International Investment Protection

International Investment Protection

    The last three decades have seen a surge in foreign direct investment around the world. Governments which have embraced economic liberalisation have encouraged investors to pour capital into their economies. Investors have taken advantage of favourable fiscal and political regimes to invest in new countries and regions. 

    In parallel with this trend, a range of instruments have developed which are designed to allay investors' concerns about the protection of their legal rights in the event of interference by host governments. The most important of these instruments are the modern network of investment treaties and contractual stabilisation provisions. 

    In recent years, there has been a trend towards governments asserting their sovereignty more forcefully against foreign investors' contractual rights. This has resulted in a proliferation of investor-state disputes.

    This Quickguide considers the mechanisms that exist to protect foreign investors and also looks at how investment disputes are resolved.

    What mechanisms exist to protect investors?

    There are broadly four mechanisms offered by states to protect investors: 

    • investment legislation;
    • investment contracts;
    • bilateral investment treaties; and
    • multilateral investment treaties.

    A state may enact investment legislation ensuring certain treatment for investors. Such legislation might guarantee exemption from taxation regimes or provide a specific fiscal regime for investors in a particular industry sector. However, investors may be concerned that any protections contained in legislation may be subject to revocation by a subsequent government. 

    An investor may enter into an investment contract with a host state. Examples of such contracts in the extractive industries are concession agreements and production sharing contracts, under which investors receive certain protections so that they can invest in the exploitation of a state's natural resources. The investment contract may protect investors from changes in law or regulation which adversely affect their interests. However, the effectiveness of these clauses in the face of government action can be variable. 

    One of the most striking features of the explosion in foreign direct investment has been the increase in investment treaties entered into by host states. Investment treaties can take the form of bilateral investment treaties between two states or multilateral investment treaties between multiple states (BITs or MITs). These treaties, which are devised to encourage foreign investment, commonly include provisions which establish specific protections for investors from the respective states. 

    MITs, as the name suggests, enable a number of states, often on a regional basis, to offer these protections. Recently there has been negotiation of major trade agreements involving nations controlling much of the world's trade. For example, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), one of the largest trade agreements after the North American Free Trade Agreement (NAFTA). 

    Importantly, both BITs and MITs cover arrangements entered into between investors and private parties in the host state, as well as arrangements directly between investors and host states. The number of BITs alone increased by a factor of more than five in the 1990s.

    Investors may have the benefit of one of the above instruments or a combination of instruments. For example, an investor who enters into an investment contract with a host state might also fall within the protections provided for in a BIT. 

    How can parties to investment contracts protect their investments?

    Long term investment contracts between investors and host states (or state entities) often involve substantial investment of capital. Investors seek reassurance that the contractual protections on the basis of which they have invested will remain in place for the life of their investment. In order to achieve this, investment contracts often contain stabilisation clauses. 

    There are different formulations as to types of stabilisation clauses. However, there are broadly five categories of stabilisation clauses:

    • freezing clauses;
    • "intangibility" clauses;
    • "economic equilibrium" clauses;
    • allocation of burden clauses; and
    • hybrid clauses.

    Freezing clauses are some of the most frequently adopted stabilisation clauses. They are intended to freeze the national legislation affecting the investor for the life of its investment. The clauses typically provide that legislation enacted subsequent to the investment contract will not bind the investor. Clauses of this type have declined in popularity in recent times. 

    Intangibility clauses provide that a host government cannot unilaterally nationalise a project or modify an investment contract. Any changes require the consent of the investor. 

    Economic equilibrium or rebalancing the benefits clauses provide protection to investors by ensuring that, in the event of a change of law which adversely affects the investor, the host government will ensure that the investor is not disadvantaged. This will typically involve specific mechanisms for agreeing compensation to the investor by the host government. Modern stabilisation clauses invariably adopt this form. 

    An allocation of burden clause is similar to an economic equilibrium clause. It provides that if there is a change in legislation, the burden of such change will be met by the host state. Such a clause may appear in a contract entered into between an investor and a state entity. For example, a production sharing contract in the oil industry might provide that the burden of any tax changes would be carried by the state oil company rather than the private investor. 

