Facing growing criticism that they impede sustainable development goals, investment protections afforded by traditional international investment agreements (IIAs) are steadily eroding. Increasingly, the trend is toward provisions allowing host states greater flexibility to regulate environmental, transparency, human rights and other social impacts. At the same time, enhanced corporate social responsibility (CSR) obligations have become more common in recent IIAs.
Moreover, when evaluating investor claims, such as those grounded in stabilization or “fair and equitable treatment” (FET) provisions, arbitration panels often evaluate the reasonableness of both host state and investor conduct. Panels are less likely to find expropriation or protectionist intent, for example, if state action is deemed a reasonable exercise of bona fide regulatory discretion. If investor conduct is deemed unreasonable or unlawful, however, arbitral panels are more likely to reduce any damages award, to deny the investor’s claim and even to award costs to the host state in extreme cases. While arbitral decisions may not represent binding precedent, combined with evolving IIA language, they provide valuable insights on current trends impacting investor risk.
In light of these trends, robust due diligence focused on environmental and social impacts of long-term, capital intensive cross-border projects or acquisitions is increasingly important to managing investment risk. “Good international practice” for mitigating project impacts should be investigated, along with anticipated political risk. Evaluating the extent of host state bona fide regulatory discretion provisions and foreign investor CSR obligations embodied in applicable IIAs also is prudent. Investment contract and treaty reviews should be performed before project development or acquisition, and periodically thereafter, to ensure optimization of investor protections and compliance with investor obligations under shifting standards.
Traditional Stabilization Clause and IIA Investor Protections
Protecting investor and lender expectations is particularly important for capital-intensive projects with long investment horizons, such as those typical in the extractive industries and large infrastructure projects. Because projects often take many years to develop and to achieve returns on investment, they face risk of significant changes to the regulatory landscape that can be detrimental to project viability. Increased taxes or royalties and enhanced environmental or labor standards are common examples of regulation that can adversely affect project economics.
Because large projects entail significant capital investment well before generating revenue, once completed their investors are particularly vulnerable to extortionate or protectionist regulation. Examples include retroactive application of new environmental or decommissioning obligations, seeking a higher share of revenue than committed in mining concessions or power purchase agreements, and coercive legislation or enforcement seeking higher operating consortium ownership by national petroleum companies.
Thus, agreements between private developers and host states, such as petroleum or mining concessions or production sharing contracts (PSCs), often include stabilization clauses attempting to preserve investment-backed expectations. Traditional “freezing” clauses typically provide host-country law will continue to apply notwithstanding subsequent amendments or new legislation. More contemporary stabilization provisions, termed “economic equilibrium” clauses, seek to preserve investor expectations by requiring compensation from the host government for increased costs resulting from new regulation not anticipated at project inception.
Investor protection also is a key feature of bilateral investment treaties (BITs) and free trade agreements (FTAs). Developed nation IIAs often include investment chapters discouraging inequitable treatment of foreign investors by developing or transitional states, including FET requirements and neutral international arbitration provisions. Until recently IIAs typically have not imposed sustainable development obligations on investors or have included only non-binding recitals that host states and investors will strive to respect international CSR norms.
Enhanced Focus on Sustainable Development and Investor CSR Obligations
More recently, many stakeholders have questioned the traditional model, arguing that contractual and treaty provisions inhibiting state sovereignty impede sustainable development and human rights goals in emerging economies. Critics assert that stabilization clauses, FET and similar investor protections “chill” progressive regulatory reform, undermining efforts to improve environmental and social protections. Some argue traditional investment provisions are imbalanced, insulating foreign investors from the costs of beneficial regulatory reforms while failing to impose reciprocal obligations to respect internationally recognized environmental and social standards.
Some observers go further, claiming the imbalance actually can backfire, increasing political risk for multinational corporations and financial institutions. By perpetuating or exacerbating environmental harm and social inequities in host states, these critics assert that investor-friendly IIAs contribute to heightened risk of labor strife, indigenous population protests, and even sabotage or civil unrest, thereby increasing risk of political instability, diminished economic returns and asset nationalization.
