The Evolution of BITs and the Promotion of Foreign Direct Investment.

Introduction The large number of treaty arbitration in recent years has been a product of an exponential growth in the number of Bilateral Investment Treaties (BITs).1 The movement of BITs began in the 1950s with the signing of the first BIT by West Germany and Pakistan in 1959. Throughout the 1960s, 70s, and 80s we see a steady increase in the amount of BITs being signed with 72 in the first decade, to 93 in the following and 220 in the 80s until the 1990s when we experience what has been termed a BIT boom2 when a total of 1472 BITs are signed.3 As of 2008 the total number of BITs in existence stood at 25004 given a projection of 828 for that the decade.5 The One key feature of any BIT is its provision allowing for any investment dispute to be brought to arbitration, once all local administration procedures and remedies had been exhausted. Investors benefit from this new form of arbitration in a number of ways. This could mean arbitration under the Washington Convention,6 if both parties are signatories or if only one is a signatory under the ICSID Additional Facilities rules. Where neither party has signed up to the Washington Convention the type of arbitration is left to the imagination of the parties and can take any form, be it ad hoc with the UNCITRAL rules or under another arbitration institution such as the International Centre for Settlement of Dispute Resolution , so long as the parties mutually agree. Direct recourse to arbitration against host states provides greater assurances that investments will be treated fairly.7 Where arbitration was not available, because it was not expressly mentioned in the contract or the parties do not agree jointly to go to arbitration, this meant that the investor would have to rely on customary international law rules or domestic courts of the host states where applicable. This often left the investors with little satisfactions as host states can change their laws after the investment has been made and host country officials may not always act fairly or impartially towards foreign 1
McLachlan, C. QC & Shore, L. & Weiniger, M. International Investment Arbitration: Substantive Principles Oxford University Press, 2007. Chapter 2, pg 26, The Basic features of Investment Treaties. 2 Newcombe, Andrew Paul & Paradell, Lluis Law and Practice of Investment Treaties: Standards of Treatment Kluwer Law International, 2009. Chapter 1, pg 48, Historical Development of Investment Treaty Law. 3 http://www.unctad.org/en/docs/poiteiiad2.en.pdf 4 Dolzer, R. & Schreuer, C. Principles of International Investment Law Oxford, 2008, pg 2; http://italaw.com/documents/NewcombeandParadellLawandPracticeofInvestmentTreaties-Chapter1.pdf 5 From 2000- 2008 an average of 83 BITs were signed per year. 6 In this case the arbitration would take place in Washington, USA at the International Centre for Settlement of Investment Disputes (ICSID). 7 Capper, P. International Arbitration: A Handbook LLP, 3rd Edition, 2004. Chapter 11, pg 136, Investment Treaty Arbitration.

investors and enterprise.8 So with foreign direct investment (FDI) flows increasing there was a demand for alternative and more reliable resolution for investment disputes. What this essay intends to look at is the relationship between the growth of BITs and FDI. How BITs many benefits helped build investor confidences to utilise resources in other countries which it would not have had access to in its own country but equal to help that state with its inability to utilise its resources through lack of capital. Also how the freely negotiable BIT was more efficient than other types of investment treaties to achieve this. In this essay well look at the historical context in which BITs began such as the need for FDI in post World War 2 era and the effect of the global recession of the 1980s on the ability and access of less developed states to borrow money. Also well look at how the BIT instrument has changed from a couple of pages to a more substantial text covering more areas than just the protection and encouragement of investment, to concerns about the environment and greater protection of human rights.9 In doing this well examine the draft model US BIT 2004 and the Canadian Foreign Investment Protection Agreement (FIPA) as new the new form of BITs going forward.

