India's Ministry of Finance recently published its draft model bilateral investment treaty in March this year (the "Draft BIT"), inviting comments from the public before planning to roll it out and replace the existing 83 agreements that are currently in place.1
Following the recent Vodafone tax case and the issue of retrospective tax obligations and the cancellation of 2G telecom licenses, several foreign companies have invoked the provisions of their home state's relevant bilateral investment treaty seeking recourse against the Government of India.
The increase in dispute filings under these treaties has led the Government of India to revisit its obligations and the rights afforded to foreign investors. This article looks critically at the Draft BIT and assesses its impact on investor confidence.
2. Bilateral Investment Treaties
Bilateral investment treaties (otherwise known as bilateral investment promotion and protection agreements in India) are agreements between states that essentially give foreign investors rights against the host state in the event that a change in law or other measures devalue or expropriate the investment made. As of December 2013, India had signed 83 bilateral investment treaties, of which, 72 were in force.2
3. Recent BIT Jurisprudence
There has been no shortage of cases filed against the Government of India recently.
In November 2011, the arbitral tribunal in the case of White Industries v Republic of India held India liable for failing to ensure its treaty obligation to provide "effective means of asserting claims and enforcing rights" pursuant to Article 4(2) of the India-Australian BIT read in conjunction with Article 4(5) of the India-Kuwait BIT.
The tribunal held that the delay in enforcing an award in favor of White Industries against Coal India was a denial of the effective means to enforce its rights relating to an investment and awarded White Industries the sum of just over USD 4 million (with interest).
In 2012, Vodafone B.V. invoked the India-Netherlands Bilateral Investment Treaty claiming that India's Direct Tax Bill, which sought to retrospectively tax its 2007 acquisition of Hutch Telecom, was a failure to accord 'fair and equitable' treatment, notwithstanding India's Supreme Court ruling in favor of Vodafone over its tax dispute with the Government of India.
Russian firm Sistema has also filed a notice under its relevant bilateral investment treaty, following the cancellation of telecommunications licenses for 2G Spectrum by India's Supreme Court, which effectively expropriated its investment..
In March 2012, the Children's Investment Fund ("CIF") filed a notice of dispute, invoking the India-UK and the India-Cyprus Bilateral Investment Treaties. CIF had invested in Coal India and alleged that its sale of assets below market value on the directive of the Government of India was essentially a devaluation of its shares.
More recently, in March 2015, Cairn Energy filed a notice under the India-UK Bilateral Investment Treaty in relation to a USD 1.6 billion tax claim brought in context of a group re-structuring that Cairn submit triggered no transfer of value or taxable event in India.3
4. The Draft BIT
Faced with a rising spike of claims against it, the Government of India has rolled out the Draft BIT that raises eyebrows for several reasons.
The first thing to note is the overly narrow definition of "Investment" which simply:
"means an Enterprise in the Host State, constituted, organized and operated in compliance with the law of the Host State and owned and controlled in good faith by the Investor."
Noticeably, it does not refer to the business or assets of the Enterprise (or the Investor) and one would normally expect to see a far more comprehensive list of examples as to what form this might take.
Ideally, the definition of "Investment" should be much broader, explicitly including: (a) shares and other forms of equity participation; (b), debentures, bonds, loans, and other forms of debt instruments; (c) rights in contracts, including turnkey engineering procurement and construction contracts, concession agreements, revenue sharing agreements and all other contractual rights; (d) intellectual property rights; (e) rights to licenses, permits and authorizations (enabling the execution of a project); and (f) other tangible and intangible property and assets.
In context of (c) and (e) above (and particularly in context of large scale infrastructure projects), it would be preferable to include any concession agreement or license issued by an authority of the Government of India (enabling the project) ensuring that any expropriation, nationalization, termination or cancellation of concessions or licenses (by such authority) are (in the absence of fraud committed by the Investor) fairly and squarely deemed to be an expropriation and hence, the subject matter of the treaty.
However, rather than re-affirming what an Investment may include, the Government of India has not only left the definition narrow, but it has further excluded particular assets from recognition, including:
- any interest in any debt security issued by a government or a government owned enterprise;
- pre-operational expenditure relating to the establishment of the Investment in India;
- portfolio investments;
- claims to money that arise from commercial contracts for the sale of goods and services;
- goodwill, brand value, market share and similar intangible rights;
- claims to money that arise in connection with the extension of credit in connection with commercial transactions; and
- any other claims to money that do not involve interests set out in the definition of Investment.
Clearly, such exclusions are unlikely to promote general investor confidence.
4.2 Real and substantial business operations
It is also noticeable that the definition of "real and substantial business operations" (which is an essential part of the definition of "Investor") requires that an Enterprise employs a substantial number of employees in the Host State and makes a substantial contribution to the development of the Host State through its operations, along with the transfer of technological knowhow where applicable.
The definition raises three key concerns: Firstly, what constitutes a substantial number of employees? Would an Investor who has invested large amounts of capital into India, employing relatively few people qualify for protection? If not, would this mean that investors in e-commerce and other online businesses (which are traditionally employee light) be excluded from the ambit of the treaty?
