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Investor-State Arbitration by Dugan, Christopher F; Wallace, Jr, Don; Rubins, Noah; Sabahi, Borzu (18th September 2008)

I Introduction

From: Investor-State Arbitration

Christopher F. Dugan, Don Wallace, Jr., Noah Rubins, Borzu Sabahi

From: Investment Claims (http://oxia.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved. date: 17 January 2019

Portfolio investment — Foreign Direct Investment — Investor — Arbitration — Aliens, treatment

(p. 1) Introduction

Cross-border investment is fundamental to twenty-first century commerce, but it is hardly a new phenomenon. Although national and political frontiers have traditionally slowed the migration of both people and capital from one country to another, only in rare instances have such barriers proven insurmountable. And for good reason: Although the emigration of capital necessarily means that the funds do not promote development at home, it is likely that the funds have found a more productive use elsewhere, and some portion of the investment proceeds will find a way back to the investor’s home economy.1

There are three broad categories of cross-border investment: portfolio investment, direct investment, and indirect investment.2 Portfolio investments include publicly traded securities, such as stocks and bonds of foreign companies. Foreign direct investment (FDI) typically consists of medium- and long-term infusions of cash, equipment, expertise, or other assets in another country, into either ongoing enterprises or new companies created for the purpose of carrying on some business. The International Monetary Fund (IMF) defines this kind of investment as “investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor’s purpose being to have an effective voice in the management of the enterprise.”3 As a result of a scarcity of commercial bank loans, improved macroeconomic conditions, and liberalizing regulatory regimes, the flow of direct investment across borders grew (p. 2) exponentially during the last decades of the twentieth century.4 Indirect investments, meanwhile, are methods used to move resources across borders in a targeted fashion without actually participating in the resulting program or project.5 Examples include patent licenses and other intellectual property transfers, technical assistance agreements, and joint marketing arrangements.6

Likewise, the concentration of natural resources and labor in developing countries of the metaphorical south made cross-border investment an essential part of sustainable development and continued economic growth for the entire world. Because the expertise and initial capital necessary for exploiting resources remained largely in the north, less developed countries (LDCs) could not unlock the potential of their natural assets without at least a boost of FDI at the outset of development initiatives.

The increasing importance of international investment has been accompanied by the rapid development of a largely new field of international law, defining the obligations of host states toward foreign investors and creating procedures for resolving disputes in connection with those obligations. Primarily, this new law is codified in a vast network of bilateral and multilateral investment treaties, supported by an ever-evolving body of customary international law. In general under these treaties, foreign entities from a signatory state that have made a qualifying investment in the territory of another signatory state enjoy a range of protections, in particular from discrimination and expropriation without compensation, as well as a requirement of fair and equitable treatment and full protection and security of investments. When an investor feels that its rights under the treaty have been violated, it can bring a complaint for redress before an international arbitration tribunal, normally composed and administered under the auspices of a prominent arbitral institution but occasionally created ad hoc.

In contrast to traditional systems, investor beneficiaries of investment treaties of this sort no longer need to appeal to their own governments to espouse their claim diplomatically. They can proceed directly to arbitration against the host state, thus eliminating the diplomatic and political barriers to direct dispute resolution that exist at customary international law.7 The subject of investor-state arbitration lies at the cutting edge of international law and dispute resolution, and promises to (p. 3) play an increasingly important role in the development of the global economic system. Furthermore, study of this form of arbitration provides insight into the evolving content of customary international law, the inevitable conflict between capital-importing and capital-exporting states, and the status of individuals and corporations in the international legal order.

Chapters I–III of this book cover the history of the treatment of aliens and investments under international law and provide an overview of the most important international treaties that give investors a right to arbitration of claims. This historical analysis is essential for understanding the development of investor-state arbitration and such concepts as state responsibility, denial of justice, exhaustion of local remedies, and espousal. Chapters IV–VIII provide an analysis of the arbitration rules most commonly employed in investor-state dispute resolution. Chapters IX–XIX outline the most important elements of substance and procedure that characterize investor-state arbitration, including applicable law, consent, national and most-favored nations treatment, fair and equitable treatment, minimum standard, full protection and security, expropriation, umbrella clauses, and finally the issue of damages. Chapters XX and XXI deal with challenge and enforcement of the awards, especially annulment proceedings under the Law of the International Centre for Settlement of Investment Disputes (ICSID) Convention. Chapter XXII considers the future development of investor-state arbitration. Central themes in this concluding section include the challenges of globalization, the clash of capital-importing and capital-exporting countries, restrictions on state sovereignty, and the evolution of an international investment jurisprudence.

