LLM, Trade and Investment Law track
10 August 2015
Thesis topic:
Extending investor protection to Host-state companies seeking
protection in good faith from their own governments
Written by Mihai Avram (10865721) Supervised by E. Kentin (Esther) LLM
Preface... 1
1. Introduction ... 2
2. Methodology ... 3
3. Weak legal systems – corruption and bad faith ... 3
4. Bad Faith by state in Investor State disputes ... 5
4.1. FET and bad faith ... 5
4.2. Patterns of bad faith conduct against investors ... 6
5. Extending investment protection to nationals ... 8
5.1. Why do domestic companies need investment protection? ... 8
5.2. Will the weak legal systems become better as a result of investment-derived harmonization? ... 9
5.3. Methods of protection ... 13
6. Treaty shopping ... 14
6.1. Nationality planning: focus points ... 15
6.1.1. Lessons learned from Tokios Tokeles ... 17
6.1.2. The problem of timing and consent ... 18
6.1.3. Lessons learned from Phoenix Action Ltd v Czech Republic ... 19
6.1.4. Lessons learned from TSA Spectrum v. Argentina ... 20
6.2. Nationality planning behavior model ... 21
7. Joint Ventures: focus points ... 23
7.1. Introduction into how Joint Ventures work in Investor State Arbitration... 23
7.2. Joint Venture planning model ... 26
8. Utilitarian Effect of the Behavior Models ... 29
8.1. Role of domestic companies ... 29
8.2. Role of the government ... 30
8.3. Role of the international organizations ... 32
9. Conclusion ... 32
Preface
The reason for choosing this topic is that I am from a developing country, Moldova, and the occasional references will be seen in the paper. In addition to my own country knowledge, I have experience with accessing funding for investments in developing countries and LDCs. This experienced allowed me to see the investment climate in developing countries from the perspective of a foreign investor’s perspective. Non-developed countries have in common the same patterns of corruption, lack of enforcement, political instability and high-investment risks. This made me to want to research more about it, from the perspective of investment law, and to try to offer some solutions to the existing problems.
1. Introduction
The Tokios Tokeles case was the first example of domestic companies accessing investor-equivalent protection against their own government acting abusively. The case itself opened the door to interesting new possibilities and also offered insight into a new need – a need for
protection of domestic investor at the same level as foreign investors in developing countries. A spectrum of problems immediately arise when domestic companies want to go against the tide since the ICSID convention and most BITs state that the investment arbitration mechanism has a different scope. Furthermore there is the problem of jurisdiction, sovereignty of the state and numerous cases that prove that it is not possible for domestic companies to do what was done in
Tokios Tokeles. Even if a company may not directly enjoy the benefits of investor-equivalent
protection, there should be ways for indirect access. Two of these methods that are studied in this paper are the nationality planning method and the investment via joint-venture method. The findings will show that there is a high chance of success for domestic companies to indirectly access investor-status by planning ex ante their investments in line with the supporting academic theory and case law.
Showing that these methods of obtaining good faith protection was not enough for this research as long as the practice of nationality planning by domestic companies would have more
destructive effect than benefits. The impact of investment law on weak legal system needed to be analyzed as well under the assumption that it may lead to harmonization and long-run
improvements. There are strong grounds for reform of the weak legal system based on the practice of investment arbitration of the governments of developing countries; however there are factors preventing the reform to happen. These obstacles are analyzed in the last part of the paper and recommendations are given to the relevant stakeholders on how to overcome them and how to stimulate the reform. Even if the focus is on private company behavior, the method of
perceiving the problem is at a multi-stakeholder context. This approach is in line with CSR standards and for policy-makers this is in line with the principles of good governance.
This research will show how local companies can access investor-status in order to hedge their business risks deriving from the unstable political situation. Afterwards, it will prove how on the
long run, the utilitarian effect of these practices can manifest themselves to produce better functioning legal systems in developing countries.
2. Methodology
The objective of this research is to identify a possibility of how companies may acquire good faith protection from their governments acting in bad faith. The research is done by analyzing books, academic papers, web articles as well as cases related to the topic. Since there is limited information written on this specific niche subject, the research will focus on separate components as: corruption, weak legal systems in developing countries, bad faith in international investment arbitration, nationality planning, investment arbitration case law on joint venture practice and treaty shopping. The analysis will draw lines between these separate components in an attempt to produce a clear image of how domestic companies can access investor-state arbitration and what are the benefits of this. There are also very limited cases of domestic companies trying to sue their own governments and for this reason some of the recommendations will be purely theoretical.
3. Weak legal systems – corruption and bad faith
The weak legal system of a country relates to its informal economy which makes it a specific trait for developing countries. The Republic of Moldova is currently the poorest country in Europe and it can serve as an illustrative example of a country with a weak legal system.1 According to the World Bank it has a fragile economic and political environment and its key challenges are fighting corruption, improving the investment climate, and improving the judicial and administrative sectors. 2 Additional elements that make the legal system in the Republic of Moldova inefficient are: corruption in administration and court system, unreasonable taxation regime, bureaucracy in registration and licensing.3 This report by the World Bank was created to give greater impetus to policy reforms; however this information is also used by investors in their assessment of investment-related risks when entering a new market. According to the
1 World Bank Moldova Overview (Last Updated 2015) Accessed at
http://www.worldbank.org/en/country/moldova/overview#1 on 31st May 2015.
2 Moldova Investment Climate Assessment (May 2014) Accessed at
http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2005/10/05/000090341_20051005131415/Rend ered/PDF/336930MD0ICA.pdf on 31st May 2015.
EBRD, the weak judiciary and complex enforcement procedures undermine investors'
confidence.4 These obstacles for economic development and flow of FDI into Moldova are not unique. This example shows how inefficient legal system impedes efforts of development, but the World Bank analyses the same indicators (i.e. corruption, enforcement procedure duration) world-wide and most developing countries face the same challenges.5
A weak legal system is both a cause for and a consequence of corruption on behalf of the lack of effective accountability of public sector representatives.6 When a state is incapable of enforcing its own rules effectively and impartially, bribes and private protection are necessary to fill the void left by weak enforcement by the delegated institutions.7 Bureaucratic traditions in
developing countries favor recruitment and promotion of civil servants on arbitrary grounds not based on merits; this together with the low salaries in the public sector cause corruption.8 The ineffective enforcement in weak legal systems is disadvantageous to both foreign and domestic companies that are facing the same corruption, bureaucracy and legal uncertainty. An example is the granting of a business license or a building permit where both domestic and foreign
companies are subjected to the same unreasonable waiting periods and procedures.
The state is a legal person and its intention to engage in harmful conduct is abstract. For this reason, bad faith is established on the basis of the ill-will driving the actions performed by its organs and agents.9 The bad faith conduct by the state results from a set of one-off acts of state agents driven by personal interests to the detriment of public interest. Using public office for personal gain is the one way to define corruption that also makes reference to patterns of bad faith.10 The bad faith conduct by the state results from a set of one-off acts of state agents driven by personal interests to the detriment of public interest. Actions of agents of the state are based
4 Commercial laws of Moldova: An assessment by the EBRD (July 2014) Accessed at
http://www.ebrd.com/documents/legal-reform/moldova-country-law-assessment.pdf on 1st August 2015.
