September 27, 2024
Balancing the risk of regulatory measures is a formidable challenge for businesses venturing into foreign markets. On one hand, regulatory measures can offer stability and protection, yet also pose potential hurdles ranging from bureaucratic complexities to sudden policy shifts, to arbitrary and discriminatory actions driven by political purposes. Navigating this terrain requires meticulous research, strategic foresight, and, more importantly, a comprehensive understanding of the landscape of risks in each case.
From the host States’ perspective, the balancing act involves the need to attract investment to foster development, while ensuring responsible business conduct and the protection of broader societal interests, including labor, environmental, and health standards.
An equilibrium between interests, often seemingly impossible to reach, demands a delicate interplay of business and legal acumen to mitigate uncertainties.
This is particularly the case when recent research indicates that the existing body of international investment agreements (IIAs) and the arbitral tribunals interpreting international law struggle to find a happy medium themselves, with many opposing the idea of a medium to begin with.
In this post, we briefly discuss the treatment of regulatory measures under existing IIAs vis-à-vis decision makers and address what measures can be taken by investors to mitigate increasing legal and regulatory risks in an era of ESG awareness.
IIAs in Flux
Early IIAs focused nearly exclusively on facilitating investment flows by minimizing barriers and providing protection for investors. However, as global economic dynamics evolved, there has been a trend towards broader inclusion of environmental, labor, and social considerations in treaty texts, reflecting a growing recognition of the interconnectedness between investment, sustainable development, and human rights.
This process started with the North American Free Trade Agreement (NAFTA)[1], which introduced in its Chapter 11 the notion that investments should be considered within a broader policy context. The NAFTA model, particularly with its later revisions, spearheaded a State-driven revolution of sorts, and the format was copied by many more recent IIAs.
For example, early on, the Hungary-Russian Federation BIT (1995)[2] and the Netherlands-Costa Rica BIT (1999)[3] also explicitly reserved policy space for environmental regulation. More recently, the space reserved for State regulatory measures in IIAs has become more creative and diverse.
Brazil’s Cooperation and Facilitation Investment Agreements introduced in 2015 and the most recent European Union investment treaties, for instance, go a step further and change the traditional IIA mechanisms of dispute resolution in attempts to find more State-friendly interpreters, who will, at least in theory, be more open to public policy considerations.
Another relevant development in States’ efforts to protect their right to regulate and curb investment protection seen to inhibit this right is the European Union’s recent decision to withdraw from the Energy Charter Treaty (ECT). The ECT was being seen by the public at large as protecting foreign investors at the expense of environmental protection measures. And while there is value in rethinking the structure of existing frameworks, the radical measure has led to significant legal uncertainty.
Short of that, most IIAs entered into since the 2010s include explicit reference to States’ right to regulate either as part of their general provisions[4], or as non-preclusion or exemptions clauses in the context of national treatment, fair and equitable treatment clauses, and expropriation clauses.[5]
This presents an increased risk of regulatory action affecting investments. Especially when overbroad language may leave room for arbitrary, disproportionate, or discriminatory conduct by States without adequate accountability or where chosen mechanisms of dispute resolution severely limit investors’ access to justice.
The Arbitral Tribunals’ Approach
Interestingly, an analysis of arbitral case law for the same period indicates a contrasting approach. Recent case law shows that international arbitral tribunals have tended to observe the overall intent of investment treaties to safeguard investments and have, in most instances, interpreted new treaty language as complementary to, but not displacing the existing body of law favoring investors.
For example, a 2022 report by the United Nations Conference on Trade and Development (UNCTAD) highlighted 175 disputes between investors and states related to climate change/environment between 1987 and 2021.[6]
An analysis of the results of the study shows that climate change/environmental investor-State disputes have focused on three types of cause of action: (i) violation of fair and equitable treatment (EFT or, at times, a minimum standard of treatment, MST), (ii) indirect expropriation, or (iii) the government’s failure to take adequate measures to protect the environment. For the first two, States have increasingly relied on the police powers doctrine and on counterclaims based on allegations of an affirmative duty to secure a social license and ensure observance of human rights. But while IIAs increasingly include language in support of these defenses, arbitral tribunals have been cautious not to give States carte blanche and uphold certain protections even when valid public reasons are concerned.
