies by invoking MFNC and importing provisions from third party agreements was a violation of fundamental rule of international law[27] because a BIT is the result of negotiation by the parties at the time of its adoption.

The ICSID Tribunal thereafter laid down that even if dispute resolution clauses were not expressly covered under the MFNC[28], dispute settlement arrangements were inextricably related to the protection of foreign investors and in such a case, MFNC must also cover enforcement of procedural rights in BITs. The award in Maffezini vs. Spain was confirmed in another arbitration case of Siemens A.G. v. Republic of Argentina.[29]

Law relating to investments comprises of rules that regulate investment. Such a body of rules could be domestic law of the host country or could be international law. Since bilateral investment treaties cannot only be interpreted through the domestic laws of the host countries, general principles of international law and its sources may be referred to, for interpreting such treaties, due to the sheer lack of uniformity or universality in laws governing investment agreements across all nations of the world and which is binding on all.

In the context of the adjudicatory framework, Article 38(2) of the statute of ICJ, treaties have been mentioned as a source of international law.

If such BITs were expressly submitted to be interpreted by the VCLT and the general principles of international law, such rules may apply. However, in absence of such express submission, discretion of arbitration tribunals other multilateral agreements can be referred to for interpreting the same.

In the past there were attempts that had been made by nations to conclude a multilateral agreement on investment, but for various reasons including the ones where the clauses of such agreements served the interests of capital-exporting developed countries more than the capital-importing developing countries, these agreements did not materialise. The closest these negotiations came to was when the ICSID Convention was drafted. Even though ICSID Convention was ratified by many nations, it remained a procedural convention that provided rules regarding setting up of dispute settlement machinery through arbitration including the rules regarding admissibility of a dispute for settlement. Although ICSID was primarily aimed at building substantive principles for investment protection, the interpretation of Bilateral Investment Treaties was not dealt with exhaustively. Furthermore, because of an investor-friendly take, it led to Bolivia and Ecuador to withdraw from ICSID at a later point of time. The lack of universality in the rules of interpretation, of BITs and its clauses that deal with standard of protection for investment in host countries, has made the position of host countries vulnerable. Apart from the ICSID Convention, there has been an increasing practice to negotiate free trade agreements out of which some are bilateral and some regional, such as, NAFTA, ASEAN framework Agreement on Investments, Mercosur Agreement, which also provide for investment protection along with dispute settlement mechanisms to facilitate free movement of investment across the signatory nations. But to have common standards of protection and their interpretation across divergent treaties is highly unlikely, which further contributes to the varying standards of interpretation by different compensation tribunals.[30]

In fact many governments have expressed concerns about the uncertainty linked to the perceived inconsistency of treaty interpretation in Investor-State dispute settlement (ISDS).[31]

After the favourable award for the investor in White Industries case, a floodgate of arbitration notices were sent to India claiming relief under MFNC by various investors.[32]

India realized that the arbitrary interpretation of the MFNC by arbitral tribunals was a risk that India could ill-afford considering the financial condition of the country. Therefore, in August 2015, India sought to review and revise its model BIT. The 260th Report of the Law Commission of India in August 2015 thereby did away with the most-favoured nation clause altogether.

The recommendations by the Law Commission of India[33] were prospective in nature[34] and could not prevent India from being sued based on the previous BITs. Therefore the decision to terminate BITs and adopt a state-friendly Model BIT was a reaction to India being sued by several foreign investors before international arbitration tribunals. The government concluded that these claims were an outcome of India’s badly designed BITs, signed in the 1990s and 2000s that were based on a laissez faire template.[35]

However, the question still remains that if the removal of the most-favoured nation clause (MFNC) the solution to all problems relating to foreign investments?

Foreign direct investments are important to a country’s economy. To ensure an attractive investment climate consistent macroeconomic policies, good governance, economic stability, guarantee of property rights, rule of law and absence of corruption must be ensured. Consistency and predictability in economic policies and political stability are preconditions to attract FDI.[36] However, investors want more than just a lenient tax regime and other favourable investment options in the host country, as this can change with the change in domestic laws and regulatory freedom of a sovereign nation. The investors want a reasonable protection for their investment in the host countries and for which they can hold the host country accountable for, through the means of a treaty obligation.