The Good, The Bad and The Ugly BITs There are numerous advantages to BITs over other forms of investment treaties such as Multinational Investment Treaties (MITs). Agreements between two parties are usually more easily reached10 rather than the balancing of interest between many states which is the case in MITs. BITS allow for tailored treaties between two parties which can be specific to each others needs. BITs are easily altered through mutual consent of both parties and each individual BIT can be exclusive to the contracting parties and can contain broad definitions of what constitutes an investment or a national of a party state, or what constitutes substantial business activity. Equally it can narrow the scope of such terms, as to approved projects only,11 or to companies incorporated within its jurisdiction. They also eliminate the possibility

Salacuse, Jeswald W. & Sullivan, Nicholas P. Do BITs Really Work? An Evaluation of Bilateral Investment Treaties and Their Grand Bargain (2005) 46 HVILJ 67. 9 http://www.unctad.org/en/docs/poiteiiad2.en.pdf 10 As can be inferred by the US attempts to promote Multinational Investment Treaties within the OECD after previously failing with that idea at the Uruguay Round Agreement. 11 UK- Malaysian BIT. This issue arose in the case of Malaysian Historical Salvors SDN BHD V The Gov. of Malaysia, where the investment in question did not fall within the approved projects clause of the BIT.

of any blocking coalition which can be a common feature of MITs or any Free Trade Agreement (FTA).12 BITs have risen to prominence during a period in which the international regulation of foreign investment was subject to great change, uncertainty and controversy.13 Investors were increasingly concerned both the security of their investments in foreign jurisdictions, and their concerns were if they would be treated fairly to a minimum standard or at least equivalent to host state investors or would their property be expropriated or nationalized by the host state. Customary international law was too vague and did nothing to instill confidence in the market.14 As a result, investors had no assurances that investment contracts and arrangements made with host state governments would not be subject to unilateral change by those governments at some later date.15 However BITs brought certainty to the table as any changes to rules needed expressed mutual consent by both parties. What the expected standard of treatment of the host state towards the investors could now be expressly stated in the BIT, such as would there be a most favoured nation (MFN) clause which meant that their investors would be treated with equal beneficial provisions as afforded to other foreign investors of other states, fair and equitable treatment and certainty to laws e.g. tax rates would not change or a more favourable rate would be applied. In particular the MFN clause was extremely advantageous where the draftsmen of the BIT were not as savvy as other, investors of those states could now extend their benefits to include the benefits given to other investors by virtue of a better worded BIT.16 The high risk associated with foreign investment before BITs were available, left little or no incentive for capital rich states to investment in developing states in need of such capital, thus creating a need for an international stable legal framework in which to govern these contracts. One of the most important advantages of a BIT is the protection of the investors investment and the early BITs tended to be modeled on agreements by capital exporting states17 which tended to favour their investors. The main

12 13

Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 67. Guzman, Andrew T. Why LDCS Sign Treaties That Hurt Them: Explaining The Popularity of Bilateral Investment Treaties (1998) Summer Virginia Journal of International Law 639. 14 Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 67. 15 Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 67. 16 An example of a MFN clause was in Emilio Agustin Maffezini v. Kingdom of Spain (ICSID Case No. ARB/97/7), where the MFN clause was instrumental in Mr Maffezini skipping the required 18 month in national courts period before he may institute international investment arbitration under the Argentina- Spain BIT. Mr Maffezini argued that under the Chile- Spain BIT specifically and under subsequent BITs that Spain entered into it, allowed this benefit to those investors, and because the MFN clause was so broadly worded the arbitral tribunal extended it to allow Mr Maffezini to proceed. 17 Newcombe, Andrew Paul & Paradell, Lluis (note 5 supra) pg 52.

protection was that against expropriation. This not only covered expropriation of physical or legal property but also any measures by the host state which whilst not depriving the investor of a right to property had the affect of diminishing the value of the investment or any other benefit derived from that.18 It is standard for a BIT to contain an expropriation clause although there is no extensive guidance to the parties on the characteristics of such an event, however a safe conclusion that can be drawn is that states tend to incorporate the standard that is applicable in customary international law.19One definition that is often cited is that of the Hull Rule which stemmed from the US Secretary of State Cordell Hulls note to the Mexican Government, Under every rule of law and equity no government is entitled to expropriate private property for whatever purpose without provision for prompt, adequate and effective payment therfor.20 What is deemed to be adequate compensation is fair market value of the asset prior to the breach.21 It is worth noting at this point too, the fact that BITs are not mutually exclusive of the legal world around them, they draw definitions and influences22 from both domestic and international law, it is this flexibility that helps form the common ground between two states whose nationals laws prima facie are polar opposites. States entering into these investment treaties were very advantageous to their investors. As I said early if an investment dispute arose the investor would have to rely on the national courts of the host states to come to a resolution. If an investor wanted the benefits of arbitration there needed to be an expressed clause in the contract stating this. Initially BITs only allowed for dispute resolution through state- state arbitration and were confined to disputes over the amount of compensation owing due to an expropriation, so a scorned investor would need to submit to the International Court of Justice (ICJ). However with these disputes becoming more depoliticised we see in 1968 the first investor- state arbitration clause was expressly incorporated, though with qualifications, into the IndonesiaNetherlands BIT.23 Thus this created a whole new legal right and what BITs now inferred on these investors was arbitration without privity, instead of an arbitration clause in contracts, states could

18 19 20

Capper P. (note 7 supra) McLachlan, C. QC & Shore, L. & Weiniger, M. ( note 1 supra) pg 275, Expropriation. US Secretary of State Cordell Hull note to Mexican Government in 1938 demanding such compensation for the Americans who lost their farmland in the Agrarian reforms of the 1920s. 21 Kantor, M. Investor- State Arbitration Over Investment in Financial Services: Disputes Under New U.S. Investment Treaties (2004) 121 Banking Law Journal 579. 22 See US- Bolivia BIT Article III which incorporates into the Treaty customary international law standards for expropriation. 23 Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 44.

agree to arbitrate in future disputes through their BITs.24 It is no wonder that the business committee started lobbying their governments to sign these treaties as they realised the opportunity these presented,25namely an investor could now directly enforce their rights against a government of another state. As mentioned in the introduction if the arbitral institution happens to be the ICSID in Washington this too is highly advantages to the investor as they get the many benefits associated with such an institution. All the benefits of ICSID arbitration are beyond the scope of this essay, but to mention briefly a few keys points, first of these being its huge jurisdictional reach. As of the 5th May 2011 157 states26 have signed up to the Convention which means an ICSID award is enforceable within any of those jurisdictions. As ICSID is affiliated with the World Bank, this connection facilitates enforcement as any disobedience of a national court of one of the signatories could mean sanctions put on that state by the World Bank such as not being able to receive any further loans.27 Noncompliance with any such enforcements too, could potential harms the business reputation of the state and may negatively affect any future dealings between the states. Secondly the finality of the award, if you are a winning party of an ICSID award it is not capable of being challenge by any national court of any state, it is seen as final as though handed down by the highest court of that jurisdiction. However it possible to challenge an award but this jurisdiction rests solely with ICSID and is only allowed on limited grounds. Finally another contribution noteworthy of ICSID is their list of model BIT clause which they complied in 1969 and have published on their website.28 In order to address the appearance of favouritism in the above section towards BITs there are some disadvantages to states who enter into such treaties. As was mentioned earlier BITs were predominantly in favour of the capital exporting states and capital importing states needed in order to attract investment often enter into a race to the bottom with other capital importing states. In the short term such measures are harmful to the development of such states as any benefit which would have been gained through the investment is often lost through the favourable tax rate they may have agreed. Another downside to BITs can be the disadvantage to the capital exporting states economy, as with FDI flows out of such states it can deprive the state of jobs, better infrastructure and tax revenue as 24 25
Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 44. In the 1970s, the US business community began lobbying the US government to conclude Bits as a means to provide to US investors protection similar to those available to investors from other capital exporting states. 26 http://icsid.worldbank.org/ICSID/FrontServlet?requestType=ICSIDDocRH&actionVal=ContractingStates&ReqFrom=Main 27 Refern & Hunter International Arbitration OUP Oxford, 5th Edition, 2009, pg 148. 28 http://icsid.worldbank.org/ICSID/StaticFiles/model-clauses-en/main-eng.htm

