INVESTMENT ARBITRATION AS AN APPROACH TO DISPUTE RESOLUTION FOR PPP PROJECTS

The Belt and Road Initiative announced in 2013 opens a new chapter in the history of the “going global” strategy of Chinese enterprises. Over the past four or five years, we have witnessed remarkable growth in outbound investments by Chinese enterprises in terms of project number, value and method of investment, and degree of participation. In 2017, particularly, despite an almost 30% year-on-year reduction in the amount of Chinese enterprises’ overall non-financial outbound direct investment, the amount of such investments in Belt and Road countries basically remains stable compared to that in 2016, demonstrating strong resilience^[1].

Chinese enterprises’ investment in countries along the Belt and Road, substantially involve the fields of infrastructure construction, energy, telecommunication, and park construction. Their means of involvement have been gradually transformed from conventional engineering contracting and construction to investment and financing as well as long-term operation at a higher-level^[2]. It is particularly noted that, as there are substantial demand of construction and operation of infrastructure and public utilities in countries along the Belt and Road while a boom of project construction through public-private partnership (PPP) arises in China, PPP has become a new model favored by engineering construction enterprises, state-owned and private investors in outbound investment, and is expected to play a more and more important role in the Belt and Road Initiative and outbound investment by Chinese enterprises^[3] .

Subject to numerous factors jointly, such as the outbound investment experience, the social environment and geopolitical climate of the investment destinations and the inherent characteristics of PPP projects, Chinese enterprises are inevitably exposed to risks in various aspects in the process of going global and may therefore come across substantial disputes^[4]. From experience in international and domestic PPP projects, risks generally include the following: first, affected by international political and geopolitical factors, some countries may interfere with the outbound investment and related projects of Chinese enterprises by official or non-official diplomatic means; secondly, subject to the social, economic, culture and legal systems of the investment destination, social unrest, underdevelopment of rule of law and inconsistent policy of the investment destination will obstruct the normal construction and operation of a project; thirdly, PPP projects are characterized by long operation period and high requirements for management. Chinese enterprises that may lack operation and management experience and will hence be exposed to risks in project management, pricing and billing^[5].

Outbound investment is constricted by laws and regulations at multiple levels, including laws of the investor’s home country, laws of the investment destination, and bilateral or multilateral treaties. Accordingly, there are multi-level and multi-dimensional dispute resolution platforms and means. Investors may resort to negotiation, diplomatic protection, litigation or arbitration in the investment destination, submission to the court of the investor’s home country, or international commercial arbitration. The investor, as a commercial entity, is not comparable in its position to the investment destination country as a sovereign country. Common means for commercial dispute resolution generally fail to justly and impartially protect investors’ interest. In such case, initiating international investment arbitration against the investment destination country government is an important means to resolve the dispute and mitigate investment losses, sometimes even the final remedy.

Starting from the characteristics and risks of PPP projects, this article preliminarily explores the key issues that investors need to pay attention to in adopting investment arbitration for protection of their lawful rights and interests.

I. Jurisdiction basis of investment arbitration

For the purpose of this article, international investment arbitration refers to the arbitration initiated by an investor as the applicant against the investment destination country government as the respondent for resolution of a particular investment dispute. