Friday, May 7, 2010

Protection of Foreign Direct Investment Interests: Facing Host Government Regulation and Insuring Against Risks

Protection of Foreign Direct Investment Interests:
Facing Host Government Regulation and Insuring Against Risks

                                                                                                                        by: Unentugs Shagdar

I would like to draw your attention to the Protection of Foreign Direct Investment Interests: Facing Host States Regulations and Risk factors, and International investments agreements etc.

Introduction: Overview

Investment is a capital transaction in which the investor expects a return.---

Today, an international legal framework for FDI has emerged. It consists of many kinds of national and international rules and principles, of diverse form and origin, differing in strength and degree of specificity.
In the past decades, there have been significant changes in national and international policies on foreign direct investment (FDI). These changes have been both cause and effect in the ongoing integration of the world economy and the changing role of FDI in it. They have found expression in national laws and practices and in a variety of international instruments, Bilateral, Regional and Multilateral[1].

FDI acquired increasing importance as the twentieth century advanced, and it began gradually to assume the forms prevalent today. In international legal terms, however, FDI long remained a matter mainly of national concern, moving onto the international plane, where rules and principles of customary international law applied, only in exceptional cases, when arbitrary government measures affected it in a negative manner.

One important problem for empirical studies analyzing FDI is that most of the data of FDI flows reflect not only current decisions about home-country firms establishing new affiliates in host countries, but also a large volume of reinvested profits that are driven by past investment decisions not be related to the current drivers of FDI. As a result, data on current FDI flows from countries that have built up large stocks of FDI overseas in the past may not reflect current decisions on entry into new host countries. Thus, inferences about the relation between these FDI flows and corruption may be misleading. Empirical evidence for the interaction of home and host-country levels of corruption is mixed.

The international protection of investments is concerned with the safeguarding of foreign investments against interference by the host State. The nature and duration of investments as well as the special Risks involved make stability and predictability particularly important in this area of international economic and investment law. Once the investor has sunk in its resources, it becomes vulnerable to changes in the position of the host State. This is why the nature, structure and purpose of foreign investment law are distinct in comparison to trade law.

At the same time it is important to protect the Host State’s interests. There is no doubt that foreign investments are subject to the law and administrative control of host States. The guarantees afforded to foreign investors must not jeopardize the States’ right to legitimate regulation. In some areas of investment important interests of the local population are at stake. The task of international investment law is to find an appropriate balance between these potentially conflicting interests.

International investment law has undergone substantial changes during the second half of the 20th century. After the demise of colonialism, major investments were often governed by agreements between host States and investors, usually termed concessions. These agreements typically granted far-reaching rights to foreign investors and left the host State with limited control over their activities. The 1970s saw a new assertiveness of developing host States towards foreign investors often described as New International Economic Order (NIEO). The position of these States was bolstered by the doctrine of Permanent Sovereignty over Natural Resources (Natural Resources, Permanent Sovereignty over).
In the 1980s and 1990s, the failure of these policies led to a new pragmatism coupled with a desire to attract foreign investment. These new attitudes were driven by the recognition that foreign investment was an important tool of economic development. Contributing factors were a growing trend towards globalization as well as the belief in the superiority of market economies and a resulting wave of privatizations of previously public services.

In the 1980s, a series of national and international developments radically reversed the policy trends prevailing until then, with an immediate impact both on national policies regarding inward FDI and on regional and world-wide efforts at establishing international rules on the subject. At the end of the 1990s, host countries sought to attract FDI by dismantling restrictions on its entry and operation, and by offering strict guarantees, both national and international, against measures that seriously hampered investors’ interests[2].

The desire to attract foreign investment has led most countries, especially developing countries, to adopt policies that are designed to create a favorable investment climate. An important part of these policies are legal safeguards. These legal safeguards include the stability of the legal conditions under which an investor can operate the quality of the local public administration, the transparency of the system of local regulations and an effective system of dispute settlement. Many countries have adopted investment codes which are designed to combine clarity with favorable conditions for foreign investments.

In addition to guarantees contained in domestic law, potential host States to investment also give international legal guarantees to investors. These are mostly laid down in Bilateral as well as Multilateral treaties.

The Effect of Home Country and Host Country Corruption on FDI

The evidence on Home-Host State corruption interactions is thus mixed.--

The section on the effect of corruption on foreign direct investment (FDI) by Multinational corporations (MNCs) is both extensive and noteworthy for the lack of agreement on whether corruption influences FDI. In part, this is because there is little uniformity across studies in terms of: the reasons why FDI should be affected by corruption, the countries and times employed in estimating the effects of corruption, the econometric methods used to obtain these estimates, and the control variables used to explain FDI.
One important problem for empirical studies analyzing FDI is that most of the data of FDI flows reflect not only current decisions about home-country firms establishing new affiliates in host countries, but also a large volume of reinvested profits that are driven by past investment decisions not be related to the current drivers of FDI. As a result, data on current FDI flows from countries that have built up large stocks of FDI overseas in the past may not reflect current decisions on entry into new host countries. Thus, inferences about the relation between these FDI flows and corruption may be misleading.

A second contribution is that we are able to disentangle the effects of corruption on two types of investment decisions: the FDI location decision, where the MNC makes a choice about whether or not to invest in a country; and the FDI volume decision, where the MNC decides how much to invest, possibly by choosing among possible modes of entry.

The earliest studies of the effect of corruption on FDI focussed on host-country corruption levels because host-country corruption was viewed as an additional cost of doing business in that country for foreign investors[3]. While a number of studies did find a negative effect of host-country corruption on FDI inflows, others failed to find a significant negative effect. Authors of studies who failed to find a significant negative coefficient for the “corruption” variable attributed this to the fact that, under certain circumstances, for example in highly regulated economies, bribes could allow the MNC to circumvent burdensome regulations and bureaucratic obstacles at relatively little expense and thus function more efficiently. This, of course, is an application of the more general view that corruption may “grease the wheels” of business.

