Article by Gerold Zeiler and Katarina Hruskovicova

Many bilateral investment treaties (BITs) contain provisions under which investments have to be made in accordance with the host state's laws. A violation of domestic law bears the imminent danger that the investor will lose the protection of the BIT. Gerold Zeiler and Katarina Hruskovicova of Schoenherr address the scant jurisprudence on this point.

For many foreign investors, the protection of their investment by international law is an essential criterion when they decide to invest. The extent of this protection largely depends on whether the host state has concluded a BIT with the investor's home state and whether it is a party to the European Charter Treaty and to the Icsid Convention.

If the host state and the investor's home state concluded a BIT, this BIT will in many cases define the term "investment" by reference to the host state's law. The Austrian-Romanian BIT, for instance, contains the following provision: "For the purposes of the Agreement [...] the term 'investment' shall include all assets invested in by an investor of a contracting party in the territory of another contracting party in accordance with the latter's laws".

The importance of these provisions has been demonstrated by recent jurisprudence of international arbitral tribunals dealing with cases in which the investor violated host state laws and at a later stage tried to protect its investment by raising claims against the host state.

Jurisprudence of international arbitral tribunals

The tenor of the argument raised by the host states was that only the host state's laws are relevant for determining whether the investors had actually made an investment or not. Investments which do not qualify as investments under the host state's laws do not enjoy protection under the BIT. The host states argue that the arbitral tribunals consequently lacked jurisdiction to decide the investors' claims.

This argument was rightly rejected by the tribunals, which decided that the term "investment" must be interpreted solely in accordance with the BIT and the criteria established under international law.

However, the tribunals also found that the purpose of the reference to national law is that certain unlawful investments are excluded from the scope of the BIT. In these cases the arbitral tribunals would lack jurisdiction to decide on claims raised by the investors. If the investor violates national law when making his investment, he runs the risk of losing the protection provided by the BIT.

This was the crux of the decision rendered in the cases of Inceysa v El Salvador and Fraport v Philippines. In both cases, the respective arbitral tribunals found that the investor had consciously violated the host state's law when investing. In Inceysa, the host state argued that the investor obtained the relevant concession contract by fraud, as he had consciously presented incorrect financial figures and false information on his experience gained in similar projects.

In Fraport, the investor sought to circumvent the host state's laws on the maximum participation a foreigner may hold in a Philippine company by acquiring indirect participations and concluding undisclosed side letters with other shareholders in order to increase his control over the Philippine company.

The arbitral tribunals held that host states do not subject themselves to the unlimited jurisdiction of arbitral tribunals. On the contrary, the arbitral tribunals' jurisdiction is limited to investments which have been established in accordance with the domestic laws of the respective host states. Consequently, if an investor does not make an investment in accordance with the host state's law, the arbitral tribunal lacks jurisdiction.

As can be seen from this line of jurisprudence, it is of utmost importance for investors to comply with the host state's laws. Arbitral tribunals have realised, however, that this somewhat rigid approach requires restrictions on several points.

Limitations of the approach

Conformity with the host state's law only at the time the investment was made would lead to considerable legal uncertainty if the investor fears that any infringement on his part of the host state's domestic law during the time he holds his investment would deprive him of the protection of the BIT.

The tribunal in Fraport therefore limited the timeframe within which the investor must not have violated the host state's law. It restricted this requirement to the time when the investor first establishes his investment rather than extending it to the entire duration of the investment.

This limitation is generally welcome. At second glance, however, it is problematic. Of course the point in time in which an investment may be considered to have been established is not easily defined. In Fraport, for instance, the investor acquired shares in a local company and concluded agreements with other shareholders during a longer period of time. The "establishment" of the investment therefore may extend over a longer period of time. Not knowing precisely when his investment was "established" may bring about considerable legal uncertainty for the investor.

Good faith of the investor

When an investor invests, he often sails into relatively uncharted legal waters. The Fraport tribunal attempted to address this reality by taking into account whether the investor acted in good faith when violating the host state's law. In the tribunal's reasoning, an investor will not lose the protection of the BIT if the host state's domestic law was unclear and the investor, although violating the law, acted in good faith.

For instance, according to the tribunal, a legal due diligence report on which the investor relied but which failed to indicate the relevant provision of the host state's law may prove the investor's good faith. A further indication may be that the violation of the host state's law was not of primary relevance for the profitability of the investment. The tribunal held that this can be assumed if the investor could have established his investment in accordance with the host state's domestic law without any loss of profitability.

The tribunal's decision, however, did not explain in any more detail when the criterion of ambiguity of the domestic law is fulfilled, which created legal uncertainty for the investor. It is the investor's burden to establish that he acted in good faith, something which may prove difficult in practice.

Minor violations of the host state's law

Another argument, which the tribunal in Tokios Tokelès v Ukraine provided to investors who violated the host state's law, was that the violation was only minor. The tribunal had been faced with the allegation that the investor had disregarded certain formal requirements when establishing a company in the host state.

The tribunal considered the infringements to be minor and would not exclude the investor from the protection of the BIT, as this would run counter to the BIT's object and purpose. The arbitral tribunal, however, did not specify where the line is to be drawn between minor infringements that bear no relevance for the jurisdiction of the tribunal and larger violations that do.


Exceptions to the relevance of violations of domestic law have been established by tribunals on a case-by-case basis, which allow for induction towards more general rules. Of course, the law is still being developed. Investors are therefore advised to study the relevant BIT for references to the host state's law before investing, and to meticulously adhere to domestic law, especially in the initial phase of the investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.