By Their Provisions, You Can Know Them

“By Their Provisions, you can know them”

Are BITs the Magic wand for investments in LDCs?

Forji Amin George

LL.M (Helsinki), Maîtrise (Dschang), Licence (Dschang)

Helsinki, 16 October 2006

INTRODUCTION

With the world fast becoming a global village, investors are more than ever before looking for new places to expand their investments. Meanwhile the developed world affords them with significantly adequate protection; the same is not often true for the developing countries. In fact, one of the major concerns of foreign investors is usually on the potential risks of the institutions and the enforceability of the law in the Less Developed Countries (LDCs). Bilateral Investment Treaties (BITs) which guarantee for certain standards of fair treatment that can be enforced through binding investor-to-state dispute settlement outside the domestic juridical system play a vital role, call it bridge, in that investors believe these give them the much needed assurances. The recent explosion of these bilateral investment and trade agreements and investor-state disputes is of growing concern. First and foremost, a bilateral investment treaty is an agreement between two States, designed to promote and protect international investments flowing between them.[1]

BITs purport to have two related objectives to wit:

a) That they protect the flow of foreign direct investment (FDI), by highlighting on a series of rights and guarantees, and

b) By encouraging economic cooperation, thereby enhancing the flow of FDI into developing states.[2]

Less Developed Countries (LDCs) are known to be in desperate need of Foreign Direct Investment (FDIs) for economic growth. They try to attract these in BITs agreements by accepting restrictions on their sovereignty,[3] and further agreeing to protect foreign investors’ investments from political and other risks. Some academic scholarship[4] has concluded that in concluding BITs, developing countries are ‘trading their sovereignty for credibility’ (Elkins, Guzman and Simmons 2004, p. 4).

Sornarajah, M opines that the starting point of a discussion of the law of foreign investment must be the abeyance to the general international legal norm, which is the right of a state to exercise complete control over the entry of foreign investment.[5]Reason being that irrespective of the protections that may be afforded to foreign capital, the host state continues to retain the right to territorial sovereignty, and must as a result retain the right to elect whether to or not to exclude the investment.[6]

The first bilateral investment treaty was signed between the Federal Republic of Germany and Pakistan on November 25, 1959. It was however not until the 1990s that these agreements began to witness an unprecedented growth in their number, covering rules on foreign direct investment. Countries have signed bilateral investment treaties, included investment chapters in their trade agreements, and negotiated investment protocols and decisions. It is during this decade that many developing countries have modified their investment codes to attract foreign investors, by blending the documents with all kinds of favorable protections and guarantees. The United Nations Conference on Trade and Development (UNCTAD) in it’s BITs Database indicate that the number of BITs increased to 385 in 1989 and to 2,392 by 2004, involving some 176 countries, thus meaning that their number far outnumbers the membership of the WTO.[7]

By embracing BITs, LDCs commit themselves protecting FDIs, especially against strife, government interference and expropriation. It hass been fashionable since the 1990s for LDCs to clearly spell out specific protection guarantees to FDIs in their domestic laws, with the most common being national treatment and most favoured nation clauses.

Sornarajah for example see BITs to be of unique importance to international law, in that they have by and large afforded a solution for the time-being of what was hitherto an essentially private international law issue; that is the problem of contracting between investors and the host state. Treaties between home states of importing capital and host states has meant that the problem of international personality is being overcome making the relationship to hence be subject to international law.[8]

In an article published by The American Journal of International Law (AJIL) - The Political Economy of BITs, Kenneth J. Vandevelde (Professor) of Thomas Jefferson school of Law, argues that the astonishing explosion of BITs agreements concluded during the 1990s appears to signal the emergence of a liberal International investment regime. [9] His reasoning may have been based on the fact that the protections afforded in a BIT are often a supplementary offer provided to the signatory countries other than those specified in the national laws. This is one of the things that make BITs different anyhow.

In their substantive provisions, the treaties offer a form of lex specialisn to supplement the under-developed rules of customary international law related to thetreatment of aliens and alien property.[10] The provisions are intended to secure a legal environment for foreign investors. That is, the BITs provisions typically guarantee certain standards of treatment for the foreign investor (Dolzer and Stevens 1995; UNCTAD 1998). [11]

The scope of application of investment treaties is determined by the definition of investments and investors which are covered by their provisions and thus enjoy the protection accorded by them. Recent BITs and the investment chapters of the trade and integration arrangements have a broader scope of application than other traditional investment agreements.[12] These new instruments have expanded their definition of covered investments to include new forms of transactions and are being applied to a more diverse group of investors. There is an important degree of uniformity in the type of language used to that effect. [13]

In addition to determining the scope of application of the treaty, that is, the investments and investors covered by it, virtually all bilateral investment treaties cover four substantive areas: admission, treatment, expropriation and the settlement of disputes.