Empirical evidence for the interaction of home and host-country levels of corruption is mixed. Another strand of the literature seeks to estimate the effects of both home and host-country corruption by using either panel or cross-section data on FDI and home and host country corruption and economic characteristics.

The evidence on home-host country corruption interactions is thus mixed. The role of the two types of corruption appears to vary with the level of development of the host countries. The role of corruption distance suggests a relationship between home and host-country corruption, but the fact that the same value of the explanatory variable can be generated by a corrupt host country and an non-corrupt home country or vice versa, and this variable will then have exactly the same effect on FDI seems counterintuitive. Even taking into account that the studies cited, as well as others not cited due to space limitations, use different measures of FDI (some using flows, others stocks of FDI) and different control variables for the economic drivers of FDI, it seems clear that the relationship between home and host-country corruption requires further study.

Corrupt host countries are less likely to receive FDI inflows than are less corrupt ones. Home country corruption influences outward FDI in a non-linear way. The most corrupt and the least corrupt home countries are less likely to undertake FDI than are countries at intermediate levels of corruption. I guess that this is due to the fact that countries at intermediate levels of corruption provide a domestic environment that makes home-country MNCs invest in both market-oriented firm-specific sources of competitive advantage as well as in the acquisition of skills that enable them to operate successfully in corrupt environments.
Interpretation of Investment Treaties

Treaty interpretation, by contrast, has remained focused upon the parties to a treaty, with even textualist approaches to treaty interpretation being justified as the best means of ascertaining the intent of the contracting States.----

Ø Bilateral Investment Treaties
The most important source in contemporary investment law is bilateral investment treaties (‘BITs’). BITs are a principal element of the current framework for FDI. More than 1,941 bilateral treaties have been concluded since the early 1960s, most of them in the decade of the 1990s.
As elements of the international legal framework for FDI, BITs have been useful since they have developed a large number of variations on the main provisions of international investment agreements (IIAs) – especially those referring to the ways in which national investment procedures may be taken into account. Although the treaties remain quite standardised, they are able to reflect in their provisions the differing positions and approaches of the many countries which have concluded such agreements. The corpus of BITs may thus be perceived as a valuable pool for IIAs[4].

BITs were initially addressed exclusively to relations between home and host, developed and developing, countries. Yet, they have shown over the years a remarkable capability for diversification in participation, moving to other patterns, such as agreements between developing countries, with countries with economies in transition or even with the few remaining communist countries. Thus, while lacking the institutional structures and emphasis on review and development of multilateral and regional instruments, BITs appear capable of adapting to special circumstances. The increase in the number of BITs between developing countries suggests that they may also be useful in dealing with some of the problems in such relationships.

Even when the principal focus of BITs has been from the very start on investment protection, they also cover a number of other areas to promote investment:
- Broad definition of investment.
- National treatment.
- Most favoured nation treatment.
- Disciplines concerning expropriation and compensation.
- Guarantee the right to transfers.
- Subrogation provisions.
- Mechanisms for the settlement of disputes State to State and Investor – State.

The first country to start entering into BITs was Germany (in 1959), closely followed by Switzerland (in 1961). Other countries have followed suit. It is estimated that by 2008 there were about 2600 BITs worldwide. Countries with particularly active BIT programs are Germany (135 treaties), China (121 treaties) and Switzerland (114 treaties). Developing States have also negotiated an increasing number of BITs among themselves. Some free trade agreements (FTAs) contain sections dealing with the protection of investments.

BITs are designed to provide guarantees for foreign investors from the respective countries. They do not normally address obligations of investors, although some BITs provide that investments, in order to be protected must be in accordance with the host States law. The idea to include duties for investors, such as certain human rights, environmental and labour standards are only beginning to be reflected in treaty practice.

BITs typically  contain the following features: a broad definition of ‘investments’; a definition of ‘investor’; a provision on admission of investments; a guarantee of fair and equitable treatment (FET); a guarantee of full protection and security as well as a guarantee against arbitrary and discriminatory treatment; national treatment (National Treatment, Principle) and most-favoured-nation treatment (Most-Favoured-Nation Clause); guarantees in case of expropriation; guarantees concerning the free transfer of payments; settlement of disputes between the contracting States; settlement of disputes between the host State and the investor, including arbitration.
Although many BITs display similarities, they are by no means identical. In some respects, BITs display significant variations. Therefore, each BIT must be examined on its own terms.

Ø  Regional and Plurilateral Agreements

Regional and Plurilateral Agreements are those in which only a limited number of countries participate. Such instruments are increasingly important in FDI matters.
Regional economic integration agreements, for instance, involve a higher than usual degree of unity and co-operation among their members, sometimes marked by the presence of supranational institutions. NAFTA, APEC and the OECD are significant examples of regional agreements.

Recently, there has been a surge in regional investment, trade agreements involving a relatively small number of countries. Contrary to what the name suggests, these agreements may be concluded between countries in different geographical regions. Examples of regional trade agreements include the North American Free Trade Agreement (NAFTA), which has substantially reduced trade barriers for agricultural commodities, manufactured goods, and services in North America.

Multilateral vs Bilateral Agreements
Multilateral agreements differ from bilateral agreements in that bilateral agreements occur between two parties only. In relationship to international affairs, bilateral agreements often take place between economic trading partners that depend on each other for much or all of the exchange of certain goods and/or services. Bilateral agreements and multilateral agreements can sometimes come into conflict with one another, especially when the terms of a multilateral agreement modify or nullify the terms of a longstanding bilateral agreement.

Many liberal economists argue that free trade among nations leads to win-win outcomes for all. Economists states that welfare is maximized when each country specializes in producing goods that best use that nation's land, labor and capital, then trades its surplus for goods produced by other countries.

