Preferential Trade Agreements: Session 8, Investments

Session Eight:
Treatment of Foreign Direct Investments

Permanent Sovereignty over Natural Resources, UN GA Res 1803 (XVII)
UN Charter of Economic Rights and Duties
US Model BIT, 2004
Philippine-Australia BIT, 1995
JPEPA Chapter on Investments
US Singapore Chapter on Investments

Andreas Lowenfeld, INTERNATIONAL ECONOMIC LAW, Chapters 13 and 15

Kenneth J. Vandevelde, “Investment Liberalization and Economic Development: The Role of Bilateral Investment Treaties,” 36 colum. J. Trans. L. 501 (1998)

“The Treatment of Economic Injury to Aliens in the Revised Restatement of Foreign Relations Law,” International Lawyer (Spring, 1988)

Comments

[Gerard Joseph M. Jumamil]

“Let him who expects one class of society to prosper in the highest degree, while the other is in distress, try whether one side of the face can smile while the other is pinched.” – Thomas Fuller, British Clergyman and Author

Legal scholars claim that the classical western view on the right of a state to nationalize or expropriate foreign owned property can no longer be questioned. The right, however, is qualified by the nature of the payment necessary for the proper and legal exercise of the right. According to the Hull Formula, payment must not only be prompt, but also adequate and effective.

It is further claimed that the classical western view has achieved general consensus in most parts of the civilized world, as confirmed by the historical development of the western view amidst formidable opposition.

With the conclusion of the Iran-U.S. Claims Tribunal, the fundamental principles embraced by the classical western view have commanded a particular level of deference among states. The Iran-U.S. Claims Tribunal is said to have contributed significantly to International Law. Firstly, it has confirmed the principle that property rights of investors are to be respected. Secondly, it affirmed the principle that compensation is to be paid when the owner is deprived of rights by acts attributable to the state. Thirdly, there was an express recognition that International Law applies directly between states and foreign parties, not merely between states. Fourthly, it acknowledged that a revolution or social upheaval does not itself create liability, but does not provide justification for a state to avoid the duty to compensate. Next, the Claims Tribunal recognized the award of interest as damages for delay in payment, from the date of taking to the date of payment. Moreover, it was held that full value is determined on the basis of reasonable expectation of future earnings at the time of the taking. Finally, and perhaps most importantly, it affirmed the Chorzow Factory case (i.e. “…reparation must, as far as possible, wipe out all the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed.”)

In this light, the arguments against the classical western view, advocated by various developing nations in the middle part of the 20th century, have been suppressed and contained in the process of evolution of standards of International Law on international investments. The repudiation of private property during the Russian Revolution and the emergence of the social function of property in the course of the Mexican Revolution are now but footnotes to the contemporary standards involving expropriation and nationalization.

Even the concerted effort by the developing countries to repudiate a system of law in whose creation they had played a little or no part is looked upon with contempt and disdain by modern discourse on expropriation. The foiled establishment of a New International Economic Order (i.e. Charter of Economic Rights and Duties of States, G.A. Resolution 3281) is always underscored by a lack of consensus, since nearly all capital-exporting states either voted against the Charter or abstained.

One can argue, however, that nothing much has changed with respect to the relative economic and socio-political contexts in which developing nations are situated. In the on-going process of globalization and the heightened activities extant in international trade, the aggregate growth in welfare promised by advocates of free trade remains merely a promise.

A question may thus be posed: Has the social function of property truly lost its relevance through the development and evolution of the standards of International Law on international investments?

With the growing complexities of international trade, and the exponential increase of the welfare distance between the privileged class and the marginalized, the social function of property is as meaningful now as it was in the past century. The capacity of property as a redistributive institution remains in force, as long as it is coupled with relevant programs for technological transfer and productivity enhancement. As such, there is merit in once again highlighting the social function property. This is not to say, however, that the classical western view is evil per se. There must be a delicate balance between the merits of the two seemingly opposed perspectives, if development is to achieve a universal acceptation.

In this regard, bilateral investment treaties may play a significant role in striking the balance between the two perspectives. With these treaties, negotiations may allow for at least the recognition of interests of each negotiating state. Welfare considerations, especially from the viewpoint of developing countries, may find meaningful existence throughout the provisions agreed upon in a treaty, not necessarily confined within the provisions respecting the right of a state to expropriate.