They typically include provisions requiring investing nationals of the BIT partner to be treated as well as national firms or as well as the most favored foreign firms (MFN treatment); establish limits on expropriations of investments and require compensation when it occurs; and guarantee investors’ right to transfer funds into and out of the country using a market rate of exchange. [14]

In sum, Bilateral Investment treaties cover four main areas to wit: Foreign Direct Investment (FDI) admission, treatment, expropriation, and the settlement of disputes.[15]

Are BITs therefore playing a significant role in the inflow of foreign investments? Opinion remains divided on the subject. Investment agreements have been regarded by developing countries as an instrument to attract foreign investors.

One author (Hallward-Driemeier, 2003), argues that despite expectations about the impact of BITs on FDI, there is no evidence indicating that the adoption of BITs has actually encouraged FDI flows to signing developing countries. She continues that while half of OECD (Organisation for Economic Co-operation and Development) FDI into developing countries was covered by a BIT by 2000, the increase in FDI flows to those countries over the previous two decades were accounted for by additional country pairs entering into agreements rather than signatory hosts gaining significant additional foreign direct investment.

Soranajah on his part is confident that although BITs may not attract much FDIs in the short-run, a good reputation of honouring foreign investments will nevertheless do the trick in the long-run.[16]

Brief History of BITs

The first ever modern bilateral investment treaty has been traced to the agreement between Germany and Pakistan way back in 1959. Ever since then, capital exporting countries, mostly developed nations have negotiated and concluded such agreements with capital importing countries, mostly LDCs. M. Sornarajah (1998) attributes the origin of these treaties to the deep disagreement as to the customary international law

Standards of treatment owed to foreign investors before 1959, as well as thefailure of diplomatic efforts to conclude a broader multilateral agreement.[17]It has been widely accepted that customary law provides only very weak legal standards for foreign investment.BITs emerged as a solution to the complexities of multilateral agreements, as no multilateral treaty showed any good signs of supplanting the uncertainties of customary international law. Western investors had enormous concerns and fears at the time (many still have) of the likelihood of expropriation or nationalization and arbitrary treatment in the hands by the authorities in the LDCs.

The number of these agreements soared from 385 to 1,857 between 1980 and 1990, according to UNCTAD index.[18] The UNCTAD index of 2000 showed that there were 2100 known BITs, between 173 countries. There were 2,392 at the end of 2004 between 176 countries, [19] thus meaning that the number of countries that have entered into these treaties far surpass the membership of WTO.

BITs as Perfume on Risky Terrain

To begin with, we have to be realistic-The developing world is per se a vulnerable and risky place to do business, because there will always be political, social, security, economic, upheavals and constraints along the way of business. No realistic investor, irrespective of the nationality goes into business to make losses or do charity. In fact, investors and states have one thing in common-they do not have friends-they have interests.

The above notwithstanding, the task of enhancing the supply of both foreign and domestic investment capital remains a fundamental and durable feature of humane development policy for LDCs.

In the midst of potential risks, BITs offer perhaps the “most practical and effective means of affording treaty protection to alien investors in the Third World.[20] They do this by providing for an effective form of guarantees, emphasizing mutuality and respect for the legitimate interests of the states that are parties to them,[21] thereby creating a more stable and predictable legal environment for investment. That is, reliance on the BIT gives foreign investors credible assurances that host states will not violate their contractual undertakings and violate investors’ property, and importantly the assurance they will pay compensation in the event of breach, and will remit disputes arising from the contract to resolution through international commercial arbitration.[22]

In sharp contrast, domestic investors do not enjoy such protection under such treaties, and as a result rely on domestic law and legal institutions for protection. In this way, domestic investors are more of captives in their own market.

Comparing the above two situation (foreign and domestic investors), the importance and significance of the BIT regime is that they provide an enclave against the risks of legal, socio-economic and political failures that domestic investors traditionally face. BITs act to either substantially lessen these or eradicate this altogether for foreign investors. The security and guarantees provided by a BIT are considered to be primordial to encourage the inflow of supposedly much-needed FDIs to LDCs. In fact many developing countries are constantly reminded that it is only by providing such assurances that foreign investors will be persuaded to venture into potentially risky markets.

