Cairn Energy's dispute with the Indian Government has made headlines across the globe. The case serves as a useful reminder to foreign investors of the benefits of using bilateral investment treaties to obtain relief in circumstances where they have been unfairly treated by governments in foreign jurisdictions.
The origins of this dispute lie in a separate, but similar case between Vodafone and the Indian Government, arising out of Vodafone's purchase of a majority share of a company, Hutchison Whampoa, in 2007. Hutchison owned substantial assets in India, and the Indian Government contended that Vodafone owed capital gains and withholding tax, based on India's 1961 Income Tax Act. Vodafone disputed the Government's interpretation of the Act.
The dispute eventually came before India's Supreme Court, who in 2012 agreed with Vodafone's interpretation of the Act, and concluded that the tax claimed by the Government was not, in fact, due.
The Government responded to this decision with the Finance Act 2012, which amended the Income Tax Act retroactively to comply with its interpretation. The Government then repeated its demand for taxes from Vodafone.
This retroactive change in law also caught Cairn Energy, who in 2014 were presented with a US$1.4bn claim from the Indian Government for unpaid tax associated with the 2007 listing of its local subsidiary. In pursuit of its claim the Government seized Cairn Energy's shares in the subsidiary as well as its dividend payments.
Cairn Energy's response was to commence arbitration proceedings against the Indian Government in 2015 under the UK-India Bilateral Investment Treaty.
Bilateral Investment Treaties
Bilateral Investment Treaties (BITs) are agreements made between the governments of two countries or states to promote reciprocal foreign investment between those states. BITs typically require the signatory states to give fair and equitable treatment to foreign investors and make a commitment to ensuring that foreign investors are treated by each state the same as their own nationals.
International investments in foreign jurisdictions are very common –particularly so in the construction, engineering, energy and technology sectors. BITs have very broad application and usually cover most foreign investments as long as the investor has contracted with a foreign government (directly or indirectly). Although BITs tend to be written in broad and, consequently, somewhat opaque language, they are a valuable tool to supporting international trade and investment, particularly in jurisdictions where the rule of law is not clearly established.
Where a country fails to comply with the provisions affording protection to foreign investors, affected investors have a right to arbitrate directly against the defaulting state for breach of its obligations under international law. BIT arbitrations are not particularly common but where they do occur, they typically generate very significant arbitral awards.
The BIT between the UK and India is an agreement “for the Promotion and Protection of Investments”. Signed in 1994, the purpose of the agreement is generally to “create conditions favourable for fostering greater investment by investors of one State in the territory of the Other State”. Article 3 concerns the “Promotion and Protection of Investment” and seeks to encourage foreign investment by promising fair and equitable treatment. Article 4 deals with “National Treatment and Most-Favoured Nation Treatment” and seeks to ensure that foreign investors will not be treated any less favourably than local investors.
These types of clauses are fairly typical of BITs and do not apply exclusively to the agreement between the UK and India.
Cairn Energy PLC is a global oil and gas exploration, development and production company headquartered in Scotland. Its subsidiary, Cairn UK Holdings Limited, is the parent company of Cairn India. Therefore, as a UK company investing in India, it was entitled in principle to rely on the UK-India BIT.
Cairn argued that the Indian Government's retroactive tax legislation violated the protection awarded to Cairn under the UK-India BIT – namely, the right to fair and equitable treatment.
Cairn's claim in fact mirrored a similar claim by Vodafone, alleging fundamentally similar breaches by the Indian Government, this time of India's BIT with the Netherlands. The Netherlands-India BIT applied to Vodafone's claim because Vodafone had used its Dutch subsidiary to purchase Hutchison Whampoa.
Both cases were heard by the Permanent Court of Arbitration, located in the Hague in the Netherlands, and both cases were decided in favour of the investors.
In Cairn's case the arbitral panel unanimously determined that the Indian Government had breached the terms of the UK-India BIT; Cairn reports that it was awarded damages of US$ 1.2 billion together with interest and costs which are now payable by the Indian Government.
Where a BIT claim does arise, and where the state is found to have breached its obligations, foreign investors will understandably seek assurance that any claim for damages will in fact be satisfied.
At the time of writing, Cairn claims that it is awaiting payment of the damages awarded. It is unclear whether the Indian Government will pay those damages, or indeed whether Indian Courts will allow Cairn to enforce the judgment in India. In any event, if the Indian Government continues to withhold payment, Cairn's best option may be to look to seek enforcement of the award in other jurisdictions where the Indian Government has assets; the substantial majority of countries are bound by international law to enforce the award.
Cairn has already stated that it is looking to identify assets owned (directly or indirectly) by the Indian Government, in order to seize them. In practice, the most promising targets for such enforcement actions include aircraft; since Air India is a state-owned carrier, its assets will be a key target.
On paper, enforcing an arbitration against such assets is often not straightforward, as although aircraft locations and destinations are easily identified, the aircraft in question may be subject to complex leasing arrangements or third party ownership. However, the cost and adverse publicity associated with aircraft being detained at airports around the world due to unpaid debts is usually sufficient to dissuade governments from continuing to refuse payment, once those assets have been targeted.
BITs are commonplace but they are not completely ubiquitous, nor are they all identical. All international companies should ensure that they are aware of any protection offered by any relevant BITs, and should consider using these agreements to their advantage where unfair treatment of foreign investors arises. It may, for example, be prudent to structure deals in such a way as to ensure that the purchasing entity is based in a jurisdiction that has a relevant BIT in place.
BITs have been a bedrock for international trade for many years, but have recently come under increasing scrutiny. Recent events, including moves by some EU states to cancel intra-EU BITs without recognising the so-called ‘sunset' clauses that protect existing investors in such circumstances, have eroded some of the confidence in the protections offered by BITs. If that erosion continues it is likely to continue to erode investor confidence and hamper international investment.
As for India, this is not the first time that it has been involved in BIT disputes and their apparent reluctance to comply with BITs may be a matter of concern for foreign investors. Companies and individuals planning to invest in India may take less comfort from the protection provided by any corresponding BIT given this apparent reluctance to comply. As one of the largest emerging economies in the world, India may conclude that it needs to do more than simply paying lip service to international treaties if it wants to continue to attract significant foreign investment.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.