Japan: A Sleeping Sword – Protection For Japanese Corporations Investing Outside Of Japan

Last Updated: 25 January 2017
Article by Christopher J. Bailey and Flora Jones

A Guide To International Investment Agreements


Over the past twenty years, International Investment Agreements ("IIAs") have become an increasingly popular and valuable tool for investors to manage their foreign investment risk.

Japan signed its first Bilateral Investment Treaty with Egypt in 1978 and since then has concluded a further 26. It is also a party to numerous Free Trade Agreements and Economic Partnership Agreements, including the recent, and more controversial, Trans-Pacific Partnership. Yet despite the increasing trend for foreign investors to enforce their treaty rights through investor-state arbitration, Japanese investors have been a reluctant claimant, commencing just two of the 739 known claims.

This article will explain the evolution of IIAs of over the past twenty years before turning to focus on Japan's foreign direct investment into Asia and how treaty protection could benefit Japanese investors.

The rise of BITs and TIPs

IIAs are divided into two types: (1) Bilateral Investment Treaties ("BITs") and (2) Treaties with Investment Provisions ("TIPs").

A BIT is an agreement between two countries which establishes a framework to promote and protect the investments made by investors from the respective countries into each other's territory.

TIPs encompass various types of investment treaties that are not BITs. The most common forms are Free Trade Agreements ("FTAs") and Economic Partnership Agreements ("EPAs") with investment chapters.

BITs and TIPs vary from one to another, but they generally grant substantial rights to foreign investors, provide safeguards against the actions of the host government, and usually enable foreign investors to enforce those rights by submitting investment disputes to an international arbitral tribunal (rather than having to use the local courts).

The first BIT was signed in 1959 between Germany and Pakistan. By the early 1990s there were around 500 BITs, and by the late 1990s there were more than 2,000 BITs in force. There are now 2953 signed BITs, 2322 of which are in force, and 363 TIPs.

What is Investor-State Dispute Settlement?

Investor-State Dispute Settlement ("ISDS") is the settlement of disputes between investors and host governments, usually by way of international arbitration. Although not without controversy, ISDS provisions are supposed to ensure a neutral dispute resolution forum, and provide an arbitral award which is readily enforceable in most jurisdictions.

States started to include ISDS provisions in their IIAs in the late 1960s and early 1970s, and by the 1990s the inclusion of ISDS provisions was standard practice. According to an OECD study, only 6.5 per cent (of the 1,660 BITs reviewed) do not provide for investor-state arbitration.

ISDS: Argentine Origins

Despite the significant increase in the number of BITs entered into by states during the 1990s and the inclusion of ISDS provisions, the total number of known investor-state arbitrations initiated by the end of 1999 was only 43. Investor-state arbitration was a relatively underused and, for some investors, unknown tool.

Interestingly, it was the Argentine financial crisis in the early 2000s which changed the position. The measures taken by Argentina to respond to the economic crisis, for example changes to tariff regimes and concession agreements, the devaluation of the peso, and the adoption of the Emergency Law of 2002 which modified natural gas regulation, sparked an explosion in the number of investment treaty claims. These measures became the subject of over 40 claims.

The effect was not only to increase the total number of investor-state arbitrations, and the profile of ISDS generally, but it was in these Argentine cases that the interpretation and application of the treaty standards were tested and developed by the investors and their lawyers. As a result, the Argentine cases marked a significant step in the transition of ISDS from theoretical protection to valuable tool.

The Development of FET

The obligation of the state to accord fair and equitable treatment ("FET") to foreign investments is now the most relied upon and successful basis for IIA claims by investors.

Tribunals have interpreted the FET standard broadly to include a variety of specific requirements including the state's obligation to act consistently, transparently, reasonably, and without ambiguity. Examples of state conduct that is deemed inconsistent with the FET standard includes the revocation of operating licences, refusal to issue permits, withdrawal of tax exemptions, and suspension of tariff adjustments.

The Development of Expropriation

The obligation of the state to provide adequate compensation in the event of direct, and often indirect, expropriation is another key guarantee. Direct expropriation includes the outright physical seizure of the property, whereas indirect expropriation includes measures that fall short of physically taking the asset but that permanently destroy the economic value of the investment or deprive the owner of its ability to manage, use or control the property.

