Investment Treaty Arbitration

General Information

What is an Investment Treaty?

An investment treaty is a treaty signed between two or more states in order to facilitate investment between the signatories. There are two kinds of investment treaties.

1. A treaty signed between two states is known as a bilateral investment treaty (“BIT”) (e.g. the Austria – Nigeria BIT)
2. A treaty signed between more than two states is known as multilateral investment treaty (e.g. the Energy Charter Treaty)
    

The standard contents of an investment treaty include:

• a definition of an investor and an investment,
• the standards of protection offered to the investors and investments,
• obligations of the investor (legality, registration of investment),
• an investor-state dispute settlement clause, and
• various others, such as MFN clauses, sunset clauses, umbrella clauses, etc.

The object of an investment treaty is to provide reassurance to the investor that its investment will be protected in the host state, and that if such protection is not provided, it will have the option to request the formation of an international arbitral tribunal in order to obtain remedies such as compensation and/or restitution.[1]

Who is Protected?

Typically, an investment treaty protects foreign investments and hence the foreign investor. Therefore, an investment treaty generally defines an investor for the purposes of protection under the treaty. Generally, an investment treaty would protect natural persons or legal persons that are nationals of the signatory states.
For example, the Austria – Nigeria BIT defines the term “investor” as
“(a) a natural person having the dominant and effective nationality of a Contracting Party in accordance with its applicable law, or
(b) an enterprise constituted or organised under the applicable law of a Contracting Party, making or having made an investment in the other Contracting Party’s territory.”

Denial of Benefits Clauses

Several treaties contain a denial of benefits clause. A denial of benefits clause is a provision in a treaty that precludes investments and/or investors that “do not have an economic connection to the state on whose nationality they rely on” from protection under the treaty.[2] 
For example, Article 12 of the Austria – Nigeria BIT titled Denial of Benefits reads: 
“A Contracting Party may deny the benefits of this Agreement to an investor of the other Contracting Party and to its investments, if investors of a Non-Contracting Party own or control the first mentioned investor and that investor has no substantial business activity in the territory of the Contracting Party under whose law it is constituted or organised.”

What is Protected?

As stated above, the primary objective of an investment treaty is to protect foreign investment. Therefore, the question arises as to what an investment is for the purposes of a treaty. Investments are generally defined in investment treaties. However, these definitions are not always clear, which is why various approaches have been developed. The most common approaches to defining investment are the “asset-based approach” and the “enterprise-based approach.”^[3]

Asset-Based Approach

Under the asset-based approach, the definition of investment encompasses all the assets of the foreign investor as investments such as portfolio investments (shares), intangible assets (intellectual property), etc.^[4] This approach has come under scrutiny in recent times because treaties with broad asset-based definitions might require the state to have to extend protection in situations that it did not envisage when entering into an investment treaty.^[5]

Enterprise-Based Approach

Under the enterprise-based approach, the definition of investment only extends to the establishment or acquisition of an enterprise in the host state.^[6] This kind of definition is narrower than the asset-based definition.

The Salini Criteria

In addition to satisfying the parameters of the applicable treaty, an investment also must satisfy independent criteria to qualify as a protected investment under the treaty. This two-step test for recognition of an investment is known as the “double-barreled test.”^[7]
The second set of that is criteria essential for an investment to be qualified as an investment, in addition to the definition under the applicable treaty, was devised in the landmark case Salini v. Morocco. These are known as the Salini criteria.
According to the Salini criteria, an investment has four essential characteristics:

• a substantial commitment of capital,
• a certain duration,
• an assumption of risk, and
• a contribution towards the development of the host state’s economy.^[8]

1. These criteria have largely been recognized across the board in investment arbitration practice.^[9] However, certain non-ICSID tribunals have dismissed the Salini criteria’s applicability to non-ICSID arbitrations and have ruled that the only applicable criteria for an investment to qualify as such are the ones mentioned in the relevant BIT.^[10]

How to Enforce This Protection / Remedy a Breach of the Obligation to Protect?

As mentioned above, the purpose of an investment treaty is to protect an investment. However, sometimes the host state might fail to provide that protection and breach its obligations under the applicable treaty. In these instances, investment treaties provide for an investor-state dispute settlement (“ISDS”) system. The ISDS system, essentially, provides the investor with a right to obtain a remedy for the host state’s breach of its obligation to protect the investor and the investment. The most common method of ISDS is investor-state arbitration, also known as investment arbitration. Through investment arbitration, the investor can request the constitution of an international arbitral tribunal which has jurisdiction to render a binding and enforceable award.
However, not all treaties provide for investment arbitration as the primary method of ISDS. Some treaties also provide for a right of action before the local courts of the host state^[11] or investor-state mediation^[12] to resolve investor-state disputes. 

