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Investment accords - conceptual & procedural contentions

SUNS | 18 September 2015

Investment accords - conceptual & procedural contentions

Andrew Cornford

Geneva - The first part of this article (SUNS #8094 dated 17 September 2015) dealt mainly with framework issues of the Indian model treaty such as the definition of investments covered, exceptions and non-applicability, and the major obligations of the two parties (Indian and external).

The second part below focuses on particular issues and procedures in investment treaties which have proved especially contentious at both conceptual and practical levels.

In the Indian model treaty, nationalisation and expropriation "for reasons of public purpose" is legitimate but must be accompanied by adequate compensation. The determination of whether a measure or measures should be classified as expropriation "requires a case-by-case, fact-based inquiry."

The evidence that expropriation has taken place should include the following: "(i) permanent and complete or near complete deprivation of the value of the Investment; and (ii) permanent and complete or near complete deprivation of the Investor’s right and management and control over the Investment; and (iii) an appropriation of the Investment by the Host State which results in transfer of the complete or near complete value of the Investment to that party or to an agency or instrumentality of the Party or a third Party" (Article 5.2).

"Non-discriminatory actions by a Party that are designed and applied to protect legitimate public welfare objectives such as public health, safety and the environment shall not constitute expropriation" (Article 5.4).

These conditions are stringent and are likely to narrow the range of cases in which the existence of expropriation can be demonstrated. They are consistent with correspondingly stringent rules concerning exceptions (already discussed) and dispute settlement (see below).


The main issues under the heading of compensation concern the period of time before compensation is paid (promptness), the form in which it should be paid (sometimes characterised as effectiveness of compensation), and how much. The third of these issues is the crucial one since performance under the other two depends on settlement of the question of how much.

Under the heading of promptness allowance has to be made for delays due to the resolution of practical problems which have to be dealt with in disputes. Delays are often reflected in interest charges which accrue from the date of the expropriation.

The rules as to the form in which payment is made usually guarantee that the currency of payment should be convertible and not subject to restrictions on transfer. If payment is made in financial instruments, the rules guarantee their value (with compensation for discounts from face value, etc.).

Concerning how much compensation should be paid, agreement is necessary as to the date of expropriation or other forms of "taking". This is often contentious since the loss of earnings which is to be compensated will be determined by the extent of expropriation or "taking" on this date.

But the most difficult problem associated with how much compensation should be paid is that of valuation of the assets or the "taking". Terminology under this heading is fluid. The concepts denoting compensation go under several names: "market value", "fair market value", "genuine value", and "just compensation", but mostly boil down to one of a limited number of valuation methods.

A useful classification of these methods is that of Robert Herz, former chairman of the United States Financial Accounting Standards Board (FASB) (Herz, 2013: 182-191). This classification consists of three headings: (i) amortised cost, the original cost minus amortisation plus the sum to be received at final settlement; (ii) fair value, the amount for which an asset could be exchanged between knowledgeable parties in an arms-length transaction; and (iii) current value, the present discounted value of the future net cash flows that an asset is expected to generate.

Each of these valuation methods has advantages and disadvantages.

* Amortised cost is based on contractual features of an asset and thus avoids the misleading volatility and noise which often characterise reported financial results.

* Supporters of fair value stress incorporation by the concept of current market and economic conditions, and not the past costs and prices used to estimate amortised costs. But application of fair value can be problematic when market prices are not available. In their absence, United States accounting rules suggest alternatives such as the prices of similar assets or valuation based on models.

* Current value picks up the phasing in time of inflows and outflows associated with an asset and also makes possible the incorporation of the effects of changes in interest rates through the discount rates used in estimation. The problem with current value is due to the difficulty of identifying in advance the future inflows and outflows used in the calculation.

Cursory consideration points to the difficulties associated with these valuation methods in investment disputes, especially when one of the parties is a developing country lacking a market for the shares of the investment in question or characterised by economic conditions that complicate estimation of prospective revenues and costs.