Secondly, what constitutes a substantial contribution to the development of the Host State? Clearly, the definition is ambiguous and requires greater clarity. Thirdly, what do we mean by the transfer of technological knowhow and in what circumstances is it applicable? Does it go beyond merely licensing rights to the Enterprise? What does this mean for the intellectual property rights of the Investor?
Article 2 of the Draft BIT maps out its scope and general provisions. It states that the treaty applies to Investments in existence on the date of entry into force of the treaty and nothing in the treaty shall apply to either party in respect of any Measure of Law that existed before the date of entry into force of the treaty.
It further goes on to say that the treaty does not apply to any pre-investment activity relating to the establishment of the Investment, which is clearly intended to limit the liability of the Government of India for all preliminary expenditure (which could be substantial in major infrastructure or energy and natural resource projects).
But the key point to take away about the scope of the article is the exclusion of certain types of transaction (including government procurement)4 and certain types of dispute (including taxation) from the scope of the treaty
Excluding government procurement will likely impact the confidence of investment into the defense sector (a central plank of the Make in India campaign)5 and cancellation of procurement will likely mean that foreign defense companies will be unable to resort to the treaty to counter claim against any cancellation or termination by the Government of India. It should be noted in this context that last year, the Government of India cancelled a contract for the supply of 12 AugustaWestland helicopters with Finmeccanica, on allegations of corruption.
Excluding tax disputes is unlikely to promote investor confidence either. Following the invocation by Vodafone and Cairn Energy of their home state's respective bilateral investment treaties with India, it is clear that the intention is to make taxation measures exempt from the scope of the treaty. The Draft BIT clearly states that where the Host State asserts (in its own discretion) that the subject matter of the dispute relates to taxation, any decision of the Host State shall be non-justiciable and excluded from the scope of the treaty.6 Clearly, a disproportionate tax dispute, determined solely by the Host State, could amount to an effective expropriation of the Investment.
If the new provisions take effect, it would effectively mean that any retrospective taxation ruling taken in accordance with Indian law would be binding on the Investor. If it effectively expropriates the value of the Investment, the Investor will be unable to seek compensation from the Government of India through international arbitration.
Finally, of note, the Draft BIT excludes the issuance of compulsory licenses granted in relation to intellectual property rights, or the revocation, limitation or creation of intellectual property rights, to the extent that it is consistent with the law of the Host State.7 What the carve out intends to achieve, or the rationale for it, remains to be seen, though it should not override the legitimate and secured intellectual property rights of Investors.
4.4 Standard of treatment
It is customary under bilateral investment treaties for the host state to ensure that investors receive fair and equitable treatment and are provided full protection and security, on terms no less favorable than those offered to other investors and entities of the home state.8 The Draft BIT dispenses with this requirement and instead, simply says that Investors will not be denied justice under customary international law and that the Host State will not subject Investors to legal measures which constitute:
- un-remedied and egregious violations of due process; or
- manifestly abusive and outrageous treatment involving continuous and unjustified coercion or harassment.
A quick reference to the dictionary indicates that egregious means "outstandingly bad" or "shocking" which would mean that bad or less than shocking violations of due process are acceptable forms of behavior. Furthermore, what constitutes manifestly abusive and outrageous treatment? Does it mean that manifestly abusive treatment that is slightly less than outrageous is an acceptable form of behavior? Clearly, customary rights afforded to Investors have been jettisoned and much higher (and ambiguous) thresholds have been imposed, limiting the recourse of Investors.
4.5 National Treatment
It's customary for bilateral investment treaties to guarantee foreign investors the same treatment that the host state affords its own entities. The Draft BIT says that each Party shall not apply measures to Investments that are less favorable in like circumstances to domestic investments with respect to the management, conduct, operation, sale or other disposition of investments in its territory.9 However, it excludes from its purview, acts that are lawfully discriminatory10 or acts by regional or local government.11
This would prima facie suggest that: (i) discrimination sanctioned by domestic law; and (ii) the actions of State Governments violating this provision, would be exempt from review by the treaty. This is particularly problematic for Investors, since their Investments are not only subject to actions by Central Government, but also, by State Governments, in accordance with applicable law.
Furthermore, it should be noted that discretionary acts by the Host State in relation to when or when not to enforce a measure, fall outside the scope of the treaty.12 Clearly, this is prejudicial to Investors because it essentially means that there is no requirement to treat Investors in the same circumstances equally.
Article 5 of the Draft BIT deals with expropriation of the Investment and the consequences thereof. Out goes the customary international legal obligation to ensure that the Host State provides adequate, prompt and effective compensation.13 In comes a new standard, which simply says that compensation has to be adequate.14
The Draft BIT acknowledges that expropriation may occur for a public purpose, in accordance with law, the effect of which (if not directly expropriating the ownership of the Investment) essentially deprives the Investor of control, ownership or otherwise, permanently and completely depriving the value of the Investment.15
It is worrying that the Draft BIT excludes from the scope of the treaty, expropriation by the Host State, acting in a commercial capacity16 and actions of the State, expropriating the Investment through regulatory action designed to protect public health, safety and the environment.17 In both circumstances, the Investor will have no remedy for the expropriation of the Investment.