Fork in the Road Clauses
 

Several treaties contain a “fork in the road clause.” According to such a clause, if an investor chooses one forum for ISDS, it is precluded from going back and selecting another forum for the same cause of action.^[13] For example, if the treaty provides for both arbitration and local courts as the forums for ISDS and the investor were to ask the local courts for relief, that investor would not be able to later request the constitution of an arbitral tribunal under the treaty.^[14]

When to Enforce the Protection / Opt for the Remedy?

If an investor decides to pursue an action against a state, it faces the question of when to pursue such an action. Several treaties contain provisions such as the exhaustion of local remedies, cooling-off periods, local litigation requirements, etc. in order to limit an investor’s power to initiate an action straight away. The question of whether these requirements can be bypassed remains open. On the one hand, some have argued that such requirements concern the issue of admissibility and not jurisdiction and can therefore be bypassed. On the other hand, others have argued that these requirements are jurisdictional and cannot be circumvented.^[15]

Exhaustion of Local Remedies

According to the exhaustion of local remedy clauses, before an investor can approach an investment arbitral tribunal, it must file an action before the local courts of the host state. Only if the investor is not satisfied with the remedy provided by the local courts can the investor approach an arbitral tribunal.^[16]

Cooling-Off Periods

According to cooling-off period clauses, an investor must notify the host state about the dispute and the fact that it intends to request the constitution of an arbitral tribunal, as well as attempt to settle the dispute amicably.^[17] After such notification, the investor must wait for a certain period of time that is stipulated in the treaty. Only after the expiration of such time will the investor be entitled to file for arbitration.^[18] The tribunals have generally treated such requirements as procedural and directory in nature rather than mandatory.^[19]

Local Litigation Requirements

According to local litigation requirement clauses, before requesting the constitution of an arbitral tribunal, an investor must file an action against the state in the local courts and wait for a certain period of time that is stipulated under the treaty. At the expiration of such a period, the investor is entitled to file for arbitration.^[20]
The mandatory nature of local litigation requirement clauses has been subject to much debate, most notably in the landmark case BG Group v. Argentina before the US Supreme Court. In this case, the majority ruled that the eighteen-month local litigation requirement in the Argentina – UK BIT was not a mandatory requirement. Hence, the non-satisfaction of this requirement would not be a barrier to the jurisdiction of the arbitral tribunal.^[21] Chief Justice John Roberts and Justice Anthony Kennedy delivered a dissenting opinion, reasoning that the local litigation requirement in the Argentina – UK BIT was a jurisdictional requirement and could not be overridden.^[22]
It is essential to clarify the difference between the exhaustion of local remedies and the local litigation requirement. The exhaustion of local remedies requires a conclusive remedy granted by the local courts of the host state. The local litigation requirement, in contrast, does not necessitate any decision but only requires the investor to wait for a certain period.^[23]

Intricacies of the Investment Arbitration Process

Enforcement of an Investment Arbitration Award

One of the most critical practical considerations in international arbitration is whether the award will be enforceable, as well as potential barriers to enforcement. This consideration is equally applicable to investment arbitration. An investment award can be enforced in two ways, depending upon the destination of enforcement and the regime to which the arbitral award is subject. 
An investment award can either be enforced under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (“Washington Convention” / “ICSID Convention”) or the under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”).

Enforcement of an Investment Award under the ICSID Convention

The International Centre for Settlement of Investment Disputes (“ICSID”) is an international organization whose primary objective is the administration of investment disputes. What distinguishes ICSID from other arbitral institutions is the facts that it has an autonomous enforcement regime. In other words, arbitrations under the auspices of ICSID are delocalized, self-contained, and automatically recognized after surviving ICSID’s autonomous annulment procedure.^[24] Consequently, arbitral awards rendered under the auspices of ICSID are directly enforceable as if they were final judgments of the courts of the enforcement state, without any further scrutiny being required.

Enforcement of an Investment Award under the New York Convention

A second way for investment arbitration awards to be enforced is the New York Convention. This is particularly useful for the enforcement of ICSID and non-ICSID awards in states that are not signatories to the ICSID Convention. However, unlike ICSID enforcement, awards enforced under the New York Convention are subject to review by the enforcing courts and might be refused enforcement on the grounds mentioned in

ICSID Arbitration vs. Non-ICSID Arbitration: Which is Preferable?

