Source: https://iclg.com/practice-areas/investor-state-arbitration-laws-and-regulations/3-substantive-protections-in-investment-law
Timestamp: 2019-04-20 10:51:28+00:00

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Investment treaty arbitration is a relatively new but rapidly expanding forum for the resolution of international disputes. It allows investors that do business in foreign countries to seek recourse against the governments of those countries for serious interference with their businesses. The operative legal instrument creating this remedy is an investment protection treaty, if one exists, ratified by the home State of the investor and the host State of the investment. Investment protection treaties set out the substantive protections that are available to qualifying investors. They also allow investors to refer their claims against the host State government to international arbitration. While the precise scope of the protection available to an individual investor depends on the language of the specific treaty, some basic commonalities can be discerned from the general body of jurisprudence in this area. This note offers a primer on key investment protections available in investment treaty law.
At its core, expropriation is the taking of private property by a government acting in its sovereign capacity. The basis of this legal claim is the taking itself, as opposed to the reasons for the taking. Whether or not an investment is expropriated for the benefit of the State, whether it is destroyed (rather than taken), or whether the taking was intentional, is of little consequence. The threshold question is whether the subject government measure deprives an affected investor of all meaningful benefits or of its rights in the investment.
Expropriation can take the form of either a direct taking or indirect taking. While direct expropriation covers outright seizures, indirect expropriation encompasses acts that, without divesting the investor of its formal property rights, affect its control or enjoyment of the investment. Indirect expropriations can be effected through a wide range of governmental actions. For example, indirect expropriations can take the form of the following: (a) interference with business operations of the investment in the host State (CME v. Czech Republic); (b) interference with the management of the investment in the host State (Biloune v. Ghana); (c) intervention with the investor’s marketing of its products through fixing of sales prices (Benvenuti v. Congo); and (d) revocation or denial of government permits necessary for the company’s business (Middle East Cement v. Egypt). Expropriation provisions in many bilateral investment treaties also encompass measures that are “tantamount to” or “equivalent to” expropriation. Tribunals are not uniform in their views as to the precise import of those terms. Some tribunals have held that they expand the scope of the protection (Waste Management v. Mexico) and others have found that they merely represent another way of referring to indirect expropriation (Pope & Talbot v. Canada). Ultimately, however, the meaning of these words will depend, and is to be interpreted, in the context of a specific treaty.
To constitute expropriation, the deprivation of an investor’s rights to use or enjoy the benefits of its property must be: (a) substantial (rather than ephemeral); and (b) of a permanent nature (rather than temporary). To meet the “substantial” requirement, an expropriation must be of a certain magnitude, degree and intensity. Tribunals have found that substantial deprivation has occurred where: (a) the investor’s control over the use and operation of the investment was no longer effective; (b) the raison d’etre of the investment was undermined; or (c) the investor’s rights were rendered so useless that they must be deemed to have been expropriated. Where the interference is not sufficiently substantial, a claim for expropriation will not stand. In Glamis Gold v. United States, for example, Glamis Gold maintained that the United States had expropriated its gold mining rights through a series of federal and local government measures designed to protect Native American lands. Key to the tribunal’s dismissal of the expropriation claim was its analysis of whether Glamis Gold’s mining rights had lost its economic value. The tribunal found that Glamis Gold’s project retained a value in excess of $20 million (out of the alleged $49.1 million prior to the relevant measures), and thus the complained-of measures did not cause a sufficient economic impact to effect an expropriation. The requirement of “permanency” ensures that a deprivation that is only temporary or ephemeral in nature does not qualify as compensable expropriation. In SD Myers v. Canada, for example, the tribunal dismissed a claim for expropriation based on a regulation that lasted for approximately 16 months, holding that the deprivation did not satisfy the “permanency” requirement.
Indirect expropriations may take the form of “consequential” (or regulatory) expropriation or “creeping” expropriation (or both). Consequential expropriation occurs when the taking becomes a consequence of the host State’s failure to maintain an appropriate regulatory framework. A host State may effect expropriatory measures through the enactment of a decree, regulation or legislation that has the effect of depriving an investor of the “use” and “benefit” of his or her investment. For example, in Middle East Cement v. Egypt, the claimant, a Greek investor that set up a business in Egypt to carry out the importation, storage and sale of cement, brought an expropriation claim based on Egypt’s issuance of a decree prohibiting the intended activity. Given that the decree deprived the claimant of the value of its investment, it amounted to an expropriation, even though the claimant retained nominal ownership of its rights in the investment. Similarly, in Kardassopoulos v. Georgia, the claimants held the exclusive rights to operate a pipeline facility in Georgia until the State issued a decree that designated a new, State-owned entity to take over those privileges, thereby preventing the claimants’ use of their rights. The tribunal found that the decree constituted an expropriation because it had extinguished the claimants’ rights in the investment.
