22 September 2005
Key Points:
Investment protection treaties can work.
When assessing the viability of entering into contracts involving foreign investment all sensible investors consider the risk of inequitable treatment at the hands of the host government. In an attempt to soothe investors' fears and entice foreign investment, many countries enter into bilateral investment treaties (or BITs), which give varying degrees of protection against unfair treatment (including expropriation and discriminatory treatment) and usually allow an investor to arbitrate any investment dispute directly with a host government. These types of provisions are often included in free trade agreements as well.
The big question is how much protection do these treaties really provide in practice? Often attempts by private investors to invoke the protection of a treaty have been fraught with difficulty, particularly in persuading tribunals that the matter involves an "investment". However, the determination handed down by an arbitral tribunal in CMS Gas Transmission Company v the Argentine Republic[1] is an excellent example of investment protection working in practice. The foreign investor in this case - CMS Gas Transmission Company - was provided with very real protection against government measures adopted in the face of an economic crisis.
Investment in a privatised industry
In 1989 the Argentine Republic commenced a process of economic reform. One of the pivotal laws enacted during this period was the Currency Convertibility Law, which fixed the Argentine peso at par with the United States dollar. A number of state-run industry sectors were also privatised, the gas sector being one of these. After the privatisation one of the companies formed was Transportadora de Gas del Norte ("TGN"), of which CMS was a major shareholder.
TGN was granted a licence that allowed TGN to charge a tariff on both the exporting and importing of gas. Under the licence, this tariff was to be adjusted every six months in accordance with the United States Producer Price Index with further periodical adjustments. Tariffs were to be calculated in US dollars and converted to pesos at the date of payment.
The peso sinks - and so does the investment
The late 1990s saw the emergence of a severe economic crisis in Argentina which resulted in drastic political and social consequences. In 2002 an Emergency Law nullified the effect of the Currency Convertibility Law, so the peso was no longer pegged with USD and was devalued. The right of public utilities to adjust tariffs according to the United States Producer Price Index was terminated as was the calculation of tariffs in dollars. At the same time all tariffs were redenominated in pesos at the rate of one peso to one US dollar.
CMS suffered large losses, including:
CMS claimed that a number of provisions in the Argentina-United States Investment Treaty had been violated and sought redress by referring the matter to arbitration.
What breached the Treaty, and what did not
The arbitration was conducted under the auspices of the International Centre for the Settlement of Investment Disputes in Washington. CMS claimed US$261.1 million for breaches of the Treaty plus interest and costs.
The Tribunal considered a number of arguments in relation to expropriate and unfair treatment.
CMS argued that the measures adopted by the Government resulted in indirect expropriation. The Tribunal considered the fact that CMS still had control of the investment, the government did not manage the day to day operation of the company and that CMS retained full ownership of the investment. Given this, the Tribunal found that Article IV of the Treaty - which relates to expropriation - had not been breached.
CMS also claimed that the Government violated the standard of fair and equitable treatment required under Article II(2)(a) of the Treaty. What constitutes fair and equitable treatment is not clear. However the preamble to the Treaty states that a principal objective is that fair and equitable treatment is desirable to maintain a stable framework for investments. The measures adopted by the government entirely altered the legal and business framework in which TGN operated. The Tribunal concluded that the measures taken resulted in a breach of the standard laid down by the Treaty.
CMS further claimed that the Government undertook arbitrary and discriminatory measures in violation of Article II(2)(b) of the Treaty, because other public services relying on dollar-based tariffs were treated more favourably. The Tribunal held that there had been no impairment in respect of the management and operation of the investment, and ultimately held that there was no arbitrariness or discrimination present in the context of the crisis.
CMS argued that the Government's breaches of the obligations under the licence amounted to contractual breaches and therefore Article II(2)(c) of the Treaty was violated. The Tribunal held that not all contract breaches will amount to treaty breaches. The Treaty only offers protection where the breach of contract results in a specific breach of Treaty rights or obligations. Under the licence the Government breached the obligation not to freeze tariffs and not to alter the basic rules of the licence without TGN's consent. Both these obligations would draw the protection of the Treaty and therefore the Government was in violation of the Treaty in this respect.
State of emergency and the effect on the Treaty obligations
In its defence the Government contended that it should be exempt from liability due to the existence of the state of necessity or state emergency. The Tribunal addressed this question in the context of Argentine law, customary international law and under the Treaty.
The Tribunal held that a state of necessity under Argentine domestic law does not offer an excuse if the result of the measures in question is to alter the substance or the essence of contractually acquired rights.
In relation to customary international law, the Tribunal was of the view that the crisis was severe enough to meet the requirements of the Articles on State Responsibility[2]. However the government was unable to satisfy the Tribunal that the measures adopted were the only way in which the state could safeguard its interests.
In relation to the Treaty the Tribunal held that, without profoundly serious conditions, Treaty obligations would prevail over any plea of necessity. Here the crisis was severe but did not result in total economic and social collapse, leaving the Treaty obligations in place.
Ultimately the Tribunal awarded CMS US$133.2 million plus interest as compensation, which, although much less than the amount claimed, was still a substantial sum.
A new era for investment protection?
Previous attempts to use investment protection treaties have often foundered on jurisdictional disputes, so this is an important decision. Of course, much depends upon the wording of the relevant treaty, but this decision shows that investment protection treaties can work and, as the first of many cases arising from the Argentine crisis, provides food for though for both governments and private investors.
Considering the severity of the Argentine crisis, most governments must be wondering just how severe a crisis must be before their actions will not contravene an investment protection treaty. By contrast, the decision leaves private investors with a sweeter taste in their mouth. In this case a private investor was afforded more than a modicum of protection in relation to its foreign investments.
The complexities of the Argentine currency crisis may seem remote to Australian readers. However, investment protection of this sort already exists both for Australian investors in other countries as well as foreign investors here (Australia has 19 BITs, mostly with countries in the South-East Asia region and a number of free trade agreements incorporating investment protection such as those with Singapore and Thailand). A claim by an Australian investor overseas or a foreign investor against the Australian government is simply a matter of time.
[1] Case No. Arb/01/8 dispatched to the parties 12 May 2005
[2] Responsibility of States for Internationally Wrongful Acts, UNGA Resolution 56/83, January 28, 2002. It was agreed by the Tribunal and the parties that this reflected the state of customary international law on the question of necessity.
