International Investment Arbitration and the Conduct of National Courts
Abstract
International investment arbitration is used by foreign investors to seek compensation from host states for the violation of various investment protection commitments made in international investment agreements (IIAs). IIAs contain elaborate investment protection obligations on host states requiring them to treat the investments of foreign investors in a manner which complies with international standards of justice and due process. International law recognises that actions of state organs i.e. the legislature, executive and judiciary, are attributable to the state itself. Accordingly, the role of national courts has become crucial to a state’s ability to afford the requisite protection to foreign investments. This article gives an overview of the mechanism through which investors and states resolve their disputes in case of a treaty violation by the state, the salient features of a typical IIA, and a discussion on the implications of the procedural conduct and substantive decisions of national courts, on the state’s international treaty obligations.
INTERNATIONAL INVESTMENT ARBITRATION
A prominent feature of modern international trade is foreign investment by individuals and corporations in other countries. Foreign investment however is susceptible to innumerable risks in host states and therefore protections must be provided to foreign investors to encourage investment.
Taking over property or other investments within its territory by a sovereign state is recognised in international law as a sovereign right. This is called expropriation. However, international law imposes certain conditions on expropriation by a sovereign state. The expropriation is required to be for a public purpose; on a non-discriminatory basis; in accordance with due process of law; and accompanied by compensation.[1] These conditions are also imposed in the domestic law of nation states. In Pakistan, Article 24 of the Constitution of Pakistan 1973 imposes such conditions. Where these conditions are not met, the expropriation is considered unlawful.
With the aim to protect foreign investments or provide an appropriate remedy against illegal expropriation, sovereign states enter into international investment agreements (IIAs). These IIAs not only impose certain investment protection obligations on host states, they also provide for an investor-state dispute settlement (ISDS) mechanism to allow foreign investors to make direct investment related claims against host states.
ISDS enables an investor to seek compensation against expropriation or other breaches of international law by host states, without the trappings of local court procedures, domestic law and application of domestic legal standards. Rather than bringing a claim under domestic law, investors can bring claims against a host state before an international arbitral tribunal.
The settlement of investment disputes between investors and host states through arbitration has advantages similar to any other international commercial arbitration: the decision-makers are neutral; the place of arbitration is a neutral jurisdiction; the parties are free to select arbitrators that have the requisite expertise and qualifications; the decision is binding and final; the proceedings are efficient and speedy, and facilitated by a credible institute; and the decision can be enforced globally.
Most ISDS mechanisms provide for investment disputes to be settled in accordance with the rules of the International Centre for Settlement of Investment Disputes (ICSID) established by the Convention on the settlement of investment disputes between States and nationals of other States, 1965 (Washington Convention),[2] or the arbitration rules of the United Nations Commission on International Trade Law (UNCITRAL).
International Investment Agreements
ISDS Provisions
The ISDS mechanism is found in the international investment agreements (IIAs) made between two or multiple states. These investment agreements are usually in the form of bilateral investment treaties (BITs) and multilateral investments treaties (MITs), but are also found in investment protection clauses of free trade agreements (FTAs). These treaties are meant to provide guarantees and protections to investors and often provide for arbitration of disputes between investors and the host state.
ISDS against a host state is a mechanism available to all citizens of a state which has entered into an IIA with that host state. However, IIAs are entered into only between state parties – investors are not party to such treaties. However, international law recognizes ISDS provisions in a treaty between states as constituting unilateral consent or standing offers by states to nationals of the other signatory state. The agreement to arbitrate investor claims is perfected when investors give notice to the host state to arbitrate a claim. It is at this time that the ISDS agreement is concluded between an investor and a state.
Definitions of ‘Investor’ and ‘Investment’
In order for an investor to have a claim, and an arbitral tribunal to have jurisdiction to decide upon the claim, the investor must fall within the definition of investor in the IIA. Investors can be natural or legal entities, but some IIAs contain residency or domicile requirements. Similarly, the investment of the investor must also fall within the agreed definition of investment as provided in the relevant treaty. Therefore, definitions contained in the IIAs often determine the scope of protection guaranteed by the host state and its eventual liability in case of failure to provide that protection.
Many IIAs also contain ‘in accordance with host state law’ and ‘anti-corruption’ clauses which impose requirements upon investors to comply with the domestic law of a host state. Non-compliance gives a defence to a host state against any investor’s claim.
Standards of Treatment and Protection by Host States
The major characteristic of IIAs are investment protection clauses which set out the obligations of the host state and also provide the standards which are to be met in providing such protection and treating the relevant investments of the foreign investor. Some of the popular clauses in IIAs include the following:
National Treatment (NT): NT clauses protect foreign investments against discrimination and obligate host states to treat them as equal to domestic investments by nationals of the host state.