Creeping expropriation typically involves a series of acts attributable to the State that, over a period of time, culminate in an expropriatory taking. The distinct feature of this expropriation is that it occurs in the absence of a single decisive act, and instead results from a series of acts and/or omissions that collectively result in a deprivation of property rights. The focus is thus on the cumulative effect of the host State’s acts – not a single stand-alone measure.
Importantly, it is not necessary for the injured investor to establish that the host State intended to expropriate in order for a measure to be deemed expropriatory. Nor must the injured investor show that the expropriatory measure was adopted for the obvious benefit of the host State. It is the effect of the measure on the subject investment that plays the determinative role. As the Metalclad v. Mexico tribunal stated, so long as the “incidental interference with the use of property… has the effect of depriving the owner, in whole or in significant part, of the use or reasonably-to-be-expected economic benefit of property”, an expropriation has occurred.
All types of expropriation – direct, indirect, consequential, and creeping – are equally prohibited by international law, unless they satisfy certain conditions of lawfulness and the investor is properly compensated. The conditions of lawfulness are set out in the relevant treaties, but they typically include requirements that the expropriation was: (a) done for a public purpose; (b) accomplished under due process of law; (c) not discriminatory; (d) accompanied by prompt, adequate and effective compensation, freely realisable; and (e) not violative of any specific contractual engagement. A host State can rely on those conditions of lawfulness to demonstrate that it acted within its sovereign authority and for legitimate purposes and that, therefore, its actions were lawful. Should any of the relevant conditions of lawfulness remain unmet, however, the expropriatory act will be regarded as unlawful.
The Fair and Equitable Treatment (FET) standard is frequently invoked by foreign investors because it may offer relief where facts do not support a claim for expropriation. The ambit of the FET standard is wide, as it is intended to fill in gaps left by other, more specific treaty standards. A former judge of the Iran-US Claims Tribunal, Charles Brower, posited that the term “fair and equitable treatment” is “an intentionally vague term, designed to give adjudicators a quasi-legislative authority to articulate a variety of rules necessary to achieve the treaty’s object and purpose in particular disputes”.
Some treaties qualify the FET standard as an expression of the “minimum standard of treatment” of aliens under international law. This minimum standard of treatment is a set of obligations developed through informal State practice in the 19th and 20th centuries that, generally, impose only minimal restraints on a State’s ability to regulate foreigners and their property within the State’s territory. However, where the treaty giving rise to the FET obligation does not expressly link this obligation to the minimum standard of treatment of aliens under international law, tribunals have tended to interpret the FET obligation under an “autonomous” standard (i.e., one derived from the treaty rather than directly from customary international law). The tribunals addressing such “autonomous” protection have tended to focus on the literal meaning of the provision itself and the context of the relevant treaty.
FET clauses generally refer to “treatment” of investments. “Treatment” refers to the host State’s conduct towards the investment. In other words, all actions by the host State (or those whose actions are attributable to the host State) may give rise to an FET claim if they violate the investor’s right to enjoy “fair and equitable treatment” of their investments.
As noted above, this broad and flexible standard of protection cannot be confined to any one simple definition. The FET standard may be violated by a host State’s: (a) actions that defeat investors’ legitimate expectations; (b) denial of justice and the lack of due process; (c) manifest arbitrariness in decision-making; (d) discrimination; and (e) outright abusive treatment. The hallmark of the FET standard is the protection of the investor’s “legitimate expectations”. This standard of protection was created in recognition of the fact that an investment is not a transient one-off transaction, and therefore there is a risk that the environment within which the investment operates may be changed so substantially with time as to undermine the very reason for that investment.
A host State may violate its FET obligations by reneging on assurances it provided to an investor that informed, and possibly induced, the investment decision. To make a claim for the violation of this standard of protection, an investor has to show that: (a) it had a legitimate expectation that the legal framework it relied upon when making its investment would remain in place; and (b) its expectations were breached by the host State.
The existence of legitimate expectations. This category of protection is based on the overarching principle of good faith, which precludes a host State from promoting an investor’s legitimate expectations and later reneging on the commitments that had given rise to those expectations. Tribunals are, however, split as to what may constitute the foundation for an investor’s “legitimate” expectations.
An investor’s legitimate expectations are based upon an objective understanding of the legal framework within which the investor has made its investment. The legal framework on which the investor is entitled to rely consists of the host State’s international law obligations, its domestic legislation and regulations, as well as the contractual arrangements concluded between the investor and the State.