The topic of investor-state dispute resolution differs markedly from other related areas of law. It differs from public international law (and the subtopic of diplomatic protection) in that one of the parties involved is nearly always a private party, not traditionally considered a subject of international law at all.8 Although investor-state arbitration borrows a great deal of procedure from international commercial arbitration,9 the standards for liability and compensation in this new category of disputes are derived not from the parties’ agreement but largely from the language of treaties and the free-standing body of customary international law.10

(p. 4) A.  The Importance of Investment Flows for Capital Importers and Exporters

Cross-border investment brings benefits not only to the investors, but also to the recipients in both developed and developing countries. A developed country such as the United States can be both an importer and exporter of capital.11 Foreign investment has tremendously contributed to the prosperity of the United States.12

In developing countries, the positive effects of FDI are more than simply providing scarce financing for needed improvements. Management experience, new technologies, and the establishment of lasting commercial links with other countries that can be used to increase future exports are all felicitous side effects of increased foreign investment.13

The effect of FDI on the economy of developing countries is hardly undisputed, however.14 Some argue that freedom of investment equals a license for multinational corporations to pillage the assets of poorer countries, buying resources for less than their true value, and expatriating them to their home country. At the very least, the influx of capital does not necessarily mean that the profits gained from that investment will remain in the developing host country. Between 1965 and 1986, “net transfers” on FDI, meaning the flow of investment adjusted for the repatriation of profits, was either negative or only slightly positive for developing (p. 5) countries.15 Therefore, some argue that an increase in direct investment into a less-developed country may not necessarily provide substantial support for long-term development projects, infrastructure improvements, or other welfare-enhancing activities.16 Furthermore, the drain of repatriating profits may in fact harm a capital-importing country’s balance of payments if FDI flows are inconsistently renewed, and the outward transfer of profits continues.

These concerns were part of the impetus that drove the new international economic order (NIEO) movement among developing countries, one aim of which was to remove the act of nationalization from the protections of international law.17 The NIEO ultimately had little effect on targeted institutions such as the Bretton Woods system, the General Agreement on Tariffs and Trade (GATT), and the World Trade Organization (WTO). Subsequent attempts to include NIEO principles in U.N. documents elaborating development strategy also failed to achieve any consensus.18

In its place a more balanced, pragmatic approach to foreign economic participation gained currency, one that recognized both the humanitarian risks of unregulated capitalism and the simple fact that “less-developed countries compete on a worldwide scale for scarce private investment capital, and that capital will not come unless there is security and a good chance of profit making.”19 Thus, in 2000, the United Nations Conference on Trade & Development (UNCTAD) urged, “Continuing efforts to ensure a pro-investment policy regime through an appropriate mix of macroeconomic and market pressures and incentives will be required to meet target growth rates of 6 percent and above [in developing countries].”20 Indeed, even non-governmental organizations (NGOs) sympathetic to the developing world now recognize the importance of investment flows.21

(p. 6) B.  The Purpose of Investment Protection22

Investors have choices regarding the placement of their resources, but one key to any investment decision is the issue of security. One commentator notes the following:

Private investors invest to make profits and not for reasons of benevolence. Thus, if they make profits they expect, albeit not unnaturally, to keep them, subject to payment of appropriate taxes to the local authorities; if they acquire property they expect to be entitled to keep it. The feeling of insecurity in these respects is, perhaps, the major deterrent to the flow of direct foreign investment in less-developed countries (LDC[s]).23

Thus, one of the principal purposes of the global investment protection regime is to reduce this investor insecurity, increase investment, and reduce poverty, especially in the developing world. Opportunities for investment exist throughout the world, and the market for capital placement is driven by the realistic rate of return investors can expect. The real rate of return, meanwhile, is determined not only by the expected income of a given project, but by the risks—especially political risks—to which a given investment will be subjected. By submitting themselves to the institutions of investment arbitration, states raise the sword of Damocles high over their own heads, constraining their own future action within accepted international limits, and assuring potential investors that an arbitral tribunal will vindicate their risk expectations, even if the state eventually chooses to disregard its own commitments.