5 World Bank, CPIA transparency, accountability, and corruption in the public sector rating (2014) Accessed at
http://data.worldbank.org/indicator/IQ.CPA.TRAN.XQ on 31st May 2015.
6 Claes Sandgren, Combating Corruption: The Misunderstood Role of Law (2005) The International Lawyer
Vol. 39, No. 3, p. 724 para 4.
7 Sandgren, p. 724 para 3-4. 8 Sandgren, p. 725 para 2.
9 Deyan Draguiev, Bad Faith Conduct of States in Violation of the ‘Fair and Equitable Treatment’ Standard in
International Investment Law and Arbitration (2014) p. 278 para 1.
10
Cheryl W Gray & Daniel Kaufmann, Corruption and Development in 35 Finance & Development 7 (Mar. 1998). Available at www.imf.org/external/pubs/ft/fandd/1998/03/pdf/gray.pdf accessed 10th May 2015.
on improper motives when there is intention to deteriorate the investment or to deprive investments of profitability.11 Systematic harassment, bribery and duress of an investor can amount to bad faith conduct because these actions have the cumulative effect of indirect
expropriation and frustrate the business activity of the investor.12 There is no per se international obligation binding the state agents, and in case of breach, the legal person of the state retains responsibility. In the assessment of bad faith, tribunals often use arbitrariness, lack of due process, betrayal of legitimate expectations or non-reasonableness of the actions. These obligations are encompassed in the FET to be found in the relevant BITs. Even so, no arbitral award has been decided entirely and exclusively on findings of bad faith as breach of FET.13 There is a difference between proving bad faith in an arbitral tribunal and the need of investors to take precautionary measures against it. Bad faith conduct by the state against a foreign investor may manifest in the form of harassment, denial of justice, or extortion in the form of corruption. In Rompetrol v. Romania, the investor wanted to prove malicious conduct or bad faith acting by the government and was unsuccessful in doing so. The tribunal set a higher standard of proof for bad faith, beyond the investor’s allegations based on the balance of probabilities or
circumstantial evidence.14 The lower or higher standard of proof does not make the phenomenon magically disappear and thus there are grounds for companies to seek protection against it. Even when the claimant fails to prove bad faith, there are other available instruments as was the fair and equitable treatment in Rompetrol v. Romania.15
There is an assumption that political communities such as a state should ensure its own
functioning driven by political interest. Abusive acts by the state challenge the governing in good faith assumption and on the short run inhibit investments and transactions for both local
companies and investors. On the long-term effect these actions have negative impact of FDI and slow down economic development.
4. Bad Faith by state in Investor State disputes 4.1. FET and bad faith
11 Supra note 9, Draguiev, p. 274 para 2. 12 Draguiev, p. 274 para 2.
13
Draguiev, p. 283.
14
The Rompetrol Group N.V. v. Romania (ICSID Case No. ARB/06/3), Award, 6 May 2013, para. 289.
The fair and equitable treatment standard includes transparency, protection of investors’ legitimate expectations and good faith. Bad faith conduct by states against investors has been defined before as an autonomous variety of breach under the Fair and Equitable Treatment. Bad faith results from a breach of the duty of the state to act in good faith; for instance the state has an obligation to refrain from deliberately setting out to destroy or frustrate the investment by improper means.16 The test for bad faith established by Draguiev is – ‘actions damaging the investment, procured with deliberate purpose to harm and not justified upon a legitimate regulatory concern.’17 Frequent legislative modifications may amount to FET breach because they imply the lack of predictability, stability and transparency. Political instability is harmful for economic growth of developing countries.18 Bad faith conduct is more likely to occur in
developing countries because of the volatile political environment. Tokios Tokeles19,
Rompetrol20, Arif v Moldova21, Saluka22, Genin23 are investment arbitration cases showing that
bad faith allegations are brought up in cases against developing or transition economies.
4.2. Patterns of bad faith conduct against investors
Draguiev managed to gather the most relevant investment arbitration cases in which the
arbitrators found evidence of bad faith conduct even if they chose to define it differently. In the assessment of bad faith conduct, the arbitral tribunals have to back-trace the damage to the investor to the motives behind the harmful acts. The difference between good faith governance in the interest of the people, and actions in bad faith is that the latter produce harmful effect in exchange for profit of the state agents responsible.
In Vivendi v. Argentina24 the conflict arose on behalf of a nullification of a concession agreement between Argentina and a French water management company. Because of the volatile political
16 Waste Management v. Mexico (ICSID Case No. ARB/00/3), Award of 30 April 2004. 17
Draguiev, p. 274 para 2.
18 Said Jaouadi, Lamia Arfaoui, & Azza Ziedi, Political Instability and Growth: Case of the Developing Countries
(2014) International Journal of Social Science Research [Online], p. 19-28. Accessed on 30 May 2015 at http://www.macrothink.org/journal/index.php/ijssr/article/view/3973/3737
19
Tokios Tokelés v. Ukraine (ICSID Case No. ARB/02/18), 29 April 2004, paras 86, 126.
20 The Rompetrol Group N.V. v. Romania (ICSID Case No. ARB/06/3), Award, 6 May 2013. 21 Arif v Moldova (ICSID Case No. ARB/11/23) Award of 8 April 2013, para 489.
22 Saluka Investments BV v Czech Republic (PCA Case No. IIC 210) Partial Award of 17 March 2006, paras
289-290.
23
Genin & Baltoil v. Estonia (ICSID Case No. ARB/99/2) Award of 25 June 2001, paras 367, 371.
environment, after elections, the new government made serious efforts to impede the
concessionaire’s attempt to make their investment into a viable business. These actions by the government included: calling customers of the water company to ‘join civil resistance against the concessionaire’, the legislature tried to retroactively modify the terms of the agreement, open disregard for the concession by members of the executive and instigating customers to not pay their water bills.25 All these actions amount to deliberate intent to frustrate the concessionaire’s investment. Moreover all these actions initiated by the new government were not based on genuine concern for the well-being of the people, but on primarily extra-legal considerations in an unreasonable campaign against the investor. The tribunal decided that it is not legitimate to use governmental authority to exert pressure based on political motive where government agents would politically benefit from such conduct. Even if this case is exceptional, the actions of the government agents were still profit driven and had a harmful intent and thus fall under the scope of bad faith. A legal alternative was reasonably available to the new government however the policy choice was not only illegal but also ineffective and against public interest. In the end it resulted in damages to be awarded by Argentina to the investor. This is a key observation, because it shows a pattern in which the government agents act in bad faith both towards the investor and towards the public.