capitalists seek out cheaper labour, lower manufacturing costs, tax incentives, more relaxed environmental laws and expansion into other global markets. One argument which has gained academic debate it that of the constitutional issue connected with BITs and states limiting their sovereignty by entering into these treaties. Increasing awards against Latin American states and a renewed interest in the nationalisation of the energy industry has led many Latin American states to reconsider their commitment to investor- state arbitration under BITs.29 In Bolivia the laws approving several BITs have been challenged on the basis of their constitutional validity, however any such claims have been dismissed as the treaties are only subject to constitutional review ex ante.30 This issue though still raises a question for the future of BITs which I will look at in more detail later. However it is the view expressed in this essay that, the value of an investment is never to be judged in the short term. If such measures do attract other side investment, although harmful in the short term may turn out to be beneficial to the state as a whole in the long term. The pros of capital inflow, new technology, improvement of infrastructure and the creation of jobs do for the most part outweigh any cons associated with BITs and it is this reasoning why we still see even to this day increasing number of states signing these treaties some fifty years after their introduction.

The Liberalisation of Capital and Promotion of FDI

It is no coincident that BITs have proliferated at the same time as FDI has experienced phenomenal growth.31 In 1973 a mere four years after the signing of the first BIT, annual FDI was $25 billion.32 At the end of the BIT boom it had reached $1.1 trillion in 2000.33 The competition for FDI coupled with an increasing acceptance of liberal economic policies provided the fertile ground for the conclusion of BITs.34 To put it simply capital importing states sign BITs to attract capital and capital exporting states sign BITs to protect their investors and as a means of fostering market liberalisation35. As some 29 30 31 32 33 34 35

Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 51. Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 51. Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 71. Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 71. Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 71. Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 49. Lecture slides week 2 FDI and Investment Treaties, slide 6.

nationals laws acted as impediments to the entry of foreign capital BITs were the instrument that facilitated this. If we look at the preamble of any BIT, most will read as follows The Government of X and the Government of Y, desiring to create favourable conditions for greater investment between by nationals and companies of one Sate in the territory of the other State; Recognising that the encouragement and reciprocal protection and under international agreement of such investment will be conducive to the stimulation of individual business initiatives and will increase prosperity in both States;36 history has shown this not to be entirely true in all situations. Notably first is that the intention of the parties is for the reciprocal investment of both states in each others territory but in reality it tends to be one sided in that developing countries tend not to export any of their capital to the other contracting party, usually a developed state37. Also as previously mention earlier BITs tended to favour investors to determent of host state governments. Indeed host states, particularly with the over burdensome provisions demanded by the US, grew skeptical about the benefits of these investments38 and we see in the 1970s very few states entering into BITs in the years between 1970- 1979 only a 100 BITS are signed.39 It can be hard to see where the benefit lays for host states to provide more favourable conditions to foreign investors to come in and take their natural resources and not really transfer knowledge because the locals the employ only work in low skilled positions. If we look at the historical context of the very first BIT between West Germany and Pakistan, the setting is a post-World War II economy, Germany had lost all of its FDI due to its loss in the war. As a catalysis to source new FDI it took the lead in this new era of bilateral treaty making,40 with the other European power houses such as the UK, France, Switzerland following within a short period. One explanation that is offered to explain the BIT boom is the global recession of the 1980s and its effects on developing states. Lending to such states was curtailed as indebtedness and defaults increased.41 Similarly due to the economic climate developing states contributions of official state aid to developing states started to declining leaving no other alternative to these states but to go forth and 36
Preamble of the Agreement between the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of ___ for the Promotion and Protection of Investments. 37 Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 79. 38 Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 73. 39 Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 46.