International investment takes place in a world of nation-states, without a global authority that can dictate and enforce the rules. Also, agreements never make everyone happy. Agreements that increase access to each member country's markets are supported by sectors that export their products but are opposed by sectors that face competition from imports.

Investment in the Multilateral Context

Foreign investment is one of the driving forces of globalization; carrying ideas, jobs and export markets as well as capital from industrial to industrializing countries. Most economic development strategies are now based on attracting foreign firms, while both large domestic firms and stable governments can rely on access to international financial markets to fund their activities. While this process has been generally positive in the sense of stimulating economic growth in developing countries, if not necessarily in reducing poverty, the rapid changes involved clearly create both losers and winners, and it is the role of international regulations and national authorities to ensure that the economic benefits are maximized while the social costs are minimized - particularly among the poor countries

Ø  Multilateral Treaties

With the increased influence globalization, the actions of one nation bear on other nations more than ever. Multilateral agreements have become an increasingly important means for nations to resolve important issues in a way that establishes common ground and resolves actual and potential points of difference. Multilateral agreements frequently require complex negotiations necessary to resolve the differences between the various parties and bring them into agreement.

Multilateral Agreements Defined
A multilateral agreement is defined as a binding agreement between three or more parties concerning the terms of a specific circumstance. Multilateral agreements can occur between three individuals or agencies; however, the most common use of the term refers to multilateral agreements between several countries. Multilateral agreements are often the result of a recognition of common ground between the various parties involved concerning the issue at hand.

The first efforts to create a multilateral treaty protecting foreign investments dates back to the 1950s and 1960s. Between 1995 and 1998 the Organization for Economic Co-operation and Development (OECD) launched a new initiative to establish a Multilateral Agreement on Investment (‘MAI’). The breakdown of this effort was caused by a number of factors, including widespread opposition by non-governmental organizations and the desire of France to protect French culture. An effort in the framework of the World Trade Organization (WTO) started in 1996 but came to a halt in 2004. The main reason was the fear of developing countries that a multilateral treaty might unduly narrow their regulatory space.[5]

On the regional level the North American Free Trade Agreement (1992) (‘NAFTA’) between Canada, Mexico and the United States (‘US) addresses both matters of trade and investment. Its chapter 11 covers most of the issues that can be found also in BITs including investor-State arbitration.
Other regional arrangements that cover investment protection include the Agreement Establishing the Association of Southeast Asian Nations (ASEAN), the Protocol of Colonia for the Promotion and Protection of Investments (MERCOSUR) and the Dominican Republic–Central AmericaUnited States Free Trade Agreement (‘CAFTA).

In 1995, the 29 OECD Member countries plus the European Commission[6] started the negotiations of a Multilateral Agreement on Investment in order to make up for the necessity of international co-operation to treat comprehensively the FDI matter. The MAI sought to facilitate capital flows among countries, eliminate investment barriers, improve the level of treatment and, consequently, properly protect investors and their investments.
The basic provisions contained in the MAI were:
- Scope.
- Treatment and protection of investment.
- Exceptions and safeguards.
- Financial services.
- Taxation.
- Transfers.
- Performance requirements.
- Expropriation and Compensation.
- Reservations.
- Relationship to other international agreements.
- Dispute settlement.

Because of the number and complexity of the topics covered, after long negotiations and internal consultations the MAI was suspended. Notwithstanding the good will of the governments, the difficulty to link the differing interests in a single text plus the complex negotiation system, stopped negotiations in April 1998. The objective was that each country make internal consultations and re-think its position carefully. Nevertheless, in December 1998 the MAI was definitely suspended.

Multilateral treaties exist in specialized areas of investment law. These include the Convention on the Settlement of Investment Disputes between States and Nationals of Other  States (‘ICSID Convention), which provides a framework for the settlement of disputes between host States and foreign investors through arbitration and conciliation (see also Arbitration and Conciliation Treaties). The Convention Establishing the Multilateral Investment Guarantee Agency (MIGA) establishes an international framework for political risk insurance. The Agreement on Trade Related Investment Measures (‘TRIMS) of 1994 regulates aspects of foreign investment which may lead to direct negative consequences for a liberalized trade regime including so-called performance requirements. The General Agreement on Trade in Services (1994) (‘GATS) of 1995 provides for market access in the services sector, allowing inter alia commercial presences in the host State.

Ø  Trade Related Investment Measures (TRIMs).

After the Uruguay Round, international investment became a relevant issue in the core of the multilateral trade system. Even when, at a glance, only exists the Trade Related Investment Measures Agreement (TRIMs) with a reduced scope limited to certain performance requirements, other agreements, especially the General Agreement on Trade in Services (GATS), and less relevant, the Trade Related Intellectual Property Rights (TRIPs) and the Agreement on Subsidies and Countervailing Measures (ASCM), incorporate disciplines related to investment. Further, any conflict arising on investment will be settled by the rules established in the Understanding on Dispute Settlement[7].

Trade Related Investment Measures (TRIMs) Agreement recognizes that certain measures on investment can cause trade distortions. It limits its scope to investment measures related to trade in goods (not in services) and forbids Member States to apply a TRIM not compatible with the obligations established in the 1994 GATT Articles III (National Treatment) and XI (General Elimination of Quantitative Restrictions).

There is an illustrative list of TRIMs attached to the Agreement which describes those measures that are inconsistent with the obligations mentioned above since they are mandatory or enforceable under domestic law or under administrative rulings, or because their compliance is necessary to obtain an advantage. It includes measures that:
- Require the purchase or use by an enterprise of products of domestic origin or from any domestic source.
- Require that an enterprise's purchases or use of imported products be limited to an amount related to the volume or value of local products that it exports.
- Restrict the importation by an enterprise of products used in or related to its local production or the exportation or sale for export by an enterprise of products.