In EDF v Romania26 the long-term lease for the airport premises given under concession to the investor was not renewed and the investor made allegations that several persons solicited bribes from them claiming that they represented the host government. The evidence was insufficient for the tribunal to qualify the conduct as bad faith also on behalf of the lacking ‘attribution’
element.27 This is a rejection to extend the concession contract was not justified upon a
legitimate regulatory concern. By indirectly asking for a bribe to extend the concession contract for the airport, the state agents have prioritized their own profit over the interest of the general public. This pattern falls exactly under the definition of bad faith even if the evidence produced was insufficient. Evidence related to corruption, bribery, harassment, denial of justice is not easy to produce and this is why proving bad faith is much more difficult than going for the broader FET breach. Even so, bad faith is a breach variation underlying an existing phenomenon, and it
97/3) Award on 20 August 2007.
25
Vivendi v. Argentina, paras 4.11.2 ; 7.4.40 ; 7.4.26 ; 7.4.37.
26
EDF (Services) Limited v Romania (ICSID Case No ARB/05/13) Award of 8 October 2009.
can frustrate the legitimate expectation of the investor and frustrate the planned profitability of the investment.
5. Extending investment protection to nationals
5.1. Why do domestic companies need investment protection?
Investment treaties are signed between countries in order to protect investors in one another’s market. The first BIT was signed between Germany and Pakistan and the intention was to protect German investors abroad. The added value of the BIT was that it offered a neutral dispute
settlement framework that would substitute the need to refer to local courts with investment-related matters. BITs act as complements to good institutional quality in developed countries, but BITs are more useful in countries with poor institutional quality. In non-developed countries, the BITs provide security and minimum standards of treatment to foreign investors in cases in which domestic institutions fail to deliver these standards. For failure to apply the BIT standards, countries are liable to pay damages to investors and reduce incentives for further investments from abroad. The FET is an example of a higher standard of protection for the foreign investor detached from the host states’ domestic law. Failure to maintain governance in line with
transparency, stability and predictability was found to be sufficient to cause a breach of the FET standard.28 Foreign investors have a lot to gain from the capacity to enforce BIT-derived rights in developing countries in the cases in which the local remedies are either insufficient or
ineffective. Even so, the investor state arbitration remedies rarely go beyond compensation (i.e. specific performance).
The practice of treaty-shopping shows patterns of companies trying to access better legal protection by incorporating into other countries. Developing countries’ companies also
sometimes seek to incorporate abroad for tax, market-access and also legal reasons. Among other benefits, investment arbitration would allow domestic companies to be safe from direct and indirect expropriation. Other than these two, the host state would be held liable in relation to its obligation to offer treatment which is fair and equitable to the claimant.
28
Metalclad Corporation v The United Mexican States (ICSID Case No ARB AF/97/1), Award paras 71-99; and Técnicas Medioambientales Tecmed, S.A. v The United Mexican States (ICSID Case No ARB AF/00/2) Award, paras 154-164.
The Tokios Tokeles case presents the first example of a domestic company attempting to sue its own government. The incorporation in good faith was accepted by the Tribunal even if the company was de facto controlled by nationals of the host state.29 The decision on jurisdiction made an extensive assessment of nationality, definitions in the BIT, intention of the BIT drafters, intention of the investor and other circumstances. Even if there is no precedent doctrine in IIA, some tribunals in the past allowed nationals to sue their own governments. This phenomenon presents a very interesting method for overcoming state sovereignty and escaping domestic jurisdiction. Seeking good faith protection in anticipation of bad faith acting by the Government is within legal norms as it was decided in the Tokios Tokeles case. The use of human rights to hold the host state accountable is an instrument that is available only for individuals owning assets in ECHR signatory states. The use of investment arbitration by domestic companies in developing countries is the method that will be the focus of this research. By using international legal remedies, a domestic company can avoid the ineffective legal system in its host state if it is a developing country with a weak legal system.
Investment law standards are in place for the exact reasons why EU law and the ECHR were created – to offer a legal remedy in situations in which the local remedies are ineffective. The BIT standards create a better investment climate in high-risk countries, by improving the legal framework of the host state. This better climate and better legal framework are to the benefit of the foreign investor and the next question is – how many of these benefits also positively affect the domestic investors?
5.2. Will the weak legal systems become better as a result of investment-derived harmonization?
The traditional role of investment law is to protect investments abroad. Even so, the utility of investment law may go beyond this by creating pressure on developing countries to better their legal systems. Developing countries enter into bilateral investment treaties (BITs) in the belief that this will increase investments into their markets and support their economic growth. The interest of developing countries is to increase foreign direct investment (FDI), import capital into
their economies and benefit from the new jobs being created. What is less obvious is the benefit behind legal spillovers resulting from investments. By entering into BITs, a developing country usually binds itself to comply with a higher standard of law and it is pressured to maintain a well-functioning legal system. A deviation from this high standard of law may lead to breach of a BIT obligation. Breach of an investment-related obligation has the following negative effects: expensive litigation process, monetary penalty to compensate damages of investor, scaring-off of potential investors because of higher risks associated with the market. Moreover, when risks associated with investments abroad are higher, the investor will take more expensive insurance and will expect higher return on his investment. Expected higher return on investment may affect the population of the host state in the form of i.e. more expensive utility costs when investor is in water management or energy sector. For these reasons, there should be objective intention to not reach conflict and thus there is pressure on developing states to comply with this higher standard of law so as to not cause a BIT breach. Secondly, there is pressure to harmonize so as to create a low-risk investment environment. This type of reform happens for EU countries via
harmonization of national legislation with EU law. The government of an EU member state is obliged to conform to its obligations under threat of financial penalty. The EU is a balanced system in which the privilege of market access is balanced with the obligation to harmonize national legislation in areas in which the EU has competence to regulate.30 The pressure to reform is exerted by the EU community on the government of the non-conforming state as it is clearly seen in the example of Greece. In the EU, the possibility for individuals and companies to exercise vertical direct effect against their governments creates additional pressure for
harmonization.
Another method of reform of weak legal systems is for legal persons within the state to access international legal remedies. An example of access of international legal remedies is the use of the ECHR article 6 (right to fair trial) in countries such as Moldova, Ukraine, Uzbekistan and Russia. The ECHR has a supra-legislative status in domestic legal orders and, therefore, takes precedence over conflicting national laws or conflicting decisions by national courts. The ECHR has direct effect in some countries (such as the ones mentioned above), but not in all i.e. the UK.
30
Exclusive competences (Article 3 of the TFEU), shared competences (Article 4 of the TFEU), and supporting competences (Article 6 of the TFEU).
Since the ECHR can become part of the national legal order, it creates pressure on the government to harmonize and abide by international law.