It is at first sight perhaps difficult to understand why governments would voluntarily limit their sovereignty by submitting to such processes of arbitration-enforced discipline. One needs to realise, though, that by accepting such external, politically less malleable discipline, a country gains in reputation, in lowering its political risk reputation and enhancing its ability to participate and benefit fully from the global economy. Governments who don’t are seen as higher risk and therefore penalised, usually with good reason, in many ways by investors and the global markets. Submitting to such external disciplines also provides governments with a defense against domestic pressure groups—business lobbies and ideological interest groups—which can often capture the domestic regulatory machinery and manoeuvre it for protectionist policies which in the end damage the country at large and the wealth-creating potential of the global economy.24

(p. 7) This axiom, that limits on sovereignty are as beneficial to capital-importing states as they are for the world’s wealthy nations, has long been central to the mandate of organizations such as the Organization for Economic Cooperation and Development (OECD) and the World Bank in the field of investment protection.25 The OECD has been active for several decades in promulgating guidelines for its member states on the management and liberalization of capital flows. For example, the organization’s Code of Liberalization of Capital Movements and Code of Current Invisible Operations gradually helped loosen the grip of capital account controls and similar constraints on cross-border transactions in services.26 According to the International Bank for Reconstruction and Development (IRBD), “creation of an institution designed to facilitate the settlement of disputes between states and foreign investors can be a major step toward promoting an atmosphere of mutual confidence and thus stimulating a larger flow of private international capital into those countries which wish to attract it.”27

But whether formalized investment protection actually increases investment flows is hotly disputed. One recent article by a distinguished commentator concludes that strong protections do indeed increase flows:

But it is clear that a U.S. BIT is more correlated with FDI inflows than other BITs … The regression results indicate that the presence of a U.S. BIT has large, positive, and significant association with a country’s overall FDI inflows.

If a developing country truly wishes to promote foreign investment, it is better to sign a BIT with high protection standards, like those advocated by the [United States], than one with weaker standards as evidenced by certain other OECD countries. Signing a US BIT may also tend to lead to increased FDI flows from other OECD countries because OECD investors by virtue of the MFN clause … gain the protection of the high protective standards in U.S. BITs.28

(p. 8) Other commentators have reached similar conclusions, finding that investment treaties exert a significant positive effect on FDI.29 Conversely, and in contrast to the aforementioned studies, many earlier studies found little correlation between investment protection and increased capital flows, or were “agnostic.”30

But even assuming that foreign investor protection increases investment flows, some have disputed the assertion that such increases are unquestionably in the interest of the developing world. Developing countries may well be concerned about increased economic domination by foreign interests, loss of public control over vital industrial sectors, undue influence of foreign investors over internal politics, and so on.31 For example, one commentator takes issue with the World Bank’s claim that investor-state arbitration promotes “an atmosphere of mutual confidence” between capital importing countries and foreign investors:

The whole idea of “confidence” in an economic context is linked inexorably to Western, market-oriented, conceptions of economic organisation. In no sense does the ICSID Convention increase a developing state’s “confidence” that a foreign private investor will behave in a manner consistent with public policy or national aspirations. The only real increase in “confidence” that may be experienced by the host state is derived from the fact that, under the ICSID régime, confidentiality is assured, so that disputes can be settled (p. 9) without negative publicity. Otherwise, the foreign investor is the only party whose level of confidence is enhanced significantly.32