Claimants in several of the investor-state arbitrations arising out of the 2000-2002 crisis alleged that Argentina's measures to deal with the crisis constituted acts of indirect expropriation. However, in nearly all of those cases, the tribunals rejected the claim on the grounds that those measures did not amount to a permanent, substantial deprivation of the economic substance of the investment (see Siemens v. Argentina (ICSID Case No. ARB/02/8B), where the tribunal did find that Argentina's actions constituted expropriation).

ISDS: The Steady Rise

Since the Argentine cases, investor-state claims have steadily risen and as of August 2016 there were 739 known treaty-based investor-state arbitrations, 72 of which were initiated in 2015. 479 of these arbitrations were (or are) administered by the International Centre for Settlement of Investment Disputes ("ICSID"), 88 by the Permanent Court of Arbitration, and 36 by the Stockholm Chamber of Commerce.

According to UNCTAD, the two types of state conduct most frequently challenged by investors in 2014 were (i) cancellations or alleged violations of contracts or concessions, and (ii) revocation or denial of licenses or permits.

From South America to Europe

Today, the Energy Charter Treaty ("ECT") is by far the most frequently invoked treaty in ISDS claims (95 cases as of August 2016). The ECT came into force in 1998 and has been signed or acceded to by 52 states, including Japan. 32 of those 95 claims made under the ECT arise out of a series of renewable energy reforms undertaken by the Spanish Government as a result of the Global Financial Crisis. Similar claims are emerging against Italy. The ECT was also the basis for the $50 billion award in favour of Yukos Oil Company against Russia, although that has recently been set aside (UNCITRAL, PCA Case No. AA 227).

Japan's BITs and TIPs

Japan has entered into a total of 27 BITs (of which 20 are in force), and 20 TIPs (of which 17 are in force). The majority of Japan's BITs and TIPs are with Asian countries (14 of 27). Six are with states in the Middle East, and three with South American countries. Japan has just two European BITs (Ukraine, which is signed but not yet in force, and Switzerland), and only one with Africa (Mozambique). It does not have a BIT with the US, but both Japan and the US are parties to the Trans-Pacific Partnership ("TPP") which was signed in February 2016.

Japanese investment

The relatively high concentration of IIAs with Asian countries reflects Japanese investment into that part of the world. FDI outflows in 2015 totalled US $ 128.6 billion, making Japan the second largest investor in terms of FDI outflow (behind the U.S. whose FDI outflow was US $ 299.9 billion and just ahead of China, at US $ 127.5 billion). Noticeably, Japanese FDI flows to the ASEAN-6 countries during the past 5 years have more than doubled as compared to investment in 2006-2010.

Several reasons are cited for this increase, among them the need to diversify following the 2011 earthquake, low Japanese growth and interest rates, balanced against the high GDP growth in its neighbouring South East Asian countries, an abundance of natural resources, and deterioration of relations with China. This trend is matched globally, as East and South-East Asia together continues to be the largest FDI recipient region in the world.

But Japan's investment into South East Asia is set to rise even further: according to the Japan Bank for International Cooperation ("JBIC"), roughly 56% of Japanese firms intend to expand business into ASEAN in the next three years. The TPP (whose signatories include Malaysia, Singapore and Vietnam) will, if implemented, lower tariffs and cut trade barriers in the region. In addition, in May this year the Japanese parliament approved a change to the operation of JBIC, which will permit JBIC to finance risker infrastructure projects, thereby leading to greater investment into ASEAN.

More generally, Asian countries continue to liberalise foreign investment, making them ever more attractive as investment destinations: Indonesia recently increased the foreign investment cap in several industries, including for pharmaceuticals, venture capital operations and power plant projects carried out as public-private partnerships. Myanmar recently removed 11 items from the prohibited list for foreign investors, and India has liberalized foreign investment in Indian railway infrastructure.

Using BITs and TIPs to Protect that Investment

In a time where Japanese foreign direct investment into Asia is growing and is set to increase further in the coming years, Japan's treaty protection with its Asian neighbours is increasingly important. Despite the numerous and lucrative investment opportunities, much of South East Asia remains an uncertain environment for Japanese investors. Legal and political risks mean that careful thought needs to be given to planning investments in order to mitigate these risks.