With regard to investment arbitration-related harmonization – there are limited benefits in terms of legal spillovers of investment law, especially in developing countries on behalf of the poor institutional capacity. According to a study, the more developed a country – the more it is likely to fix the mistakes that lead to its investment arbitration liability.31
The host state should maintain good governance standards in order to avoid liability. Lack of stability, predictability and effective enforcement affecting a foreign investor are enough grounds to cause liability of the host state. There are certain factors that prevent the state from taking action ex ante to protect itself from possible breaches of BIT standards. The first factor is that when there is an alternative to domestic remedies, the investors will always use the international remedies and thus there is no incentive to make effective the domestic remedies. It is not
reasonable for an investor to refer to a domestic court when there is a legal basis to go directly to an arbitration tribunal. Secondly, the case law on investment law is not easily accessible to decision-makers on behalf of its complexity and lack of consistency in interpretation of standards such as the FET. Thirdly, in developing countries with poor institutional capacity, the decision-makers tend to act irrationally with regard to the consequences of investment treaties and liability.32 In theory, the responsible government agents should be stimulated by the threat of monetary liability and act rationally with a resource-maximizing intention.33 In reality, the decision-makers are unaware of the threat of international liability and they don’t take regulatory decisions with a preferential caution for investors. In developing countries, the poor institutional quality it would be impossible for all decisions taken to be proof-checked for investor-friendly impact. This is impossible on behalf of the little knowledge, the limited resources and the threat of regulatory chill.34 Moreover, there is a lack of incentive to avoid harm, because the tax-payers’ money is used to pay damages resulting from investment arbitration awards and the
31 Mavluda Sattorova, The Impact of Investment Treaty Law on Host State Behavior: Some
Doctrinal, Empirical and Interdisciplinary Insights, (2014) In: The Role of the State in Investor-State Arbitration. Brill Nijhoff, pp. 174-176.
32 Lauge N. Skovgaard Poulsen and Emma Aisbett, When the Claims Hit: Bilateral Investment Treaties and
Bounded Rational Learning (2013) World Politics 65, no. 2, p. 301.
33
David Cohen, Regulating Regulators: The Legal Environment of the State (1990) University of Toronto Law Journal 40 (1990): 245.
decision-makers are not penalized.35 On behalf of all of these factors, the threat of liability is not a catalyst for reform in developing countries. There is no doubt that the jurisprudence on
investment law provides for a valuable source for reform suggestions, especially in the area of administrative law.36 However, for this reform to take place there needs to be external
intervention in the form of capacity building and assistance to governments of developing countries.37
Corruption, bribery, harassment, and denial of justice are part of the reality of developing countries governance, as was described in the previous section. These bad faith patterns negatively impact foreign investors, but it is logical that these negative factors also impact the domestic companies. The domestic companies are dealing with the same bureaucracy, corruption and politically unstable environment as the foreign investors. One advantage that domestic companies have over foreign investors is that the former have more experience in managing their affairs in these unstable environments. On the other hand, the domestic companies have no access to investor-state arbitration since they don’t ordinarily fit the ‘investor’ and ‘investment’ criteria under the ICSID and the relevant BIT.
As discussed above, governments in developing countries most likely don’t take decisions based on previous case law or with caution so as not to breach investment law. Even so there is proof of governments exhibiting preferential treatment of to some foreign investors, especially if the investor is from a BIT signatory state.38 The basic assumption is that a state would treat its companies at least as good as it would treat an investor. This is the assumption on the basis of which both investment law NT and WTO law NT work. Even so, there is evidence that states sometimes offer preferential treatment to the foreign investors in the form of privileges that they don’t offer to their domestic companies. An example of this is China’s super-national treatment phenomenon that positively discriminated foreign investors because it was in need of foreign
35
Eric A. Posner and Alan O. Sykes, Economic Foundations of International Law (2013) Cambridge, Mass.: Harvard University Press, p. 115.
36 Rudolf Dolzer, The Impact of International Investment Treaties on Domestic Administrative Law (2005)
New York University Journal of International Law and Policy 37, no. 4, p. 970.
37
More details on this external intervention will be elaborated in part 8 of this paper.
38
Ibrahim F. I. Shihata, Legal Treatment of Foreign Investment: "The World Bank Guidelines"(1993) Kluwer Academic Publishers, pp. 80-82.
capital and advanced technologies.39 It is common practice for developing countries to offer certain privileges to stimulate investments into their respective markets.
There is a difference between the legal instruments that are available to investors and the
availability of the same remedies to local companies. Foreign investors under the BIT framework have access to investor state arbitration and in addition to this they may have access to other investment protection clauses in trade agreements. For both foreign and domestic companies, if the country is an ECHR signatory, there is the possibility to use the articles of fair trial and right to property. Even so, there is value in domestic companies gaining the ratione materiae to allow them to go to investor-state arbitration. The foreign investors in developing countries doubt the effectiveness of the local remedies i.e. on suspicion of corruption and lack of impartiality and as a result choose an international dispute settlement mechanism. Since the foreign investors have the option to choose the best remedy and they choose the non-local one, it is already enough proof that the local remedies are often ineffective. Corruption affects the fairness of the trial in domestic courts of developing countries and this is a second reason why domestic companies would benefit from having access to an international arbitration remedy. Since the legal spillovers have limited benefits, there is value in assessing whether it is possible for domestic companies to gain access to an alternative, and more effective, international legal remedy.
5.3. Methods of protection
International investment arbitration and other international instruments are an effective method for ensuring legal certainty for investors. Developing countries’ companies often seek to
incorporate abroad for tax, market-access and also legal reasons. These companies want to gain access to better legal protection i.e. for the protection of shareholder rights.40 Another example of this is how in the ECHR framework, individuals can refer cases related to expropriation on the basis of the right to property.41 Another way in which this is done is by incorporation abroad so as to ‘reach out’ to other legal systems and benefit from their protection from their own
Governments acting in an abusive manner. One of these legal systems is the investment
39 People’s Daily Online, China ends foreign firms' "super-national treatment" (2010) accessed at
http://en.people.cn/90001/90778/90861/7217484.html on 9 August 2015.
40 Orrick, Russian Start-ups forming a holding company in the US (2013) accessed at
https://www.orrick.com/Events-and-Publications/Documents/incorporation-abroad-for-russian-start-ups-considerations-and-decisions-english.pdf on 9 August 2015.
arbitration system and the method is for local companies to achieve ‘investor’ legal standing. Host-state companies may access the ‘investor-status’ protection in good faith, so as to protect themselves to their own governments acting in bad faith.
In Tokios Tokeles, incorporation in good faith was accepted by the Tribunal even if the company was de facto controlled by nationals of the host state.42 Important elements to consider are the jurisdiction, nationality, definitions in the BIT and other circumstances. Even if there is no precedent doctrine in IIA, some tribunals in the past allowed nationals to sue their own governments. This phenomenon presents a very interesting method for overcoming state
sovereignty and escaping domestic jurisdiction. Seeking good faith protection in anticipation of bad faith acting by the Government is within legal norms as it was decided in the Tokios Tokeles case. The use of human rights to hold the host state accountable is an instrument that is available only for individuals owning assets in ECHR signatory states. The use of investment arbitration by domestic companies in developing countries is the method that will be the focus of this research. By using international legal remedies, a domestic company can avoid the ineffective legal system in its host state if it is a developing country with a weak legal system.