BITs have thus been lauded for the discipline they impose on developing states (hitherto seen to be very risky terrains to do business) in their dealings with foreign investors.

Hence they become a substitute for risks- that is a substitute for the quality of poor institutions and political risks that are common with LDCs.

In this way, BITs are helping to positively shape the economies of LDCs- An instititution of a good investment regime today will surely pay off more than two-fold for the future. They are functioning as substitutes for good domestic institutional quality, and this can only be good news to LDCs and to investment.

Despite efforts by many LDCs to come up with sound investment codes, some scholars remain skeptical. Sornarajah (1986, p. 82), for example, suggests that ‘in reality attracting foreign investment depends more on the political and economic climate for its existence rather than on the creation of a legal structure for its protection’[23].

Some scholars, such as Kim Sokchea(2006) argue that only countries with higher risk tend to rush to sign BITs in order to signal their commitment to provide protection for private foreign investment. He continues that it will be absolutely unnecessary for countries such as Hong Kong, Singapore, South Korea and Taiwan to use BITs to signal foreign investors.

SUBSTANTIVE ISSUES IN BITS

BITs have become the dominant means through which investment in low and middle income countries is regulated under international law. (Walker 1956; Schwarzenberger 1969; Kishoiyian,1994). The preambles of the thousands of existing BITs state that the purpose of BITs is to promote the flow of FDI and, undoubtedly, BITs are so popular because policy makers in developing countries believe that signing them will increase FDI.

Again, in their substantive provisions, the treaties offer a form of lex specialisto supplement the under-developed rules of customary international law related to thetreatment of aliens and alien property.[24] The provisions are intended to secure a legal environment for foreign investors. That is, the BITs provisions typically guarantee certain standards of treatment for the foreign investor (Dolzer and Stevens 1995; UNCTAD 1998). [25]

Typically, developed countries prepare a model treaty based on the 1967 DraftConvention on the Protection of Foreign Property and on already existing BITs. These model treaties are then modified for use in a variety of situations.

BITs and related instruments covering both trade and investment, such as NAFTA, are currently the dominant means through which investment in low- and middle-income countries is regulated under international law. [26]The treaties are a response to the weaknesses and ambiguities of customary international law as applied to investments by international firms in countries at low levels of development.

General Treatment Clauses

"Treatment is a broad term which...refers to the legal regime that applies to investments once they have been admitted by the host State."[27]

Almost all modern BITs include provisions dealing with disputes between one of the parties and investors having the nationality of the other party. In this respect most provide for arbitration under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID Convention) which entered into force in 1966.[28]

Policies welcoming foreign investments have become a common feature in developing countries in the last fifteen years, after the failure of attempts to impose some forms of control over the activities of transnational corporations and the flows of foreign direct investment (FDI) and technology.[29]

BITs have to be understood as a part of the broader neo- liberal project to encourage the free flow of goods, services, capital, and ideas across national borders.[30]

However, most BITs equally contain clauses that exclude investments in particular areas such as national security, telecommunications, and finance.

Key questions are often on theprotection or non-protection of certain types of investment and further on whether or not the treaties’ apply as soon as a contract has been signed or whether funds must actually have been invested.

Since there is no unified document governing BITs, it goes without saying that each of these agreements is different in its own way. Nevertheless, every BIT contains certain substantive provisions.

The most important of these substantial issues includes: National Treatment (NT) clause, Most-Favoured Nation treatment (MFN), Right of Establishment (RE), Fair and equitable treatment and full protection and security, Expropriation and Nationalization, and the last but not the least, a provision for the Settlement of Disputes. In sum, Bilateral Investment treaties cover four main areas to wit: Foreign Direct Investment (FDI) admission, treatment, expropriation, and the settlement of disputes.[32] BITs generally provide for resolution of both country-country and investor-host country disputes by an international body such as the World Bank Group's InternationalCenter for the Settlement of International Disputes (ICSID), or other arbitration systems, such as those operated by the International Chamber of Commerce (ICC). The United Nations Commission on International Trade Law (UNCITRAL) has a framework document that can govern arbitrations but does not operate an arbitration institution (UNCTAD 1998).[33]

Numerous BITs contain a provision requiring a state to observe any obligationit may have entered into with regard to investments. Such provisions are termed“umbrella clauses”.[34]The meaning of umbrella clauses has been the subject of some debate. [35]