Legitimising International Investment Law: Objectively Defining an 'Investment' on the Basis of Risk Capital (Part 1/2)

International investment law, or IIL, is the growing collective body or sources of law that an investor looks to when its cross-border investment goes wrong. Comprised largely of bilateral investment treaties (BITs), the development of IIL, and in particular the subsequent growth of investor-state disputes arising from by IIL, has not been without its critics. According to Franck, ‘[p]arties and non-parties have cheered and jeered the efficacy, efficiency, and fairness of the current system for resolving investment treaty disputes’.[1] Sornarajah is more critical: ‘the system generated many systemic imperfections, such as inconsistent awards, allegations of arbitral bias and charges of expansionary interpretations of treaties that resulted in its legitimacy being queried’.[2] This article will focus on the primary area of IIL interpretation and incoherence for a foreign investor: determining the type of investment that qualifies for treaty protection.

Developing countries, competing amongst their peers to attract foreign investors, execute BITs in the expectation of attracting foreign capital along with expertise, employment and technology, leading to further economic development of the host state.[3] Salacuse and Sullivan describe it as ‘a grand bargain: a promise of protection of capital in return for the prospect of more capital in the future’.[4] This article postulates that whatever else, foreign direct investment (FDI) is primarily a source of external capital for a host state, which allows domestic capital to be allocated elsewhere including for public utility.

In the next section below, this article establishes the origins of the “Salini criteria” , a set of four parameters that gave rise to an approach for defining an investment under international investment law, and which were to gather significant support within the treaty arbitration community. However, to create a mapping of investments, using the author’s alternative criteria of duration and complexity, this article postulates a simple two dimensional segmentation of different investment types, based on three well known cases, Pantechni, Salini and Fedax whilst also contrasting these investments against a simple commercial sales contract. In addition, this section looks at two cases in 2008 and 2009 when the “Salini criteria” had their first significant rejection from a tribunal panel, leading to a split amongst the supporter base.

In part 2 of this article, I will introduce the concept of risk capital which this article postulates is a defining component of an investment. Moreover, if one looks “through” the investment, from the perspective of a financial investor, to the underlying financial instrument, then this may help in establishing a more objective definition of an investment. Finally, the article will consider how international investment law could be reformed, by improving how an investment is defined, and in particular, by predefining an investment before the transfer of capital to the host state. If all the relevant stakeholders could recognise FDI’s underlying financial instrument, as investors do, then this article’s approach to defining a protected investment could lead to more consistency in arbitration outcomes. As Franck comments ‘[t]he question is not whether perfection is possible—but how to minimize errors, abuses, and ambiguities in a way that promotes legitimacy’.[5]

The Origins of the Debate: Establishing the Salini Criteria

The fundamental purpose of investment treaties is useful. By creating a ‘stable’ investment environment well beyond the changing policies of 4-5 year terms of governments, investors were prepared to be make long-term commitments of capital for developing states. As recounted by Douglas, ‘[t]he principal objective of an investment treaty is to stimulate the flow of private capital into the economies of the contracting states’.[6] By reducing risks to investors, this reduces the cost of capital and increases efficient use of capital on a global basis. As emphasised by Sykes, ‘the function of international agreements is to reduce the perceived risk of expropriation and related events for private investors and thereby to reduce the cost of capital for capital-importing nations’.[7] Ultimately a lower cost of capital means less capital outflow from the host state, compared to the original capital inflow, perhaps dampening the hostility to foreign capital and the appetite for expropriatory measures.

An investor cannot proceed to claim under treaty protection if the investment at the centre of the dispute does not qualify for protection under the relevant treaty. According to Douglas, ‘[o]f all the provisions of an investment treaty, legal certainty about the proper scope of the term investment is perhaps most critical if the treaty is to achieve its objective of attracting foreign investment’.[8] If the putative investment does not qualify under the relevant treaty, then an arbitration panel will not have jurisdiction to hear the substantive issues of the investor’s claim. As Sornarajah notes, ‘[i]n virtually every treaty-based dispute that has arisen, the jurisdiction of the tribunal has been queried’ and host states have had some success with this strategy to evade an arbitration.[9]

As the number of BITs in force expanded in the second half of the 20th century, so too did the concept and definition of investment within the drafting of BITs (and their interpretation by arbitration panels for demonstrating their jurisdiction to hear the claim). A more recent example of defining an ‘investment’ can be seen in the Energy Charter Treaty which came in force in 1998 (and which currently has 55 contracting states)[10] ‘means every kind of asset, owned or controlled directly or indirectly by an Investor’.[11] By keeping the definition of an investment as wide as possible, this allows jurisdiction on the widest possible array of investment destinations for the capital-exporting countries.