With the removal of the MFNC, India’s model BIT fails to create a balance between the interests of investors and that of the host country. The intended use of MFNC is to afford better competition conditions and not for overriding negotiated arrangement.[37]

One of the glaring proofs that removal of the MFNC has done more damage, than mere salvaging India from litigation-happy investors, is the fact that India and USA do not have a BIT yet despite having done rounds of negotiations on a mutually agreed BIT.[38] According to Rossow- India’s revisions to its model BIT, however, cut more deeply. The two changes raised most frequently include removing the principle of “Most-Favoured-Nation” and making it much more difficult, both in terms of time and process, to initiate arbitration. Clearly there are deep differences between our models. There is certainly middle ground. But to find that middle ground, both sides will have to break from their model in some areas. This will require the kind of senior-level leadership in our economic relationship that we have seen applied to our defence relationship. And it will need a clear articulation of the relative benefits to each side in concluding a quality BIT. India needs to generate investor confidence.[39]

Treaty-shopping, done by foreign investors, to invoke benefits from other treaties, for a favourable treatment, is a practice that has cost host nations a fortune over the years. Through effective drafting of such bilateral investment treaties and better conduct of judiciary in treating such investment dispute cases, such practice can be avoided. Additionally, such effective drafting would also prevent a tribunal from extending the process by constructing consent to its jurisdiction, undermining consent of the parties as the basis of arbitration.[40]


This Article is written by Asst. Prof. Anwesha Pal working as an Assistant Professor of Law at KIIT School of Law, KIIT Deemed to be University Bhubaneswar.


References:

[1] Nimal Sanderatne, The importance of Foreign Direct Investment: Imperatives for Economic Development, Columns- The Sunday Times Economic Analysis (May 29, 2011) Available at: http://www.sundaytimes.lk/110529/Columns/eco.html.

[2] U.S. Department of State Archive, Bretton Woods Conference, 1944. Available at:  https://2001-2009.state.gov/r/pa/ho/time/wwii/98681.htm

[3] M. Sornarajah, The International Law on Foreign Investment, 262 (Cambridge University Press 3rd edition 2012)

[4] Prabhash Ranjan, India and Bilateral Investment Treaties, (OUP, 1st edition, 2019)

[5] See, M. Sornarajah, The International Law on Foreign Investment, (Cambridge University Press 3rd edition 2012)

[6] In a BIT the protections afforded to foreign investors are multifarious. These protections include: rights against “expropriation”, both direct and indirect, of an investors’ investment; and a Most Favoured Nation (MFN) provision, which guarantees an investor a treatment not less favourable than a treatment afforded to any other investor claiming rights under any other BIT. See: Rudolf Dolzer and Christoph Schreuer, Principles of International Investment Law, (Oxford University Press, 2nd edition 2012)

[7] Prabhash Ranjan, Harsha Vardhana Singh, Kevin Jarnes, Ramandeep Singh, “India’s Model Bilateral Investment Treaty: Is India too risk averse?” Brookings India, Impact Series No. 082018, 5 (August, 2018)

[8] Dr. Prabhash Ranjan, Building confidence, BIT by BIT, The Hindu (June 19, 2019) Available at: https://www.thehindu.com/opinion/op-ed/building-confidence-bit-by-bit/article28067297.ece

[9] Prabhash Ranjan, Harsha Vardhana Singh, Kevin Jarnes, Ramandeep Singh, “India’s Model Bilateral Investment Treaty: Is India too risk averse?” Brookings India, Impact Series No. 082018, 5 (August, 2018)

[10] Ibid

[11] General Agreement on Trade and Tariffs is an agreement entered by many countries for promotion of trade and commerce across borders by reducing or eliminating trade barriers such as tariffs and quotas on a reciprocal and a mutually advantageous basis. It was signed on 30 October 1947, and took effect on 1 January 1948. However, The World Trade Organisation being a successor of GATT, the GATT Text has been modified under the WTO framework and is now available as GATT 1994.

[12] Alejandro Faya Rodriguez, The Most-Favored-Nation Clause in International Investment Agreements:  A Tool for Treaty Shopping? 25(1) Kluwer Law International  Journal of International Arbitration: 89–102 (2008)

[13] The Havana Charter of 1948 for the International Trade Organization (ITO), which was supposed to have come into existence after the Second World War contained provisions on investment in Articles 11 and 12. GATT contains a part of this Havana Charter which had originally envisaged the rules relating to the International Trade Organization which failed to come into existence. See, M. Sornarajah, The International Law on Foreign Investment, 262 (Cambridge University Press 3rd edition 2012)

[14] M. Sornarajah, The International Law on Foreign Investment, 200 (Cambridge University Press 3rd edition 2012)

[15] The original text of GATT, General Agreement on Tariffs and Trade, The Text of the General Agreement, Geneva, July 1986

[16] General Agreement on Trade and Tariffs is an agreement entered by many countries for promotion of trade and commerce across borders by reducing or eliminating trade barriers such as tariffs and quotas on a reciprocal and a mutually advantageous basis. It was signed on 30 October 1947, and took effect on 1 January 1948. However, The World Trade Organisation being a successor of GATT, the GATT Text has been modified under the WTO framework and is now available as GATT 1994.