It is important to say that the Parties committed to review the Agreement before the following five years after its entry into force. The review would include a possible enlargement of the illustrative list and the addition of complementary provisions related to policy competition for investment.

The TRIMs Agreement has certain limitations:
- It only focuses on goods but ignores the services sector.
- The illustrative list only considers a limited number of TRIMs, if compared to the comprehensive list contained in NAFTA Article 1106 (Performance Requirements).
- It basically codifies current GATT jurisprudence, allowing the Parties a temporal escape from their obligations.

Ø  General Agreement on Trade in Services (GATS).

The GATS is considered the agreement of the multilateral trade system comprising the largest number of provisions – protection and liberalization - related to investment. It rests on three pillars:
a) A framework of general provisions applicable to all measures affecting trade in services (e.g. MFNT, transparency, disclosure of confidential information, increasing participation of developing countries, economic integration, mutual recognition, general exceptions).
b) Specific commitments of national treatment and market access applicable only to those sectors and subsectors included in the lists of commitments of each country.
c) Some Annexes that explain the manner in which GATS rules are applied to specific sectors (e.g. air and maritime transport, financial services, telecommunications).

Even when the GATS does not mention the term “investment”, this is included in the third mode of supply (commercial presence). In this sense, commercial presence is defined as any type of business or professional establishment, including through: i) the constitution, acquisition or maintenance of a juridical person; or, ii) the creation or maintenance of a branch or representative office within the territory of a Member for the purpose of supplying a service.

Dynamics of Liberalisation.
- The GATS Agreement does not grant the right of establishment. On the contrary, it is subject to the terms set out in the lists of commitments.
- The main provisions referred to liberalization are: Most Favoured Nation Treatment (art. II), Market Access (art. XVI) and National Treatment (art. XVII). Of those disciplines, the MFNT is the only principle applicable to all Members and services sectors, although qualified by the exceptions to that obligation.
- Market Access is defined according to six types of limitations that the Members should prevent to impose.
- The National Treatment provision obliges each Member to accord to services and services suppliers of any other Member, treatment no less favourable than that it accords to its own like services and service suppliers. Article XVII points out that the national treatment could not always be identical, provided it does not modify the conditions of competition of the foreign suppliers.
- The GATS allows Members to maintain non-conforming measures provided they list them in the list of commitments under a negative approach. Likewise, Members may adopt new discriminatory measures in those sectors not established in the list of commitments (on a MFN basis) or in sectors subject to MFNT exceptions.

Other applicable provisions
- Article V establishes a general exception with respect to Economic Integration Agreements.
- There are general exceptions similar to those contained in the GATT.
- Provisions of future negotiations on safeguards and subsidies are established.
- GATS applies a test of “substantial business operations” to determine who qualifies to obtain the benefits of the Agreement. There are property and control elements included.
- There are no provisions on performance requirements or monitoring.

Investment Protection.
The GATS has only a few provisions related to the protection of investment:
- Payments and transfers.- It is not a general obligation; Members should not limit the current payments and transfers in committed sectors.
- Balance of payments clause.
- No provisions on expropriation and compensation.
- The Understanding on Disputes Settlement is applied.

Ø  Free Trade Agreements.

Free trade agreements worldwide are about integrating economies. Their primary purpose is to reduce the relevance of national borders relative to international trade. Competition among the world's producers, without interference from governments, is the ultimate purpose of most, if not all, free trade agreements.

Free trade agreements typically concern the gradual reduction of tariffs over time. A tariff is a tax on imports, making the imported good more expensive and hence, making domestic production more attractive to consumers. Many such agreements seek to eliminate tariffs completely. This permits firms to invest in each other's economies with little adjustment.

Comparative advantage is the main function of a free trade agreement. Put simply, comparative advantage is about the maximization of efficiency. Those economies that can produce goods more efficiently should be able to freely import them into other countries. The ultimate beneficiaries are the consumers of the world, that can buy these goods at a lower price. Free trade agreements, therefore, are about putting consumers first, giving them a choice among a wide range of products, rather than subsidizing domestic producers.

Free trade is one of the marks of the modern, global economy. Producers and consumers, rather than states and governments, are put first. The ultimate purpose of all free trade agreements is to create a global marketplace where borders no longer matter, where goods, labor and capital can move freely with minimal hindrance.

Free trade agreements build goodwill among countries through economic cooperation. These agreements fight corruption in that to compete with major firms, local firms must retool their processes and become more transparent, streamlined and efficient. Since efficiency is rewarded in the marketplace, fewer resource are used in the production of goods. Consumers have greater choice among products; and since competition among firms is greater, prices tend to be lower.

Free trade agreements permit capital to move freely, thereby evading many local regulations on the environment or labor. Labor also moves freely, which acts as an incentive for firms to invest where labor is cheaper, negatively affecting the wages of domestic workers. Free trade agreements remove any government control over the economic life of the nation and place this control in the hands of corporations. Put differently, free trade removes “politics” from economic transactions. But this can mean that the public good is no longer important in economic relations, only profits and efficiency.
To illustrate the value of free trade agreements (FTAs), the case of Mexico is a good example. Mexico has become a very attractive country to foreign investment thanks to its broad net of FTAs. Today, Mexico has a preferential access to 850 million consumers in 32 countries[8].

All the FTAs signed by Mexico include investment chapters. These chapters contain the following principles and provisions:
- Broad definition of investment, based on the concept of enterprise.
- National treatment.
- Most-favoured nation treatment.
- Minimum standard of treatment.
- Senior management and board of directors.
- Reservations and exceptions.
- Performance requirements.
- Expropriation and compensation.
- Transfers.
- Investor – State Dispute Settlement Mechanism.