6. Treaty shopping
Treaty shopping is the practice of investors using more favorable treaties by bringing claims from third countries as opposed to the directly applicable Home-Host treaty or in case there is no Home-Host BIT.43 Previously, treaty shopping has been divided into two types, the first of which relates to arrangements that can be made after the dispute has arisen and the second one relates to arrangements made before the dispute.44 The first type of treaty shopping is a high risk practice, as the arbitral tribunal may decline jurisdiction as seen in Phoenix v Czech Republic.45 The second type of treaty shopping involves careful planning of the investment in anticipation of the dispute, and it is considered to be safer and of a lower risk. Neither of the two practices is per se banned, but the low-risk practice has a higher chance of success because it is done in good faith.
42 Tokios Tokeles, para 52.
43 Matthew Skinner, Cameron A. Miles & Sam Luttrell, Access and advantage in investor-state arbitration: The law
and practice of treaty shopping, http://jwelb.oxfordjournals.org.proxy.uba.uva.nl:2048/content/3/3/260 accessed 13 April 2015.
44
Skinner, p. 260 para 1-2.
The fact that there is no formal precedent principle in international investment law reduces the certainty of effectiveness even more. For the purposes of this study, the focus shall be on ‘front end’ treaty shopping because the intention is to identify good faith protection seeking
mechanisms. One of the main methods of ‘front end’ treaty shopping is nationality planning.46
6.1. Nationality planning: focus points
Nationality planning is to incorporate a company into a third country which has a favorable BIT with the state where the investment is to be made, and invest from the new company. The scope of the nationality planning is to make a more favorable BIT applicable to a potential dispute arising from the investment. Other than gaining access to substantive advantages, nationality planning can open up new procedural solutions such as right of enforcement of the investor rights via ICSID, rather than ad hoc or litigation in host state domestic courts.47 Nationality planning is a strategy to protect a company and hedge the investment-related risks as much as possible and it is a relatively expensive practice in expectation of a probable dispute. For choosing the most advantageous nationality and treaty the following variables need to be taken into account: definition of investor, definition of investment, the presence of a denial of benefits clause, the nature of investment, the timing of investment and the arbitration clause.48
The investment arbitration tribunals have authority to determine their own jurisdiction as
opposed to i.e. commercial arbitration tribunals that derive the jurisdiction based on the contract between the parties. The investment arbitration tribunals have to analyze firstly if the investor fulfills the requirement of ratione personae under the relevant treaty. For treaty shopping, it is crucial that the investor definition in the chosen BIT requires ‘incorporation alone’.49 The ‘incorporation alone’ requirement is different from provisions that require that the investor have the nationality of the Home state, conduct business in the Home state, to have its ‘seat’ in the Home state50, or to maintain a genuine economic connection with the state.51
46 Skinner, p. 261 para 1. 47 Skinner, p. 261 para 1. 48 Skinner, pp. 270-272. 49 Skinner, pp. 270 para 3. 50
Agreement between the Czech Republic and the People’s Republic of China on the Promotion and Protection of Investments (concluded on 8 December 2005), article 2b.
For this exact reason there are some primary target countries for ‘incorporation’, the Netherlands being one of them. The Dutch foreign trade policy is amongst the most liberal in the developed world, and on behalf of this it has entered into 105 BITs with other states.52 For this reason, the Netherlands is one of the primary choices for nationality planning. Transnational companies investing abroad have been using Dutch BITs to bring claims against other country governments for over 100 billion dollars for damages resulting from alleged harm to their investments.53Few Dutch BITs require an additional element of ‘place of business’ requirement. In these cases a claimant that has a Dutch shell company will not qualify as an ‘investor’ under the respective BIT. The definition of ‘investor’ is the key to choosing the right treaty for protecting an investment.
The denial of benefits clause is included by some countries in their BITs in order to limit the access of third country companies. Under this clause, the sending state reserves the right to deny the treaty-derived benefits of a company that has no economic connection to the sending state on whose nationality it relies.54 The economic connection means control by nationals or substantial business activities in the relevant state. Treaties with such clauses are usually circumvented by companies seeking more favorable protection in other systems.
The nature of the investment should also be considered as some treaties contain sector-specific exemptions (petroleum and petrochemical) to protect the industry in countries as Mexico.55 The timing is important with respects to purchasing existing assets that were established before the applicable investment treaty came into force.56
The arbitration clause is the second most important aspect after the ‘investor’ definition. The most effective structure is one that grants access to the ICSID jurisdiction and avoids any rules that claims must be prosecuted in local courts first. Access to the ICSID means direct access to a reliable system of dispute resolution (impartiality, objectiveness), access to substantial
52
Skinner, p. 275 para 3.
53 Roos van Os & Roeline Knottnerus, Dutch Bilateral Investment Treaties: A gateway to ‘treaty shopping’ for
investment protection by multinational companies, http://www.somo.nl/publications-en/Publication_3708/at_download/fullfile accessed 13 April 2015, p. 2.
54
R Dolzer & C Schreuer, Principles of International Investment Law (OUP, New York 2008) p. 55.
55
NAFTA Annex III (1) (a) and (b).
jurisprudence (62% of all investment treaty arbitration cases solved under ICSID)57, arbitration without privity58 and highly probable enforcement (article 53-54). From the perspective of transnational corporations, the ICSID system is also advantageous because it limits the award annulment grounds and the resistance to enforce by states.59
6.1.1. Lessons learned from Tokios Tokeles
Tokios Tokeles (Tokios), a company incorporated in Lithuania, sued the Ukrainian government for abusive action directed against the subsidiary of Tokios in Ukraine. The key issue in this case was related to jurisdiction because Tokios were owned by Ukrainian nationals (99 percent of shares) and its management was two-thirds Ukrainian. The ICSID tribunal had to decide whether the ICSID jurisdiction requirement of ratione personae was satisfied when the claimant company is owned and predominantly controlled by nationals of the host state. The tribunal ruled in favor of awarding jurisdiction and this lead to a domestic company suing its own state. It is important to look at the tests used and the factors that led to this decision of the tribunal that led to a domestic company to be treated as a foreign investor.
The tribunal based its decision on a narrow interpretation of ‘investor’ (incorporation only) as found in the Ukraine-Lithuania BIT: “any entity established in the territory of the Republic of Lithuania in conformity with its laws and regulations”60. The second important argument was that there was no abuse of legal personality by the claimant, who made no attempt to conceal its national identity. The claimant did not manifestly create Tokios to gain access to the ICSID jurisdiction because the time of incorporation was six years before the Ukraine-Lithuania BIT entered into force.61 This requirement is interesting because it is a disguised requirement of good faith incorporation and this resulted in unintentional treaty shopping.62 Based on these two observations, the BIT with incorporation only is more likely to allow a domestic company to incorporate abroad and become an ‘investor’. Also, the incorporation in good faith and not specifically for the purpose of treaty shopping is more likely to be successful.