This position seems both petulant and untenable. Although capital-importing and capital-exporting states enjoy increased confidence of different varieties, it can hardly be said that the only security developing countries enjoy as a result of investment treaties is secrecy for their misdeeds. This position neglects small countries’ desire that investment disputes will not be resolved by diplomatic and economic pressure from the investor’s home government, regardless of the merits of the investor’s claim. Developing states may well be more satisfied dealing with a neutral arbitral tribunal than with officials from one of the world’s larger economies, whose leverage over smaller states on a range of unrelated issues is likely to be considerable. Indeed, until the United Nations Charter outlawed the unprovoked use of force, powerful states frequently employed the threat of military action, or gunboat diplomacy, to prevent harm to investors or to induce a favorable settlement of investment disputes with less developed countries.33

Just as importantly, capital-importing states may derive benefits from the mere codification of standards of treatment. By agreeing to a level of investment protection that is clearly defined, governments in the developing world can avoid overpaying, implementing too-generous (and politically unpopular) legislation to ensure that foreign investors do not petition their home governments to intervene on their behalf under vague standards of customary law. Finally, investment treaties may give capital-importing states confidence in the continued flow of foreign direct investment—no small assurance when economic reform, infrastructure development, health initiatives, and other improvement programs must be planned, justified, funded, and implemented over long periods of time.

Although there are doubtless other ways for developing states to obtain development financing, most importantly through lending by international organizations (such as the World Bank, the IMF and foreign aid agencies of the industrialized democracies), the potential for mutually beneficial symbiosis (p. 10) between developing governments and private foreign investors is prodigious. Even smaller states can establish relatively favorable conditions for foreign participation in the local economy, as long as they are prepared to offer treatment at or above international standards after the investment has been made.34

In the end, of course, the central purpose of investment treaties is investment protection, and there is evidence that that goal is being achieved:

Morales States That International Arbitration is Stopping Nationalization

The Bolivian president, Evo Morales, stated today that the threat of multinationals demanding millions in international arbitration is “stopping” the advancement in “the recuperation of companies and natural resources.”

During a visit to a plant expropriated a year ago from the Swiss company Glencore, Morales stated “when we nationalize, multinationals complain … to international arbitrations…”35

Undoubtedly, the rapidly developing regime of investor protection is one manifestation of globalization. And like other manifestations—in particular, world trade—the growth of this regime is unlikely to be reversed or even slowed in coming years.


Bernardo M. Cremades, Promoting and Protecting International Investments, Int’l Arb. L. Rev. 53 (2000) (“Capital tends to flow to places where it can be more productive (i.e., where the return is higher), and from economies where it is abundant, such as developed countries and financial centres, towards countries where capital is scarce and where the capabilities associated with private enterprises are lacking.”).

K. V. S. K. Nathan, The ICSID Convention: The Law of the International Centre for Settlement of Investment Disputes 111 (Juris Publishing 2000) [hereinafter Law of ICSID].

IMF Balance of Payments Manual 136 (4th ed. 1977).

Ibrahim Shihata, Legal Treatment of Foreign Investment: The World Bank Guidelines 2 (Martinus Nijhoff 1993) [hereinafter Treatment of Investment]. Annual FDI flows to the developing world increased from US$500 million in 1965 to US$38 billion in 1992. World Bank, Global Economic Prospects and Developing Countries 27 (1993).

World Bank, The Role of Foreign Direct Investment in Development, Presentations to the 41st Meeting of the Development Committee 39 (1991).

Nathan, Law of ICSID, supra note 2, at 111.

On the right of investors to directly initiate arbitration against a state, see Chapter X on consent.

I. Brownlie, Principle of Public International Law 57–8 (Oxford University Press 6th ed. 2003) (referring to states and international organizations as “normal types of persons on the international plane”); see also 1 Restatement (Third) of the Foreign Relations Law of the United States, 70 (American Law Institute 1987).

This is especially so when an investment treaty arbitration is conducted under the United Nations Commission on International Trade Law (UNCITRAL) Arbitration Rules and any other set of rules except the ICSID Convention. For a comparison of the differences between the UNCITRAL and the ICSID rules see Chapter IV.