Given both the expansive definition of investment within BITs and the diverse types of investments that were presented to arbitration tribunals, it was not surprising that panels began reaching for a common set of characteristics to qualify an investment. In Fedax v Venezuela the panel claimed ‘[t]he basic features of an investment have been described as involving a certain duration, a certain regularity of profit and return, assumption of risk, a substantial commitment and a significance for the host State’s development’.[12] This characterisation of an investment was subsequently narrowed where four of the parameters (substantial commitment, a certain duration, assumption of risk, and a significance for the host state’s development) were adopted in Salini v Morocco in 2001.[13] Thus Fedax was ultimately the origin or basis for what was to become known as the “Salini criteria” for determining whether the domestic recipient of foreign capital qualified as an investment.[14]

The use of the Salini criteria by arbitration panels was highly divisive, with detractors claiming that the four criteria unreasonably narrowed the definition of investment.[15] According to Dolzer and Schreuer, the first substantial rejection of the “Salini criteria “ was from the arbitration panel in Biwater Gauff v Tanzania in 2008.[16] In this dispute, the claimant outlined why the matter in dispute, a long-term contract to manage and operate Tanzania’s water and sewerage system, qualified as an investment using the criteria of duration, regularity of profit and return, risk, substantial commitment and development of the host state.[17] The Republic of Tanzania as the Respondent, however, claimed the tribunal did not have jurisdiction on the basis that the long-term contract does not meet the requirements of an investment, as defined in Article 25 of the ICSID Convention.[18] In this case, the panel decided it did have jurisdiction, principally because the definition in Article 25 together with travaux préparatoires of the Convention shows clearly that the concept of investment is not, and was never intended to be, narrowed by external criteria. Moreover the panel went on to state that the “Salini criteria” are ‘problematic’ and a ‘pragmatic approach to the meaning of “investment” is appropriate’.[19]

Another well-known rejection of the “Salini criteria” is the annulment decision in Malaysian Historical Salvors v Malaysia in 2009, less than twelve months after the Biwater Gauff turning point. Again, the respondent in Historical Salvors argued that the matter in dispute, a contract for marine salvage off the coast of Malaysia, did not qualify as an investment as per Article 25 of the ICSID Convention.[20] The original tribunal, in its Award on Jurisdiction found that the dispute did indeed not meet the criteria for an investment under Article 25 of the ICSID Convention and declared that it did not have jurisdiction to hear the dispute.[21] However, the annulment committee, referring to Biwater Gauff, annulled the original tribunal’s rejection of jurisdiction stating that the tribunal ‘exceeded its powers by failing to exercise the jurisdiction with which it was endowed by the terms of the Agreement and the Convention’.[22] Both the Biwater Gauff and Historical Salvors outcomes effectively split the arbitration community into those sought a rigid approach through strict application of the “Salini criteria” and those who opted for a more flexible approach to defining an investment, arguably consistent with what the ICSID Convention intended.

As part of the route to a definition of an investment, one must traverse the border between a short term commercial sales contract and an investment. In its simplest form, a commercial sale can be considered as a transfer of a product or a service but not capital to the host state; moreover a one-off sale infers a single transaction without any ongoing or future commitment to the host state. Here again there is inconsistent jurisprudence: in Pantechniki v Albania it was stated that ‘while the sale of a single tractor could not be labelled an ‘‘investment’’, investment treaty protection ought not to be denied to a transaction involving the delivery of a large number of machines and envisaging a deferral of payments for a substantial period’.[23]