Investors may be faced with an ISDS provision in the applicable treaty that provides for an option between ICSID arbitration and non-ICSID arbitration, such as ad hoc arbitration or arbitration administered by a non-ICSID arbitral institution. An award arising out of an ICSID arbitration will be automatically recognized and enforceable in the ICSID signatory states. An ad hoc arbitration or arbitration administrated by other institutions, however, would not only be subject to review by the courts of the seat of arbitration but also by the enforcement courts under the grounds contained in Article V of the New York Convention. This key fact makes ICSID arbitration a preferable forum as it essentially removes a significant barrier to enforcement.

Treaty Claims and Contract Claims

Frequently, an investment operates through an investment agreement between the state (or state-entity) and the investor. Such agreements are standard commercial contracts that might contain a commercial arbitration clause. The question then arises for the investor whether recourse for a breach of contract by the state or state-entity should be sought through commercial arbitration or investment arbitration. The general answer is that if the claim were for breach of contract, the claim should be brought before a commercial arbitral tribunal, while if the claim were for a violation of the terms of the treaty, it should be brought before an investment tribunal.^[25] However, this scenario changes in the presence of umbrella clauses.

Umbrella Clauses

Umbrella clauses (also known as observance clauses) are an undertaking contained in a treaty by which the host state commits to observing its previously assumed commitments in relation to investments made by the foreign investors.^[26] Umbrella clauses are known to elevate contract claims to treaty claims.^[27] As mentioned earlier, only the violation of a treaty can lead to the possibility of approaching an investment tribunal. However, umbrella clauses are a broad commitment to protect the investment. Through such clauses, a breach of contract can be considered a violation of this treaty obligation, leading to a right to obtain remedy from an investment arbitration tribunal. 
It is, however, essential to point out that this is not the only interpretation of umbrella clauses. Tribunals have taken different views on the effects of umbrella clauses on investment claims.^[28] Therefore, it is necessary to evaluate the treaty at stake in light of the alleged violation as well as the contractual conduct.

Standards of Protection

Substantial parts of investment treaties are dedicated to outlining the obligations of the host state, which are also known as the standards of protection. These standards of protection become the substantive bases of an investment claim. Following are the most common standards of protection incorporated in treaties:

Fair and Equitable Treatment

The fair and equitable treatment (“FET”) standard is not only part of most investment treaties but also one of the most frequently invoked standards by investors.^[29] Often, the scope of FET is linked to minimum standards of treatment under international law. In other words, a conduct is considered to be in breach of FET if it violates codified or customary international law. However, the exact scope of such clauses is an unsettled matter and therefore is largely dependent upon the arbitral tribunal’s interpretation. 
FET clauses have been interpreted broadly and are understood to cover several different standards of protection, such as the legitimate expectations of the investor, denial of justice, transparency, due process, etc.^[30]

Full Protection and Security

The full protection and security standard is an obligation of the host state to protect an investment against acts attributable to the state and/or against acts of private persons. The scope of this standard has been understood to entail physical protection of the investor/investment.^[31]

Unlawful Expropriation

The term expropriation means the transfer of property (investment) from the hands of the investor to the hands of the state.^[32] Expropriation as such generally does not constitute a breach of treaty standards, as it is not in and of itself unlawful. However, for an expropriation to be lawful, it must be (i) non-discriminatory, (ii) for a public purpose, (iii) in accordance with due process, and (iv) must accompany lawful compensation. ^[33] If any of these conditions is not satisfied, the expropriation would be unlawful and in breach of the treaty. Expropriation can be direct (direct transfer of title of the investment) or indirect (depriving the investor of control and/or profitability of the investment).^[34]

Creeping Expropriation

Creeping expropriation is a kind of indirect expropriation. It is a series of regulatory measures by the host state which renders the investment unprofitable or without any economic benefit. Creeping expropriation is considered unlawful, and it can be a substantive basis for an investment claim.^[35]

Denial of Justice

As a standard of protection, denial of justice would fall under the umbrella of FET. However, in recent times, a vast amount of arbitral jurisprudence has emanated from denial of justice itself. While FET extends to all the acts attributable to the state, denial of justice refers to judicial acts.^[36] Denial of justice encompasses lack of access to local courts, excessively lengthy proceedings, lack of due process in courts, etc.^[37] If an investor faces any of these issues in the local courts of the host state, the denial of justice standard provides a substantive basis of action for a claim before an investment arbitration tribunal.

