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A BIT of protection

Feature Articles

Cite as: (2009) 83(02) LIJ, p. 38

Bilateral investment treaties (BITs) are an increasingly popular source of substantive rights for foreign investors.

By Beth Cubitt and James Clark

Bilateral investment treaties (BITs) are similar to bilateral and regional free trade agreements, which may contain foreign investment provisions. However, the investor protections afforded by BITs are typically more extensive and impose higher standards of conduct. This type of international instrument has been traditionally neglected in Australia. This article gives a basic outline of BITs and the main rights they confer, and canvasses some of the difficulties associated with successfully asserting those rights.

Features of BITs

BITs are agreements between nation states that establish a framework of fundamental investor protections. At their core is a desire to encourage foreign direct investment.

BITs perform both normative and protective functions. By guaranteeing certain fundamental rights for foreign investors, BITs permit foreign investors to make a more informed assessment of their investment risk. They also provide foreign investors with mechanisms for enforcing those rights – typically via international arbitration.

BITs impose obligations on the host state that prevent distortion of investors’ risk calculations and market assumptions.1 That distortion might arise as a consequence of legal or regulatory change (potentially leading to the expropriation of investments), or an ineffective or inefficient judicial system. BITs empower foreign investors to redress that imbalance, enforcing “their own treaty-generated substantive rights by initiating international arbitral proceedings directly against the host state”.2

Australia has concluded BITs with European, American and Asian states. These treaties provide reciprocal protections for the encouragement of foreign investment.3 Although they vary in content, common provisions impose minimum standards – fair and equitable treatment, most-favoured-nation treatment, national treatment, and full protection and security – and contain umbrella clauses and guarantees against the expropriation or nationalisation of investments. These common provisions are discussed below.

Fair and equitable treatment

“Each party shall ensure that investments are accorded fair and equitable treatment.”4

This provision has been a feature of most BITs since 1948.5 Although common, the standard of conduct it imposes remains unclear. The normative standard of treatment is absolute,6 and not relative to the host state’s treatment of its own nationals or investors from other states. It is inherently flexible,7 leaving arbitrators with a measure of discretion as to how it should be applied,8 but investors face uncertainty about what rights it will actually confer.

Tribunals have invoked the fair treatment standard to grant investors protection in cases of “wilful disregard of due process of law, an act which shocks, or at least surprises, a sense of judicial propriety”.9 Typically, this involves disallowing “improper and discreditable” conduct by the host state and discrimination against foreigners.10 The standard thus ensures transparency, prevents arbitrariness and injustice, and upholds investors’ legitimate expectations;11 freedom from coercion and harassment;12 procedural propriety and due process;13 and good faith.14

In Loewen Group Inc v United States,15 a Canadian funeral services company claimed it was forced into settlement by a Mississippi jury’s award against it of $500 million (the largest damages award in the state’s history). The company contended that the trial was prejudiced against it, as the trial judge had permitted the claimant’s counsel to make “extensive irrelevant and highly prejudicial references” to “[Loewen’s] foreign nationality . . . race-based distinctions . . . and class-based distinctions”. Further, the trial judge refused to direct the jury that such discrimination was impermissible.16 Loewen alleged that the jury award and the appeal process breached the fair treatment standard under art 1105(1) of the North American Free Trade Agreement (NAFTA).17

The tribunal (see “Resolution of disputes under BITs” below), presided over by Sir Anthony Mason, concluded that “the conduct of the trial by the trial judge was so flawed that it constituted a miscarriage of justice amounting to a manifest injustice as that expression is understood in international law”.18 However, despite acknowledging unfairness towards the foreign investor,19 the tribunal determined that the conduct of the trial court did not violate the fair treatment standard because the US had made adequate remedies reasonably available to the complainants through, for instance, domestic appeal avenues: “In the last resort, a failure by that nation to provide adequate means of remedy may amount to an international wrong but only in the last resort”.20

The tribunal concluded that state responsibility for a breach of the fair treatment standard was only triggered once appeal avenues had been exhausted. This case highlights the value of the fair treatment standard, while also underscoring the inherent uncertainty of what such abstract principles can mean when fixed within particular factual and legal circumstances.