40 41

Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 73. Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 48.

seek FDI, BITs were one way they could do this. Since investors now have a new safeguard instrument in which to rely on when investing into a volatile market BITs were instrumental in increasing FDI inflows to those states when they needed it the most.

The Best BITs Yet To Come

Historically where other types of investment treaties have failed BITs have flourished. Earlier attempts to create an international framework for foreign investment were derailed by disagreements, particularly with the Latin American states, between capital importing and exporting states about the standard of treatment for foreign investors,42 as a result capital exporting states began signing BITs. The old proverb money makes the world go round is somewhat true here as BITs primarily concerned the protection of investment. They did not deal with issues such as anti- trust law, trade or commercial disputes which were factors contained in MITs. One can be forgiven for looking upon a BIT as an insurance policy against bad investment decision however this is not the purpose of a BIT as was denounced in Emilio Maffezini v Kingdom of Spain.43 The content in BITs is evolving to reflect more societal concerns that were not provided for in BITS, as we see in the Draft Model US BIT 200444 the mentioning of improvement of living standards.45 It is worth examining this BITs content in particular, in great detail as the USs position on investment protection is one of the most influential voices in the worldwide discussion about investor- state arbitration.46 Firstly under Article 29 it aims to increase transparency in the entire procedure of investment arbitrations. This may be done through opening up to the public the arbitral proceedings or sending to an adjacent room through video link. It also envisages the complete disclosure of all relevant documents pertaining to the proceedings including notes of the arbitrators all with the caveat subject to the procedures of protected information.47 There will be no requirement to exhaust local remedies prior to initiating arbitration. This has the potential of speedily move things on and to a faster resolution and 42 Newcombe, Andrew Paul & Paradell, Lluis (note 2 supra) pg 41. 43 Tweeddale, Andrew & Kerren. Arbitration of Commercial Disputes: International and English Law and Practice Oxford
University Press, 2007, pg 470 44 http://www.ustr.gov/sites/default/files/U.S.%20model%20BIT.pdf 45 Agreeing that a stable framework for investment will maximize effective utilization of economic resources and improve living standards. 46 Kantor, M. (note 21 supra) 580. 47 Tweeddale, Andrew & Kerren. (note 43 supra) pg 472.

should be seen as a positive step forward.48 There is now a provision for the state of the investor to make submissions on interpretation issues. This could potential be beneficial to the arbitral tribunal as a whole in assisting it making a more informed decision, however arbitration should not become a too politicised.49 Also interested third parties are now allowed to make unsolicited submissions through the amicus curiae provision. Thus public interests groups, such as environmentalist groups can now voice their opinions in investment arbitrations at the discretion of the arbitrators, which is similar to World Trade Organisation (WTO) arbitration.50 In this BIT States are not allowed to bring an action against an investor, they may only raise a counterclaim if an investor has initiated proceedings against them.51 There is an amended fork in the road clause whereby arbitral proceedings will no longer be barred if the investor first pursues the matter in court, however they will be barred from judicial proceedings if they first initiate arbitration.52 The last comment to make about this new BIT is its generously broad definitions. The scope of investment activity is very broad and extends to a variety of long term transactions that also encompass, long- term debt financing.53 Similarly the Canadian new model on Foreign Investment Protection Agreement (FIPA), Canadas equivalent to a BIT, has made changes along the same lines as the US although there are some important differences. Canadas stated objective in redrafting its model FIPA were to clarify substantive investment obligations and to maximise transparency and efficiency in dispute resolution process.54 Some of the differences to note is that under the definition of an investment government issued debt securities will not be covered.55 The minimum standard of treatment (MST) provision has been change to reflect the Free Trade Commissions (FTC) interpretation, the provision now reads fair and equitable treatment with the customary international minimum standard. Any breach of another international obligation will not in itself constitute a breach of MST. Unlike the US model BIT, this FIPA includes a modified General Agreement on Tariffs and Trade (GATT). 48 Tweeddale, Andrew & Kerren. (note 43 supra) pg 472. 49 Tweeddale, Andrew & Kerren. (note 43 supra) pg 473. 50 Tweeddale, Andrew & Kerren. (note 43 supra) pg 473. 51 Tweeddale, Andrew & Kerren. (note 43 supra) pg 474. 52 Kantor, M. (note 21 supra) 593. 53 Kantor, M. (note 21 supra) 589. 54 Newcombe, Andrew Canadas New Model Foreign Investment Protection Agreement online article
www.italaw.com/documents/canadianFIPA.pdf 55 Newcombe, A. (note 54 supra)