Responding to growing criticism, the International Finance Corporation (IFC) and United Nations (UN) investigated whether stabilization clauses affect state implementation of international human rights obligations, defined broadly to include environmental, labor, transparency and other social regulatory concerns. Their 2009 report, titled “Stabilization Clauses and Human Rights,” concluded most stabilization provisions applicable outside the Organization for Economic Cooperation and Development (OECD) “either insulate investors from having to implement new environmental and social laws or…provide investors with an opportunity to be compensated for compliance with such laws.” By contrast, the study found contracts applicable within OECD nations did not exempt investors from new laws, “and only rarely offer an opportunity for compensation for compliance with the same breadth of social and environmental laws as in non-OECD countries.”
Balancing Sovereign and Investor Obligations
Another trend impacting investor protections is the rising number of arbitration claims brought under investment contracts and treaties, prompting some prominent emerging economies to reassess IIA commitments. For example, following the November 2011 White Industries v India decision holding that delayed access to judicial process comprised a breach of India’s BIT with Australia, India experienced a significant increase in arbitration claims and undertook a fundamental reevaluation of its BIT regime. Ultimately, India served notice to renegotiate 58 BITs and announced a new model BIT in 2016. Among other revisions intended to better balance investor protection with state regulatory discretion, India’s new model BIT replaced the traditional FET standard with a “Treatment of Investments” provision focused on denial of justice, emphasizing fundamental fairness of treatment rather than preservation of investor expectations.
Similar repercussions followed the December 2016 Churchill Mining v Indonesia decision. After finding claimants’ mining rights had been forged and that they had neglected to conduct adequate due diligence to discover their local business partner’s fraud, the International Centre for Settlement of Investment Disputes (ICSID) tribunal held the investors’ claims inadmissible, awarding arbitration costs of nearly US$9.5 million to Indonesia. While not focused on CSR or FET standards, this opinion illustrates the emphasis some panels place on scrutinizing the reasonableness of investor expectations and due diligence, even where the ICSID Convention and applicable BIT text do not specifically address unlawful investor conduct. This and other recent arbitration claims prompted Indonesia to follow India’s lead, initiating a comprehensive review of BIT and FTA commitments and development of a more balanced model BIT.
Arbitration tribunals also scrutinize both host state and investor conduct in the context of IIAs between OECD nations. Methanex Corp. v United States, for example, considered a Canadian company’s claim under the North American Free Trade Agreement (NAFTA), seeking damages for alleged regulatory expropriation following California’s ban of MTBE as a fuel additive. In its 2005 opinion, the ICSID tribunal held California’s ban a lawful regulation based upon bona fide public policy and awarded arbitration costs to the US, finding no evidence of corruption by local government or competitors and observing that investors should anticipate enhanced regulation in jurisdictions such as California.
Thus, it’s not just emerging economies where investor protections are being scrutinized; OECD states also are reassessing existing IIAs, both under pressure to encourage sustainable development abroad and to defend their own national sovereignty. The 2012 US model BIT, for example, includes an express mutual commitment not to weaken laws respecting environmental or social protections for the purpose of encouraging investment. It also includes new exceptions to certain investor protections where the host government regulation comprises a reasonable exercise of discretion implementing bona fide public policy objectives.
The recently ratified US-Mexico-Canada Agreement (USMCA), replacing NAFTA, also includes an extensive new Environmental Chapter and significantly re-written Investment Chapter, encouraging enforcement of investor CSR obligations and adopting mutual commitments not to weaken environmental or social protections to attract foreign investment. The USMCA pares prior expropriation protections, clarifies its FET commitment does not create additional substantive rights and ties its minimum treatment standard to traditional principles of international law.
Navigating Investment Risk in the Sustainable Brave New World
Lawyers experienced in cross-border transactions frequently negotiate agreements with governmental or government-owned entities seeking consistent treatment of project economics for the life of the financing and beyond. Many practitioners have assumed reliance on contractual stabilization clauses or similar investor protections in applicable treaties, combined with a well-drafted international arbitration clause, will protect client interests by assuring favorable arbitration results or by discouraging expropriation in the first place. However, recent trends prioritizing a balance between investor protections, sustainable development and preservation of bona fide sovereign authority are combining to erode the reliability of these investment risk mitigation tools.
In light of these trends, reliance on traditional IIA investor protections alone may not suffice; robust due diligence and CSR measures also should be employed to effectively manage cross-border investment risk. Due diligence should focus on a project’s environmental and social impacts and “good international practice” for mitigating impacts as well as investigate corruption and political risk. Host state sustainable development regulatory discretion and investor CSR obligations embodied in applicable treaties, PSCs or other pertinent IIAs also should be investigated and periodically reexamined.