Most-Favoured Nation (MFN): MFN clauses protect foreign investments against discrimination with regard to investments from a third-country national and obligate host states to treat the foreign investment as equal to the third-country investment by nationals of the other state.
Fair and Equitable Treatment (FET): FET clauses require hosts states to treat foreign investments or investors “fairly and equitably” as per international legal standards. This term is very wide and is often susceptible to an arbitral tribunal’s subjective interpretation. It is considered to give maximum protection to foreign investors. This clause typically protects investors/investments from arbitrary and abusive treatment by the host state and can include actions which amount to denying justice in judicial or administrative proceedings and denying the legitimate expectations of foreign investors.
Expropriation: Expropriation clauses provide for payment of compensation to foreign investors in case the host state nationalises the properties of the foreign investors or takes away foreign investment in any other manner.
As mentioned before, additional conditions are also imposed in such clauses. The expropriation must be for a public purpose, be non-discriminatory, and follow due process.
Some expropriation clauses are worded widely to include indirect expropriation i.e. where the host state does not purport to take over any investment but takes certain actions (such as legislation, regulatory measures, etc.) which indirectly deprive the foreign investor of its investment.
Such clauses may also contain clarificatory language or carve out exceptions which permit the host state to take certain measures in the interest of public health or safety, or the environment. These are then excluded from the definition or scope of indirect expropriation.[3]
CONDUCT OF NATIONAL COURTS
State Responsibility for National Courts
As a matter of public international law, host states are responsible for the decisions of their national courts.[4] This is now well established in international law, codified by the Articles on State Responsibility drafted by the International Law Commission and approved by the United Nations General Assembly in 2001.[5] Article 4 states:
“1. The conduct of any State organ shall be considered an act of that State under international law, whether the organ exercises legislative, executive, judicial or any other functions, whatever position it holds in the organization of the State, and whatever its character as an organ of the central government or of a territorial unit of the State.
2. An organ includes any person or entity which has that status in accordance with the internal law of the State.”
The judiciary is, therefore, seen as a component element of the state. In the Salvador Commercial Company case (1902),[6] an international arbitral tribunal observed that,
“…a State is responsible for the acts of its rulers, whether they belong to the legislative, executive, or judicial department of the Government”.[7]
Further, it is irrelevant from an international perspective that as a matter of national law, the judiciary is “independent” of the state.[8]
Role of Courts in Respect of the State’s Breach of Treaty Obligations
The conduct of national courts can thus be attributable to a host state which has made investment protection commitments pursuant to an IIA.
The manner in which national courts can cause the deprivation of a foreign investor’s investment can occur mainly in two ways:
- through a ‘denial of justice’, which primarily relates to issues of procedural fairness and due process failings of the courts;[9] and
- through judicial expropriation i.e. a substantive decision of the court which takes away the foreign investment.[10]
Some instructive examples of international investment awards which have dealt with the role played by national courts include the following:
i. Yukos v. The Russian Federation (Yukos Award);[11]
ii. Rumeli and Telsim v. Kazakhstan (Rumeli Award);[12]
iii. Saipem v. Bangladesh (Saipem Award);[13]
iv. Karkey Karadeniz v. Pakistan (Karkey Award).[14]
i. Yukos Award
The Yukos Award was the result of a dispute involving the obligations of Russia as the host state under the Energy Charter Treaty (1994). A series of adverse actions against a UK-based investor led to the bankruptcy of the Yukos Oil Company and eliminated all value of the investor’s shares in Yukos. Regarding the adverse role of the Russian courts which led to the resulting expropriation, at paragraph 1583 of the Yukos Award the tribunal concluded the following:
“Yukos was subjected to processes of law, but the Tribunal does not accept that the effective expropriation of Yukos was “carried out under due process of law” for multiple reasons set out above … The harsh treatment accorded to Messrs. Khodorkovsky and Lebedev remotely jailed and caged in court, the mistreatment of counsel of Yukos and the difficulties counsel encountered in reading the record and conferring with Messrs. Khodorkovsky and Lebedev, the very pace of the legal proceedings, do not comport with the due process of law. Rather the Russian court proceedings, and most egregiously, the second trial and second sentencing of Messrs. Khodorkovsky and Lebedev on the creative legal theory of their theft of Yukos’ oil production, indicate that Russian courts bent to the will of Russian executive authorities to bankrupt Yukos, assign its assets to a State controlled company, and incarcerate a man who gave signs of becoming a political competitor..”