In the case of the Iran-United States Tribunal, where identification of the nature and extent of the "taking" was itself often a complex matter, "each case was examined in detail, with accountants and industry experts, in some instances presented by the parties, in others called by the Tribunal itself. The awards rarely accepted the experts’ detailed submissions but reflected also the judgements of the Chamber hearing the case" (Lowenfeld, 2008: 552).

While Bilateral Investment Treaties often specify criteria for compensation in cases of expropriation or measures tantamount to expropriation, corresponding criteria are not included for other violations of treaty terms (such as National Treatment, Fair and Equitable Treatment, or protection and security). In such cases arbitral tribunals have typically borrowed from rulings concerning expropriation (Lowenfeld, 2008: 567). The absence of such criteria makes judgements under such treaties concerning, for example, the impact of regulation more unpredictable or even arbitrary.

Under the Indian model bilateral investment treaty, compensation "shall be adequate and reflect the fair market value of the expropriated Investment, as reduced after application of relevant Mitigating Factors" (Article 5).

The Mitigating Factors specified include the following: (a) current and past use of the Investment; (b) duration and previous profits; (c) compensation and insurance pay-outs received from other sources; (d) options available for the mitigation of losses and reasonable efforts made towards such mitigation; (e) conduct of the Investor which has contributed to damaging the Investment; (f) relief of obligations due to the expropriation; (g) liabilities owed to the government of the host state; (h) unremedied harm or damage to the environment or to the local community; (i) other relevant considerations regarding the need to balance the public interest and the interests of the Investment.

Moreover, "The computation of the fair market value... shall exclude any consequential or exemplary losses or speculative or windfall profits claimed by the Investor, including those relating to moral damages or loss of goodwill"

(Article 5). The Mitigating Factors and the exclusion of speculative gains are clearly capable of significantly constraining the amount of compensation. Moreover, the rules of the Indian model treaty leaves unsolved the problem mentioned above of which method of valuation should be used, a problem likely to be especially difficult to resolve in the case of takings other than straightforward expropriation.


Cross-border financial transfers and the access of foreign personnel in connection with operations linked to the investment are subjects which also arise under the heading of international trade in financial services of the WTO General Agreement on Trade in Services (GATS).

On transfers, Article 6 of the Indian model bilateral investment treaty specifies rules similar to those of Article XI of the GATS which permit all funds of an investor related to an investment in its territory to be freely transferred.

Likewise, the treaty permits temporary restrictions on transfers "in the event of serious balance-of-payments difficulties or threat thereof, or in cases where, in exceptional circumstances, movements of capital cause or threaten to cause serious difficulties for macroeconomic management, in particular, monetary and exchange rate policies" (Article 6). Government policy regarding transfers would also be covered by the General Exceptions of Article 16 which include actions and measures "remedying serious balance-of-payments problems, exchange rate difficulties and external financial difficulties or threat thereof".

On the access of foreign persons, each of the parties to the treaty shall permit persons of the other party and employees of the investor or investment, subject to domestic law and considerations of reciprocity, to enter and remain in their territory for the purpose of engaging in activities connected to the investment (Article 7). Under Article 16 of the WTO GATS, limitations on the access of foreign persons employed in connection with the cross-border provision of financial services are to be a subject in the negotiation of specific commitments.


Dispute settlement is now one of the most contentious of the subjects of bilateral and multilateral trade and investment treaties. This is to a significant extent due to provisions for ISDS (Investor-State Dispute Settlement).

As of 1945 investment disputes were settled either through national courts or through international tribunals of which the most important was the International Court of Justice. Article 34 of the latter’s statute permits only states to be parties before the Court. Thus, if a private investor wanted to bring a suit against a government, the investor would have had to persuade its government to pursue the case on its behalf, thus transforming the case into a dispute between states (Folsom, Gordon and Spanogle, 1991: 1098-1101).