However this new model too like the US model BIT has as a main objective the increase of transparency to the public, allowing public access to hearings, documents and submissions by nondisputing parties under Article 38.56 There is too here a provision for amicus curiae under Article 39. One major fact lacking rather surprisingly was that unlike the US model BIT there were no public consultations regarding the drafting of this FIPA which would have addressed issues such as relationship between investment and labour.57 One thing that is clear now, BITs need to consider more their societal impact and address the inequalities such treaties can create. Bolivias constitutional issue case is just one example of the changing attitudes of developing states towards BITs.

Conclusion An interesting question is, are BITs now a part of customary international law? The inefficient standard of protection offered by customary international law for the protection of FDI created a demand for BITS but now, in some weird poetic justice, has the popularity of BITs, which are seen as not just convenient but rather as obligatory, become a new international consensus? 58 Despite attempts to introduce an international framework for investment protection on a multi national level BITs are here to stay and will continue to be the primary investment protection tool used. New BITs still continue to be signed, albeit not at the same rate in the 1990s and states are starting to diversify who they are signing them with. We see the face of BITs are evolving, particular in North America as we have seen them evolve from a basic form of treaty whos main concern was investment protection and encouragement to a more substantial treaty concerned with improvement of living standards, increasing their transparency to the public, and generally respondent to society needs as they always have. This is to keep in line with the huge impact they have had on FDI particularly in the 1990s were FDI inflows to less developed countries was in its 100s of billions of dollars. The flexibility of BITs over other forms of investment treaties will ensure their survival for another 50 years to come. 56 57
Canadas FIPA Article 38. Newcombe, A. (note 54 supra)

58 Salacuse, Jeswald W. & Sullivan, Nicholas P. (note 8 supra) 71.

Bibliography
Books:
Tweeddale, Andrew & Kerren. Arbitration of Commercial Disputes: International and English Law and Practice Oxford University Press, 2007. Refern & Hunter International Arbitration Oxford University Press, 5th Edition, 2009. Capper, P. International Arbitration: A Handbook LLP, 3rd Edition, 2004. McLachlan, C. QC & Shore, L. & Weiniger, M. International Investment Arbitration: Substantive Principles Oxford University Press, 2007. Newcombe, Andrew Paul & Paradell, Lluis Law and Practice of Investment Treaties: Standards of Treatment Kluwer Law International, 2009.

Journals:
Salacuse, Jeswald W. & Sullivan, Nicholas P. Do BITs Really Work? An Evaluation of Bilateral Investment Treaties and Their Grand Bargain (2005) 46 HVILJ 67. Vandevelde, Kenneth J. Investment Liberalization and Economic Development: The Role of Bilateral Investment Treaties (1998) Columbia Journal of Transitional Law 501. Guzman, Andrew T. Why LDCS Sign Treaties That Hurt Them: Explaining The Popularity of Bilateral Investment Treaties (1998) Summer Virginia Journal of International Law 639. Kantor, M. Investor- State Arbitration Over Investment in Financial Services: Disputes Under New U.S. Investment Treaties (2004) 121 Banking Law Journal 579.

Electronic Resources:
www.google.com www.icsid.worldbank.org www.italaw.com www.kluwerarbitration.com www.uncitral.org www.unctad.org www.ustr.gov