    Finally, an investment contract may include a hybrid clause which contains elements of the different types of stabilisation clause outlined above.

    Stabilisation clauses have attracted widespread criticism, particularly from non-governmental organisations (NGOs). NGOs have alleged that stabilisation clauses impair the ability of states to improve their environmental, health and safety and human rights regimes. In one high profile case involving the construction of a trans-national oil pipeline, international pressure forced investors to enter into a side letter agreement ensuring that they would not enforce stabilisation provisions in a manner which would prevent host states from improving their human rights legislation. 

    What bilateral/multilateral investment treaties may be relevant?

    There are currently over 2,000 BITs in force. Although there is no standard form for BITs, many contain broadly similar protections. Many states have "model" BITs which form the basis for negotiation of new treaties. 

    MITs have also enjoyed great popularity in recent decades. Important MITs include:

    • the North American Free Trade Agreement (NAFTA) between Mexico, Canada and the US;
    • the Association of South East Asian Nations (ASEAN) Agreement for the Promotion and Protection of Investments between Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam;
    • the Colonia Investment Protocol of the Common Market of the Southern Cone (or Mercosur), between Argentina, Brazil, Paraguay and Uruguay;
    • the Cartagena Free Trade Agreement between Columbia, Mexico and Venezuela; and
    • the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam.

    These MITs provide protection for investors on a regional basis, seeking to encourage trade and mutual investment.

    Another significant MIT, and one which provides investor protection on an industry rather than regional basis, is the Energy Charter Treaty (ECT). The ECT entered into legal force in April 1998. To date the ECT has been signed or acceded to by over 50 states, as well as the European Community and Euratom. The ECT also currently grants "observer" status to over 30 states, as well as to international organisations such as the World Bank and the World Trade Organisation. It provides for protections in relation to energy sector trade and investment.

    How do investment treaties protect investors?

    BITs and MITs generally contain similar investor protections. The most common protections found in these instruments are:

    • protection from expropriation without compensation;
    • most favoured nation provisions;
    • national treatment provisions;
    • fair and equitable treatment;
    • full protection and security; and
    • free transfer of investment and returns.

    At the core of most investment treaties is protection from expropriation without compensation. Investment treaties do not prevent a host state from expropriating assets (it should also be noted that some acts which might be classified as expropriations will not entitle the investor to any compensation at all, on the basis that they fall within the normal exercise of state powers). The aim of protection from expropriation provisions is to provide the deprived investor with an entitlement to prompt and effective compensation, and to regulate the circumstances in which such a deprivation occurs. It is recognised in the context of this type of protection that expropriation may be indirect as well as direct. Generally, direct expropriation occurs when the investor is deprived of title to his assets. An example of creeping expropriation (a form of indirect expropriation) is where there is a series of government acts which do not individually amount to an expropriation, but whose cumulative result is to deprive the investor of the economic use and enjoyment of his rights.  

    A most favoured nation (MFN) clause provides that investors covered by the relevant treaty are entitled to treatment from the host state which is no worse than that afforded to any other investors under a separate treaty. The practical effect of this is that it may allow claimant investors to rely upon a host state's more favourable treaty commitments with other states (or nationals of them) although there is case law in which tribunals have precluded investors from using the MFN clause in such manner. 

    Similarly a national treatment provision requires the host state to afford equivalent treatment to foreign investors as it does to entities which are nationals of the host state. 

    Treaties often oblige host states to extend fair and equitable treatment to investors. This prevents host states from taking any arbitrary, grossly unfair or discriminatory measures against foreign investments. The extension of fair and equitable treatment to investors under investment treaties is effectively a "catch-all" protection, and consequently is commonly cited in investment treaty claims. 

    An investor may rely on an obligation of a host state to provide it with full protection and security in situations where the host state failed to prevent, via its control of law and order authorities, the physical destruction of property owned by the investor. It may also be successfully cited in relation to intangible assets.

    It is also common for investment treaties to provide that an investor may be able to rely on free transfer of investment and funds in and out of the jurisdiction in which it has invested.

    How are investment disputes resolved?