When talking about FTAs we refer to new investments and more exports and, consequently, more and better paid jobs and a stronger domestic market. We understand that, certainly, the FTAs will not solve immediately the ancient problems of inequity, unemployment and marginalization, but they will – and they have to – contribute to solve them efficiently.
Ø  Treatment of Investors and Investments

International protection is restricted to foreign investments. The foreignness of the investment is determined by the investor’s nationality and not by the origin of the invested capital. The investors nationality determines from which treaties it may benefit. Exceptionally, the status of a foreign investor may be extended to permanent residents.[9]
National Treatment (NT) and Most Favoured Nation Treatment (MFN) The MAI provides that contracting parties shall accord to investments protected under the agreement, treatment no less favourable than that accorded to its own nationals’ investments (NT) or to investments from any other country, whether or not a party to the MAI (MFN); and in any case, shall accord to them the more favourable of NT and MFN. Both NT and MFN are relative standards of treatment, i.e. they refer to other already existing bodies of rules in the recipient country. This implies that the investment treatment accorded to a foreign investor under the MAI has to be, at least as favourable (but not necessarily more), than that already provided for in the domestic legislation applicable to both local investors and other foreign investors. Therefore, NT and MFN determine the rules applicable to foreign investment by referring to the host country’s domestic law. This, in turn, has important implications for developing countries.
Investors may be individuals but are, more often, companies. An individuals nationality is determined primarily by the law of the country whose nationality is claimed. The nationality of a corporation is typically determined by the place of its incorporation or by the main seat of its business.  
The concept of an ‘investment’ is not clearly established. It may involve the use of capital, technical and managerial skills, patents and other intellectual property as well as a variety of other assets. Activities that have been accepted as investments include mining operations, the construction and operation of hotels, banking, infrastructure projects, and provision of various services, civil engineering and construction projects, shareholding as well as financial instruments including loans.  International investment law does not distinguish generally between direct investments and portfolio investments.
Legal standards on the Special Risk of Expropriation

As indicated in this section, one of the most important risks that a foreign investor faces is that of expropriation. As noted there, “expropriation risk” is one species of “political risk”, and it is the threat that the government of a Host Sate where an FDI is situated will take the property of the investor. Such a taking can be either dramatic and sudden or it can be subtle and slow-so called “creeping expropriation”.

Expropriation raises three basic questions: Lawfulness, compensation, and defenses. Stated more fully, these issues are:

·          Lawfulness – the question of whether the circumstances in which an expropriation occurs were such as to give the host country the right to undertake the expropriation (a key concept here is that of “public purpose”);

·          Compensation – the question of whether compensation is owed, and (it so) how much compensation is owed, to the foreign investor in respect of the expropriation  (and this involves the subsidiary questions of when and in what form compensation is to be paid);

·          Defenses – the question of what grounds are available under international law to defend a host country against a legal action brought by a foreign investor whose assets have been expropriated (key concepts here are those of “act of state” and sovereignty).

These three issues are discussed in the following paragraphs[10]. As you study them, consider how you might advise a client whose FDI assets have been recently expropriated by the host government in a country with the foreign investor's home country does not have a BIT - and assume for these purpose that your client did not obtain any insurance of the shall examine in this section.

Ø  Expropriation and Compensation

The topic of expropriation substantively originates from the discussions on investment protection. Within Bilateral investment treaties, the protection of investors from expropriation, and corresponding access to compensation, are two of the principal objectives. Expropriation or Nationalization can be briefly explained as the taking of private property by the State using legal or administrative acts to transfer the property to the State or State-controlled legal entities. Once the investment has passed the pre-establishment phase in might be sublect to expropriation or nationalization, which terms basically mean the same thing, by host country State authorities.

Due to national sovereignty, changing political opinions and prospective amendments to national law in the host country of investment, investors are faced with latent uncertainly and danger that they may lose their investments in either substance or value.

The former procedure (substance) is called direct expropriation more however do exist. Although, during recent decades, outright expropriations of foreign owned property have not been significant, it appears appropriate, in light of what are nevertheless major taking of investment, to reconsider legal instruments to improve protection of foreign investments with regard to expropriation and comparable regulatory takings.

Bilateral treaties, in almost every case, include provisions dealing with expropriation and compensation. In addition, some regional investment treaties refer to this subject, whereby Article 1110 NAFTA Treaty and Article 13 Energy Chapter are the most prominent examples using similar standards. However, there is no multilateral investment agreement dealing with such standards –creating one, ideally combined with a dispute settlement mechanism, will certainly enhance an investment’s security and predictability as well as an investor’s willingness to conduct foreign investments.

The problem of defining the process and scope of expropriation, nationalization or similar takings appears to be a major debate when addressing this issue of international investment law.
A broad interpretation of the term would cover as many of State authorities. However, it is criticized by others because profit making would be valued higher than environmental measures undertaken by host country governments as such measures are increasingly considered to be regulatory takings.

Further, sufficient protection against the infringement of intellectual and industrial property rights often in not guaranteed under BITs however Multilateral Investment Treaties (MAI) may be able to do so. Another problem is the definition of the term compensation, the calculation procedures for compensation payments, as well as the payment distribution procedure.

Finally, it remains doubtful that the terms will be defined and specified sufficiently in the agreement leaving this task to panel or court rulings. Nevertheless, before being able to rely on such rulings, an enforceable dispute settlement system must be established or an existing one enhanced to apply on a multilateral level.

