CC's Audley Sheppard discusses the value of bilateral investment treaties as insurance policies against government interference

As the fourth annual economic summit between the US and China began last week, there were calls in the US for the Obama administration to pursue negotiations towards a bilateral investment treaty (BIT) between the world's two largest economies.

Bilateral and multilateral investment treaties are intended to promote investment by protecting investors by giving them independent legal recourse in the event of unlawful expropriation and other unjustified government interference with their investment. But do BITs fulfil that objective?

Investment treaties

A BIT is a short agreement between two states providing for the mutual promotion and protection of investments made by investors of the other state. There are over 3,000 BITs in existence. The UK, for example, has entered into over 120, the US over 50 and China over 80. There also exist several multilateral treaties that provide the similar protections and rights to investors, such as the Energy Charter Treaty and the Association of Southeast Asian Nations (ASEAN) agreement. Investment chapters may also be found in Free Trade Agreements (FTAs).

Most of these treaties provide that the host government shall not expropriate investments, unless it is for a public purpose and is accompanied by compensation, usually required to be "prompt, adequate and effective".

Additional protections include the requirement to provide fair and equitable treatment (ie, to provide a stable and transparent legal framework, not to act arbitrarily or contrary to the investor's legitimate expectations).

Very importantly, most BITs give the investor the right to bring international arbitration against the host state for breach of the BIT. Thus, the investor has an alternative to bringing proceedings against the host government on its local courts. Unusually, the recent US-Australia agreement only provides for government-to-government dispute resolution.

The investor will usually be able to choose between a number of arbitral rules and institutions, the principal ones being the rules of the International Centre for the Settlement of Investment Disputes (ICSID) and the rules of the United Nations Commission on International Trade Law (UNCITRAL).

Typically, a BIT arbitration will take two to three years, although sometimes longer. There have been about 450 known investment treaty cases commenced. The statistics suggest that investors have obtained at least some compensation in 30% of completed cases (in 40% the state was successful and 30% of cases settled).

Enforcement against a state may be problematic, particularly where it is difficult to find assets that are not protected by state immunity. However, a failure by a state to pay may deter future investment. And the state may face diplomatic pressure.

Do BITs promote investment?

The jury is out. Studies have been carried out as to whether agreement of a BIT between a capital importing country and a capital exporting country increases foreign direct investment into the former. The results are inconclusive. Brazil provides a notable counterfactual. It resolutely resists entering into BITs, but has no trouble attracting huge investment.

Do BITs protect against expropriation?

On 1 May, Bolivia's President Evo Morales marked May Day with a nationalisation – ordering troops to seize Bolivia's main electricity transmission grid from Spain's Red Electrica Espanola. Last month, Argentina dramatically announced the nationalisation of most of Repsol's 57.4% stake in Argentina's biggest oil group, YPF.

Over recent years, there have been high-profile nationalisations elsewhere in South America, especially Venezuela and Ecuador. In Africa and Asia, too, governments are increasingly requiring foreign investors to give up ownership rights or imposing new taxes.

It is not surprising that resource nationalism has repeatedly been identified as one of the key risks for investors in the natural resources sector in recent years. (See, for example, Ernst and Young's "Business risks facing mining and metals 2011-2012".)

Claims for breach of the fair and equitable standard are even more common. Recent examples in the news concern claims against India relating to cancellation of 2G licences and also possible claims by Vodafone for retrospective imposition of tax.

It might appear that investment treaties are not achieving their prophylactic purpose. On the other hand, some governments have accepted that they must pay compensation and have done so. No doubt the likelihood of a BIT claim has been an incentive. In several BIT cases, investors have been awarded hundreds of millions of dollars in arbitration awards.

Do BITs have a chilling effect on law reform?

An argument made against BITs is that they dissuade governments from enacting modernising social law reform, for example in relation to employment rights and the environment, for fear of being sued under a BIT for breach of fair and equitable treatment.

However, there is no evidence of this. And the weight of existing case law indicates that an investor would have difficulty in bringing a claim in the event that the host government enacted legislation that was consistent with accepted international standards and was not applied in an arbitrary or discriminatory manner.

Conclusion

Is it worth governments such as the US and China expending political capital to agree a BIT? In my view, the answer is: yes. BITs are no panacea. They probably do not cause an immediate increase in investment. They cannot create a force-field around an investment that protects it from interference. Nor do they ensure that any damages fully compensate the investor for all their loss.

However, they are a strong signal of intention and commitment by the respective governments. And they are very a useful insurance policy that may provide the only recourse available to an investor to obtain compensation in situations of egregious government interference. The US and China will hopefully agree that a BIT would be useful.

Audley Sheppard is a partner and global head of the international arbitration group at Clifford Chance, based in London.