Foreign Investment Arbitration case study:
To complete a foreign investment plan, there is a signing of foreign investment Agreement that legally binds the parties involved in the investment plan. A bilateral foreign investment involves two sovereign states with terms of agreement that tie the parties to undertaking direct foreign investment in infrastructure, project financing, job creation and economic participation through improvement of revenue collection. As may be understood, the investment treaties are subject to breaches just like any other agreement. This is particularly important because of the increased number of investment agreements between countries and the subjectivity the terms of the agreements have on climatic changes and economic dynamics. Due to the possible losses that would go with such changes that bear direct impact on the investing country, the need to enforce arbitration for breaches of terms of contract and the rights of the investor is called for. These, notwithstanding, the host countries are also fighting to ensure the welfare of their citizens and protection of fundamental wealth of their economies.
With this understanding, we consider this case of Fusia and Lassia, where an agreement of direct foreign investment was subjected to environmental effects and policy changes in the host country. Given the anticipation of possible conflicts in such agreements, there are investment agreement arbitration options that the parties in the agreement can visit to seek redress of their case. The determination from such arbitration cases may, as matter of fact, affect the decision by the investing country on investment in the host country. In this case in which Falcoa from Fusia has been adversely affected by the policy changes in the host country, Lassia, we lay on the table the facts of the case that necessitates arbitration, similar cases and the rulings on breaches of agreements in foreign investment partnerships and later o look at the argument and counterargument under the given circumstances.
Facts in the case
From the statement of the case, it is apparent that the parties involved in the investment agreement are the Fusia and Lassia. These are sovereign states with full authority to enter into a foreign direct investment agreement.1 This mandates the two states to enter bilateral trade agreement though firms from the two countries. In this case, Falcoa is the intermediary company investing directly in Lassia. Under this agreement, the agreement between these two countries binds Falcoa to operate according to the terms of the agreement
It is also important to also note that under the agreement, the terms were clear that the investing country would mine bauxite and use it to produce export aluminium that would in turn generate revenue for the host country. To facilitate this, the agreement committed the host to supply electricity at a fixed rate for a period of 20 years which was, however, reviewed after four years (under the twenty years agreed in the treaty). The economic and environmental impacts due to fluctuations in productivity were not included in the agreement (at least not of any that is stated here). Therefore, it is a fact that the parties were expected to honor the contract by cushioning the other from the adversities of such events.
Given these facts, it is imperative to say that there are notable breaches of treaty that were committed by the host country while handling the changes that were having direct impact on its economy. To start with, the price of the electricity supplied to Falcoa was hiked indefinitely. This breached the agreement in which they were supposed to supply electricity at fixed cost for a period of twenty years. This did not cover the possibilities of climatic changes that would affect the generation of the electricity. This was not even reviewed after better times came. Other than this, the policy change on usage of electricity in the country found Falcoa caught up in the upward review of the cost of supplying electricity contrary to the agreement.
My argument and related cases
Like most developing countries, Lassia presents to Fusia the perception that the current dispute might automatically lead to indirect expropriation of their foreign investment. While this is a possibility if Lassia proves beyond reasonable doubt that Falcoa is undertaking activities pausing threat to the welfare of the citizens of Lassia, the facts on the table in this case indicate that the breach of the agreement terms started with the host country. Under normal circumstances, diplomacy would be called in. However, the two sovereign countries have a bilateral investment treaty with clear terms. The argument here is in view of the provisions in multilateral investment treaties and their role in protecting foreign investment from such breaches. I have in mind the provisions in NAFTA which are said to be similar and applicable to the Lassia and Fusia scenario.
In lieu with the international investment law, Fusia stands a chance to seek arbitration for determination and confirmation of the breaches of agreement committed by Lassia. This is just one of the cases which Sornarajah would call a tussle between developed and developing nations on foreign investment. The case presents the effects of political and economic factors on international trade and investment. Under the given circumstances, redress can be sought from the International Chamber of Commerce International Court of Arbitration. This is however subject to the interpretation of NAFTA provisions by such international arbitration courts for foreign investment. The chance that Fusia has in the case is the provision by NAFTA in non-discriminatory treatment of member parties in protecting their investments from expropriation except by the provisions of the international law.
In addressing this case, I draw from a similar case of international investment that of Karaha Bodas Company Vs the Indonesia government. Under similar circumstances, a contract on investment in the country was terminated by a presidential decree when the country faced tough economic times and financial crisis. 2 Pursuant to the provisions in the contract dispute resolution, the contractors sought arbitration from Geneva seeking damages for the investment that was terminated in which the company was awarded, upon successful argument of the case, for the expenses incurred in the setting up and operating the investment and for the profits they lost due to the decision to terminate the contract.
Although this is a unique case in which the complainant had the contract terminated, we still find links of similarity with the Fusia and Lassia case. To start with, the case draws on a case of investment agreement change without consultation and subsequent cancellation of contract owing to natural causes that the host country faced, and which impaired their ability to sustain their part of the agreement. In principle, the compensation for the Falcoa company losses would be directly calculated from the fair market value of the aluminum they would have sold if the production volume would have been maintained. Although later disclosures of the Karaha Bodas Company case indicated unwarranted dealings, the Falcoa case presents clean deals in which the host benefited directly from the revenue from the export of the aluminum. It is also true that the government participated in every undertakings of the company.
