Most contractors will, of course, be familiar with international commercial arbitration as a means of resolving their disputes, but where an employer is a national government or government entity, consideration should also be given to the possibility of bringing claims under an international investment treaty. Investment treaty arbitration is arbitration between a company or an individual investor against a state for breach of that state's obligations under international law to protect the investor's investment. Sana Mahmud explains further.
Whilst international commercial arbitration is usually prescribed by contract, an investment treaty claim is based on rights arising from bilateral or multilateral investment treaties (“BITs” or “MITs”). These are treaties between two or more states for the promotion and protection of investments of foreign nationals.
Investment treaty arbitration is generally underused in international construction disputes, sometimes because contractors are unaware that the basis of their contractual claims may also constitute breaches of treaty protections for which a host state could be liable. A BIT is a treaty between two states under which each state agrees to afford rights and protections to investors from the other. There are 2,290 BITs currently in force globally.1 An MIT is a similar treaty but between more than two states. These apply regardless of whether there is a contractual relationship between the state and investor.
Broadly, the following types of treaty claim might arise in the context of an international project:
- Claims under a relevant construction contract with the state where the state has failed to carry out its contractual obligations;
- Claims against a state for the conduct of its public authorities if the actions of those authorities have adversely affected works under a relevant contract;
- Claims against the state for legislative changes, including changes to taxation or other industry regulations, which make the performance of a contract significantly more onerous;
- Claims for the expropriation of companies or assets; and
- Denial of justice claims where the courts in the host state have, without legitimate reason, refused to enforce a valid commercial arbitration award.
Most claims concerning construction contracts often fall into the first category and that is the focus of this article. In that context, the first step when considering an investment treaty claim is to establish whether events that have occurred under the framework of a commercial contract can form the basis of claims under an applicable treaty.
Considering an investment treaty claim
In order to commence an arbitration under a relevant investment treaty, contractors must ensure that the following conditions are met:
- A BIT or other investment treaty must be in force between the employer's state and the state in which the contractor is incorporated;
- The contractor must qualify as an investor under the terms of the relevant treaty;
- The works contract must qualify as an investment under the terms of the relevant treaty;
- The employer must be a state or an organ of state;
- The employer, as either a state of an organ of state, must have breached the obligations contained in the relevant treaty; and
- Those breaches resulted in damage and/or loss to the contractor as an investor.
Is there a relevant investment treaty in force?
The United Nations Conference on Trade and Development (or UNCTAD) retains a database of investment treaties currently in force globally.2 The database is free and can be searched by country.
With respect to EU member states, however, it should be noted that, in 2018, the European Court of Justice decided that investment treaty arbitration between a member state and an investor from another member state was not compatible with EU law.3 Based on the ECJ's decision, the majority of EU countries entered into an agreement, effective from 20 August 2020, that terminated “intra-EU BITs”. This means that construction projects in the EU carried out by companies incorporated in other member states may no longer benefit from the protections afforded by “intra-EU BITs”.
Is a contractor an investor?
Only an investor, as defined in a treaty, can bring an arbitration claim pursuant to that treaty. Depending on the treaty's definition of an investment, construction companies that carry out works under an infrastructure contract with a foreign state or public authority may qualify as investors.
Investment treaties define investors as nationals of a state other than the state where the investment occurs. Typically, this includes corporate entities such as companies incorporated in the investor's home state. As is often the case on large infrastructure projects, international companies sometimes register local subsidiaries to carry out the contract works in another country, and depending on the wording of the treaty, it may be possible for a foreign parent to claim on behalf of a local subsidiary.4
The dispute resolution clauses in investment treaties normally contain provisions under which the host state grants the investor the right to choose to settle disputes relating to its investment through national courts or arbitration. In most cases, arbitration is provided pursuant to the ICSID or UNCITRAL Rules. Where the treaty provides for arbitration under the ICSID rules, jurisdiction is also limited to investors as defined in the ICSID Convention. Where the treaty definition of an investor differs from the ICSID Convention definition, both must be satisfied if the arbitration is to be under the ICSID Rules.
Is the construction contract an investment?