In Santa Elena v. Costa Rica, the Costa Rican government expropriated the investor's property to expand a national park. Although both parties agreed on the expropriation, the Costa Rican government argued that it was motivated by public interests such as environmental protection and ecosystem conservation.[8] Consequently, the government sought to exempt the investor's property from compensation, citing these public interest considerations.[9] The tribunal ruled that, according to international law, the host government is entitled to expropriate foreign investors' property within its territory for public interest purposes.[10] Nevertheless, the host government also has the obligation to provide immediate, adequate, and effective compensation.[11] In other words, even if environmental protection is acknowledged as a legitimate public good, the fundamental obligation to compensate remains unaltered, irrespective of the overall benefits expropriation might confer upon the community.[12] In this case, an investor may receive compensation, but not full coverage.
In Copper Mesa v. Republic of Ecuador, a Canadian mining company faced significant opposition from local communities in exploiting a mining concession granted by the government of Ecuador. In 2008, following significant pressure, the government terminated the mining for concession for Copper Mesa’s failure to get adequate approval of the project’s environmental and social impact assessment and to consult with the local communities. On arbitration under the Canada-Ecuador bilateral investment treaty, the tribunal found that although Copper Mesa’s actions could be considered contributory, the government had acted in an arbitrary manner in violation of due process when it terminated the Canadian company’s concession, therefore resulting in expropriation for which compensation was due.
In Eco Oro Minerals Corp. v. Republic of Colombia, the claimant contended that the State performed measures involving the Santurbán Páramo habitat, resulting in the claimant losing mining rights provided under its concession. This deal encompassed several minerals, including gold and silver, at the Angostura deposit in Santander's Soto Norte district.[13] The tribunal held that the Colombian government's decision to ban mining in ecologically sensitive wetlands did not constitute indirect expropriation by operation of the police powers doctrine.[14] However, the tribunal also found that the delays and inconsistent treatment by different parts of the Colombian government regarding the protection and boundaries of the wetlands violated the minimum standard of treatment in international law.[15] In this process, the majority of the tribunal bypassed the environmental exception in the underlying IIA. They did not consider whether this exception could be used as a defense in the case, but only in relation to excluding the obligation to pay compensation after liability had been proven.
As far as the third type of cases is concerned, the UN Global Climate Litigation Report for 2023 shows a staggering number of 2,180 climate-related cases filed in 65 jurisdictions as of December 2022 between international and local courts, tribunals, and other adjudicatory bodies.[16]
An interesting case is that of Peter A. Allard v The Government of Barbados, where the claimant asserted that the State had not implemented sufficient measures to safeguard their investment in an ecotourism facility from environmental degradation.[17] While the tribunal determined that the claimant had failed to meet the burden of proof required for their case, the host government’s inaction on environmental protection is also a consistently controversial subject. A State’s inaction may constitute as a “taking” where leading to an investor’s “deprivation” of its investment.[18] An inaction may also impose liability on the State or the investor depending on context.
In sum, the cases above show a fundamental conflict between modern IIA provisions and arbitral tribunals’ interpretation of the established international law framework regarding regulatory measures.
Modern IIAs increasingly allow States’ regulatory space for public policy measures. Arbitral tribunals still favor investment protection in their majority, penalizing States particularly for failure to adhere to investors’ due process rights, even when investors’ conduct is far from ideal.
Nonetheless, the demand for business accountability and protection of public interests only grows and is increasingly legally supported by regulation, enforcement actions and private contractual arrangements. The differing approaches, however, and inconsistent application of regulations have the side effect of undermining the reliability of legal systems and increasing risks for all stakeholders, creating a barrier to needed developmental investment.
What Can Investors Do?
Whereas some would advocate for full dominance of one over the other, we take a more optimistic approach. Businesses must stay informed about these changes and adopt strategies accordingly. A thorough risk analysis and allocation at the onset of an investment supported by specialized professionals can help avoid the balancing nightmare described above.
Legal Due Diligence and Risk Assessment: Legal due diligence plays a pivotal role in investments in foreign countries, serving as a critical safeguard for investors against legal and regulatory risks and potential legal pitfalls. This undertaking necessitates comprehensive research and analysis of the environment in which the business or investment operates. This includes evaluating the stability of the government, understanding the regulatory framework governing economic activities, assessing the security situation, scrutinizing the human rights record, gauging the corruption level, and considering the social and cultural norms prevalent in the specific country or region. Such a meticulous examination is fundamental for making informed decisions and formulating strategies that are resilient to political uncertainties and challenges, ensuring the sustainability and success of the business or investment endeavor. A well-conducted due diligence by experienced attorneys can help a business identify, assess, manage, and mitigate the potential impact of regulatory and political factors on an investment and avoid significant losses. It can, for instance, help a business better understand the risk of expropriation, political violence, and social unrest that may affect its investment and devise the best ways to mitigate those risks, be it through stakeholder engagement, contractual undertakings and the implementation of internal compliance measures commensurate with the risks identified and the business capabilities.