The problem at hand here is the loss of income that was inflicted upon the investing company because of the upward tariff adjustment for the electricity supplied to the company. It is important to note that contrary to the agreement to have the electricity supplied at an unadjusted rate for twenty years was breached after a mere two years. The venture of mining and production of aluminum would take a long term and therefore, the contractual relationship between the two parties would require a stabilization period honored. Within the twenty-year period, any violation of the terms of agreement made by the host country impacted the rights and obligations that were upholding the contract. 3
The contravention of this agreement destabilized the contractual period between the two parties but it had worse impact for Falcoa and by extension, Fusia. This claim is supported by the stabilization clause for such a long-term contract in which the hosting government has the obligation to honor the terms of the contract and prevent any legislative intervention in altering the terms in order to protect the foreign investor.
What is observed in this scenario is the complete opposite of this obligatory requirement. Instead, by legislative change, the Lassian government changed the terms of supplying electricity to Falcoa into a permanently adjusted tariff, all in the name of controlling the electricity usage habits of the country. While the purpose of the upward adjustment was morally correct to the country and for the well being of the country’s economy and habit control, the legal intervention contravened the right and obligations of the investing company.
If on the other hand the hosting government wishes to cancel or alter the terms of the agreement, then it must be willing to fully compensate Falcoa for all the damages and profit losses incurred as a result of such an action. It was observed by a scholar that:
Governments have the power to cancel contracts by legislative fiat – an act of expropriation. The question is if the added presence of a stabilization clause should lead to increased compensation. If one would ignore the existence of a stabilization clause for compensation purposes and allow expropriation with normal compensation, the added presence of the stabilization commitment would have no effect. 5
As such, as was the ruling in the Chorzow Factory case6, the compensation should serve to undo the inflicted material harm due to the breach by Lassia on its international obligation to keep the terms of the agreement. In reference to this case it can also be observed that the actions by Lassian government surmounts to an illegal act on an international scale and practice. And therefore it can then be argued that respective reparations following this breach of agreement to Falcoa should be sufficient penalty that would also facilitate erasure of the consequences of the actions and therefore, create room for restoration of the original state of the agreement.
My argument is therefore in the support of the fact that if the case is confirmed, heard and ruled by an international court then the breach of the stabilization clause should be an enforceable fact that should facilitate compensation to the Falcoa Company by the hosting country. This notwithstanding the morality and legislative authority of the legislative action that resulted in the breach, the government has to bear the full responsibility. The severity of the illegality of the actions can be weighed against the Hadley v Baxndale case in which an English court listening to a damages claim and used the following words in the ruling:
The party breaking the contract…at the most, could only be supposed to have in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract.7
If these wordings would be borrowed in the sense of Lassian’s breach of their international obligation to protect Falcoa and its activities during and even beyond the stabilization period, then they are supposed to face the full impact of the damages claim due to breach of the stabilization clause of international investment law. Therefore, it should be cleared that unlawful breach of contract should not be absolved on the argument of nationalization as far as foreign investor expropriation is concerned.
An argument can then be drawn in line of lawful expropriation of a foreign investor. The element of indirect expropriation in the event the country feels about a foreign investor has been applied under NAFTA with the aim of environmental protection, health concerns or any other social welfare concerns identified by the hosting country about the investor. Therefore, the argument here would be the concern that the government raised about the irresponsible usage of electricity in the country, which would otherwise be regulated by the upward review of electricity supply tariffs. In such a case, the hosting government can expropriate the foreign investor without having to compensate for the damages or profit loses.
However, there are gaps in the enforcement of the indirect expropriation and measures taken by the hosting government for regulatory purposes. Whether such a scenario will not attract a compensation claim or penalty still remains unclear because of lack of criteria for examining such international investment treaties and the threshold for applicability of indirect expropriation. In the situation of Fusia v Lassia, the host has already deprived Falcoa of the profits in what can then be termed as ‘wealth deprivation’8 in indirect expropriation.
This is partly mentioned in the FTA of the US-Singapore in which the federal government can regulate the investment for the purpose of protecting the interests of the consumers, the environment and safety. This means that the action by the host country to expropriate a foreign investor should be based on verifiable facts about a treat from their activities in the host country on the environment, the social welfare of the people, threat on consumer rights, health and safety concerns and such issues.
The case at hand has, however, other priorities included in the way the host government undertook the actions that are qualified here as breaches. The adjustment of the prices in the pretext of bad weather and high cost of electricity, for example, preceded the deprivation of the profits when legislation was used to sustain the hiked prices. As such any legality of such deprivation cannot find justification in the name of national or social interest.
Falcoa has a strong chance of getting compensation from Lassia if arbitration is sought for the damages caused and the profits lost due to the breach of the stabilization clause that destabilized the obligations set out in the direct foreign investment agreement entered. It has many options from where it can seek this arbitration that can administer the compensation sought including redress from the provisions of the OECD Draft Convention on the Protection of Foreign Property and those of the NAFTA that give the mandate to protect foreign property and the fundamental freedoms of foreign investors. In particular, NAFTA can be sought for the purpose of protection against expropriation and wealth deprivation for foreign investments that have resulted from the legislative incursion by the host country.