    The principal mechanism for resolving investment disputes is via the International Centre for the Settlement of Investment Disputes (ICSID). ICSID was established under the 1965 ICSID Convention (also known as the Washington Convention). It has been ratified by over 150 states. The first case before ICSID was in 1972. Since 2000, registration of cases has increased markedly. 

    The principal requirements for ICSID arbitration are:

    • party consent in writing; and
    • the existence of a legal dispute arising from an investment between an ICSID Contracting State1  and a national of another ICSID Contracting State.

    Consent to ICSID arbitration by a host state may be contained in national investment legislation, an investment contract or an investment treaty. ICSID is a self-contained system which provides for enforcement in Contracting States. It derives its authority from its status as an institution of the World Bank. 

    Investment disputes may also be heard in other fora. Of the total investment disputes known to have been referred to arbitration, the overwhelming majority were filed with ICSID or under the ICSID Additional Facility (which provides for ICSID arbitration in circumstances where one of the parties is not an ICSID Contracting State (or national of such a state)). However, the Stockholm Chamber of Commerce, the Permanent Court of Arbitration in the Hague and the International Chamber of Commerce (ICC) and UNCITRAL have also been chosen by parties for the settlement of investment disputes. 

    It should be noted that ICSID proceedings are often expensive. They are also public. Copies of ICSID arbitral awards are published on the ICSID website. This may be an incentive to investors to use this forum, since the host state may want to avoid negative publicity from the case. 

    Present controversy and criticism

    ICSID arbitration is controversial and, despite attempts to "depoliticise" the field, strongly divergent views are held, including among those called upon to serve as arbitrators. Such divergence in views and decisions has led to accusations that the ICSID system fuels uncertainty and inconsistency in international law. 

    Critics have argued that the ICSID system is overly focused on safeguarding commercial concerns at the expense of the public interest. For example, the action taken by the tobacco firm Philip Morris against Australia in relation to the introduction of plain packaging laws has brought to the public's attention the direct conflict between commercial and public interests posed by investment treaties. Consequently, many treaties now specifically exclude measures relating to public health and the environment.

    The European Commission has responded to these criticisms by creating an alternative Investment Court System for resolving investor-state disputes. This was adopted in the EU's trade deal with Canada, the Comprehensive Economic and Trade Agreement (CETA) (which provisionally entered into force in September 2017).

    What are the key legal issues in investment disputes?

    Umbrella clauses

    Protection under BITs and MITs exists independently of contractual rights which investors may have against the host state. A question which frequently arises in investment treaty law is whether breaches of contractual rights give rise to claims under investment treaties.

    This is where umbrella clauses play a role. An umbrella clause is where a host state confirms in a treaty that it will observe any legal obligation that it has entered into with foreign investors or in relation to their investments. Such clauses are also referred to as "observance of undertakings" clauses and the drafting of such clauses varies widely.

    Investors frequently argue that a breach of contract can be "elevated" by an umbrella clause into a claim under an investment treaty so as to gain the protections and remedies available under the relevant treaty. States frequently respond that a breach of contract only entitles an investor to contractual remedies.

    Caution should be exercised when reviewing how investment arbitration tribunals have considered umbrella clauses. The drafting of umbrella clauses differs and one investment treaty may contain very different provisions to another. In any event the decisions of arbitration tribunals have not been consistent. In one case a tribunal refused to elevate a contractual breach into an investment treaty breach because the consequences of doing so would be "so far-reaching in scope, and so automatic and unqualified and sweeping in their operation [and] so burdensome in their potential impact upon a Contracting Party". The tribunal held that clear and convincing evidence would be required to show that the intention of the investment treaty was to render contractual breaches treaty breaches.2

    However, a different tribunal held that an umbrella clause in a different investment treaty would be meaningless if it did not have the effect of elevating the relevant contractual breach into a treaty breach.3

    What is an investment?

    The definition of an investment in investment law is of fundamental importance to the question of whether an investor can gain redress for an act by a host state. Investment treaties often define "investment" in some detail, frequently setting out a list of categories of items which constitute investments. 