Mitigation Mechanisms: To mitigate the increased risk of regulatory action, investors can use legal mechanisms such as political risk insurance (PRI) and stabilization clauses. PRI protects investors against losses arising from political events like expropriation, political violence, and currency inconvertibility. PRI provides financial compensation, ensuring that investors can recover their investments even if adverse political events occur. Stabilization clauses, when included in investment contracts, serve to assist investors in managing uncertainties arising from regulatory changes. These clauses help mitigate political risks associated with the investment.[19] However, it is worth noting that (i) governments are frequently reticent to accept such clauses, in particular where they impose limitations on the government’s ability to change regulations based on new factors, and (ii) some arbitrators advocate for the idea that governments should have the freedom to act in the broader public interest, even in the presence of these clauses.[20]
Stakeholder Engagement: In the international investment sector, community engagement is vital for building trust and mutual understanding between investors and local communities. Community engagement involves transparency, active communication, cultural sensitivity, and addressing concerns, ensuring that investment projects align with local needs and values. Experienced attorneys can help advise on creating an outreach plan involving: communication strategy, the development of sustainable internal policies, negotiation of collaboration agreements, the establishment of channels of communication, and the creation of mechanisms to address local communities’ concerns. By fostering positive relationships, investors can avoid harmful – if not fatal – disputes to an otherwise valuable investment, promote sustainable development, and create lasting social and economic benefits for both investors and local communities.
Authors:
Fádia Tuma Antunes
Counsel at Wiss & Partners LLP
Tzu-Ching Lin
Collaborating Attorney at Wiss & Partners LLP
Footnotes:
1 North American Free Trade Agreement, U.S-Canada-Mexico, Article 1114 (1) (1992).
2 See Article 2(3):” This Agreement shall not preclude the application of either Contracting Party of measures, necessary for the maintenance of defence, national security and public orde3r, protection of the environment, morality and public health.”
3 See Article 10: “The provisions of this Agreement shall, from the date of entry into force thereof, apply to all investments made, whether before or after its entry into force, by investors of one Contracting Party in the territory of the other Contracting Party in accordance with the laws and regulations of the latter Contracting Party, including its laws and regulations on labour and environment.”
4 See e.g., Article 8.9 of the EU-Singapore Investment Protection Agreement (2018), which states: “The Parties reaffirm their right to regulate within their territories to achieve legitimate policy objectives, such as the protection of public health, social services, public education, safety, environment or public morals, social or consumer protection privacy and data protection and the promotion and protection of cultural diversity.” See also Article 4.4 of the EU-Vietnam Investment Protection Agreement (2019): “Nothing in this Agreement shall be construed as preventing a Party from adopting or maintaining measures for prudential reasons, such as: the protection of investors, depositors, policy-holders or persons to whom a fiduciary duty is owed by a financial service supplier; or ensuring the integrity and stability of a Party’s financial system. The measures referred to in paragraph 1 shall not be more burdensome than necessary to achieve their aim.”
5 See Article 6(2) of the Belarus-Turkey Agreement Concerning the Reciprocal Promotion and Protection of Investment (2018): “Non-discriminatory legal measures designed and applied to protect legitimate public welfare objectives, such as health, safety and environment, do not constitute indirect expropriation.”
6 UNCTAD, Treaty-based Investor-State Dispute Settlement Cases and Climate Action, Investment Policy Hub (2022), available at https://investmentpolicy.unctad.org/publications/1270/treaty−based−investor−state−dispute−settlement−cases−and−climate−action.
7 Compañía del Desarrollo de Santa Elena S.A. v. Costa Rica, ICSID Case No. ARB/96/1, Final Award, ¶ 18 (Feb. 17, 2000).
8 Id.
9 Id.
10 Id., ¶¶ 71-72.
11 Id.
12 Id.
13 Eco Oro Minerals Corp. v. Republic of Colombia, ICSID Case No. ARB/16/41 9 September 2021, ¶ 5.
14 Id., ¶¶ 643-99.
15 Id., ¶ 920.
16 United Nations Environment Programme, Global Climate Litigation Report: 2023 Status Review, Nairobi (2023), available at global_climate_litigation_report_2023.pdf (unep.org).
17 Peter A. Allard v The Government of Barbados, PCA Case No, 2012-06, Award, 27 June 2016, ¶ 110.
18 Amco Asia Corp v Republic of Indonesia (ICSID No ARB/81/1) (Award) (20 November 1984), ¶ 158.
19 Katja Gehne & Romulo Brillo, Stabilization Clauses in International Investment Law: Beyond Balancing and Fair and Equitable Treatment 9–10 (2017).
20 Id., ¶ 14.
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