Due to this yet non-exhaustive list of problematic issues arising while negotiating multilateral investment rules in the area of expropriation and compensation it remains doubtful whether an accord can be found in near future. Existing provisions in bilateral investment agreements could serve as a helpful basis for further discussions, nevertheless, they do not constitute customary international law and therefore ongoing debates are pre-programmed.
Ø  Lawfulness

First, was the taking of the foreign investor’s property by the Host State government lawful? It’s generally thought (and expressed in the literature on the topic) that in order for a government’s expropriation to be lawful, it must be both 1).for a public purpose and 2). non-discriminatory.
The first of these requirements – that the taking be foor a “public purpose” –reflects a compromise between two competing views. On the one hand, a sovereign nation is ofthen said to have full and permanent sovereignty over its natural resources and its economic activities. Numerous UN General Assembly resolutions have expressed that view, and it is generally accepted in the international community, at least as a theoretical matter (and subject in recent years to the obligation of a country not to use its natural resources in way that brings environmental harm to another country)[11]. That sovereignty over natural resources and economic activities, it is asserted, gives the nation’s government the right to take privately owned property, whether that property is owned by nationals of that country or by foreign nationals.

Ø  Defenses
The third key issue relating to expropriation arises when a foreign direct investor actually sues (or lodges some other official complaint against) the Host State government that has expropriated its property interests. What defenses under international law are available to the Host State government that expropriated an investor’s property? The answer involves the act of State doctrine[12], Sovereign immunity[13], and the Calvo doctrine[14]. These are important enough to warrant a brief summary[15].

Ø  Standards of Protection

Treaties for the protection of investments, especially BITs, typically provide for certain standards of protection. These standards are FET, full protection and security, protection against arbitrary and discriminatory treatment, national treatment and most-favoured- nation treatment. These standards may be found in most investment protection treaties.
Some tribunals have regarded some of these standards as being closely interrelated. In fact, FET was at times seen as an overarching standard that embraced the other standards. The better view, subscribed to by a majority of tribunals, is to see the standards as analytically distinct even though there may be a certain degree of overlap among them.

Ø  Fair and Equitable Treatment

Fair and equitable treatment (‘FET’) has become the most important standard in investment disputes. The FET standard is designed as a rule of international law and is not determined by the laws of the host State. The FET standard may be violated even if the foreign investor  receives the same treatment as investors of the host States nationality. For the same reason, an investor may have been treated unfairly and inequitably even if it is unable to benefit from a most-favoured-nation clause because it cannot show that investors of other nationalities have received better treatment.
It is possible to identify typical fact situations to which the standard of FET has been applied  by investment tribunals. On the basis of these fact situations certain principles have evolved  which may be described as transparency, consistency, stability and protection of the investor’s legitimate expectations, compliance with contractual obligations, procedural propriety and due process, action in good faith (bona fide) and freedom from coercion and harassment. These categories by no means exhaust the possibilities of the FET standard.

Ø  Full Protection and Security

Most investment treaties contain clauses promising ‘full protection and securityalthough the exact wording may vary. Some treaties refer to ‘constant protection and security’ or to ‘security and protection. These clauses suggest that the host State is under an obligation to take active measures to protect the investment from adverse effects. The duty to grant physical protection and security may operate in relation to encroachments by State organs.

Traditionally, the primary purpose of this standard was to protect the investor against physical violence, including the invasion of the premises of the investment. But there is also authority  that indicates that the principle of full protection and security reaches beyond safeguards from physical violence and requires legal protection for the investor. In  fact, some treaties specifically refer to protection and legal security.
The standard does not provide an absolute protection against physical or legal infringement. In terms of the law of State responsibility, the host State is not placed under a strict liability to prevent such violations. Rather, it is generally accepted that the host State will have to  exercise due diligence and will have to take such measures protecting the foreign  investment  as are reasonable under the circumstances.  

Some treaty provisions on protection and security tie the standard to general international law  (‘full protection and security in accordance with international law). Other treaties refer to protection and security as an independent standard. To clarify the issue for the purposes of NAFTA, the three parties have stated in a note of interpretation that not only the standard of fair and equitable treatment, but also the provision on full protection and security in Art. 1105 (1) NAFTA, merely reflects customary law. etc...
Ø  Investment Protection

Clearly, investment protection is an issue of key importance for developing countries, particularly the poorest ones where the social and political context tends to be more unstable. The regime delineated by the MAI has the following central elements:

o    Each contracting party shall accord to foreign investment fair and equitable treatment and constant protection and security. In any case, such treatment should be no less favourable than that required by international law. This standard of treatment is ‘absolute’ (i.e. it is not contingent on host country’s legislation), as opposed to NT and MFN (relative standards).
o    Expropriation of foreign investment (and measures having similar effects) shall, be limited to cases of public interest, be applied in a non-discriminatory manner in accordance with due process of law, and be subject to prompt, fully convertible and transferable compensation at fair market value. Interest rate payments or exchange loss adjustments shall be borne, when applicable, by the host country.
o    In case of war, civil disturbance or armed conflict of any sort, compensation to foreign investors should be in accordance with the better of NT and MFN (except that loss of property occurs from requisitioning or unnecessary destruction by the host country’s armed forces, in which case full compensation is due).
o    All payments to or from the foreign investor shall be freely transferred into and out of the host country in a convertible currency. Transfers may only be delayed to protect creditors or to comply with domestic securities or criminal laws. Transfers of data and information in and out of host country shall also be freely made.
o    The MAI would protect investments made before and after its entry into force.

These ‘absolute’ standards and rules for the protection of investment are essential for the improvement of the investment climate in the developing countries.


Today, international investment faces a patchwork of regional and bilateral instruments that regulates FDI flows. On one hand, the existence of such a quantity of instruments definitely makes evidence of the levels of convergence that have been reached on investment, as well as the interest of the countries to guarantee more stability in the investment rules. On the other hand, it also introduces elements of confusion, inefficiency and uncertainty since it enhances the fragmentation and overlapping of different regimes applicable to FDI in a world in which investments are global or regional.    
From this, it can be inferred that a multilateral negotiation on investment would be convenient. A multilateral framework could be useful to reduce the conflict among the rules of different countries and, at the same time, would reduce the inefficiencies and the wrong distribution of resources that provoke the number and diversity of rules on investment.