57 Piero Bernardini, ICSID versus non-ICSID Investment Treaty Arbitration,
http://www.arbitration-icca.org/media/0/12970223709030/bernardini_icsid-vs-non-icsid-investent.pdf accessed 13 April 2015, p. 3 para 5.
58 Krista Nadakavukaren Schefer, International Investment Law: Text, Cases and Materials, Edgar Elgar Publishing
2013, p. 400 Para 4.
59 Skinner, p. 266 para 2. 60
Article 1(2)(b)(ii) of the Ukraine-Lithuania BIT.
61
Tokios Tokeles, para 73.
The arguments against awarding jurisdiction were that the origin of the capital should have been relevant and even decisive of whether Tokios was an investor.63 The tribunal dismissed the origin-of-capital requirement as it had no basis in the treaty text for such an obligation.64 The second argument was that the ICSID mechanism is not an instrument to be used in purely
domestic disputes where Ukrainian jurisdiction should have been applied. The ICSID convention was overruled by the BIT interpretation that seems to have taken a flexible approach to what a foreign investor is. The Ukraine-Lithuanian BIT makes a distinction between (i) investors from Ukraine, (ii) investors from Lithuania, and (iii) entities established under the law of any third state, which is controlled by nationals of the contracting parties.65 Because of this clear
distinction in the text, the intention of Lithuania and Ukraine is clear and cannot be considered as an omission or mistake. Since the BIT is superior in legal hierarchy to the purpose and object of the ICSID convention, and the award by the tribunal is in conformity with international law. These observation point to the importance of choosing a flexible BIT in the process of treaty shopping for situations in which domestic companies want to incorporate abroad. This paragraph also points to the similarities between treaty shopping and nationality planning for domestic companies aiming for investor-status.
6.1.2. The problem of timing and consent
Consent is considered to be the “cornerstone of the jurisdiction” of ICSID and it is a delicate issue for both tribunals and the host states.66 Kjos argued that a restrictive interpretation of ‘investor’ by the ICSID tribunal would dissuade investors from resorting to the ICSID arbitration and choose alternative fora such as the UNCITRAL, where the applicable law is decided by the parties.67 Strangely enough, the particular Tokios Tokeles dispute would have not been possible under any other fora because, in this case, Ukraine gave its consent to arbitrate under a pre-chosen jurisdiction before the dispute. On behalf of the acting in bad faith that occurred, Ukraine would have never given consent to arbitrate on an international forum and would have claimed domestic jurisdiction over the dispute.
63
Tokios Tokeles (dissenting opinion).
64 Tokios Tokeles, para 77.
65 Translated extract of the relevant BIT text is available in the Skinner article, p. 278.
66 Report of the Executive Directors, at para. 23. See also Hege E. Kjos, 2004: Tokios Tokelés v. Ukraine, Decision
on Jurisdiction of April 29, 2004, Transnational Dispute Management Vol. 1, Issue 3, p. 8 para 2.
67
Hege E. Kjos, 2004: Tokios Tokelés v. Ukraine, Decision on Jurisdiction of April 29, 2004, Transnational Dispute Management Vol. 1, Issue 3, p. 8 para 1.
The best way to understand the irrationality of WLS countries such as Ukraine is to imagine that it has a bipolar nature. Some of its public servants are acting in good faith and some of them are acting in bad faith with no coordination in between. The state actors responsible for the BIT negotiation were acting in good faith with the intention of promoting investments as described in the preamble of the Ukraine-Lithuania BIT. However, the public servants that harassed Taki Spravy, the subsidiary of Tokios Tokeles, were acting in bad faith in the scope of intimidating companies that openly supported the opposition parties before the elections. The conduct of both groups of civil servants is attributable to the Ukrainian government. Consent of Ukraine to arbitration without privity is for when Ukraine was in ‘a better place’ and it is difficult to see how they would give consent to arbitrate in a situation in which they are certain to lose i.e. in UNCITRAL. The arbitration without privity generated this possibility for the owners of Tokios Tokeles to overpass sovereignty and this would not have been possible in any other way. The willingness to give consent is variable.
6.1.3. Lessons learned from Phoenix Action Ltd v Czech Republic
Two Czech companies, Benet Praha and Benet Group, went through proceedings in domestic Czech courts and on behalf of tax and customs duty evasions, the assets of Benet Praha were frozen and seized. After the proceedings, the owner sold both companies to Phoenix Action Ltd (Phoenix), a company incorporated under the laws of Israel and controlled by other members of the owner’s family. In two months, Phoenix gave its host state notice of existence of an
investment dispute.68 The Czech Republic argued that the tribunal lacks jurisdiction because the Israeli company was created for the sole purpose of treaty shopping by creating diversity of nationality.69 In light of the facts of the case, it is already clear that this is an example of ex postum treaty shopping that was done after the dispute has arisen. The domestic company tried to sue the Czech state based on an obligation that did not exist at the time of breach. The tribunal introduced a ‘timing’ test in order to assess the good faith incorporation of the Czech company. This timing test included elements such as the time of the investment, the time of the claim, the substance of the transaction and the nature of the operations. The tribunal concluded that there is no jurisdiction over pre-investment violations.70 Also, there was not investment but merely a
68
Skinner, p. 280.
69
Phoenix Action Ltd v Czech Republic (ICSID Case No ARB/06/5) Award of April 15, 2009, para 34.
rearrangement of assets within a family to gain investor-status.71 Finally, the tribunal emphasized that the transaction was not bona fide and that it amounted to abuse of rights.72
Assessment by the tribunal of the Phoenix treaty-shopping sheds light on the abuse of process criteria and the lacking good faith of the domestic company. Already here there is a difference between Phoenix and Tokios Tokeles since (1) the timing of the claim, investment was different; and (2) the substance of the transaction was different. These two elements caused the tribunal to classify one incident as good faith conduct and the second as bad faith conduct. From this simple analysis it is clear that the tribunal is more inclined to accept good faith protection seeking by domestic companies as opposed to ex postum abuse of process. This means that the ‘front end’ nationality planning is more likely to succeed for domestic companies. Moreover, as discussed above, the BIT choice is again very important since the language of the applicable treaty dictates what an investor is and how an investment should look like. The timing was a problem in
Phoenix, but the timing in Tokios Tokeles is on the other extreme - incorporation took place before the entry into force of the BIT. Somewhere in between Phoenix and Tokios Tokeles, there is a method for seeking protection in good faith for domestic companies.
6.1.4. Lessons learned from TSA Spectrum v. Argentina73
TSA Spectrum wanted to sue Argentina, by virtue of being owned by a Dutch firm TSI Spectrum International NV. This case puts together the element of nationals suing their own state with the Dutch BIT and the principle of piercing the corporate veil. TSA Spectrum is yet another case in which the arbitrators have severely disagreed on the jurisdiction decision, similar to Tokios Tokeles. Not only is there no precedent doctrine in IIA, but also, the existing practice of host-state companies suing their own government is inconsistent. The conclusions from the TSA Spectrum case will build up on the already existing guidelines because, as mentioned before, the most important part of nationality planning is to choose the right BIT. The Dutch-Argentina BIT has a narrow non-liberal definition of investor: “legal persons constituted under the law of that
71
Phoenix case, para 140.