Most Favored Nation

Most favored nation (“MFN”) clauses have their origin in trade treaties. While the wording and precise object of each MFN clause differs, their core objective is to prevent the host state from subjecting investments and/or investors to treatment that is less favorable than the treatment accorded to investments and/or investors of other states.^[38]

Topical Issues

Security for Costs

Security for costs is a provisional measure in an arbitration proceeding where a party requests the arbitral tribunal to order another party to furnish security (e.g. via bank guarantee) in order to secure its right to recover the award and the legal costs and expenses arising out the arbitration.^[39] As outlined earlier, the right of action in investment arbitration lies with the investor. Therefore, security for costs is generally requested by the Respondent host state to shield itself from unmeritorious or sham claims. It must be noted that security for costs is an extraordinary remedy. 
Given that it is a provisional measure, all elements of provisional measures, such as irreparable harm, urgency, and proportionality, need to be proven in order to successfully obtain security for costs.[^40]

Disclosure of third-party funding

The rise of third-party funding in international arbitration has been reflected in investment arbitration and is an element that is relevant to the granting of security for costs. It is essential to clarify the connection between third-party funding and security for costs. 
The objective of security for costs is to protect the respondent state from a sham claim. The aim of third-party funding is to provide funds to an impecunious or non-impecunious party in order to initiate a legal claim. However, what if the terms of the funding agreement contain a provision excluding the funder’s liability in case of an adverse costs order against the funded party?
This was the case in the recently decided security for costs application in Unionmatex v Turkmenistan.^[41] In this case, the funding terms included a provision whereby the funder excluded its liability to cover any adverse costs order against the Claimant. In such a case, the Respondent host state would have lost its opportunity to claim legal costs from the impecunious Claimant, which is why the tribunal ordered the Claimant to furnish security for costs.^[42] Therefore, the disclosure of third-party funder^[43] and the funding terms has become a critical element in security for costs proceedings.
ICSID has recently put this issue on its agenda, and security for costs is set to be reflected soon in the amended arbitration rules.^[44]

Counterclaims

Counterclaims are a common feature of commercial arbitration but given the asymmetrical nature of investment arbitrations, counterclaims in investment arbitration have long remained a controversial subject. The ICSID Convention foresees the possibility of counterclaims under Article 46. However, Article 46 also stipulates the conditions for the admission of counterclaims. One of the major barriers for states to bring a counterclaim is that the purported counterclaim must arise out of the subject matter of the principal claim.^[45] In other words, the host state will have to prove that both the claim and the counterclaim are closely connected or related. There remains a significant gap in the jurisprudence as to the specifics of the close connection and subject matter requirements.^[46] The viability and relevance of counterclaims remain uncertain.

Standards for the Annulment of an Investment Arbitration Award

An investment award can be subject to various governing regimes. Frequently, an investment arbitration is governed by the ICSID Convention or UNCITRAL Rules. An investment arbitration governed by UNCITRAL Rules would be akin to commercial arbitration and would therefore have a seat of arbitration. Consequently, an award would be subject to the annulment regime of the seat of arbitration. The widely adopted UNCITRAL Model Law is a good indicator of the grounds of annulment that are applicable in most legal jurisdictions. By contrast, the annulment procedure under ICSID is self-contained, and the grounds of annulment differ.

Grounds for annulment under Article 34 of the UNCITRAL Model Law

The grounds for annulment of an arbitral award under Article 34 of the UNCITRAL Model Law mirror the grounds for refusal of recognition and enforcement under Article V of the New York Convention. 
An arbitral award can be annulled on the grounds of incapacity of parties; invalidity of the arbitration agreement; improper notice; award outside the scope of the arbitration agreement; improper constitution of the arbitral tribunal; lack of subject matter arbitrability; and public policy.

Grounds for annulment under Article 52 of the ICSID Convention

Under Article 52 of the ICSID Convention, an arbitral award can be annulled for the following reasons: improper constitution of the tribunal; the tribunal manifestly exceeded its power; corruption of member(s) of the tribunal; serious departure from the fundamental rules of procedure; and failure to state reasons.

It is worth noting that the ICSID Convention does not list subject matter arbitrability or the violation of public policy as grounds for annulment. On the other hand, the UNCITRAL Model Law mention a failure to state reasons as a ground for annulment. The remaining grounds under both regimes are comparable.

Therefore, both regimes have their own merits, and the parties must weigh their circumstances with these factors as well as the enforcement scenarios under both regimes in order to make the most suitable choice. This is particularly so when a treaty has a fork in the road clause offering an option between ICSID arbitration and ad hoc or non-ICSID institutional arbitration seated in a Model Law jurisdiction.