Many of these tribunals relied on the concept of “stability and predictability” of the legal framework, particularly where the relevant investment protection treaty guaranteed “legal stability” (CMS v. Argentina and LG&E v. Argentina). One tribunal, for example, found that the host State’s change of its tax regime for oil exports had changed the underlying legal and business framework for the investment and, as such, violated the State’s FET obligations (see Occidental v. Ecuador (LCIA Case)).
Second approach: “Legitimate” expectations can be based only on specific representations made by the host State. Tribunals adhering to this school of thought have considered that it is not realistic to require host States to never change their laws. One tribunal in particular has noted that “it is [not] the BIT’s purpose that States guarantee that the economic and legal conditions in which investments take place will remain unaltered ad infinitum” (El Paso v. Argentina). It reasoned that “it is unthinkable that a State could make a general commitment to all foreign investors never to change its legislation whatever the circumstances, and it would be unreasonable for an investor to rely on such a freeze”. Another tribunal explained that “[i]t is each State’s undeniable right and privilege to exercise its sovereign legislative power”, that a host State “has the right to enact, modify or cancel a law at its own discretion [unless a stabilization clause exists]”, and that “any businessman or investor knows that laws will evolve over time” (Parkerings v. Lithuania). A recent tribunal found that a regulatory scheme in reliance on which the investor at issue had made its investment did not represent “specific commitments” by the host State to the investor and, as such, the regulation could not have generated a legitimate expectation that its benefits would not change (Charanne v. Spain). The tribunal concluded that “[t]o convert a regulatory standard into a specific commitment of the state, by the limited character of the persons who may be affected, would constitute an excessive limitation on [the] power of states to regulate the economy in accordance with the public interest” and found that no legitimate expectations existed.
The legitimate expectations of a foreign investor can only be examined by having due regard to the general proposition that the State should not unreasonably modify the legal framework or modify it in contradiction with a specific commitment not to do so.
Another tribunal (Blusun v. Italy) held that, in the absence of specific commitments, a host State may modify its regulation, but that “this should be done in a manner which is not disproportionate to the aim of the legislative amendment, and should have due regard to the reasonable reliance interests of recipients who may have committed substantial resources on the basis of the earlier regime”.
This obligation of a host State to refrain from “unreasonable” modification of its legal framework is premised on the proposition that “legitimate expectations” is an objective concept that is the result of a balancing of interests and rights of both the investors and the host States. Tribunals adopting this middle-ground approach tend to take into account a panoply of factors, including: (a) whether the host State has made any specific representations or commitments to the investor, on which the investor has relied; (b) whether the investor was aware of the general regulatory environment in the host country; and (c) the relative weight of the investor’s expectations as compared to the legitimate regulatory activities of the host State.
Violation of legitimate expectations. When assessing whether a particular complained-of measure constitutes an FET violation, tribunals have taken into account the “proportionality” of the measure. One recent tribunal (Charanne v. Spain) ruled that the proportionality requirement “is satisfied as long as the changes are not capricious or unnecessary and do not...suddenly and unpredictably eliminate the essential characteristics of the existing regulatory framework”. Another tribunal (Eiser v. Spain) explained that the proportionality requirement is “fulfilled inasmuch as the modifications are not random or unnecessary, provided that they do not suddenly and unexpectedly remove the essential features of the regulatory framework in place” (emphasis omitted). Proportionality, accordingly, is to be assessed through the prism of reasonableness of the measure and the magnitude of its effect on the investor’s business. A “total alteration of the entire legal setup” clearly amounts to a violation of the investor’s legitimate expectations (El Paso v. Argentina). Similarly, a host State that “completely dismantl[es] the very legal framework constructed to attract investors” violates the legitimate expectations of investors relying on that framework (LG&E v. Argentina). A disruption of a legal regime upon which the investor relied at the time of investment may also constitute a breach of the investor’s legitimate expectations. For example, one tribunal found a violation of legitimate expectations where the host State stripped the claimants of certain tax incentives “reduc[ing] almost to nothing [the] advantages” of claimants’ investment and violated their legitimate expectations (Micula v. Romania).
Many international instruments include Full Protection and Security (FP&S) provisions designed to protect the security and integrity of an investment. This provision sets out the host State’s guarantee to protect the security and integrity of a qualifying investor’s investment. The scope of this provision is two-fold: (a) it requires host States to refrain from actively interfering with foreign investments; and (b) it imposes on host States an obligation of due diligence and vigilance in protecting investments from the actions of third parties. These two obligations are sometimes referred to as “the duty to abstain and the duty to protect”. The former (duty to abstain) means that the State has a negative obligation to refrain from engaging in actions that may jeopardise the security of investors. The latter (duty to protect) means that the State has an affirmative obligation to protect investors from harmful activities carried out by third parties in its territory and to punish wrongdoers. A violation of the FP&S standard can arise where the host State fails to: (a) prevent damage to a qualifying investment; (b) restore the conditions that existed before the violation; or (c) punish a perpetrator.
