This article is authored by Akash Krishnan, a student of ICFAI Law School, Hyderabad. It discusses in detail the conflict of interests faced by the arbitral tribunal while resolving disputes between investors and home states.

Introduction

Investor-state dispute settlement is the alternative dispute resolution mechanism provided to investors to call for arbitration against the host-states in case of violation of Bilateral Investment Treaties. However, like every other approach, it has its own errors that need to be rectified in order to ensure the efficiency of the mechanism. Due to this approach, the hands of the host states are tied to regulating legislation within their own boundaries.

In the apprehension of heavy monetary claims and to maintain international relations, states tend to back away from enacting legislation that is essential for public welfare. Conversely, investors being alien to the nation, the government can expropriate their property. To protect the same, tribunals consider the doctrine of legitimate expectation of the investor to ensure fair and equitable treatment. In this process, tribunals tend to overlook the sovereign right by creating a regulatory chill. Hence, there is a stringent need to analyze the problem from both sides. State Sovereignty and legitimate expectation being the two swords of ISDS, the need of the hour is to provide equilibrium to retain public trust and ensure justice to both sides.

State sovereignty

The principle of sovereignty can be defined as the ability of the Central State government to make policies and legislations without internal or external disturbance. The state is supreme and has the right to regulate all its activities freely, without any disturbance from any other states or international bodies. It is an accepted principle of customary international law that respects the autonomy of the state to make non-commercial, political, legal and economic decisions required for the protection of the state.

Investors possess a huge threat, as they are obligated to the laws and policies of the host country. There is a threat of indirect expropriation or discriminatory government regimes, biased towards its citizens that could lead to huge losses to the investors. While the state is under the duty to protect its citizens, it is also necessary for states to have foreign investors for economic development. This conflict results in the state imposing a restriction on its own absolute sovereign power.

The investors claim to be vulnerable and unjustly interfere in the legislation of the state or claim compensation for indirect expropriation. Indirect expropriation means a change in the legislation by the state that directly interferes with the contract and denies the investor certain benefits and could possibly affect their business. Going by this, the state will hold no power to enact legislation after the entry of investors into the host state.

In the case of Enron Corporation Ponderosa Assets L.P v. Argentine Republic (2007), investors received compensation for indirect expropriation as a consequence of emergency measures taken by the government to tackle the financial crisis. The state should be given more priority to exercise its sovereign power in such cases and it would be unjust to not do so. Argentina witnessed a setback of $450 million in the 2005-08 period, most of which was due to a breach of fair and equitable treatment. This clearly shows the pro-investor stance taken by ICSID.

In Metalclad v Mexico (2000), the tribunal deliberated an award in favour of the American investor and held the government liable for imposing impediments for declaring a natural area for the protection of rare cactus. In Occidental Petroleum Corporation v. Republic of Ecuador (2004), US$1.76 billion were awarded as compensation to two American companies. The state terminated the BIT with the two companies for the violation of public laws and the agreement itself. The tribunal ruled in favour of the investor for the violation of national treatment obligation and to ensure fair and equitable treatment. Similar awards were passed in favour of the investor in a plethora of cases perpetuating a threat to state sovereignty which could also impact the rights and freedoms of the citizens.

In Saluka Investments B. V. v. Czech Republic (2006), the arbitral tribunal recognized the need to balance the interest of both the parties by stating that: “protection of foreign investment is not the sole aim of the treaty… a balanced approach for both parties… the host state possess a legitimate right to regulate domestic matters in the public interest”. It is necessary for more tribunals to understand and consider the same.

It is necessary for providing public policy space in international law. Unlike the dispute settlement system of the World Trade Organization (“WTO”), the tribunals are apprehensive to protect the investors rather than contemplating the intent and importance of the legislature. There is a need to learn the WTO law here, whose one of the four-core foundations is to protect and promote societal interests together with regulation of increased levels of trade in goods and services.

It is necessary to provide policy space to the host states and preserve their right to regulate. In 2001, North-American Free Trade Agreement (NAFTA) clarified the position of fair and equitable treatment by laying reasonable limitations to it. The Phillip Morris case brought into light the necessity of regulating tobacco for public welfare. This was first discussed and changed in Trans-Pacific Partnership (TPP) negotiations. A similar measure was taken by Australia and Singapore by amending their Free Trade Agreement (“FTA”). The justification of such a measure was said to be health-related and made in good faith for the protection and welfare of the citizens.

Legitimate expectation

Arbitral tribunals rely on the legitimate expectations of the investors while deciding whether the host states alleged violations can constitute a treaty breach or not. The doctrine of legitimate expectations as an element of the Fair and Equitable [“FET”] standard is of relatively recent origin.

In CME v. Czech Republic (2003), the tribunal held that “the Media Council breached its obligation of fair and equitable treatment by the evisceration of the arrangements in reliance upon which the foreign investor was induced to invest.”

In MCI v. Ecuador (2007), the tribunal rejected the protection of mere assumptions that formed the basis of investment, observing that legitimacy of the expectation depended not only on the intent of the parties but also ‘on certainty about the contents of the enforceable obligations’.

In David Minnotte v. Poland (2014), the tribunal observed that it must make a decision on breach of legitimate expectations based on the evidence before it, and those specific expectations had to be specifically created and proved.

As per these awards, the collective conclusion that can be drawn is that an expectation may only be legitimate if it is premised upon a fair pre-existing or specific expectation with regard to a specific right or set of rights that must be analysed objectively, in light of the business conditions and such other factors, and must have been reasonably relied upon by the investor.