    If the dispute is to be resolved in ICSID arbitration, the investor will have to satisfy both the BIT/MIT definition of an investment and the ICSID definition; ICSID arbitration is only available in circumstances where an investment exists. The definition of investment under the ICSID Convention has given rise to significant case law. The leading case provided that the following must exist for there to be an investment:

    • substantial duration;
    • regularity of profit and return;
    • assumption of risk by both parties;
    • substantial commitment of money; and
    • significant contribution to the development of the host state.4

    These are known as the Salini criteria. Since the Salini criteria were proposed, there has been a general move from ICSID arbitration tribunals towards a more flexible definition of investment.5 In one casean ICSID tribunal held that the Salini criteria should be supplemented by two further tests:

    • were the assets in question invested in accordance with the laws of the host state; and
    • was the investment of the assets made in good faith?

    The tribunal found that although the investor had invested his assets in accordance with the laws of the host state, the investment had not been made in good faith. Rather it had been made as a means of bringing what was properly a domestic claim against the host state in an international arbitration forum. The tribunal found that the investment was not protected for the purposes of ICSID.

    Who is an investor?

    The question of who constitutes an investor has also arisen in many disputes. In order to enjoy the protection of an investment treaty, an investor will need to show that he falls within the categories of investors defined in the relevant treaty. Often the key issue will be whether the investor has the necessary nationality such that he is entitled to protection. This is particularly an issue in the case of corporate investors.

    Different mechanisms have been used to determine whether an investor has the requisite nationality. Tribunals have looked at where the investor is incorporated, where the investor's seat is located and the nationality of the controlling shareholders of the investor.

    The nationality of an investor has special significance in the context of investment treaty arbitration under ICSID. This is because protection is only available to investors who are nationals of an ICSID Contracting State other than the state in which the investment is made. This rule is qualified by the fact that the parties to a dispute can agree that a national of the Contracting State in which the investment is made shall be considered a national of a different Contracting State by virtue of foreign control. So, where a host state requires an investment to be made by a company incorporated in that state, that company could still be considered a national of a different Contracting State if it were controlled by nationals of that Contracting State. This satisfies both the host state which may wish to see investments made through local companies and the investor which, despite the nationality of the investment vehicle, is able to enjoy the protections of ICSID. 

    Tribunals have taken differing approaches to this requirement. In one case a claimant argued that it should be treated as Dutch because its immediate parent company was Dutch. The tribunal held that "foreign control" had to be established objectively. It took the view that on the facts, although the immediate parent company was Dutch, the claimant's ultimate owner was an Argentine national. Accordingly jurisdiction under ICSID was denied.7

    However, in a different case an arbitral tribunal refused to pierce an investor's "corporate veil" and examine the nationality of the shareholders of the investor. Although 99 per cent. of the investor's shares were owned by nationals of the host state, the investor was held to be a national of a different Contracting State by virtue of being incorporated there.8

    The definition of "investor" gives rise to the potential for forum shopping by an investor. This is where an investor incorporates a company in a specific jurisdiction to gain the protection of an investment instrument. An example would be where a British investor invested in the United States via an Egyptian company in order to gain the protection of the United States-Egypt BIT.

    To prevent forum shopping, host states often include a "denial of benefits" provision in their investment treaties. This provision usually requires the investing company to have substantive business activities in the country in which it is located. 

    Enforcement and sovereign immunity

    It is important that investors consider issues of

    It is important that investors consider issues of enforcement and sovereign immunity when they enter into investment contracts with states. The ICSID Convention provides that consent to arbitration by a party prevents it from pleading immunity as a means of preventing arbitration proceedings taking place.

    However, there is no provision in the ICSID Convention which has the effect of waiving the law of a host state with regard to its entitlement to claim sovereign immunity. Parties which enter into investment contracts should ensure that they obtain a waiver of sovereign immunity from the host state. In any case, there are few examples of awards being successfully enforced against states. In some cases, states have voluntarily honoured awards but significant practical hurdles exist to enforcement. Identifying state assets outside the state itself is problematic. If such assets are identified, issues of sovereign immunity are often raised to resist enforcement against state assets abroad.

     when they enter into investment contracts with states. The ICSID Convention provides that consent to arbitration by a party prevents it from pleading immunity as a means of preventing arbitration proceedings taking place. 