10  See Chapter IX on applicable law. See also Chapter XIX on damages.

11  In fact, at the beginning of the twentieth century, the United States was nicknamed “the greatest debtor nation in history.” Mira Wilkins, The History of Foreign Investment in the United States to 1914, at 144 (Harvard University Press 1989). After World War I, it gradually emerged as one of the main lenders in international markets and until the 1980s was a net exporter of capital. At that time, however, the tide changed again. Curtis M. Jolly et al., U.S. Competitive Position and Capital Investment Flows in the Economic Citizen Market: Constraints and Opportunities of the U.S. Investor Program, 57(2) Am. J. Econ. & Soc. 155, 157 (1998). At the end of 2005, for example, the United States was by far a net importer of foreign capital. See Bureau of Econ. Analysis, U.S. Dep’t of Commerce, News Release: U.S. Net International Investment Position at Yearend 2005 (June 29, 2006), http://www.bea.gov/bea/newsrel/intinvnewsrelease.htm.

12  For statistics regarding the positive effects of FDI on the United States economy see U.S. Department of State Fact Sheet, How Foreign Direct Investment Benefits the United States (Mar. 13, 2006), http://www.state.gov/r/pa/prs/ps/2006/63041.htm (based on data provided by the Bureau of Economic Analysis of the U.S. Department of Commerce showing that FDI creates jobs, boosts wages, and strengthens U.S. manufacturing).

13  Shihata, Treatment of Investment, supra note 4, at 11.

14  For an assessment of the effect of FDI on the economic welfare of the host countries, see, e.g., United Nations Conference on Trade & Development (UNCTAD), World Investment Report 2006: FDI from Developing and Transition Economies: Implications for Development 183 (United Nations 2006).

15  The World Bank, 1 World Debt Tables 1992–93, at 20–21 (1992).

16  Shihata, Treatment of Investment, supra note 4, at 9.

17  See Chapter II.

18  Russel Lawrence Barsh, A Special Session of the U.N. General Assembly Rethinks the Economic Rights and Duties of States, 85 Am. J. Int’l L. 192, 192–93 (1991).

19  Frank Ruddy, Book Review: Foreign Investment in the Present and a New International Economic Order, 84 Am. J. Int’l L. 961, 962 (1990).

20  UNCTAD, Trade and Development Report, 2002, U.N. Doc. UNCTAD/TDR/(2002), at XI, available at http://www.unctad.org/en/docs/tdr02.en.pdf.

21  See, e.g., Luke E. Peterson, Bilateral Investment Treaties and Development Policy-Making (International Institute for Sustainable Development 2004), available at www.iisd.org/pdf/2004/trade_bits.pdf; see also Center for International Environmental Law (CIEL), Foreign Investment and Sustainable Development (CIEL 2002).

22  See generally Economic Development, Foreign Investment and the Law (Robert Pritchard ed., Kluwer Law International/International Bar Association 1996).

23  Adeoye Akinsanya, International Protection of Direct Foreign Investments in the Third World, 36 Int’l Comp. L. Q. 58 (1987).

24  Todd Weiler & Thomas W. Wälde, Investment Arbitration under the Energy Charter Treaty in the Light of New NAFTA Precedents: Towards a Global Code of Conduct for Economic Regulation, 1(2) Oil, Gas & Energy Law Intelligence 2, http://www.gasandoil.com/ogel/samples/freearticles/article_51.htm.

25  Amco Asia Corp. v. Republic of Indonesia, ICSID Case No. ARB/81/1 (Award on Jurisdiction, Sept. 25, 1983), reprinted in 10 Y.B. Comm. Arb. 61, 66 (1983) (investor-state arbitration “is aimed to protect, to the same extent and with the same vigour the investor and the host-state, not forgetting that to protect investments is to protect the general interest of development and of developing countries”).

26  See OECD, OECD Code of Liberalization of Capital Movements (2003); see also OECD, Code of Liberalization of Current Invisible Operations (1997), available at http://www.oecd.org/dataoecd/41/21/2030182.pdf; Rainer Geiger, Towards a Multilateral Agreement on Investment, 31 Cornell Int’l L. J. 467, 468 (1998).

27  International Bank for Reconstruction and Development, Report of the Executive Directors on the Convention on the Settlement of Investment Disputes between States and Nationals of Other States, 4 I.L.M. 524, 525 (1965).