Many tribunals have found that, absent a specific indication to the contrary, FP&S clauses are intended to provide protection for both physical and legal security (see Siemens v. Argentina, Azurix v. Argentina, Biwater v. Tanzania, and CME v. Czech Republic), although there are a number of tribunals that have found that only physical protection is covered under FP&S clauses (see Gold Reserve v. Venezuela, Saluka v. Czech Republic, and AWG v. Argentina).
Tribunals also differ on the standard to which host States are to be held. While early tribunals (see, e.g., AAPL v. Sri Lanka) adhered to the view that there is an unconditional obligation to provide absolute, or “full” protection to covered investments, subsequent tribunals adopted a more flexible approach being guided by the obligation of “vigilance” or “due diligence” (AMT v. Zaire, and Wena Hotels v. Egypt). More recently, tribunals have been willing to relax the standard even further and some have adopted a modified standard, which takes into account the host State’s particular circumstances, such as its level of development and stability (Pantechniki v. Albania).
Like protection against illegal expropriation, ensuring fair and equitable treatment, and providing full protection and security, protection against discrimination is one of the cornerstones of international investment law. Investment treaties typically offer two types of protections to foreign investors: (a) protection against discrimination based on nationality; and (b) protection against unreasonable and discriminatory measures that are not limited to nationality-based discrimination.
Protection against nationality-based discrimination. The economic rationale for prohibiting nationality-based discrimination is based on promoting efficient economic exchange and ensuring equality of competitive opportunities for investors regardless of their nationality. There are two different standards that provide for protection against discrimination based on nationality: the obligation to provide national treatment (NT) and most-favoured nation treatment (MFN). Both NT and MFN are relative standards in that they are contingent on the host State’s treatment accorded to other investments. When assessing whether the NT standard has been violated, State treatment of a foreign investment is compared to the treatment the State has accorded for domestic investments. When assessing whether the MFN standard has been violated, State treatment of a foreign investment is compared to treatment the State has accorded to other foreign investments of different nationality.
To demonstrate a breach of either the NT or MFN standard, a foreign investor must prove three main elements: (a) there must be a “treatment” accorded by the host State; (b) the claimant-investor must be in “like circumstances” with either a local investor (for purposes of the NT claim) or a foreign investor of a different nationality (for purposes of the MFN claim); and (c) the host State must treat the foreign investor less favourably than it would treat one of its domestic investors (for purposes of the NT claim) or a foreign investor of a different nationality (for purposes of the MFN claim). Key to proving a breach of either the NT or MFN standard is showing that the foreign investor was in “like circumstances” and was accorded “less favourable treatment” in relation to at least one comparator.
With regard to the first element, the “treatment” accorded by the host State generally refers to the aggregate of measures undertaken by the State that bear on the foreign investor’s business activity in that State. Relevant treatment can be either de jure or de facto.
Common market. The complained-of treatment should be compared to the treatment accorded by the host State to a comparable investment in the same business or economic sector. The compared-to investment, however, need not be identical to the claimant-investor’s investment. In Cargill v. Poland, for example, the tribunal found that the investment and the proposed comparator were in “like circumstances” as both produced sweetener products “used for the confection of beverages...and processed foods”. That Cargill’s products had additional potential uses was of no consequence to the tribunal since prospective comparators need not be in “identical” circumstances. Similarly, the tribunal in Cargill v. Mexico held that producers of high fructose corn syrup and producers of sugar were in “like circumstances” where both participated in the same industry.
Competing products. In assessing “like circumstances”, tribunals frequently consider whether the comparators have invested in businesses that compete in terms of goods or services such that the comparators’ products are “interchangeable and indistinguishable from the point of view of the end-users” (see Corn Products v. Mexico). In Archer Daniels v. Mexico, the tribunal held similarly that the appropriate class of comparators to the claimants’ investment in fructose syrup was Mexican sugar cane producers because the fructose syrup producers and the domestic sugar cane producers “compet[e] directly in supplying sweeteners to soft drink bottlers and processed food firms in Mexico”.