In Fedax, Salini, and Pantechniki the relevant panels all found that they had jurisdiction, however the investment in question in each of the three cases was very different. This article chooses to simply characterise each investment in terms of complexity and duration as shown in the figure below. A financial instrument, such as the promissory notes in Fedax, is a fairly straightforward investment which makes it readily understood and easily tradeable between investors. Nonetheless, a financial instrument can have a long duration for the investor to await its return of capital and profit. Conversely a road or other major infrastructure construction project is complex and bespoke, designed entirely for its specific location. It requires a substantial investment of capital and over a sustained period. If a commercial sale is not deemed an investment largely because the transaction and payment both occur in a short time-frame and there may be no perceived investor commitment to the host country, then this article differentiates between a simple sale of a product that is ubiquitous around the world and a complex, or more bespoke, sale such as the tractor example of Pantechniki. In this latter case, the complexity may revolve around its specific design, similar to an infrastructure project where the equipment is designed for a specific purpose or climatic conditions.

In the second and final part of this article I look at the concept of risk capital and conclude by considering how international investment law could be reformed and improved.

[1] Susan D. Franck, ‘Empirically Evaluating Claims About Investment Treaty Arbitration’ (2007) 86 North Carolina Law Review 4

[2] M. Sornarajah, ‘The case against a regime on international law’ (2013) in Leon Trakman (ed), Regionalism in International Investment Law (OUP 2013) 477 (emphasis added)

[3] D Swenson, ‘Why Do Developing Countries Sign BITs?’ (2005) 12 UC Davis Journal of International Law and Policy 131

[4] Jeswald W. Salacuse and Nicholas P. Sullivan, ‘Do BITs Really Work?: An Evaluation of Bilateral Investment Treaties and Their Grand Bargain’ (2005) 46/1 Harvard International Law Journal 77 (emphasis in original)

[5] Susan D. Franck, ‘The Legitimacy Crisis in Investment Treaty Arbitration: Privatizing Public International Law Through Inconsistent Decisions’ (2005) 73 Fordham Law Review 1613

[6] Zachary Douglas, The International Law of Investment Claims (OUP, 2009) 135

[7] Alan O. Sykes, ‘Public versus Private Enforcement of International Economic Law: Standing and Remedy’ (2005) 34/2 The Journal of Legal Studies 632

[8] Douglas (n 6) 190

[9] M. Sornarajah, The International Law on Foreign Investment (CUP, 2017) 358

[10] International Energy Charter <https://www.energycharter.org/who-we-are/members-observers/> accessed 5 April 2020

[11] Energy Charter Treaty, definitions

[12] Fedax N.V. v. The Republic of Venezuela, Decision on Jurisdiction on 11 July 1997, ICSID Case No. ARB/96/3 43

[13] Salini Costruttori S.p.A. and Italstrade S.p.A. v. Kingdom of Morocco, Decision on Jurisdiction on 16 Jul 2001, ICSID Case No. ARB/00/4 52

[14] Dolzer and Schreuer, Principles of International Investment Law (OUP, 2012)

[15] Mavluda Sattorova, ‘Defining Investment Under the ICSID Convention and BITs: Of Ordinary Meaning, Telos, and Beyond’ (2012) 2 Asian Journal of International Law 269

[16] Dolzer and Schreuer (n 14)

[17] Biwater Gauff (Tanzania) Ltd. v. United Republic of Tanzania, Award, 24 July 2008, ICSID Case No. ARB/05/22, 233

[18] Biwater Gauff (Tanzania) Ltd. v. United Republic of Tanzania, Award, 24 July 2008, ICSID Case No. ARB/05/22, 286

[19] Biwater Gauff (n 17) 314, 316

[20] Malaysian Historical Salvors, SDN, BHD v. The Government of Malaysia, Decision on Annulment, 16 April 2009, ICSID Case No. ARB/05/1013 13

[21] Malaysian Historical Salvors, SDN, BHD v. The Government of Malaysia, Award on Jurisdiction, 17 May 2007, ICSID Case No. ARB/05/1013 146, 151

[22] Malaysian Historical Salvors, SDN, BHD v. The Government of Malaysia, Decision on Annulment, 16 April 2009, ICSID Case No. ARB/05/1013 79, 80

[23] Sattarova (n 15) 280