[Anna Theresa L. Licaros]

The United Nations recognizes the sovereignty of states in terms of the determination of its economic policies and activities and it has been consistent in affirming this principle. However, with the growing internationalization of trade and economic relations, the scope of this sovereignty has been the subject of negotiated limitations among the various states. Sovereign control can even be regarded as one of the “currencies” used in international trade – a state’s otherwise sovereign control over an aspect of its economy is tempered in exchange for a reciprocal obligation of another state. One of the basic concepts in constitutional law is that the State has three great powers – that of taxation, police power and expropriation. Our organic law installs limitations on these powers but ultimately these are limitations determined and ratified by us Filipinos. The same is true for most other jurisdictions. Domestic law faces off with international law quite prominently in the field of international economic law where sovereignty, while recognized and respected is effectively interfered with because the power to enforce economic sanctions is impending. Thus, compliance with customary international economic law becomes an “optional requirement” of sorts.

G.A. res. 1803 passed in 1962 recognizes state sovereignty as including the right to expropriate, nationalize or requisition as recognized in. However, these rights are not unqualified because they may only be exercised in pursuance of public utility, security or the national interest. Moreover, in exercising these rights, the State has the obligation to pay appropriate compensation in accordance with the rules in force in the state, in accordance with international law. The way the right and the concomitant obligation are phrased shows a hierarchy in the applicable basis of the “adequate compensation.” This is reinforced by the statement that the “national jurisdiction of the state taking such measures shall be exhausted.” The same functions as the general rule on where the dispute settlement is to take place. The exception is when the parties agree to submit the dispute to arbitration or international adjudication.

Another UN instrument singing the same tune is the Charter of Economic Rights and Duties of the State or G.A. res. 3281 which was passed in 1974. In that instrument, the UN reiterated its recognition of the sovereignty equality of states as one of the bases on which the new international economic order is to be founded on. Like the earlier resolution, it recognized the right of the state to “nationalize, expropriate or transfer ownership of foreign property, in which case appropriate compensation should be paid by the State adopting such measures.” It was also similar to G.A. res. 1803 in that the compensation was to take into account its (the state’s) “relevant laws, and regulations and all circumstances that the State considers pertinent.” It went on to state a similar general rule with respect to the applicable law and venue of dispute settlement, which was the domestic law and tribunal; the exception was if parties agreed to use “other means freely agreed upon.” In essence, the two documents are consistent with the concept of state sovereignty over economic affairs to the extent that it is the expropriating state that determines what “adequate compensation” is and the determination is to be made domestically in the absence of a contrary agreement.

In Clagett’s article, he explains that as countries grew more receptive to foreign investments, the States recognized the need for fair and stable rules to encourage foreign investment. One of these rules is the rule on nationalization and expropriation. Clagett argues that the U.N. resolutions – which effectively encourage a domestic set of standards to govern the same – were not expressions of international law. The article focused on the Revised Restatement of the Law: Foreign Relations Law of the US – which ostensibly holds itself out as a “correct” statement of what international law is. Typical of the US to assert that what it considers as the applicable law is in fact what the international law is on the matter. To further support the US Restatement, Clagett says that developing nations actually accept the need for fair and stable rules and that this acceptance is manifested in the inclusion of clauses providing for traditional standards of just compensation in bilateral and multilateral investment agreements. When he refers to “fair and stable” it is assumed that he is referring to an over-arching rule that would control domestic rules on the matter. That over-arching rule is customary international law. Presumably he emphasizes this to fulfill the requirement of “state practice.”

Evaluating the 2004 US BIT model agreement, one finds a provision on expropriation that is couched in the negative and exclusionary form. It provides that expropriation and nationalization could not be done except upon compliance with the succeeding requirements. It is hinged on customary international law and not the domestic law of the expropriating party. Notably, the heading “expropriation” has a footnote that Annexes A and B would be applicable to it. Annex A defines Customary International Law as “resulting from general and consistent practice of States that they follow from a legal sense of obligation.” Annex B begins by stating that the article on expropriation is intended to reflect customary international law concerning the obligation of states with respect to the same. It expounds on what constitutes expropriation (direct and indirect). This affirms Clagett’s position that the standard of “prompt, adequate and effective” remains and this is actually expected because this is an American agreement after all.