To commence an investment treaty arbitration, the claim against the state must relate to an investment as defined in the relevant treaty. These definitions are normally widely drafted and include things like tangible and intangible property, shares, bonds, licenses, IP and concessions that might be required to construct and operate an infrastructure project.
Whether a project can be defined as an investment is a question of fact and can vary depending on the precise nature of the works and activities. The leading method used by ICSID tribunals is the Salini test, which considers whether the investment:
- Involves a contribution of money or other assets of economic value;
- Is for a certain duration;
- Includes an element of risk; and
- Provides a contribution to the host state's development.
The Salini test has often been applied loosely, as indicative of the characteristics an investment might have, and caution is advised when applying this definition outside the ICSID framework. However, it now appears to be settled that, if a project involves the contribution by a contractor of large sums, know-how and personnel over a significant period, then it will likely qualify as an investment for the purposes of a treaty claim.
Is the employer a state or an organ of state?
The answer to this question is relatively straightforward when the employer is a national government. It is sometimes less clear cut where it is a distinct publicly owned corporate entity. A host state will, however, be liable for the actions of an entity where those actions have been taken under the effective control of the state, or where the state has had significant involvement in the commission of the act.5 Whether a national authority can be defined as an organ of state will depend on the nature of its control, which will need to be assessed on a case by case basis.
Has the employer, as host state, breached the obligations set out in an applicable treaty, and have those breaches caused damage?
Treaties include an undertaking by a state towards another that the investments of its nationals on the other's territory will enjoy certain rights. Common protections afforded to investors under BITs and MITs include:
- Protection against unlawful expropriation or nationalisation, unless the state can show that it was for a public purpose and on payment of reasonable compensation.
- Fair and equitable treatment (“FET”). There is no standard definition of this term and it is often regarded as a broad “catch-all” heading for claims in investment treaty arbitration. Generally, it requires a state to maintain predictable investment environments consistent with reasonable investor expectations.
The basic aim of the FET standard is to ensure that host states do not hamper or interfere with the lawful conduct of business by foreign investors. Depending on the facts of a case, the standard could apply to claims relating to denial of justice, procedural fairness, due process and transparency, freedom from coercion and harassment, and good faith and protection of investors' legitimate expectations.6
- Full protection and security. This obligation concerns the physical protection and provision of security for investments by the host state. The host state is obliged to prevent harm to investments either as a direct action of its state officials or indirectly by the actions of others.
- National treatment. This standard obliges a state to treat foreign investors no worse than local investors. It should be noted that it may be unhelpful in circumstances where local investors are not guaranteed any protection.
- Most-favoured nation treatment (“MFN”). This provision requires the state party to one investment treaty to provide investors with treatment no less favourable than the treatment it provides to investors under other investment treaties.
- Umbrella clauses. These clauses broadly provide that a state must comply with its obligations to foreign investors. Investors have often relied on umbrella clauses to enable them to elevate a claim under an investment contract to the level of a claim under a BIT on the basis that obligations in this context includes those under the investment. Whether an umbrella clause elevates domestic law obligations in this way, and, if so, which ones, depends on the interpretation of the particular wording of the clause.
There is a legal distinction between claims made under a commercial contract to which domestic law applies and claims under a BIT or MIT to which international public law applies. To bring a claim, contractors must, therefore, either be able to show that:
- The actions of the state that led to breaches of the parties' commercial contract also amount to breaches of the above treaty obligations; or
- An umbrella clause exists in the applicable treaty or can be imported via an MFN clause that can be used to elevate contractual claims to treaty claims.
If there is no viable umbrella clause, contractors will have to go through a process of reformulating their contractual claims as relevant breaches of treaty obligations. Failure to do so properly may mean that tribunal lacks jurisdiction. Whilst there is no express bar on a contractor pursuing both contractual and treaty arbitration concurrently, there are inconsistencies in the approach investor-state tribunals have taken in circumstances where there is a prospect of parallel proceedings.7
This is a complex area of law and the process of reformulating contractual claims into treaty claims is not straightforward where a claimant's claims can also be determined in accordance with a contractual dispute resolution procedure. Whilst there is no doctrine of precedent under the investor-state regime, inconsistent judgments in such cases mean that careful consideration needs to be given to the way in which contractors' claims are presented in an investment treaty dispute and whether those claims would withstand a jurisdictional objection by the state.