72
Phoenix case, para 143.
Contracting Party and actually doing business under the laws in force in any part of the territory of that Contracting Party in which a place of effective management is situated.”74
The majority decided that the relevant BIT set an objective requirement of “foreign control”, and this restrictive approach was required to set the outer limit for the ICSID jurisdiction reach. Mr. Aldonas (dissenting) claimed that the intention of the BIT is to offer protection to genuine joint ventures, especially since there is 49% Dutch ownership of the company. Prof. Abi-Saab (majority) in the end said that certain evidence points to “control” by Argentinian nationals and piercing the corporate veil proved ultimate control by an Argentinian. Furthermore, he added that the object and purpose of the ICSID Convention is not to settle disputes “between States and their own nationals”.75
Based on the dissenting versus majority debate it is once again clear that the BIT choice is one of the most important decisions in the process of nationality planning. Even in the joint venture 49-51 set-up, the tribunal will look into the wording of the treaty and if the most restrictive
provisions are the ones requiring foreign control or siege sociale. Other examples of restrictive provisions are the ones mentioned in the dissenting opinion of Tokios Tokeles that requires an assessment of ‘origin of capital’ that led to the investment.
6.2. Nationality planning behavior model
Based on the above mentioned cases, it is possible to put together a pattern of conduct that companies are likely to engage in for successful nationality planning. Even if there is no precedent doctrine, companies are rationally aiming to increase their chances of success. The first important element of the model is the timing. When engaging in nationality planning, the domestic company needs to have an authentic good faith effort to seek protection in
anticipation of (before) potential disputes. This is based on the observations of the Tokios
Tokeles case76.
74 Dutch-Argentina BIT, Article 1 (b) (ii). 75
IA Reporter: Analysis: majority decision to pierce corporate veil in TSA v. Argentina case may be distinguishable from other cases (5 January 2009) http://www.iareporter.com/search?category=55&searchfrom=120 pp. 3-4.
The second important element is choosing the right BIT with a liberal definition of investor and investment. The objective is to have consent of the state to arbitrate in cases of ‘incorporation’-alone requirement, the consent can be extended to foreign companies controlled by nationals of the host state. Foreign control is only relevant in some BITs, but not all i.e. it was given by Ukraine as seen in Tokios Tokeles but not by Argentina as seen in TSA Spectrum.
The third element is the substance of the transaction. The transaction must be genuine so as to prevent the tribunal from applying an ‘origin of capital’ assessment in order to declare that the ‘investment’ requirement is not fulfilled. This is possible in cases of joint-ventures (as will be seen in the next part) where the foreign investor can make a contribution in kind even in the form of i.e. trainings, technology, software, experts transfer and other forms of non-physical but still quantifiable. This contribution must also be reflected in the equity division as the contribution must be made as a shareholder. The joint-venture structure choices are highly dependent on the applicable BIT as was seen in TSA Spectrum.
The last element is the ‘true nature of the investment’ which is in essence a test of intention. When the interest is not purely legal but also business oriented, this requirement will be fulfilled. As will be described further on, this hypothetical behavior models tries to predict how companies would act if they had all the information about investment law practice available. These models are merely additional elements to take into account so as to align the business interest with the legal protection access. This represents the basis for good faith intention. Nationality planning in isolation would be much more difficult to achieve by host-state companies that wish to access investor-equivalent protection from their governments acting in bad faith.
This behavior model would allow a domestic company to incorporate abroad, however the nature of the transaction and the business interest elements would be more difficult to achieve. In order to fulfill the elements of i.e. genuine economic interest, domestic companies would benefit from forming a partnership or joint-venture with a foreign company in the incorporation-destination. The new joint venture would later co-invest in the domestic company’s origin state and thus the domestic company would indirectly achieve investor-status and access to arbitration in case of disputes arising out of the investment. By doing this, the origin of capital would be mixed and the rationale for the investment would be in good faith. Other ways of substantiating transfers
from abroad back to the origin-country of the domestic company could be possible as long as there is a business rationale behind them.
7. Joint Ventures: focus points
7.1. Introduction into how Joint Ventures work in Investor State Arbitration
Joint ventures between a foreign and a domestic company can offer the domestic company indirect access to investor-state arbitration. The form of joint venture that is most relevant for this study is that in which two or more enterprises organize, and incorporate into a host-state new company. For the purposes of this analysis, only the second form is relevant where the
investment takes place in a developing country. When explicit agreement is missing, the
tribunals will make their own assessment of foreign control based on patterns of decision making within the locally incorporated company. Foreign investment law of many states makes it
mandatory for investors to incorporate locally in order to enter their market. In order to establish jurisdiction by the arbitral tribunals, the locally incorporated joint venture needs to fulfill the requirements of ratione personae.
The first requirement is the one of foreign control as described in article 25 (2) (b) ICISD. For ICSID article 25(2) (b) (second part) to permit jurisdiction in case of Foreign-Host joint venture disputes, there needs to also be an agreement stating that the Host-incorporated enterprise will be treated as an investor (national of another state) because of foreign control.77 In principle, this would already be a solution for obtaining consent of the state to engage in arbitration against an enterprise in which host-state nationals have a stake in. Once consent to arbitrate is given, the BIT has superiority over the ICSID convention and in cases in which there is a loose definition of ‘investor’, the jurisdiction could easily be established.
The intention behind this article was to extend jurisdiction to foreign investments made in the host state via a locally incorporated entity.78 The ‘foreign control’ seen above in the TSA Spectrum case is not necessarily an objective assessment of how joint ventures operate. Foreign control can be identified based on an explicit agreement with the host state or based on internal
77
Buffenstein, p. 202 para 3.
decision-making in the joint venture. The explicit foreign control that is stipulated in agreements investor-state agreements is the safe option according the Holiday Inn79. In the cases in which foreign control is not explicit, the tribunal will look into form of internal regulations for decision-making (equity participation, voting rights and management).80 Even so, control must not be seen only through the framework of the division of legal rights and duties.81 In some cases for instance, the technology-contributing partner can be the minority shareholder but his technical superiority may give him de facto control over the joint venture activities.82
Objective control is easy to assess when the foreign company has a majority stake in the shares of the Host-incorporated enterprise. In case of a minority stake, it is crucial to objectively determine foreign control for the Arbitration Center to have jurisdiction over the dispute. An accepted method to deviate from equity-ownership proof of control is by showing “any objectively verifiable financial or administrative situation”.83 In cases of minority stake of i.e. 20% it may be advisable for the investor to enter into a separate agreement with the host government in which the latter gives its specific consent to submit to arbitration any disputes arising out of the agreement between it and the joint venture.84 This is a perfect solution for a situation in which a genuine two-party joint venture is established and in which the foreign control element is too abstract to reflect the reality. Also, this would increase legal certainty of an agreement for market-operations between the investor and the host state.