The US-Singapore FTA also has a provision on Expropriation (Article 15.6) and it is also couched in the negative and in the exclusionary sense. The remainder of its provisions are identical to the US BIT Model agreement. The footnote to the provision states that it is to be interpreted in accordance with the letter exchange on customary international law and the letter exchange on expropriation, and is further subject to the letter exchange on land expropriation.

Evaluating the Philippine-Australia BIT’s own provision on nationalization and expropriation it can be seen that it is phrased in the negative and exclusionary because unless the requirements therein listed are complied with. The standards for the compensation are identical to that of the US BIT model – prompt, adequate and effective. While there is no explicit reference to the applicability of customary international law on the matter, there agreement’s dispute settlement machinery provides for different venues depending on who the disputants are. In the case of expropriation, it would always be a party and an investor of the other party. The agreement provides that if both parties are at that time party to the 1965 Convention on the Settlement of Disputes, the venue laid down is that of the International Centre for Settlement of Investment Disputes.

Looking at the JPEPA, there is a provision on Expropriation (Article 95) which is quite similar to the Philippines-Australia BIT in that the sovereign power to expropriate is couched in the negative and exclusionary. With respect to dispute settlement, the provision allows the affected investor to have access to the courts of justice or administrative tribunals of the party making the expropriation. In a later provision on Dispute Avoidance and Settlement (Chapter 15,) the agreement makes specific mention that once a dispute settlement procedure has been initiated under the chapter, or any other international agreement, that procedure shall be used to the exclusion of any other procedure. This provision seems to respect the power of domestic tribunals to make competent determinations regarding the validity of the act and to determine the compensation. The chapter on investments has a note that follows the article on General Treatment and this prescribes that customary international law’s minimum standard of treatment of aliens is the minimum standard of treatment to be afforded to the investments of the other party. This is perhaps the closest to a prescription of the application of international law to possible disputes under the article.

The three agreements differ in what they prescribe in the event of a dispute. The US BIT model and the US-Singapore FTA provide for the law to be applied by whichever tribunal is to take cognizance of a dispute – for the former it is customary international law, and the latter it is a series of letter exchanges ON customary international law. This raises the question as to what difference the two might have. Strictly speaking, it should not be a material difference since customary international law is not subject to stipulation by parties. Operationally speaking, the better question to ask is – who will complain, considering that the agreement is bilateral and both parties agreed to the same.

On the other hand, the Australia-Philippines BIT and the JPEPA provide for the tribunal to take cognizance of the dispute but does not provide for the law to be applied. The JPEPA makes reference to customary international law’s minimum standard of treatment but does so in very general terms. I find that the latter is a more liberal approach as the tribunal selected is left to determine which law and standard to apply. However, it is precisely the approach that arguably undermines confidence in the security of foreign investments. A possible reason why the parties to the last two agreements agreed despite the absence of an explicit prescription that customary international law standards will apply is that the agreements in themselves already incorporate international law’s standard and the same is what the tribunals will enforce.

It is rather odd that the parties willingly limit their sovereign power to expropriate and nationalize by couching the same in the negative, rather than first affirming that they hold this power and it may be exercised subject to certain conditions and payments. Perhaps the difference is merely sentimental but it can be argued that by the way it phrased, if the conditions are not met, there can be no expropriation or nationalization. This is quite different from a situation which can arise if the power is stated in the positive. In such a case, because the provision determines when liability attaches – upon injury – taking will always be allowed and the same will just give rise to a responsibility. That a state is sovereign over its own sovereignty cannot be but true. That its choice to “contract” or “treaty” its sovereignty away does not violate international law is likewise true. However, if states, by way of treaty, agree to be governed by a set of standards, which do not conform to customary international law, can one of the parties to that treaty, in the event of disputes arising from it, be heard to complain?

[Anthony Raphael V. Jacoba]

There has been a resurgence of signed Bilateral Investment Treaties (BIT) in recent years. Andreas Lowenfeld numbered the same to more than a thousand signed BITs. Similarly, Kenneth Vandevelde, in 1998 placed a nice round figure of 1300 signed BITs, with an expectation of an additional 180 signed BITs every year. For Lowenfeld, the numbers of signed BITs alone, which contains provisions on protection of foreign investment, constitute a paradigm shift towards the situation that existed prior to the breakdown of the consensus, that is, a State taking an alien’s property was obligated to make prompt and adequate compensation. Vandevelde, on the other hand, analyzes the value of BITs in relation to liberalization of investment and the economic development policy of States.