Investment is a capital transaction in which the investor expects a return.

Unentugs Shagdar JSD


Dr. Shagdar Mijid, Political Sovereignty and Economic Independence, Moskwa, 1976, p.281
Unentugs Shagdar, Mongolian Investment legal Environment, Seoul, 2012, p. 4-25.
Unentugs Shagdar, Legal regulation trends and issues in mineral resource of Mongolia, Mongolian Law
Review, Volume 2,National Legal Institute, 2012, p. 8-21.
Unentugs Shagdar, Law of War, The Rule, Principle: Military of the Mongol Empire, Dubai, 2012, p.12.
Unentugs Shagdar and Foreign Investment Agency of Mongolia, “Survey report on factors influencing
investment policy implementation, improving method research based on the foreign investors’ evaluation”, Seoul National University, School of Law and FIA, Seoul; Ulaanbaatar 2013, p.16.
Unentugs Shagdar, Legal regulation trends and issues in mineral resource sector of Mongolia,
Mongolian Law Review, volume 2, Ulaanbaatar 2012, p.21-47.
Unentugs Shagdar, Law and Governance: The Mongol Empire Great Law “Ikh Zasag -YASSA”, The War
Rule, Principle: The Mongol Empire, Seoul, 2013, p.15.
Unentugs Shagdar,Enforcement of Competition Policy and Law Today in Mongolia and its Challenges,
Osaka University., 2008.
Unentugs Shagdar, Developing Country’s Critical Role as Advocate for Competition and Pro-Competitive
Policies, JICA; Tokyo University, 2007. Available at:
Unentugs Shagdar. Economic Development and the Rule of Law. Mongolian Law Review.
Unentugs Shagdar, General Prospects of the Asia-Pacific Community and Mongolia’s Position. Ministry
of Foreign Affairs of Mongolia; Soros Foundation, New York; Ulaanbaatar, 2002, 2012.
Unentugs Shagdar, Signed on 25 May 1915, the Treaty of Kyakhta was a tri-party treaty between Russia,
Mongolia, and China. Russia and China recognized only OuterMongolia. General Prospects of the Asia – Pasific Community and Mongolia’s Position, Ulaanbaatar, Ministry of Foreign Affairs and Soros Foundation, 2002, p.5, Available at:
Unentugs Shagdar, Mongolia’s Future Framework, Unentogs’s Blog, 2012. Available at:
Unentugs Shagdar., Technology transfer needs and barriers in Mongolia, Mongolian Investment Legal
Environment, Seoul, 2013, p.136
Unentugs Shagdar, Signed at Peking on the 5th (18th) November 1913, Russo-Chinese Agreement, The
romantic story of the Mongolian Independence, Ulaanbaatar, 2002,  Available at:
Unentugs Shagdar, “The Treaty of Kyakhta, 1915”, General Prospects of the Asia – Pasific Community
and Mongolia’s Position, Ministry of Foreign Affairs and Soros Foundation, Ulaanbaatar, 2002, p.5.

Hi-Taek Shin, The Transnational Investment Process from the Perspective of the New Haven School of
Jurisprudence (Asia Pacific Law Review, vol 18, number1)
Al-Sadig, Ali, (2009) The Effects of Corruption on FDI Inflows. Cato Journal, Vol. 29, No.2 (Spring-Summer,1979)
Bouton, L. and M.A. Sumlinski (1996) ‘Trends in Private Investment in Developing Countries’ 1970-95
IFC Discussion Paper 31 Washington DC: International Finance Corporation.
DAC (1997) Development Co-operation 1997, Paris: OECD Development Assistance Committee.
Dunning, J.H. (1993) Multinational Enterprises and the Global Economy Harlow: Addison-Wesley.
FitzGerald, E.V.K. (1997) ‘International Capital Markets and Open-Economy Macroeconomics’ Oxford
Development Studies,
Cuervo-Cazurra, Alvaro and Mehemet Genc (2008) Transforming Disadvantages into Advantages: Developing-Country MNEs in the Least Developed Countries. Journal of International Business Studies Vol. 39, (2008)
Delios, Andrew, Ram Mudambi and Pietro Navarra (2005). Corruption and FDI: Japanese FDI Inflows into theEU, 1996-2002. In Lars Oxelheim, ed., Corporate and Institutional Transparency for Growth in Europe. Oxford, 2005.
Egger, Peter and Hannes Winner (2006) How Corruption Influences Foreign Direct Investment:
A Panel Data Study. Economic Development and Cultural Change
Hoekman, B. and P. SauvJ (1995) ‘Tentative First Steps: an Assessment of the Uruguay Round
Agreement on Services, Policy Research Working Paper , No. 1455 Washington DC: World Bank.
IFC (1997) Foreign Investment: the Lessons of Experience, Washington DC: International Finance
IMF (1997a) International Capital Markets 1997, Washington DC: International Monetary Fund.
IMF (1997b) Global Economic Outlook 1997, Washington DC: International Monetary Fund.
USDC Inside U.S. Trade (various issues), Washington DC: US Department of Commerce.
OECD (1998a) Multilateral Agreement on InvestmentConsolidated Text, Paris: OECD.
OECD (1998b): Multilateral Agreement on Investment: Commentary, Paris: OECD.
Rugman, A and M. Gestrin (1995), ‘The NAFTA investment provisions as a model for a multilateral
invsestment agreement’ in OECD Market Access Issues after the Uruguay Round Paris: OECD.
Sauvant, K. and V. Aranda (1994) ‘The International Legal Framework for Transnational Corporations’,
in: A. Fatouros (ed.): Transnational Corporations: Codes of Conduct, London: Routledge.
SauvJ, P. (1994) ‘A First Look at Investment in the Final Act of the Uruguay Round’, Journal of World
Trade, vol. 25, no. 5, pp. 3-16.
UNCTAD (1995) Incentives and Foreign Direct Investment, Geneva: United Nations Conference on
Trade and Development.
UNCTAD (1996) World Investment Report 1996: Investment, Trade and International Policy
Arrangements, Geneva: United Nations Conference on Trade and Development.
UNCTAD (1997) World Investment Report 1997: Trans-national Corporations, Market Structure and
Competition Policy, Geneva: United Nations Conference on Trade and Development.
UNRISD (1996) States of Disarray: the Social Effects of Globailsation Geneva: UN Research Institute for Social Development.
Wimmer, A. (1996): The Impact of the General Agreement on Trade in Services on the OECD
Multilateral Agreement on Investment, World Competition, vol. 19, no. 4, June, pp. 109-20.
World Bank (1996) World Development Report 1996, Washington DC: The World Bank.
World Bank (1997a) Global Development Finance, Washington DC: The World Bank.
World Bank (1997b) Private Capital Flows to Developing Countries: the Road to Financial Integration,
New York, NY: Oxford University Press.
WTO (1996): Annual Report 1997, Geneva: World Trade Organisation.