    However, there is no provision in the ICSID Convention which has the effect of waiving the law of a host state with regard to its entitlement to claim sovereign immunity. Parties which enter into investment contracts should ensure that they obtain a waiver of sovereign immunity from the host state. In any case, there are few examples of awards being successfully enforced against states. In some cases, states have voluntarily honoured awards but significant practical hurdles exist to enforcement. Identifying state assets outside the state itself is problematic. If such assets are identified, issues of sovereign immunity are often raised to resist enforcement against state assets abroad. 

    Interim measures

    Under the ICSID Convention, parties may request interim measures which protect their rights. However, ICSID arbitral tribunals have adopted a restrictive approach to the award of interim measures. In general, they will only be granted if a party demonstrates that it is likely to suffer irreparable harm, or harm which could not be compensated by an award of damages, were the tribunal to refuse the request. It is not a basis for interim measures to claim that the actions of a party would increase the potential compensation due to the injured party or that such actions would make it more difficult to resolve the dispute.9

    Cooling-off period

    Investment treaties commonly contain provision for a mandatory "cooling-off period" which is a period of time (commonly 3 or 6 months) between notification of the claim and its commencement, during which negotiations may take place. There is some difference of approach between tribunals as to whether this is to be treated as a substantive requirement that ultimately serves as a pre-condition which may lead to a lack of jurisdiction where the notice period is not respected, or whether it is a mere administrative requirement which has no such effect. It remains best advice for potential claimants to respect the cooling off period and avoid any jurisdictional risk.

    Exhaustion of other legal remedies

    The underlying contract or the investment treaty may provide that local remedies have to be exhausted before investment arbitration can be commenced. As this will usually involve having to bring proceedings first in the local courts, this can cause delay.

    "Fork in the road" provisions in investment treaties can also cause issues. These provide that once a particular dispute resolution mechanism is chosen, it is not possible to select another. So, if an investor commences proceedings in the local courts in compliance with any contractual requirement to exhaust local remedies, it may lose any rights it has to raise the same dispute in arbitration.

    Careful reading of both the underlying contract and any applicable investment treaty is therefore required.

    How do you maximise the protections available?

    Parties considering an investment overseas should ask themselves the following practical questions:

    • Which investment instruments exist in relation to investments in the state?
    • If investment legislation is in place, does the duration of the contract lead to concerns that this legislation might change over time?
    • Can the investment be structured so as to provide access to protections under a BIT or MIT?
    • If structuring the investment in this way, will the relevant criteria in the treaty cover the specific investment? For example:

      • what is the definition of an investor?
      • what is the definition of an investment?
      • is there a denial of benefits clause?
    • What are the provisions for dispute resolution under the relevant instrument? And does it provide for a "cooling-off period"?
    • If the instrument provides for ICSID arbitration, will the investment fall within the provisions of ICSID? Are the parties from Contracting States?
    • If contracting with the host state or state entity, is it feasible to seek a waiver of sovereign immunity?

    1. i.e. a state which has ratified the ICSID Convention.
    2. SGS Société Générale de Surveillance SA v Islamic Republic of Pakistan (ICSID Case No. ARB/01/13).
    3. SGS Société Générale de Surveillance SA v the Philippines (ICSID Case No. ARB/02/6).
    4. Salini Costruttori SpA v Morocco (ICSID Case No ARB/00/4).
    5. See Biwater Gauff (Tanzania) Ltd v United Republic of Tanzania (ICSID Case No ARB/05/22) and RSM Production Corporation v Grenada (ICSID Case No ARB/05/14).
    6. Phoenix Action Ltd v Czech Republic (ICSID Case No ARB/06/5).
    7. TSA Spectrum de Argentina SA v Argentine Republic (ICSID Case No ARB/05/5).
    8. Tokios Tokeles v Ukraine (ICSID Case No ARB/02/18).
    9. Cemex Caracas Investments BV v Bolivarian Republic of Venezuela (ICSID Case No ARB/08/15).

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.


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