Foreign Investment Protection: A Flawed Approach

The Model Text for Bilateral Investment Treaties (BITs) released in March 2015 reflects a regressive attitude towards foreign investment protection. With the investors sitting on the fence assessing their options, this does not bode well for India.

Anticipation and hope have been the keywords when describing investor sentiments since the change in government last year. The inflow of capital, though, has shown a restrained response. The reason for this seems to be that investors want to see positive steps implemented on the ground, marking a tangible shift in policy towards creating a conducive investment environment by the Indian government.

Government’s policy declarations, including the ‘Make in India’ push, have been steps in the right direction. However, the new Model Text for Bilateral Investment Treaty (BIT) released in March 2015 for public comments reflects a surprisingly regressive attitude towards foreign investment protection by a government, which has otherwise shown the political will to act on the promise of economic reforms.

What is now commonly referred to as BITs, i.e. bilateral investment treaties, is not of recent advent. It has been in vogue for over half a century. It’s real impact and advantage for investors, though, has only come to the forefront of public debate in the last 15 years or so – with a sudden rise in number of claims filed by investors under these treaties.

Investment treaties are unique instruments that give the right to a private individual / corporation to bring a claim against the host State for breach of any of its terms. Its terms generally guarantee fair and equitable treatment and full protection and security of foreign investments and creation of level playing field with investors of the host State (national treatment standard) and of any other State with which similar treaty is signed (most favoured nation).

Additionally and importantly, it guarantees prompt and adequate compensation for expropriation of the assets of foreign investors. All of this is then implemented through a binding consent to arbitration offered by the host State such that investors can bring their claims before neutral arbitration tribunal and obtain an enforceable international arbitration award, if their claims are found to be sustainable.

India has, until recently, had a very good track in this arena. For decades now, India has had a robust treaty protection regime for foreign investors from about 82 countries – in every which manner consistent with the best practices internationally.There has, unfortunately, been a clear move in the wrong direction since the early debacle faced by the Indian government in an investment dispute. In addition, the spurt of claims that followed the Supreme Court’s decision in the 2G case and Vodafone’s notice under the Netherland treaty to prevent a retrospective tax amendment has added to the misgivings against these treaties as a whole. Top ministers and bureaucrats in the relevant ministries clearly indicated India’s intention to revisit the foreign investor protection regime, going so far as to indicate that no protection under the international law was the direction of their choice.

All of this was during the last few years of the previous government in office. It was believed, however, that the new government will relook at this negative knee-jerk reaction and propose a more positive well thought out policy. The Model Text released in March reflects the policies of the previous regime and runs contrary to NDA’s push towards Make in India.

Foreign investors take a huge risk by investing large quantum of capital in an alien territory, with expectations of returns only futuristic. Therefore, it has been accepted that alien investment should be accorded some minimum protection, which is not subject to the political vagaries of the host State. The only manner of achieving this is to provide protection under international law, where a measure cannot be justified simply because it is permitted under domestic law of the host State and must independently pass the muster of international law.

One of the important criteria in making the strategic choice of the country where a foreign investor will direct his capital is the predictability and transparency of its legally binding obligations. Not only must the system must offer concrete protection to the investors, but it should also ensure that a change in the political regime of the country will not affect their investments.

The Model Text not only fails to meet the expectations of foreign investors contemplating entry into India, it miserably fails the Indian investors who are increasingly looking beyond our borders for safe investment options. The entire tenor and direction of the treaty is reactive and defensive. Its focus is to keep most potential measures that can lead to a breach outside the scope of the treaty. It looks to exclude the rest through a complex web of conditions and exclusions. The Model Text’s primary focus is to regulate investors through this international instrument – which is strange, as that is easily within the domains of domestic legislation. The misstep in drafting the Model Text is evident from the preamble itself, which, while highlighting the sovereign right of India to regulate the investments flowing into its territory, makes no mention of its commitment to protect such investments.

In the zeal to prevent a repeat of White Industries, telecom cases, and Vodafone, the Model Text has turned BIT on its head to add extremely onerous obligations while completely ignoring substantive protections. To begin with, the definition of protected investments itself has been considerably narrowed down when compared to the 2003 Model BIT. It excludes the rights of minority shareholders from the scope of protection. This is strange in light of existing FDI norms, which limit foreign investments to minority shareholding in many sectors. The rights existing in intellectual property have also been left unprotected.

Another very significant omission is the blanket exemption of taxation measures from the scope of the treaty, which is especially significant in light of investors’ special concerns about the predictability of India’s tax regime. At the minimum, expropriation by taxation measures, which is considered to be a norm of customary international law, ought to be available. In an otherwise trustworthy legal regime, taxation has remained India’s Achilles heel. It is, therefore, important that taxation measures are put to the test of treaty protection without sacrificing India’s sovereign right to impose taxes without discrimination.

Another striking omission is that guarantee of fair and equitable treatment is not available. Model Text replaces the standard of protection from that of fair and equitable treatment to a much higher threshold of denial of justice. Over the last couple of decades, the fair and equitable treatment standard has become the repository of all rights for foreign investors in these treaties. In advanced jurisdictions and with economically mature governments, it is easy to defy well-formulated standards such as expropriation and national treatment through a well-planned measure. However, a fluid concept that guarantees that the investor will be treated fairly and equitably is difficult to escape.

It is, therefore, no surprise that most cases in recent times have succeeded on the ground that the measure of the host State was found to be in breach of the fair and equitable standard. It is also true that the standard has sometimes controversially admitted claims that could not have been intended to be protected by the treaty, through expansive interpretation by tribunals. In our view, though, its complete omission renders an investment treaty virtually futile.

The Model Text’s most regressive step is to put multiple hurdles before an investor from bringing any claim under the treaty by creating an extremely complex arbitration regime, which not only requires multiple rounds of litigation and conciliation but also brings in the concept of counterclaim by the State on grounds which should not ideally be a subject matter of international treaty. It requires investors to pursue local remedies either to conclusion or abandonment, which is impractical or, at best, vague. It provides that India can bring a counterclaim against the investor on various grounds including evasion of tax and issues of corruption, both of which must always remain within the sovereign reach of domestic courts and not international tribunals.

It is welcome that India has put drafting of a model investment treaty high on its agenda and that it has sought public comments on the same. The Model Text, though, has failed to be a starting point in this direction. Through the Model Text, India has presented a confused policy statement. With the investors sitting on the fence carefully assessing their options, this does not bode well for India.

If India wishes to regulate without compromise through international instruments, it should choose to implement a National Investment Code, like South Africa. On the other hand, if it wishes to go ahead with BITs, it must present them as a tool of substantial protections. While making this choice, it should consider the diplomatic negotiating power that BITs provide, and that will be crucial for the new India which not only imports but also exports substantial amounts of capital.

BITs in particular and protection of foreign investors, in general, have become a controversial and politically sensitive issue in light of the conflict with sovereign freedom of States to regulate policies of public importance, such as health and environment. We commend the Indian government in reacting timely to bring this issue to the forefront in public debate. However, we also believe that the Model Text needs a holistic revisit, particularly since it appears to be in conflict with the new government’s declared economic policies and can potentially defeat its push towards “Make in India” – a project that has received encouraging response both inside and outside India.

(The authors have worked together for Society for Research in Law to prepare a detailed critique of the New Draft BIT to the government. The Critique is available here)