28  J. Salacuse & N. Sullivan, Do BITs Really Work: An Evaluation of Bilateral Investment Treaties and Their Grand Bargain, 46 Harv. Int’l L. J. 67, 106–7 (2005).

29  Peter Egger & Michael Pfaffermayr, The Impact of Bilateral Investment Treaties on Foreign Direct Investment, 32 J. Comp. Econ. 788 (2004), available at http://papers.ssrn.com/s013/papers.cfm?abstract_id=694283; Eric Neumayer & Laura Spess, Do Bilateral Investment Treaties Increase Foreign Direct Investment to Developing Countries? (May 2005), http://papers.ssrn.com/s013/papers.cfm?abstract_id=616242.

30  Bruce A. Blonigen & Ronald B. Davies, Do Bilateral Tax Treaties Promote Foreign Direct Investment? (National Bureau of Economic Research, Working Paper No. W8834, Mar. 2002), http://papers.ssrn.com/s013/papers.cfm?abstract_id=303556; Zachary Elkins, Andrew T. Guzman, & Beth Simmons, Competing for Capital: The Diffusion of Bilateral Investment Treaties, 1960–2000 (UC Berkeley Public Law Research Paper No. 578961, Aug. 2004), http://papers.ssrn.com/s013/papers.cfm?abstract_id=578961; M. Hallward-Driemeier, Bilateral Investment Treaties: Do They Increase FDI Flows? (Background paper for Global Economic Prospects 2003: Investing to Unlock Global Opportunities, World Bank, Wash., D.C. 2002). See also Jennifer Tobin & Susan Rose-Ackerman, Foreign Direct Investment and the Business Environment in Developing Countries: The Impact of Bilateral Investment Treaties, (Yale Law & Economics Research Paper No. 293, May 2, 2005), http://papers.ssrn.com/s013/papers.cfm?abstract_id=557121; Kevin P. Gallagher & Melissa Birch, Do Investment Agreements Attract Investment? Evidence from Latin America, 7(6) J. World Inv. & Trade 961 (2006); J. P. Tumman & C. F. Emmert, The Political Economy of U.S. Foreign Direct Investment in Latin America: A Reappraisal, 39(3) Latin Am. Res. Rev. 9–29 (2004); Mary Hallward-Dreimeier, Do Bilateral Investment Treaties Attract FDI? Only a Bit … And It Might Bite (World Bank Policy Research Working Paper Series, No. 3121, Wash., D.C. 2003); UNCTAD, Bilateral Investment Treaties in the Mid-1990s (United Nations, New York 1998).

31  Stephen J. Toope, Mixed International Arbitration: Studies in Arbitration between States and Private Persons 220, n.7 (Grotius 1990).

32  Id. at 221.

33  M. Sornarajah, The International Law on Foreign Investment 8–9 (Cambridge University Press 1994) [hereinafter Foreign Investment]; see also generally M. Sornarajah, Power and Justice in Foreign Investment Arbitration, 14(3) J. Int’l Arb. 103 (1997); J. Cable, Gunboat Diplomacy: Political Applications of Limited Naval Force (Praeger 1981); Matthew B. Cobb, The Development of Arbitration in Foreign Investment, 16(4) Mealey’s Int’l Arb. Rep., Apr. 2001, at 48, 49.

34  See Ian Brownlie’s remarks on the purpose of the Dutch-Czech bilateral investment treaty in CME Czech Republic B.V. v. Czech Republic, UNCITRAL Arbitration (Final Award of Mar. 13, 2003), (Concurring Op., ¶ 17), http://www.cetv-net.com/arbitration.asp (“The object and purpose is not the protection of foreign property as such but the encouragement and protection of ‘investments.’ However, there is more to the terms of the treaty than this. One of the objects is the stimulation of the economic development of the parties, as indicated in the preamble. In this connection, the context includes the end of the Cold War (the treaty was concluded in 1991) and the promotion of a market economy in the region”).

35  Los Tiempos (La Paz, Bolivia) February 7, 2008. Author’s translation.