Same regulatory regime. Tribunals have also given weight to the legal regimes applicable to particular entities in assessing whether they are in “like circumstances”. In Feldman v. Mexico, the claimant’s Mexican company was a reseller and exporter of cigarettes. The tribunal determined that “the ‘universe’ of firms in like circumstances [were] those foreign-owned and domestic-owned firms that [were] in the business of reselling/exporting cigarettes”. Mexican cigarette producers, on the other hand, though they might also export cigarettes, were not in “like circumstances” and thus not eligible comparators. In other words, the tribunal focused on comparators subject to the same legal regime: “the trading companies, those in the business of purchasing Mexican cigarettes for export”.
With regard to the third element, “less favourable treatment” means that the claimant-investor was accorded treatment not as favourable as that accorded to the relevant comparator. The term “no less favourable” means equivalent, or no worse, than the best treatment accorded to a comparator. Therefore, when assessing the treatment afforded to claimants, tribunals begin with the premise that claimants and their investments are entitled to the best level of treatment available to any other domestic investor, or foreign investor of different nationality, operating in “like circumstances”. In comparing treatment accorded to the different investors at issue, tribunals take into account: (a) whether the practical effect of the measure is to create a disproportionate benefit for host State nationals over non-nationals; and (b) whether the measure, on its face, appears to favour host State nationals over non-nationals who are protected by the relevant treaty. It is not necessary for a claimant to demonstrate that the host State had a subjective intent to discriminate and the degree of differential treatment is irrelevant.
Even if a complained-of measure is objectively less favourable than that accorded to a similarly-situated comparator, the host State may be able to defend its actions if it can show that they constitute a legitimate regulatory activity within the scope of its sovereign prerogative.
An MFN clause offers another benefit to qualifying investors. Because this provision entitles investors to treatment no less favourable than that available to other foreign investors, tribunals have consistently allowed investors to rely on more favourable protections available in other investment treaties ratified by the host State. With a few rare exceptions (see, e.g., İçkale v. Turkmenistan), tribunals are virtually uniform in holding that investors can avail themselves of substantive protections available under other treaties of the host State.
Tribunals are split, however, as to whether dispute resolution provisions can be expanded in the same manner. Where the treaty at issue clearly provides that the MFN provision is to be extended to the dispute resolution clause, tribunals typically honour the parties’ agreement. However, where the treaty does not contain specific language to this effect, there is a split of authority. Some tribunals (Maffezini v. Spain, Impreligio v. Argentina, RosInvest v. Russia and Rights of U.S. Nationals in Morocco) have held that investors can avail themselves of more favourable dispute resolution clauses in other treaties of host States, while other tribunals have reached the opposite conclusion (Plama v. Bulgaria and Ansung v. China).
Protection against unreasonable and discriminatory measures. This protection is comprised of two elements: (a) protection against “unreasonable measures”; and (b) protection against “discriminatory measures”. Tribunals generally agree that those two terms should be read disjunctively as they have separate meanings.
A host State’s conduct is unreasonable where it does not bear a relationship to some rational policy of that State. Although unreasonable or arbitrary measures may take a variety of forms, conduct that is likely to qualify as a violation includes: (a) a measure that inflicts damage on the investor without serving any apparent legitimate purpose; (b) a measure that is not based on legal standards but on discretion, prejudice or personal preference; (c) a measure taken for reasons that are different from those put forward by the decision maker; or (d) a measure taken in willful disregard of due process and proper procedure. For a State’s conduct to be reasonable, that conduct must not only be declared to further a rational policy adopted by the State, but there must also be a reasonable correlation between that conduct and the means by which the policy is implemented.
A measure is discriminatory when it provides the investor’s investment with treatment that is less favourable than the treatment afforded to another, similarly-situated investment. Significantly, a measure may be discriminatory regardless of whether the discriminatory conduct was contrary to domestic law or whether the host State had any intent to discriminate or to act in bad faith. The concept of discrimination is thus straightforward: a measure that treats two similarly-situated objects differently is discriminatory. It bears noting that, within the context of the protection at issue here, discrimination does not need to be based on nationality. As such, discrimination may well occur where a foreign investor is treated differently from another investor, whether national or foreign, in a similar situation.
It is beyond peradventure that the rise of foreign direct investment has created countless opportunities for both investors and host States. Despite its tremendous economic potential, foreign investment nevertheless remains a risky endeavour. Examples of risk factors are countless. The host State may find itself in circumstances requiring it to enact legislation that deprives the investor of the ability to carry on its business. Political turbulence or social instability in the host State may create a challenging business environment. Local guerilla groups may decide to impose an illegal “tax” on the investor for the privilege of conducting business in that country. But the protections available under international investment law both to investors and host States are equally extensive. Careful planning, both at the time of the investment and at the time when the dispute arises, will ensure that investors and host States use the tools available to them to manage risks and maximise investment opportunities.

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