Umbrella clauses

“Each Contracting Party shall observe any obligation it may have entered into with regard to investments of investors of the other Contracting Party.”21

So-called “umbrella clauses” have given rise to a great deal of debate, focused on whether the clauses elevate simple breaches of contract to treaty breaches. This divide is explained in Société Générale de Surveillance SA v Islamic Republic of Pakistan,22 where the tribunal concluded that umbrella clauses cannot extend BIT protection to any ordinary breaches of contract, but that the tribunal would have jurisdiction over claims that contractual rights had been violated where “the State interferes with contractual rights by a unilateral act . . . in such a way that the State’s action can be analysed as a violation of the standards of protection embodied in a BIT”.23

Expropriation

“Neither Party shall nationalise, expropriate or subject to measures having effect equivalent to nationalisation or expropriation . . . the investments of investors of the other Party unless . . . the expropriation is accompanied by the payment of prompt, adequate and effective compensation.”24

Security from expropriation of investments is a fundamental investor protection offered in BITs, almost without exception. This is well illustrated by the dispute between Occidental Petroleum Corporation (Occidental) and the Republic of Ecuador.25 Occidental had been granted the exclusive right to exploit hydrocarbons in an area of the Ecuadorian Amazon under a contract executed with Ecuador in 1999. In 2004, citing alleged breaches of contract, Ecuador issued a caducidad decree, terminating the contract and thereby (allegedly) depriving Occidental of “their interests under the [contract] . . . as well as the benefit of ownership of all their investments in Ecuador”.26

Occidental alleged that the fair market value of the contract was USD $2.705 billion. It claimed that Ecuador terminated the agreement as a retaliatory measure in response to Occidental’s success in a BIT arbitration against Ecuador in 2004 for unfair changes to the tax law.27

Resolution of disputes under BITs

A key feature of BITs, and investment protection generally, is the establishment of mechanisms for the settlement of investment disputes. Such mechanisms are fundamental to an investor’s ability to hold a state to the standards of conduct and treatment prescribed by BITs. Treaties commonly refer disputes either to ad hoc arbitration, or to arbitration before the International Centre for the Settlement of Investment Disputes (ICSID).

ICSID was established in 1966 by the Convention on the Settlement of Investment Disputes between States and Nationals of Other States.28 In the period from 1987 to 1998, ICSID heard 14 BIT-related cases. It has since heard at least 160 more. Two-thirds of the 259 known international investment claims were filed in the past four years.29

The jurisdiction of ICSID is outlined at art 25(1) of the Convention, and extends to legal disputes arising directly out of investments between a contracting state and a national of another contracting state. As is the case in other arbitral proceedings, the cornerstone of ICSID jurisdiction is the parties’ consent. Standing consent is frequently given under BITs. For instance, the Chile–Australia BIT allows the investor to elect between ICSID or ad hoc arbitration under United Nations Commission on International Trade Law (UNCITRAL) Rules. Should the investor choose to proceed to ICSID arbitration, then “each Contracting Party hereby gives its prior consent to submission of the dispute to ICSID”.30

Other BITs require the consent of the host state to any attempt by a foreign investor to refer a dispute to ICSID.31

In general, the ICSID rules reflect existing arbitral procedure. The arbitration follows a two-stage process, entailing a written procedure (during which memorials are exchanged), followed by an oral hearing.32 The tribunal may determine issues of its own jurisdiction and provide interim measures.33 Its award will usually include financial compensation for a breach of the BIT in question. The resulting award is binding on the parties and its enforcement is mandated by art 54 of the Convention.

Conclusion

Australian corporations investing offshore should consider any BITs that Australia has concluded with their investment’s host state, and whether their affairs can be structured to ensure that they have access to any substantive rights existing under BITs. Recourse to those rights may be a matter of last resort. However, as investment treaty arbitral activity steadily increases, so too does the guidance given by tribunals as to the content and application of investor protections. That added certainty will contribute to investor confidence offshore and to greater accessibility of BIT investor protections.


BETH CUBITT is a senior associate at Mallesons Stephen Jaques, practising in construction and international arbitration dispute resolution. JAMES CLARK is a solicitor at Mallesons Stephen Jaques.