The proliferation of investment disputes during the following 20 years, due partly to de-colonisation, communist governments in some states, and more assertive national economic policies in many developing countries, was the inspiration for the establishment of the ICSID (International Centre for the Settlement of Investment Disputes, as described above), which accommodated agreements between private parties and States for the purpose of arbitration or adjudication, although as of the 1980s, in only about 40 per cent of bilateral investment treaties was the private investor provided with direct access to arbitration; in the remainder, working through national governments was still required. (Guertin 1990: 125).

The following years witnessed expansion in the number of agreements covering international investment as well as changes affecting the scope and character of such agreements. Bilateral investment treaties remain the most frequent form of such agreements but investment-related provisions are now also included in economic partnership agreements, free trade agreements, agreements for regional economic integration, and framework agreements for economic cooperation.

Such agreements often include more than two countries as parties and cannot thus be classified as bilateral. This has led to the use of the term international investment agreement as the umbrella class. Expansion in the number of international investment agreements has been accompanied by not only expansion in the number of investment disputes subject to adjudication or arbitration but also by an increase in the number of cases involving ISDS.

Under arbitral tribunals (ICSID and others), dispute settlement involves interpretation of applicable agreements which may or may not include the possibility of ISDS. Article 25 of the ICSID Convention defines Nationals of Other Contracting States to include foreign corporations and other juridical entities whom the parties have agreed should be treated as eligible for arbitration under the Convention. Recourse to ISDS is now substantial. By the end of 2014, according to the UNCTAD data bank, the number of concluded ISDS cases had reached 356 (UNCTAD, 2015: 8).

Under the ICSID Convention, arbitration usually involves three arbitrators, one selected by each of the parties to the dispute (host state and investor) and a presiding arbitrator agreed by the two parties or, if they cannot agree, by the chairman of the ICSID, ex officio the president of the World Bank. This pattern of selection follows that of other international arbitration tribunals.

In view of these procedures and the now substantial history of ICSID and other similar tribunals, why has the subject of ISDS recently become so contentious? Partly this is simply a case of the way in which bilateral and multilateral agreements with an extensive and potentially intrusive scope as far as national regulation is concerned provide enterprises but not other groups (such as trade unions and civil-society groups) privileged access to arbitration and adjudication by offshore tribunals, with in many cases no provision for appeal against their decisions.

Moreover, the range of subjects covered in international investment agreements has broadened to large parts of domestic regulation of the environment, investment and finance, intellectual property, etc. The consequences can be perverse. Control of cross-border capital movements, for example, are increasingly accepted as a necessary part of the armory of policy measures for handling systemic financial risk and the management of the balance of payments.

Conflicts between IMF recommendations as to the use of such measures could easily conflict with obligations undertaken by a country under an international investment agreement. Estimating compensation in favour of investors in cases brought by them concerning a country’s regulation presents difficult problems. As noted above, such estimates have long been made in cases of this kind. However, established guidelines are lacking with the result that estimates of risk are unpredictable and arbitrary. How, for example, would estimation be approached for compensation of an investor due to the effect on an investment of the imposition of capital controls?

The growth of ISDS in arbitration under bilateral investment treaties has been accompanied by systemic features which raise serious questions about the justice of the decisions reached. These features (as listed in a speech by George Kahale (Kahale, 2014)), a senior arbitration lawyer, include the following:

* A "club of international arbitrators" is shaping a new body of international law, though in many cases the members of the club are not well versed in international law. Members of this group are also dependent upon the parties or arbitral institutions for future appointments - a dependence which all too easily compromises their conduct in particular cases.

* Bilateral investment treaties often contain overly expansive provisions concerning Fair and Equitable Treatment and Most-Favoured Nation.

* "Mega cases" based on a cavalier approach to legal principles and worth more than USD1 billion have been brought against states. Claims have sometimes been of the same order of magnitude as the country’s GDP.

* Although there is nothing to stop an arbitrator from applying a personal interpretation of law, their decisions can be characterised by finality in the absence of procedures for appellate review.

* In view of the selection procedures for arbitrators, impartiality is difficult to achieve. As Kahale puts it, "Experienced practitioners are able to predict the outcome of a case purely based on the composition of the tribunal".

