Part IV of this volume covers various substantive protections accorded to foreign investors in International Investment Agreements (IIAs) such as compensation for expropriation, fair and equitable treatment, non-discrimination, and umbrella clauses. Understanding these protections and their limits is especially important for investors, both before they make an investment, and before they decide to commence a lengthy and often expensive international investment treaty arbitration. This is a complex area of the law and due to the ad hoc nature of arbitral tribunals that make decisions in this field, and the lack of an appellate mechanism, there are numerous inconsistencies in the interpretation by tribunals of the scope of these protections. Therefore, it is crucial to fully understand the nature of the substantive protections found in the applicable IIAs, and to anticipate how these protections may apply in a given case.

Chapter 8: Substantive Protection I

Chapter 8 covers most of the core protections afforded to foreign investors in IIAs (national treatment and most-favoured-nation treatment are discussed in Chapter 9). These include provisions protecting investors against unlawful expropriation and, perhaps more importantly, fair and equitable treatment, as well as full protection and security, and observance of obligations entered into by host states (including so-called “umbrella clauses”). Some IIAs have more exotic provisions requiring state parties, for example, to provide investors with “effective means” of enforcing their rights.

Expropriation is the direct or indirect taking by a state of private property or property rights. States under international law have the right to expropriate property. An expropriation is not unlawful per se, provided that it is done for a public purpose, in a non-discriminatory manner, in accordance with due process of law, and fair and adequate compensation is paid. A direct taking of property leading to transfer of title may be easy to identify, but is relatively rare today. Much more common are indirect takings through government measures that seriously interfere with the investor’s right to enjoy the fruits of the investment, usually in the form of a law or administrative regulation that raises taxes or imposes higher regulatory burdens. International tribunals and some modern IIAs have developed tests to identify the threshold for an indirect expropriation; among these tests, substantial deprivation and the effects test are very important.

While the requirement to compensate for expropriation may be the most venerable protection afforded to foreign investors in modern IIAs, the most frequently invoked IIA provision is the fair and equitable treatment (FET) standard. The FET standard seeks to protect investors against manifestly arbitrary and unreasonable conduct of a host state, denial of due process by a local court, or frustration of an investor’s legitimate expectations arising from specific commitments given by the state to the investor. The FET standard is often related to another protection found in some IIAs — the obligation not to impair an investment by discriminatory, arbitrary or unreasonable measures.

The obligation of full protection and security (FPS) requires a government to provide reasonable security and police protection to investors and investments. In recent years, investors have argued that FPS extends to legal protection, such as maintaining a secure investment environment, while other tribunals and more recent treaties have held that it only extends to physical protection.

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Both FET and FPS standards are often assessed in terms of whether the conduct of the state fell below the minimum standard of treatment (MST) required by international law, especially where the applicable IIA expressly refers to MST. MST has been described in terms of preventing “an outrage” or “bad faith”.

Some IIAs contain an umbrella clause — an undertaking by the state that it will observe obligations vis-à-vis the foreign investors — such as, obligations in investment contracts and licences. Normally, under international law a commercial breach of an investment contract, such as a failure to pay invoices or non-performance for commercial reasons, does not give rise to international responsibility and can only be adjudicated in local courts. Foreign investors, however, in a number of cases have argued that an umbrella clause in the applicable IIA transforms a commercial breach into a breach of international law or a treaty breach. Host states have generally taken the position that only sovereign acts of a government fall within an umbrella clause and can breach an IIA.

Chapter 9: Substantive Protection II

Chapter 9 explores the two non-discrimination obligations found in virtually all IIAs: national treatment (NT) and most-favoured-nation (MFN) treatment. These obligations require host states to accord, in the case of NT, a foreign investor and its investments treatment no less favourable than that it accords to its own investors and their investments. In the case of MFN, host governments undertake to refrain from providing treatment less favourable than that given to investors from other states.

In order to assess whether NT has been breached, international tribunals undertake a three-step analysis: (1) the investor must identify a domestic comparator; i.e., an entity or a person “in like circumstances” or similar to the investor; (2) the investor must show that the host state has treated the domestic comparator more favourably than the investor or its investment; then (3) the burden shifts to the host state, which may demonstrate that there has been a legitimate policy reason for the differential treatment. Government regulations that treat foreigners and locals differently may, however, be justified if the purpose is to protect the public interest.

The steps for applying the MFN principle are similar to NT. In a number of cases, tribunals have allowed MFN provisions to be applied to “import” provisions from another IIA of the same host state. It is generally accepted that provisions relating to substantive obligations, such as FET and other standards, may be imported from other IIAs. For example, a claimant could argue that even though the relevant IIA does not contain an umbrella clause, the tribunal should “import” one from another IIA of the host country that does contain one. Some tribunals have also allowed the importation of less burdensome procedural requirements, such as shorter waiting periods before the investor can initiate arbitration. The development of jurisprudence on MFN has been controversial and many states in modern IIAs have tried to clarify its scope by excluding its application to procedural matters.

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