Relying on IIAs to manage investment risk is a sensible and complimentary addition to other risk mitigation methods, such as insurance and contractual protections. Establishing which IIAs exist to protect Japanese investors, and reviewing their provisions to understand the scope and level of protection afforded, is an important first step.

Assessing the availability of the BITs between host states and third countries by re-structuring assets through those countries is also sensible. Structuring investments through special purpose companies incorporated in intermediary countries has been a successful strategy for many investors. The Netherlands is often used for this purpose because of the protection offered by the Netherlands' BITs and the fact that they normally apply to investors of other states investing through Dutch incorporated companies. It is therefore not surprising that the Netherlands has originated 80 claims as home state of the claimant (second highest number of claims to the US). That being said, in March 2014 Indonesia confirmed that it would not renew its BIT with the Netherlands, and is said to be planning on terminating around 60 other BITs. We will wait to see if other countries follow suit, although India has already announced its intentions to renegotiate its BITs with 47 countries.

Japan has a BIT or TIP (or both) with each ASEAN-6 country (notably, Japan's EPA with Indonesia remains in force), and also with, Cambodia and Lao, which all contain (i) a guarantee that investors and their investments will be treated no less favourably by the host state than the host state's own investors, or investors from other states, (ii) a guarantee to protect the investments against expropriation without compensation, and (iii) a requirement that the host state provides full protection and security to Japanese investments. With the exception of the Japan –Philippines EPA, each of those IIAs also contains ISDS provisions. In relation to the Philippines, a simple remedy could be structuring the investment to take the benefit of the ASEAN Comprehensive Investment Agreement.

Japanese engagement with ISDS

By the end of 2014 there were still no known cases of Japanese investors commencing ISDS proceedings under an IIA. The position recently changed, however, when JGC Corporation commenced a claim against Spain in 2015 under the Energy Charter Treaty relating to its investments in the renewable energy sector (ICSID Case No. ARB/15/27). Eurus Energy followed suit in 2016 with a similar claim (ICSID Case No. ARB/16/4).

With a tally now at 2 claims, Japan is still seen as a hesitant claimant in ISDS proceedings (compared to, for example, the 145 cases from the US , 64 from the UK, 53 from Germany and 41 from Canada). Although this is not necessarily surprising when compared to the number of claims commenced by Japan's neighbouring Asian investors (4 claims originating in China, and 3 in each of South Korea, Singapore and India), it is perhaps more surprising when compared to the amount of money Japan invests globally through FDI. It is also interesting that the Japanese government appears to have more of an appetite for disputes, having commenced 22 cases as complainant at the World Trade Organization (in addition to involvement as a third party in a further 161 cases).

It should be noted, however, that Japanese investors have not been completely passive. There are at least two recent examples of indirect involvement of Japanese investors in investor-state claims: Saluka Investments B.V., a subsidiary of the Nomura Group, commenced a claim against the Czech Republic in 2001, and Indonesian mining company Newmont Nusa Tenggara, partly owned by Sumitomo Corporation, commenced an arbitration against Indonesia in 2014 (ICSID Case No. ARB/14/15) which was subsequently withdrawn. There are also instances of Japanese investors using the threat of arbitral proceedings to secure favourable settlements: in 2014 Nippon Asahan Aluminium, a joint venture comprised of twelve Japanese investors, threatened the Indonesian government with an ICSID claim when the parties failed to reach an agreement on the value of the joint venture's assets. Shortly after, a resolution was achieved.


The past fifteen years have seen an enormous growth in investor-state arbitrations commenced under IIAs. What is clear is that investors are increasingly using ISDS provisions as a way of enforcing the protections afforded to their investments under International Investment Agreements.

Unsurprisingly, countries are embracing investor-state dispute settlement with varying degrees of enthusiasm and appetite. The decision of an individual investor to commence an investor-state dispute might have commercial origins, but may also be affected by

political issues and sensitivities, and even local concerns or norms. We have also seen that global political and economic trends have a direct impact on both the number and nationality of claims and respondents.

While Japan has not been aggressively pursuing investor-state arbitrations, it has been securing investment protections and ISDS provisions in its IIAs since the 1980s. The JGC and Eurus cases demonstrate that Japanese investors are willing to formally utilise these protections. This is a positive sign and could indicate the start of an increasing trend to protect Japanese overseas 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.

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