* A bias against states and in favour of investors is perceived by many observers. Kahale acknowledges that there are studies showing that states win more than 50 per cent of cases but counters that this figure is "meaningless, if that same figure happens to represent the percentage of cases that never should have seen the light of day or that would never survive a motion to dismiss in a national court".

The approach to ISDS of the Indian model investment treaty is to restrict investors’ rights under the treaty regarding recourse to external arbitration. The rights apply only to investors and investments specified in the treaty. Thus, the disputes admitted are those dealing with treatment of the investor, expropriation, transfers, and entry and sojourn of the investor’s personnel. Excluded from the treaty’s scope are portfolio investments (Article 1).

Moreover, as already mentioned, cross-border transfers related to investments (such as contributions to capital, profits, interest, royalties, and management fees) must meet conditions as to compliance with a broad range of local laws and regulation (including those concerning labour obligations, and taxation) (Article 6). The control of cross-border capital movements is not only permitted as a response to balance-of-payments difficulties but may also be justified by macro-prudential reasons since, as also mentioned above, under Article 6: temporary restrictions on transfer are deployed when movements of capital cause or threaten to cause serious difficulties for macroeconomic management, in particular, monetary and exchange rate policies.

The Indian model treaty’s procedures to be pursued in investment disputes include the exhaustion of local remedies and other conditions which must precede submission of a dispute to external arbitration (Article 14). The investor must establish that continued pursuit of domestic relief would be futile because (1) there are no reasonably available legal remedies in the respondent country capable of providing relief regarding the dispute in question, or (2) the process for obtaining legal relief provides no reasonable possibility of obtaining such relief in a reasonable period of time.

Even after the transmission of the Notice of Dispute to the designated representative of the respondent party the disputing investor and the respondent party are to use their best efforts to resolve the dispute amicably through consultation, negotiation, or continued pursuit of any available domestic remedies or solutions. Non-compliance with any of the conditions set out under these procedures leads to the barring of the investor from taking subsequent steps to pursue external arbitration of the dispute.

Counter-claims against the investor are possible for breaches by the investor of obligations under the treaty regarding corruption, disclosure, taxation, and compliance with the law of the host state. Explicitly mentioned here are laws relating to labour and wages, environmental and conservation law, human rights, and fair competition and consumer protection. The eventual appointment of three arbitrators is subject to detailed provisions regarding conflicts of interest.

Such a conflict will be deemed to exist in the presence of various circumstances including the following:

* the arbitrator is or has been a legal representative of the appointing party or an affiliate of the appointing party in the three years preceding the commencement of the arbitration;

* the arbitrator is a lawyer in the same law firm as the counsel to one of the parties;

* the arbitrator is acting concurrently with the lawyer or law firm of one of the parties in another dispute;

* the arbitrator’s law firm is currently rendering or has rendered services to one of the parties or to an affiliate of one of the parties from which the law firm derives a significant financial interest;

* the arbitrator has been comprehensively briefed by the appointing party concerning the merits or procedural aspects of the dispute prior to appointment;

* the arbitrator has publicly advocated a fixed position regarding an issue in the case to be arbitrated.

These conditions should reduce the opportunities for the conflicts of interest and other abuses of the arbitral proceedings in investment disputes which were described earlier. Under Burden of Proof and Governing Law (Article 14), the treaty is to be interpreted "in the context of the high level of deference that international law accords to States with regard to their development and implementation of domestic policies".

More specifically, the governing law for the interpretation of the treaty by the arbitral tribunal should be the treaty itself, the general principles of public international law relating to the interpretation of treaties, and - for matters relating to domestic law - the law of the home state of the respondent.

The investor must establish a breach of the respondent’s obligations under the Scope and General Provisions of the treaty (Article 2 that specifies the subjects to which the treaty applies and subjects excluded from its scope).

Moreover, the investor must have suffered actual and non-speculative losses as a result of the breach, and the losses must have been foreseeable and directly caused by the breach. Decisions as to the award of compensation are to be reached by a majority of votes of the arbitral tribunal. Provisions as to the amount of compensation, which are set out under expropriation, were discussed above.