Additionally, the consequences of the expropriation (which remain subject to the treaty) should cause concern for Investors. Expropriation, per se, is not necessarily catastrophic, as long as the Investor is adequately, promptly and effectively compensated for its loss. However, it is unlikely that the Investor is going to receive adequate compensation due to mitigating factors set out in the Draft BIT, operating in the Host State's favor, effectively depreciating the value of the Investment.
These mitigating factors18 include: (i) the current and past use of the Investment and the history of its acquisition and purpose; (ii) the duration of the Investment and the previous profits made by the Investor; (iii) insurance pay outs and compensation from other sources; (iv) the value of the property that remains; (v) options available to the Investor to mitigate its loss; (vi) conduct of the Investor contributing to loss; (vii) obligations which the Investor is relieved of as a result of the expropriation; (viii) liabilities owed to the Host State; (ix) damage caused by the Investor to the environment or the local community; and (x) any other consideration, balancing the public interest and the interests of the Investment.
While clearly, some of these mitigating factors would be deemed to be reasonable, there are a few which are not logical. Why should the performance of the Investment and the profits reaped by the Investor mitigate the value of the compensation paid to the Investor? Surely, if anything, the Host State should be providing greater compensation for loss of expectation and loss of profits to such an Investor in the event that the Investment has been profitable.
Questions over the value of adequate compensation aside, Investors are posed with a further hurdle in having their Investment repatriated. Under the Draft BIT, the Host State has wide powers to restrict transfers in the event of broader macro-economic policy affecting monetary or exchange rate policy, to essentially prevent capital flight.19 Arguably, capital controls weaken general investor confidence and are a barrier to growth.
4.7 Home State Obligations
The Draft BIT contains quite an important article in the context of Investment made in the civil nuclear industry in India. It essentially provides that the Investor shall be liable for actions before the courts of the Home State for acts, decisions and omissions made in the Home State in relation to the Investment:
"where such acts, decisions or omissions lead to significant damage, personal injuries, or loss of life in the Host State."20
Further, the Home State is under an obligation to ensure that its legal system does not prevent or unduly restrict the brining of such actions before its courts in relation to civil liability for damages arising as a result of such alleged acts, decisions or omissions.21
In our article on Civil Nuclear Liability Law in India22 we suggested that it would be unlikely for a third party victim to succeed in bringing a claim in tort before the home courts of a foreign nuclear supplier, on the basis that:
- the parliamentary discussion relating to liability under Article 46 of the Civil Liability for Nuclear Damage Act (2010) expressly rejected the inclusion of a supplier in the bill; and
- Article XIII of the Convention for Supplementary Compensation for Nuclear Damage (the "CSCND") states that jurisdiction over actions concerning nuclear damage arising from a nuclear incident shall lie only with the courts of the contracting party within which the nuclear incident occurs.
Clearly, Article 13 of the Draft BIT conflicts with the analysis above and suggests that in the event a third party tort claim was brought against a foreign supplier in the courts of the Home State (and rejected) then a claim may well be possible by the Government of India for breach of Article 13 of the Draft BIT.
To the extent that there is a conflict between the CSCND and the Draft BIT (if entered into in its current form) then that conflict would need to be determined in accordance with the Vienna Convention on the Law of Treaties.23
The spike in dispute notifications issued under existing bilateral investment treaties has undoubtedly led the Government of India to reassess the terms of its existing treaties. Inevitably, an increase in foreign investment is bound to see a corresponding increase in disputes and the Government of India finds itself having to finely balance the legitimate interests of the state, with a predictable and stable environment for investment in general. The Draft BIT unfortunately, throws the baby out with the bath water. The issues in recent cases should have been taken as a pointer to reassess the fundamental reasons for the resort to arbitration in the first place, rather than responding by shutting down avenues for dispute resolution.
Practically, renegotiating India's existing bilateral investment treaties will be a mammoth task. That process of renegotiation will be made more complicated by the terms of the current Draft BIT. It remains to be seen to what extent that the Government of India intends to overhaul existing free trade agreements with Singapore, South Korea and Japan (which contain investor protections and dispute resolution mechanisms) with terms similar to the Draft BIT.
With developing economies taking a more aggressive stance on the terms of foreign investment, will the new Draft BIT mean that multi-nationals will simply not do business, or make fewer investments into India in the future? That's an unlikely scenario and the Government of India seems willing to take the risk that ultimately, the economic balance of power lies in its favor.
4. See Article 2.6(a)
6. See Article 2.6(iv)
7. See Article 2.6(v)
8. Based upon the Calvo Doctrine under Public International Law
9. See Article 4.1
10. See Article 4.2
11. See Article 4.3
12. See Article 4.4
13. Based upon the Hull Principle under Public International Law
14. See Article 5.1
15. See Article 5.1 and Article 5.2
16. See Article 5.3
17. See Article 5.4
18. See Article 5.7
19. See Article 6.4
20. See Article 13.1
21. See Article 13.2
23. See Article 19.3
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.