Are investment treaties worth the political risk?

By Shardul Thacker, Mulla & Mulla & Craigie Blunt & Caroe
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As investors and innovators alike invest billions in research and development of new technology and products, the fate of their entry into foreign markets is ultimately determined by the naked political ambition of power-hungry ministers. The strength of government institutions and the rule of law in a foreign country frequently reflects the political environment. The weaker the government institutions and the rule of law, the greater the scope for political risk. A country with a high degree of political risk is a challenging place for foreign investors to do business.

Shardul Thacker Partner Mulla & Mulla & Craigie Blunt & Caroe
Shardul Thacker
Partner
Mulla & Mulla & Craigie Blunt & Caroe

In such a place, a bilateral investment treaty (BIT) may be the only silver lining for foreign investors. BITs not only help investors to access and manage political risk but also safeguard their investments from foreign governments. Over recent years, most countries that have sought foreign investment have provided investors with a fall-back protection from inappropriate state activity, in the form of BITs.

While a bold investor may take on a foreign government in its own courts to seek compensation for expropriation of assets or damage caused by unfair treatment, the BIT arbitration mechanism is an effective alternative through which investors can obtain relief. The recent spate of international trade disputes in India is glaring evidence of this.

Investment up

With the easing in recent years of India’s restrictions against foreign direct investment (FDI), FDI into India has jumped to almost US$47 billion in 2011-12 from US$393 million in 1992-93. With a projected GDP growth of 6% for 2012, and the government’s plans to double spending on infrastructure in the coming years, India’s economy is poised to attract significantly more foreign capital.

However, India’s uncertain regulatory environment, rampant corruption in government, poor infrastructure, policy paralysis and an overburdened legal system have rattled foreign investors and have contributed to the failure of many ventures with foreign partners. A BIT seems to be the obvious solution for foreign investors in India looking to ensure protection of their investments and have access to legal recourse.

Unwelcome consequences

India entered into its first BIT in 1994, and as of this July had signed BITs with 82 countries, of which 72 BITs had already come into force. The recent spate of international trade disputes, and the growing number of foreign investors that are threatening to invoke international arbitration proceedings against India under the framework of BITs, suggest that India’s BITs are coming back to haunt it.

This year has seen a series of notices being slapped on the Indian government as it grapples with fallout from the Vodafone tax dispute and the 2G spectrum scam.

On 2 February, the Supreme Court ordered the cancellation of all 122 2G spectrum licences issued in January 2008 by the then telecom minister, A Raja. Of these, 21 belonged to Russian conglomerate Sistema. In its judgment, the Supreme Court declared the allotment of spectrum “unconstitutional and arbitrary” and maintained that Raja “wanted to favour some companies at the cost of the public exchequer” and “virtually gifted away [an] important national asset”.

The court order triggered a series of complaints from international investors and trade giants. First, on 28 February, Sistema sent a legal notice to the government threatening international arbitration proceedings under the India-Russia BIT. Close on the heels of Sistema, Telenor, a Norwegian company, threatened to invoke the India-Singapore Comprehensive Economic Cooperation Agreement to protect its investments.

On 17 April, British telecom giant Vodafone, through its Dutch subsidiary, issued a notice of dispute to the Indian government under the India-Netherlands Bilateral Investment Treaty. The telecom company asked the government to abandon or suitably amend the retrospective aspects of the proposed tax legislation under the Finance Bill, 2012, which allows tax authorities to reopen cases as far back as 1962.

Vodafone has termed the retrospective tax proposals a “denial of justice” and “a breach of the Indian government’s obligations” as they may allow the Indian authorities to collect US$2.2 billion in taxes over the company’s US$11.2 billion acquisition of Hutchison Essar in 2007.

Conclusion

India is yet to respond to these legal notices. However, one can’t help but be reminded of the last year’s arbitral tribunal award of A$4 million (US$4.2 million) to White Industries Australia, where the tribunal held that the inability of the Indian judicial system to provide an effective means for the company to enforce its rights was a breach of India’s obligations under the India-Australia BIT.

While one hopes that this penalty may serve as an eye-opener to the Indian government, the worrying thought is that it may open the floodgates for similar claims by foreign investors and the Indian government may end up paying full compensation.

Shardul Thacker is a partner at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.

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