[17] The Havana Charter of 1948 for the International Trade Organization (ITO), which was supposed to have come into existence after the Second World War contained provisions on investment in Articles 11 and 12. GATT contains a part of this Havana Charter which had originally envisaged the rules relating to the International Trade Organization which failed to come into existence. See M. Sornarajah, The International Law on Foreign Investment, 262 (Cambridge University Press 3rd edition 2012)

[18] M. Sornarajah, The International Law on Foreign Investment, 200 (Cambridge University Press 3rd edition 2012)

[19] Alejandro Faya Rodriguez, The Most-Favored-Nation Clause in International Investment Agreements:  A Tool for Treaty Shopping? 25(1) Kluwer Law International  Journal of International Arbitration: 89–102 (2008)

[20] White Industries Australia Limited vs. Republic of India, 30th November, 2011

[21] Prabhash Ranjan, India and Bilateral Investment Treaties: A Changing Landscape, 29(2) ICSID  Review-Foreign Investment  Law Journal (Oxford  University  Press),  (2014)  at page 25

[22] Ibid

[23] (2000) 5 ICSID Reports 396

[24] ICSID Case No. ARB/07/6, Decision on Jurisdiction and Competence, 19th June, 2009

[25] Plama vs Bulgaria (2005) 44 ILM 721

[26]  (ICSID Case NO. ARB/97/7), where the final award was given in the year 2000.

[27] Article 26: Pacta sunt servanda: VCLT, 1969

[28] As is the case in UK-Albania BIT where the MFNC expressly covers dispute resolution clause.

[29] ICSID Case No. ARB/02/8.

[30] See, M. Sornarajah, The International Law on Foreign Investment, 204, 322 (Cambridge University Press 3rd edition 2012)

[31] State-to-State dispute settlement and the interpretation of investment treaties, OECD Working Papers on International Investment, available at: https://www.oecd-ilibrary.org/finance-and-investment/state-to-state-dispute-settlement-and-the-interpretation-of-investment-treaties_5jlr71rq1j30-en

[32] Dr. Prabhash Ranjan, Building confidence, BIT by BIT, The Hindu (June 19, 2019) Available at: https://www.thehindu.com/opinion/op-ed/building-confidence-bit-by-bit/article28067297.ece

[33] In the Law Commission of India Report No. 260, August 2015

[34] Anirudh Krishnan , A bit for the state, a bit for the investor, The Hindu (September 8, 2015) Available at: https://www.thehindu.com/opinion/op-ed/a-bit-for-the-state-a-bit-for-the-investor/article7625893.ece

[35] Dr. Prabhash Ranjan, Building confidence, BIT by BIT, The Hindu (June 19, 2019) Available at: https://www.thehindu.com/opinion/op-ed/building-confidence-bit-by-bit/article28067297.ece

[36] Nimal Sanderatne, The importance of Foreign Direct Investment: Imperatives for Economic Development, Columns- The Sunday Times Economic Analysis (May 29, 2011) Available at: http://www.sundaytimes.lk/110529/Columns/eco.html..

[37] Prabhash Ranjan, Harsha Vardhana Singh, Kevin Jarnes, Ramandeep Singh, “India’s Model Bilateral Investment Treaty: Is India too risk averse?” Brookings India, Impact Series No. 082018, 5 (August, 2018)

[38] The on-going BIT negotiations with the US are an exception to this, primarily because US is quite keen to have a high-end BIT with India – PTI (5 August 2013), ‘India US Completes Three Rounds of Negotiations for BIT’, The Economic Times, Available at: http://articles.economictimes.indiatimes.com/2013-08-05/news/41093194_1_india-us-trade-policyforum-three-rounds-treaty as cited from: Prabhash Ranjan, India and Bilateral Investment Treaties: A Changing Landscape, 29(2) ICSID Review –Foreign Investment Law, Journal (Oxford University Press) (2014)

[39] Richard M. Rossow, U.S.-India Insight: Do Not Give Up on the Bilateral Investment Treaty, Newsletter by Center for Strategic and International Studies November 28, 2017

[40] M. Sornarajah, The International Law on Foreign Investment, 204, 322 (Cambridge University Press 3rd edition 2012)

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