But what is the real role of BITs really? For Vandevelde, the principal effect of a BIT is stabilization. This can be gleaned from the usual provisions that may be seen in a BIT: 1) a requirement that compensation be paid in the event of expropriation of covered investment; 2) a prohibition on currency exchange controls, with reasonable exceptions; 3) a requirement that the State afford covered investment both national and most favored nation treatment with respect to compensation paid for losses attributable to war or civil disturbance; 4) a general obligation of due care toward investment; and 5) a requirement that the host state honor any commitment which it may have entered into with respect to investment.

It is submitted that BITs are nothing more than tools to protect foreign investment. The requirement that compensation be paid in the event of expropriation of covered investment is one of the most important features of any BIT. Lowenfeld’s discussion reflects a huge problem with expropriation and international law in the years prior to the explosion of BITs. Lowenfeld started with the aforementioned consensus prior to the First World War, then the subsequent Breakdown of the consensus during the Russian Revolution and the Mexican Revolution which gave rise to the Calvo doctrine, then, finally, a return to the consensus and acceptance of the Hull formula. BITs are nothing more than guarantees that any expropriation exercised by a host State will not merit a huge loss on the part of any investor. This is the risk reduction mentioned by Vandevelde which provides stability for foreign investment. Vandevelde posited, however, that BITs in no way encourages foreign investment apart from the stabilization consideration. Vandevelde questions and in facts doubts, any positive correlation between signing BITs and the influx of foreign investments, which leads to the fair inference that BITs are nothing more but a tool to settle once and for all the decades old problem of expropriation and compensation.

Under an ideal world, there is no problem with this kind of setup. It’s only fair to pay adequate compensation in case a State expropriates the properties of an investor. There are different kinds of expropriation, however. One example involves expropriating with the intent to redistribute the wealth to the society similar to the expropriation in the Russian Revolution mentioned in Lowenfeld’s article. What if expropriation was exercised under the police power of the State to protect the public health, morals, etc.? In the real world, foreign investments are not necessarily above board. There are several instances wherein the foreign investors disregard environmental laws of the host State because of the drive to increase revenue. The Marcopper fiasco is illustrative of a foreign investor’s disregard of the environment. Suppose the government expropriates the properties of Marcopper to protect the inhabitants of the nearby community. Is the government required to pay just compensation notwithstanding that laws are being disregarded left and right by the foreign firm? The case of Piatco may also be illustrative. Suppose the government took over the operations of the NAIA Terminal 3 because there are irregularities in the bidding procedures mandated by law, is the government required to pay just compensation as well? The answer should be no because foreign firms are not suppose to profit from their illegal acts, but the BITs may leave the opening for a yes answer.

Take the case of the Russian Revolution. In abolishing private property, the legal regime at the time makes it illegal to own private property. This legal regime applies to foreign and local ownership of property. Under the law then prevailing at that time, the government of Russia is justified in taking the properties even without paying just compensation, yet the taking without compensation was questioned in the international arena. In the same vein, the legal taking by the government of any properties of a foreign firm because of illegal acts of the same without compensation may be questioned by the investors. In fact, provisions of the BIT relating to the subrogation may be said to make it easier on the part of the foreign investor to receive compensation notwithstanding its illegal acts. Note, that the JPEPA contains provisions on subrogation in Article 98 and expropriation in Article 95. All the foreign investor has to do is assign the claim to the State party to the BIT and the case becomes a battle between the host State and the State of the investor.

BITs, therefore, deserve a second look. Its usefulness in encouraging foreign investments is merely cosmetic because of the questioned correlation between executing BITs and an increase in foreign investments. Its usefulness as a tool to protect foreign investments through the expropriation and subrogation provisions may be attractive on the part of foreign investors but the protection of the host State should be taken into consideration as well in drafting any of the provisions contained therein. After all, the purpose of any foreign investment is to increase the revenue of the investors, while the purpose of any State is not limited to increasing its GDP. There are other things to consider as well, such as the protection of the environment, public health, etc. such that it is practically mandatory for States to take care in scrutinizing each and every detail of any agreement it will enter into.