If, however, a contractor has been through a commercial arbitration process and is unable to enforce the resulting award because the courts of a host state refuse to do so, it may be able to bring a denial of justice claim under the FET provisions of a relevant treaty without the need to reopen those claims.
What are the advantages of investment treaty arbitration over commercial arbitration?
The ICSID Convention has a self-contained regime for enforcement of awards. Where the host state is a Contracting State, an award is easily enforceable in many other jurisdictions using the mechanism found at Article 51(1) of the Convention, which requires any Contracting State to enforce the award on presentation of a certified copy by the Secretary General of ICSID. A commercial arbitration award has to be enforced under the New York Convention by a state in which the employer's assets are found. The ICSID regime is an arguably easier process.
Where the party to an infrastructure contract is a separate corporate entity controlled by the state, issues may arise if that entity is constrained in its ability to reach a commercial settlement or pay sums pursuant to a commercial arbitration award because it lacks authority or direct funds. A claim under an investment treaty offers a contractor a direct avenue to the state, bypassing the separate contracting entity.
Finally, the commencement of an investment treaty arbitration is a matter of public record. The threat or commencement of an investment treaty claim may, therefore, also assist a contractor in exerting political (as opposed to simply commercial) pressure towards a reasonable settlement.
Investment treaty arbitration in the construction sector is used less frequently compared to the prevalence of commercial arbitration as a method of resolving international disputes. There have been good reasons for this, some of which are touched on above, such as the potential for jurisdictional issues arising where a contract exists between the parties.
Another criticism has been that investor- state disputes tend to run for longer, which makes them a costly alternative (or addition) to a contractual commercial arbitration route. The average duration of ICSID arbitrations (including Additional Facility proceedings) was 3.6 years according to ICSID data previously analysed by the Global Arbitration Review. The average duration of an ICC arbitration in 2020 was 26 months.8 It is arguable that treaty arbitration has not yet been able to adopt timely and cost-effective procedures in the same way that international commercial arbitration has done, and it will be interesting to see whether it follows suit.
Annual ICSID statistics show a rise in construction related treaty claims. For example, in 2020, of all new cases registered with ICSID, 15% related to the construction sector.9 So far, in 2021, that figure is 17%.10 When the oil, gas and mining, and power and energy sectors are included, this makes up the majority of treaty claims registered with ICSID in 2019 and 2020.
It would be useful to perhaps think about how treaty protections can be maximised at the outset of a project by considering the corporate structure of the entity that carries out the works. This way, the contractor's position is protected should the need for a treaty claim arise in the future. The COVID-19 pandemic is a good example of an unexpected event that could give rise to treaty claims where changes in national legislation have resulted in losses to contractors.
This is certainly a growth area for international construction disputes, and contractors should carefully consider whether a treaty claim might be a useful tool in seeking the resolution of disputes on international projects alongside the usual commercial arbitration route.
3Achmea B.V. v The Slovak Republic, UNCITRAL, PCA Case No. 2008-13 (formerly Eureko B.V. v. The Slovak Republic): https://www.italaw.com/cases/417
4Tulip Real Estate Investment and Development Netherlands B.V. v Republic of Turkey
5Jan de Nul NV v Egypt
6Biwater Gauff (Tanzania) v Tanzania, Eiser Infrastructure Limited and Energia Solar Luxembourg Sarl v Kingdom of Spain, Tecnicas Medioambientales Tecmed SA v United Mexican States, David Minnotte and Robert Lewis v Republic of Poland, and Dan Cake v Hungary.
7See SGS v Pakistan, SGS v Philippines, Bayindir v Pakistan, Helnan International Hotels A/S v Egypt, Duke Energy Electroquil Partners & Electroquil SA v Ecuador, Hamester v Ghana
9 https://icsid.worldbank.org/sites/default/files/publications/Caseload%20... Edition%29%20ENG.pdf
This article is taken from Fenwick Elliott's 2021/2022 Annual Review. To read further articles go to Fenwick Elliott Annual Review 2021/2022
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.