In the Yukos case, the tribunal held that the primary objective of Russia was not to collect taxes but to bankrupt Yukos and appropriate its valuable assets.[15] It further held that its measures in respect of Yukos had an effect equivalent to expropriation.[16] Such expropriation was then held to be without due process and the Russian courts were found to have violated international standards of due process. The tribunal ultimately found Russia to be liable for breach of its obligations under the Energy Charter Treaty.
ii. Rumeli Award
The Rumeli case involved claims by Turkish investors under the Turk-Kazakhstan BIT. The claimants, Turkish companies, established a stock company KaR-Tel jointly with a local company and acquired a GSM licence. KaR-Tel later concluded a contract for the establishment of a GSM-standard communications network with the Investment Committee of the Kazakh government. Three years later, the Investment Committee cancelled the contract with KaR-Tel on the grounds of breach of contract. At the extraordinary general meeting of shareholders convened upon request by the claimants’ local partner, the purchase of the claimants’ shares in KaR-Tel was adopted in the absence of the claimants. Subsequently, the local partner filed a suit against the claimants in a domestic court to affect a purchase of the shares in question. The claimants resisted the suit, but the Supreme Court eventually permitted a forced purchase of the shares, following which the aggrieved claimants requested arbitration, alleging that the acts violated the Turkey-Kazakhstan BIT.
The ICSID tribunal held that the Investment Committee of the government was in violation of the FET standard, but with regard to the role that the Kazakh courts played, the ICSID tribunal held the following:
“On the other hand, the Arbitral Tribunal considers that it does not have any clear evidence that the decisions of the various Kazakh Courts which have been reviewed above were wrong procedurally or substantially, or were so egregiously wrong as to be inexplicable other than by a denial of justice. As was evidenced by the legal experts who testified during the hearing, the issues that the Courts had to decide were sometimes highly disputed issues. The Tribunal has also noted that when the decisions were appealed, they were carefully reviewed by the appellate courts and sometimes partially reversed by them.”[17]
However, even though the courts were not in violation of the FET standard, in respect of expropriation the ICSID tribunal found the following:
“The final act of ‘taking’ as regards Claimants’ investment (i.e. their shares in Kar-Tel) was the decision of the Presidium of the Supreme Court affirming the compulsory redemption of those shares.
…
Nevertheless, for reasons which the Tribunal will discuss under the heading “Calculation Of Damages And Quantum,” the valuation placed on Claimants’ shares was manifestly and grossly inadequate compared to the compensation which the Tribunal there holds to be necessary in order to afford adequate compensation under the BIT and the FIL. The Tribunal accordingly holds that the expropriation by the Presidium was unlawful.
…
In summary, the conclusion of the Tribunal is that this was a case of ‘creeping’ expropriation, instigated by the decision of the Investment Committee which was then collusively and improperly communicated to Telcom Invest and its shareholders before Claimants were made aware of it, and which proceeded via a series of court decisions, culminating in the final decision of the Presidium of the Supreme Court. The decision of the Investment Committee was moreover unfair and inequitable in itself, as the Tribunal has found.”
The Rumeli case demonstrates how even though national courts may comply with international standards of due process, if they are part of the host state’s government measures or design of indirect expropriation, whether intended or not, it can result in any decision of the court amounting to a violation of the expropriation clause of the investment treaty.
iii. Saipem Award
The Saipem Award demonstrates that a host state can be held responsible for expropriation based on illegal interference by its judiciary in commercial arbitration proceedings.
Saipem filed ICSID proceedings against Bangladesh for breach under the Bangladesh-Italy BIT. The claims alleged undue intervention of the Bangladeshi courts in a previously filed and concluded arbitration under the rules of the International Chamber of Commerce (ICC).
Saipem, an Italian company had previously initiated ICC arbitration against Petrobangla, a Bangladeshi public company. Upon rejection of certain procedural requests of Petrobangla by the ICC tribunal, Petrobangla obtained an order revoking jurisdiction of the ICC tribunal from the First Court of the Subordinate Judge of Dhaka.
When the ICC tribunal continued proceedings, a series of injunctions in that regard had been obtained by Petrobangla from the High Court Division of the Supreme Court of Bangladesh. Notwithstanding such injunctions, the ICC tribunal concluded its proceedings and eventually announced a final award. Upon Petrobangla’s application to the Supreme Court to set aside the award, it was held that, “…there is no Award in the eyes of law,” rendering the award non-existent and unenforceable in Bangladesh.