The second requirement is the agreement85 between the investor that holds foreign control and the host state that contain an arbitration clause at i.e. ICSID for disputes arising directly out of the investment. Examples of how such agreements are used to establish jurisdiction can be seen
79 Holiday Inns S.A. and others v. Morocco (ICSID Case No.ARB/72/1) Unpublished, cited in Schreuer, supra note
93, p. 31.
80 Schreuer, supra note 93, pp. 79-80; as cited in Valts Nerets, Nationality of investors in ICSID arbitration (2011) p.
32; accessed at http://www.rgsl.edu.lv/images/stories/publications/2_nerets_final.pdf on 9 August 2015.
81 Buffenstein, p. 196 para 2. 82
International Thunderbird Gaming Corporation v. United Mexican States (NAFTA) Award of 26 January 2006, para 180.
83 Buffenstein, p. 204 para 3. 84 Buffenstein, p. 205 para 3. 85
These agreements can be any kind of establishment contract, concession contract, incorporation of foreign capital companies and other contract between the foreign investor. An arbitration clause is usually included in these contracts.
in the following examples. In Amco v. Indonesia,86 PT Amco, a locally incorporated company, was controlled by its parent foreign company, Amco Asia. PT Amco (US company) and PT Wisma (domestic company) were joint owners of the new locally incorporated company. The respondent raised the argument that there was no ICSID jurisdiction over the investment-dispute that arose, since there was no agreement to treat PT Amco as a foreign investor. In the
application of Amco Asia to establish an Indonesian joint venture company there was (1) a clause stipulating ICSID jurisdiction over future disputes and (2) express recognition of foreign control over the joint venture.
In Klöckner v. Cameroon,87 a foreign investor establishment of a joint venture in the format of 51% shares owned by the foreign investor and 49% owned by the Cameroon government. The protocol (establishment) agreement with the host state contained an ICC arbitration clause. The arbitration tribunal held it is sufficient to have an ICC arbitration clause in an agreement with the Host state to justify ICSID jurisdiction. 88 There was an obligation to treat the locally
incorporated company as foreign owned. These cases prove that inclusion of an arbitration clause in a contract between a host and a locally incorporated company means that the Host state
assumed the obligation to treat the local company as foreign. Breach of this obligation, under the framework of a BIT grants the local company access to arbitration against the host state.
The relevant observations to take from these last paragraphs are that: (1) a two-party joint venture may sign a ‘foreign control’ agreement with the host state government and obtain investor status for future disputes, and (2) just to makes sure, it is recommended to sign a specific agreement between the (minority stakeholder) investor and the state to consent to arbitrate for any disputes arising out of the joint venture investment. These are important instruments through which an investor-status protection could be extended to a Host-state majority stakeholder in a genuine joint venture. For this reason, investors should have a clear corporate structure that assigns roles within a multipartite joint venture so as to avoid uncertainty with regard to jurisdiction. When engaging in nationality planning, the companies must be aware of all these elements and furthermore the Convention prohibits unreasonable choices of
nationality in order to prevent bad faith treaty shopping. This obligation is based not on
86
Amco v. Indonesia (ICSID Decision on Jurisdiction, ICSID Reports 392-397) Award of 25 September 1983.
87
Klöckner v. Cameroon (ICSID 2 ICSID Reports 14-18) Award of 21 October 1983.
legislation, but more on the de facto patterns of assessment applied by tribunals that would not allow abuse of procedure.89
Exactly as in the case of a bipartite joint venture, it is recommended to draft an agreement with the host state, for the latter to consent to arbitrate for disputes arising directly out of the
investment. In cases of corporate restructuring i.e. changes in equity ownership that may have an impact on control of the joint venture, the consent of the Host state may become no longer valid and thus the investor may forfeit his right to go to arbitration.90 However, there is a
recommended way to avoid such a problem in light of the interest of the capital-importing host state to incentivize ownership transfers to its national host companies. If the agreement to arbitrate under the ICSID jurisdiction includes a clause that would extend consent by the host state to arbitrate in cases of corporate restructuring in the favor of its domestic private
enterprises, the jurisdiction over disputes would not be lost.91 This provides for an ideal scenario of host state domestic companies gaining investor-status and obtaining protection from political fluctuations and policy-related uncertainty. This kind of insurance is extremely valuable for domestic companies in developing countries.
7.2. Joint Venture planning model
The joint venture behavior model is an overview of how domestic companies may plan their joint venture investments in order to legally ensure that they have access to international investment arbitration. As mentioned above, the political realities in developing countries are different from those in developed countries on behalf of the threat of abusive acts from the government. Since nationals sometimes need protection equivalent of investors, this model would explain how domestic companies may rationally hedge their joint venture investment risks.
Related to foreign control, in the hypothetical case of a Dutch-Moldovan joint venture, the decision-making process would have to be adapted to giving privilege to Dutch shareholders over i.e. financial and administrative decisions. Moreover, the way of proving foreign control would be to give concrete examples of the exercise of the Dutch control in taking a financial or 89 Buffenstein, p. 207 para 1. 90 Buffenstein, p. 209 para 3. 91 Buffenstein, p. 210 para 1.
administrative decision. This decision-making process is important in the initial stages of the joint venture activity at least before the consent to arbitrate is given by the Host state.
Related to clauses on arbitration, in cases such as concession contracts between a foreign investor and the government, arbitration clauses are included by default. For a situation of a private foreign/domestic joint venture, the parties must ensure that there is also an investment agreement between the foreign investor and the state. This agreement will serve as legal insurance for the future investment-related disputes. In order to fully benefit from the legal remedy of investment arbitration, the agreement with the host state should also include a clause stating that corporate restructuring to the advantage of domestic companies should not impede the validity of consent to arbitrate by the state. This is the key element for the domestic company as it is possible, to make an internal agreement between the parties to the joint venture for the transfer of shares in favor of the domestic company even before the establishment of the joint venture itself. An internal agreement for the transferring of i.e. 80% of shares from the Dutch investor to the Moldovan investor after the moment of the separate agreement signing is not per se illegal. This would create a scenario in which the Dutch shareholder may become a minority stakeholder in the joint venture and still the investment-derived disputes would have ICSID jurisdiction.
The result of applying these steps in a correct way would be to obtain the consent of the host state to engage in ICSID arbitration with its domestic host-state company acting as majority stakeholder in a joint-venture for disputes arising directly out of the investment. This means that in case of indirect expropriation, breach of the FET or the full protection of security standard, the domestic company would be entitled to investor-equivalent protection. The intention to engage in good faith seeking of protection would probably be forfeited if it became clear that the sole intention for establishing the joint venture is for the seeking of protection. The good faith requirement can be fulfilled by identifying a business interest for establishing the joint venture investment which is different from the intention to establish a joint venture exclusively for access to legal protection. The two-step process can be pursued by both foreign and domestic
companies that already plan on setting up joint ventures and co-investing in a developing country, to hedge their risks.