State sovereignty vs. legitimate expectation

A major argument that arises when considering the economic rights of the investor in contrast to the legislative operation of the state is that, Why should the investor endure monetary destruction for the havoc caused by the government? It can also be argued that the state deserves regulatory space on certain subject matters to ensure effective policy measures for its citizens. It is important to understand how one can affect the other.

The impediment of the arbitrator is to ensure fair and equitable treatment to the parties while protecting the interests of the population of the sovereign state. There was precedence laid down in the case of S. D. Myers v. Canada (2002) that curbed the right of the tribunal to adjudge governmental decisions. It stated that international law provides the right to host states to make domestic laws within their borders. 

Doctrine of expropriation

However, in Tecmed v. Mexico (2003), it was observed that the tribunal could assess governmental policy to determine if the legislative operation amounted to expropriation. Expropriation is the sovereign right of the state to take away the property of nationals or alien citizens for socio-economic or political reasons in return for compensation. The following principles can be laid down from the aforementioned case to determine whether an act constitutes expropriation: 

Step I

1. It is a permanent or irreversible act.
2. Such an act neutralizes or destroys the economic value of the use, enjoyment or disposition of the investor’s rights or assets.

Step II

“Proportionality test”: The tribunal has to ensure that such a measure holds proportionality of the public interest on the subject matter and the projected investments.

While assessing the same, the tribunal has to strike a balance between the investor and the host state ensuring that due deference is given to the state’s issues and the same are protected, while taking into account the legitimate expectation of the investors. Subsequently, in the case of Total SA v. Argentina (2010), the investor’s legitimate expectation was held as the main component of fair and equitable treatment under investment arbitration.

Regulatory chill

The concept of regulatory chill can be a stumbling block for the protection of public interest that causes a chilling effect. It could be used by the state to evade its responsibility of providing an efficient regulatory regime in the public interest, inter alia, health, education, environmental and safety regulations. ISDS proceedings tend to be expensive, therefore the state prefers to avoid it by not creating conflicting regulations that negatively affect the foreign investment, even if that hinders public interest.

It was argued by anti-ISDS groups that often ISDS tribunals tend to intrude in the regulatory space in the name of international law and investor protection and tend to prioritize and safeguard investor’s rights over the public interest. Arbitral tribunals repeatedly used the fair and equitable treatment standard to widen the scope of protection that investors enjoy. It is argued by the author that this growing jurisprudence in investment arbitration towards giving investors substantive protection based on their legitimate expectations can be considered as a misinterpretation of international law.

However, the case of Philip Morris Asia v. Australia (2015) moved the field of investment arbitration by upholding legislative measures enacted for the protection of public health. It held that the state couldn’t lose its right to legislate and enact laws in lieu of providing Fair and Equitable Treatment to investors under legitimate expectation.

The conflict of a measure being an indirect expropriation or if it is necessary for public interest turns on the critical jurisprudence of International Investment Arbitration. It is necessary to increase the legitimacy of ISDS and people’s trust in IIA. An effective international investment can ensure sustainable development in the country.

Recommendations 

Investment arbitration system drives and strives to achieve protection for the foreign investors. The investment treaties include several provisions to provide a standard of protection. However, “legitimate expectations” as a specific term of investment protection is absent in most of the treaties. In arbitral awards and scholarly opinions, the lack of a specific definition of the concept can be observed.

The tribunals accepted the legitimate expectations built on the arbitral jurisprudence and often applied it in wide discretion. Investment tribunals’ tentative moves to proportionality analysis in the context of indirect expropriation indicate that proportionality may be crystallizing as a norm in relation to when the state powers doctrine applies to defeat a claim of legitimate expectation. Similar developments can be seen in relation to fair and equitable treatment. These decisions evidence an increasing understanding of the need for international investment law to accommodate greater space for host states to regulate in pursuit of the public interest. Yet the current state of the case law lacks both a coherent methodology and an appropriate standard of review.

To prevent the clash of the two swords, i.e., State Sovereign and Legitimate Expectancy, the sovereigns can insert two types of provisions namely – “right-to-regulate” and “non-derogation” provisions. Right-to-regulate clauses include language that traces a government’s right to regulate, either in general or specific terms. Non-derogation provisions are clauses that declare that the State shall not deviate from its domestic laws in order to incentivize investment.

However, mere insertion is not enough. In order to strike an equilibrium between State Sovereign and the Legitimate Expectancy, these provisions by the virtue of their language must be used in a manner where both the swords are the winners, i.e. both State and Investor is placed on a platform where equal importance is given to them both.

Conclusion

The dilemma that the host countries suffer is with respect to the enhanced standards of investor protection. Adding to this dilemma are the views which accept that providing a stable regulatory framework by the host states is a legitimate expectation of the investors. Therefore, a balance between the states’ right to regulate and the protection of the legitimate expectation of the stable framework of the foreign investors must be accepted. Such an approach would provide greater space for host states to promulgate bona fide measures in the interest of their populations, without being liable to compensate foreign investors for a finding of indirect expropriation.

References

1. https://unctad.org/system/files/official-document/diaepcbinf2021d7_en.pdf 
2. https://uk.practicallaw.thomsonreuters.com/0-624-6147?transitionType=Default&contextData=(sc.Default) 
3. https://ustr.gov/about-us/policy-offices/press-office/blog/2014/March/Facts-Investor-State%20Dispute-Settlement-Safeguarding-Public-Interest-Protecting-Investors 

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