In respect of its jurisdiction, the ICSID tribunal held that, “…the right to arbitration and the rights determined by the [ICC Arbitration] Award are capable in theory of being expropriated.”[18]
In respect of the decisions of the court of first instance revoking the ICC tribunal’s jurisdiction and that of the Supreme Court declaring the ICC Award non-existent, the ICSID tribunal held that that the decisions amounted to illegal expropriation by Bangladesh of Saipem’s right to arbitrate.[19]
The ICSID tribunal, with regard to the conduct of Bangladeshi courts, held the following:
“…the Tribunal considers that the Bangladeshi courts abused their supervisory jurisdiction over the arbitration process. It is true that the revocation of an arbitrator’s authority can legitimately be ordered in case of misconduct. It is further true that in making such order national courts do have substantial discretion. However, they cannot use their jurisdiction to revoke arbitrators for reasons wholly unrelated with such misconduct and the risks it carries for the fair resolution of the dispute. Taken together, the standard for revocation used by the Bangladesh courts and the manner in which the judge applied that standard to the facts indeed constituted an abuse of right.”[20]
The ICSID tribunal also held that through revocation of the ICC tribunal and several injunctions against the ICC arbitration, the courts had frustrated the arbitration agreement which amounted to a violation of Article II of the New York Convention.[21]
iv. Karkey Award
In the Karkey Award,[22] Pakistan, as the host state, was found in violation of its international obligations. In the ICSID proceedings, a decision of the Supreme Court of Pakistan came up for consideration in two respects:
- Pakistan sought to rely on it with respect to challenging the ICSID tribunal’s jurisdiction, contending that the Supreme Court’s findings had established Karkey’s investments to not be in accordance with Pakistani law;
- the ICSID tribunal considered whether the Supreme Court’s decision, coupled with other acts of Pakistan, amounted to expropriation.
The Supreme Court of Pakistan’s decision had declared all contracts relating to the claimant’s rights (including others) to produce and sell electric power in Pakistan, null and void.[23] The Supreme Court’s decision was largely formed on the basis that national procurement laws had not been followed in the award of the subject contracts.
The ICSID tribunal affirmed certain established principles of international law with regard to decisions of national courts in the following words:
“Indeed, in order to decide whether the Tribunal may rely on the Judgment, the Tribunal must analyse whether the Judgment presents deficiencies which are unacceptable from the viewpoint of international law. However, contrary to what is alleged by Pakistan, there is no need that such deficiencies amount to a denial of justice … Deficiencies relating to the substance of the Judgment, in certain circumstances, may amount to a breach of international law. In particular, an international tribunal may decide not to defer to an arbitrary judicial decision which is, as such, incompatible with international law.”[24]
Upon review of the procedure and substance of the Supreme Court’s decision, the tribunal noted that the Court had treated all the rental power plants involved similarly in terms of the consequences they were liable to suffer, without setting out in its judgment “with some particularity the evidential and legal basis”. The tribunal held that this made the decision “arbitrary”.[25] The tribunal also noted that the Supreme Court failed to apply the Contract Act properly and that the judgment had been fundamentally inconsistent with regard to its findings of rental power contracts being both “void ab initio” and “rescinded forthwith”.[26]
Ultimately, with regard to the Supreme Court’s judgment, the ICSID tribunal held the following:
“…the Supreme Court Judgment which declared the Contract to be void ab initio was arbitrary, and therefore has no effect in international law, and the Tribunal is not bound by its finding that the Contract was void. For the Tribunal, it is nothing more than a fact, attributable to Pakistan as admitted by the Respondent, which started a process leading to the deprivation of Karkey’s contractual rights, the arrest of its Vessels and the seizure of its bank accounts.
…
…the Tribunal finds that Pakistan has expropriated Karkey’s investment through the Judgment which declared the Contract to be void ab initio. This is because through its Supreme Court, whose acts Pakistan accepts are attributable to it, Pakistan deprived Karkey of the use and enjoyment of its contractual rights, including Karkey’s right to terminate the Contract and, as stated below, interfered with the free transfer of Karkey’s investment.”[27]
IMPLICATIONS FOR PAKISTANI COURTS
Pakistan is currently party to 53 BITs and 7 treaties with investment provisions.[28] The courts of Pakistan are assumed to be aware of the international obligations of Pakistan in these international treaties and are obligated, as an organ of the state, to treat foreign investors in accordance with international legal standards of justice.
The China–Pakistan Economic Corridor (CPEC) is expected to give rise to opportunities involving infrastructure projects and therefore foreign investment. The trend of judicial intervention in major commercial projects in Pakistan[29] must be reassessed and carefully managed.