[1] Trends in International Investment Agreements: An Overview. UNCTAD.
[2] World Investment Report 2001: Promoting Linkages. UNCTAD.
[3] Al-Sadig, Ali, (2009) The Effects of Corruption on FDI Inflows. Cato Journal, Vol. 29, No.2

[4] Trends in International Investment Agreements: An Overview. UNCTAD.
[5] OECD Global forum on international investment. Mexico., 2001
[7] Andrew Newcombe and Lluis Paradell, Law and Practice of Investment Treaties.-Standards of Treatment., Kluwer law international, Netherlands, 2009.
[9] (Art.201 NAFTA; Art.1(7) (a) (i) ECT).
[10] John W. Head, Global Business Law, Principles and Practice of International Commerce and Investment, (2nd edition), Carolina academic Press 2007 a pre-specified portion of the faculty.  
[11] Ralph H. Folsom and Michael W.Gordon, International business transactions (Hornbook) 1995.
[12] The Act of State doctrine
The Act of state doctrine is a construct of American jurisprudence. Essentially, the doctrine asserts that a US court will not adjudge an act of foreign state. The doctrine was laid down initially in the 1897 Underhill case, and it has been applied ever since, most notably in the famous Sabbatino case. In Sabbatino, the US Supreme Court reiterated the holding of Underhill regarding the Act of State doctrine:
The classic American statement of the act of state doctrine, which appears to have taken root in England as early as 1674, and began to emerge in the jurisprudence of this country in the late eighteenth and early nineteenth centuries, is found in Underhill v. Hernandez, where Chief Justice Fuller said for a unanimous Court:
Every sovereign state is bound to respect the independence of every other sovereign state, and the courts of one country will not sit in judgment on the acts of the government of another, done within its own territory. Redress of grievances by reason of such acts must be obtained through the means open to be availed of by sovereign powers as between themselves.
Although “originally based on principles of country and sovereign immunity, the act of State doctrine was held by the Sabbatino Court to preclude the Court from “interfering in matters that were primarily the responsibility of the executive or legislative branches of the government. In this case, the Act of State doctrine (based on separation of powers theory) precluded the Court from invalidating the Cuban government’s title to a quantity of sugar that was, prior to being nationalized, the property of respondent Sabbatino.

[13] The concept of Sovereignty and the doctrine of Sovereign immunity
Sovereign immunity is a second defense A Host State government might make in a suit brought it by a foreign direct investor arising out of an expropriation. Understanding this defense, however, pre-supposes an understanding of sovereignty. What does “sovereignty”mean?
Fundamentally, “sovereignty” dictates that a nation has the right to act as it wishes within its own boundaries. Of course, this right is qualified by 1) the existence of treaties to which a nation has become a party and 2) customary international law-as discussed above in this section.

All states are sovereign within heir own territory, and … the maxim of “pari parim non habet imperium” .. means that no state could be expected to submit to the laws of another. This finds expression, for example, in the claims of certain developing states that they have the absolute right to expropriate property of foreign investors located within their territory, and are not bound by any law external to their own with regard to compensation to be paid to the investor.

[14] The Calvo doctrine
The calvo doctrine is derived from the work of Carlos Calvo, a nineteenth century Argentinan legal scholar. A response to intervention by the USA and EU powers in the affairs of latin American countries at the time, the Calvo doctrine’s two basic principle are: 1) the “National standard,” which provides that foreigners should not be granted more rights and privileges than thoe accorded nationals; and 2) the “diplomatic intervention” provision that foreign states may not enforce their citizen’s private claims by violating the territorial sovereignty of host states either through diplomatic or forceful intervention.

[15] Underhill v. Hernandez, 168 US. 1987


APEC Asia-Pacific Economic Co-operation
DAC Development Assistance Committee
DfID Department for International Development
DSU Dispute Settlement Understanding
FDI foreign direct investment
GATS General Agreement on Trade in Services
GATT General Agreement on Tariffs and Trade
ICSID International Centre for the Settlement of Investment Disputes
ILO International Labour Organisation
IMF International Monetary Fund
LDCs less developed countries
LICs low income countries
MAI Multilateral Agreement on Investment
MFN most favoured nation treatment
MICs middle income countries
MNC multinational corporation
NAFTA North American Free Trade Area
NGO Non-Governmental Organisation
NT national treatment
OECD Organisation for Economic Co-operation and Development
TRIMs Trade-Related Investment Measures
TRIPs Trade-Related Intellectual Property
UNCITRAL United Nations Commission on International Trade Law
UNCTAD United Nations Conference on Trade, Aid and Development

WTO World Trade Organisation