The Indian model bilateral investment treaty contains strong stand-alone rules. Other possible ways of confronting perceived shortcomings of investment and trade treaties have also been suggested. Two such alternatives are contained in proposals of the Global Economic Governance Programme of the Oxford University Blavatnik School of Government. One of these alternatives, which is intended for the TTIP (Transatlantic Trade and Investment Partnership) negotiations but could also be deployed in accords between developing and developed countries is an "ISDS Patches Model". The other, which is designed specifically for developing countries, involves the use of state interpretation of investment treaties.

The "ISDS Patches Model" is designed to limit recourse to investment arbitration by ensuring that ISDS is an option only in exceptional cases (Kleinheisterkamp and Poulsen, 2014):

* The first decision on the legality or illegality of acts subject to dispute settlement would be taken by local courts (the "first patch"). This will ensure that investment arbitration is the last rather than the first resort in an investment dispute.

* Under the "second patch", there would be a comprehensive state "filter" of private claims by home and host states. If both agree, the dispute should be settled by domestic judges rather than international arbitrators. The objective here would be to safeguard public policies regarding subjects such as taxation, financial stability, environmental protection, health concerns, and consumer protection.

* The "third patch" would allow parties to issue binding joint and prospective interpretations of the provisions of an investment agreement. This possibility would give states greater control over the arbitral process by steering the development of the law created by the agreements.

* Under the fourth "patch", investors and states would be given the opportunity to appeal the decisions of arbitral tribunals before an independent appellate body analogous to that available at the WTO. This would help to avoid the lack of coherence and occasional contradictions which sometimes characterise the decisions of arbitral tribunals.

The second proposal would involve state interpretation of investment treaties. States would use their full powers to limit and shape the interpretive power of arbitral tribunals regarding investment treaties (Gertz and St John, 2015). This could be done in three ways: (1) through unilateral statements of particular clauses of treaties submitted by a non-disputing as well as a disputing party; (2) joint statements with treaty partners providing agreed clarification and interpretation of clauses for future tribunals; and (3) joint statements by a number of states - not necessarily all parties to the same treaty - on mutually agreed interpretations of provisions common to many investment treaties.

Each of these options is concerned primarily with procedures to be followed in arbitration of investment disputes. The first two "patches" of the "ISDS Patches Model" are drafted in the same spirit as the Indian model bilateral investment treaty. But unlike the model treaty, neither proposal includes rules tailored to the particular issues likely to arise in investment disputes.


In response to criticism that the Indian model bilateral investment treaty is too one-sided regarding certain subjects and may excessively deter foreign investment, there have been indications of official reconsideration of key provisions in the form of a review in a recent report of the Law Commission of India (Krishnan, 2015).

Particular subjects covered by this review which may lead to modified provisions in a revised version of the model treaty include the following: (1) extension of the definition of investments covered to include portfolio investments as well as foreign enterprises (Article 1); (2) more flexible rules than the obligatory exhaustion of recourse to local courts with no allowance for re-examination by an arbitral tribunal of legal issues "finally settled by any judicial authority of the host state" or review of the merits of a decision made by such an authority (Article 14); and (3) the substitution of internationally agreed minimum standards to replace the exclusive authority accorded to the government of the host state to decide when it invokes exceptions to justify actions or measures regarding such subjects as public health, the environment, public order and morals, working conditions, and financial stability (Article 16).

The eventual outcome of any modifications is unpredictable since arguments are likely to be put forward against major modifications of the model treaty. Greater openness to portfolio investments can easily become a vehicle for back-door (unwanted) liberalisation of cross-border capital movements.

Moreover, a difficult balance would need to be achieved in a strengthening of the role of arbitral tribunals in relation to that of local law and courts. Finally, minimum international standards may be an inadequate substitute for state policy autonomy regarding exceptions to the treaty.

The above is the second part of a two-part article contributed by Mr Andrew Cornford of the Observatoire de la Finance in Geneva. The first part was published in SUNS #8094 dated 17 September 2015.

 source: SUNS