Failure by the judicial organ of a host state not only leads to an economic setback for the country in terms of financial liability but also tarnishes the image of the host state in international relations and future prospects of investment.
International cases reveal that failure to provide due process rights and fair and equitable treatment in procedural matters may not be the only reason for decisions of national courts to amount to violations of international treaty obligations. As observed in the Rumeli case, national courts must be aware of their court process being used to facilitate and enable government agencies or even private third parties to cause an indirect expropriation of foreign investment.
Additionally, where the Supreme Court of Pakistan intends to interfere in major commercial projects over grounds of violation of domestic law, it must ensure that where its decisions have the effect of expropriation, all conditions for expropriation under the relevant international treaty are complied with and the rights of foreign investors are protected.
———-
References
[1] UNCTAD, “Expropriation” UNCTAD Series on Issues in International Investment Agreements II: pg. 1, available at https://unctad.org/en/Docs/unctaddiaeia2011d7_en.pdf
[2] There are 154 contracting states to the Washington Convention. Pakistan is also a signatory.
[3] For additional reading on the framework of IIAs and other clauses see: UNCTAD, “Investment Policy Framework for Sustainable Development”, 2015 pg. 92, available at https://unctad.org/en/PublicationsLibrary/diaepcb2015d5_en.pdf#page=71
[4] Toby T. Landau, “International Arbitration and Pakistan’s State Responsibility: Redefining the Role of the Court”, pg. 17, available at www.supremecourt.gov.pk/ijc/Articles/8/3.pdf
[5] UNGA Resolution 56/83 on 12 December 2001
[6] This was a case brought by the Salvador Commercial Company and other citizens of the United States against the Republic of Salvador pursuant to a protocol for arbitration agreed between the United States and the Republic of Salvador.
[7] Toby T. Landau, “International Arbitration and Pakistan’s State Responsibility: Redefining the Role of the Court”, pg. 20
[8] Id., pg. 19.
[9] Rumeli Telekom A.S. and Telsim Mobil Telekomik A.S.Y.O.N Hizmetleri A.S. v Republic of Kazakhstan, (ICSID Case No. ARB/05/16), Award, 29 July 2008, pg. 173, paras 651-653.
[10] Id. pg. 188, para 702.
[11] Yukos Universal Limited (Isle of Man) v. The Russian Federation (PCA Case No. 2005-04/AA227). The PCA acted as registry in this arbitration and in PCA Case No. AA 228 – Veteran Petroleum Limited (Cyprus) v. The Russian Federation; and PCA Case No. 2005-03/AA226 – Hulley Enterprises Limited (Cyprus) v. The Russian Federation. However, the role of the Russian courts leading to judicial expropriation has received focused attention in the Yukos Universal Limited (Isle of Man) v. The Russia.
[12] Rumeli Telekom A.S. and Telsim Mobil Telekomik A.S.Y.O.N Hizmetleri A.S. v Republic of Kazakhstan, (ICSID Case No. ARB/05/16), Award, 29 July 2008.
[13] Saipem S.p.A. v. The People’s Republic of Bangladesh, ICSID Case No. ARB/05/07
[14] Karkey Karadeniz Elektrik Uretim A.S. v. Islamic Republic of Pakistan (ICSID Case No. ARB/13/1).
[15] Yukos Award pg. 497, para 1579.
[16] Id., para 1580.
[17] Rumeli Award, pg. 164, para 619.
[18] Saipem Award, pg. 38, para 122.
[19] Id., para 214.
[20] Id., para 159
[21] Id., para 163-169. Article II of the NY Convention obligates all contracting states to recognize and arbitration agreement.
[22] Pursuant to ICSID proceedings arising out of the Pakistan-Turkey BIT. It has recently been reported that Karkey and Pakistan have settled the matter, see: https://www.law360.com/articles/1216990.
[23] Judgment of the Supreme Court of Pakistan in the Rental Power Case (Human Rights Case Nos. 7734-G/2009 & 1003-G/2010, as consolidated with Human Rights Case No. 56712/2010, in the Supreme Court of Pakistan), dated 30 March 2012.
[24] Karkey Award, para 550.
[25] Id. para 554.
[26] Id., para 555.
[27] Id. para 645-648.
[28] See https://investmentpolicy.unctad.org/country-navigator/163/pakistan
[29] The Pakistan Steel Mills case, the Reko Diq case, the Royal Palm case are few further examples which demonstrate this trend.
An earlier version of this article appeared in the SARCO Newsletter. Republished here with permission.
The views expressed in this article are those of the authors and do not necessarily represent the views of CourtingTheLaw.com or any other organization with which they might be associated.