1. Joshua Robbins, “The emergence of positive obligations in bilateral investment treaties” (2006) 13 University of Miami International and Comparative Law Review 403, p404.

2. Robbins, note 1 above, p404.

3. See Department of Foreign Affairs and Trade, The Australian Treaties Database (2008): http://www.info.dfat.gov.au/treaties.

4. Agreement with the Republic of the Philippines on the Promotion and Protection of Investments [1995] ATS 28 (entered into force 8 December 1995), art 3.2 (Australia–Philippines BIT).

5. Organisation for Economic Cooperation and Development, Fair and Equitable Treatment Standard in International Law (2004), p4.

6. Christopher H Schreuer, “Fair and equitable treatment in arbitral practice” (2005) 6 Journal of World Investment and Trade 357.

7. See Mondev International Ltd v United States of America (2002) 67 ICSID Reports 192, [100] (Mondev).

8. However, some states hold legitimate concerns about arbitrator discretion in applying the standard. See OECD, note 5 above, p3.

9. See, e.g., Pope & Talbot v Canada (2001) 7 ICSID Reports 102 (Pope & Talbot).

10. See, e.g., MTD Equity v Republic of Chile (2004) ICSID Case No ARB/01/7 (Award).

11. See, e.g., Tecnicas Medioambientales Tecmed SA v Estados Unidos Mexicanos (2003) ICSID Case No ARB (AF)/00/2 (Award) (TecMed); Metalclad Corp v United Mexican States (2000) 5 ICSID Reports 212 (Award) (Metalclad).

12. See, e.g., Pope & Talbot, note 9 above.

13. See, e.g., Loewen Group Inc v United States (1998) ICSID Case No ARB(AF)/98/3 (Loewen).

14. See, e.g., TecMed (2003) ICSID Case No ARB (AF)/00/2.

15. Loewen, note 13 above.

16. Loewen, note 13 above, at [4].

17. Opened for signature 17 December 1992, 32 ILM 289 (entered into force 1 January 1994).

18. Loewen, note 13 above, at [54].

19. Loewen, note 13 above, at [241].

20. Loewen, note 13 above, at [242].

21. Agreement with Hong Kong concerning the Promotion and Protection of Investments [1993] ATS 30 (entered into force 15 September 1993), art 2(2).

22. (2003) ICSID (W Bank) Case No ARB/01/13 (Decision on Jurisdiction, 27 August 2003).

23. Société Générale de Surveillance SA v Islamic Republic of Pakistan, note 22 above, [84]. See also Société Générale de Surveillance SA v Republic of the Philippines (2004) ICSID (W Bank) Case No ARB/02/6 (Decision on Objections to Jurisdiction, 29 January 2004); El Paso International Company v The Argentine Republic (2006) ICSID Case No ARB/03/15 (Decision on Jurisdiction, 27 April 2006).

24. Agreement between Australia and Uruguay on the Promotion and Protection of Investments [2003] ATS 10 (entered into force 12 December 2002), art 7.

25. Occidental Petroleum Corporation and Occidental Exploration and Production Company v Ecuador (2006) ICSID Case No ARB/06/11 (US/Ecuador BIT). The tribunal delivered its award on jurisdiction on 9 September 2008.

26. See Occidental Petroleum Corporation, Request for Arbitration (17 May 2006).

27. Occidental (2004) LCIA Case No UN3467 (US/Ecuador BIT) (Final Award) at [178].

28. Opened for signature 18 March 1965, 575 UNTS 159, 4 ILM 532 (entered into force 14 October 1966) (the Convention).

29. United Nations Conference on Trade and Development, Investor–state dispute settlement and impact on investment rulemaking (Paper presented at Geneva, September 2007), p7.

30. Agreement with the Republic of Chile on the Reciprocal Promotion and Protection of Investments [1999] ATS 37 (entered into force 16 September 1999), art 11(2)(b)(i).

31. See, e.g., Australia–Philippines BIT, note 4 above.

32. See ICSID Arbitration Rules ch IV.

33. See ICSID Arbitration Rules ch V.

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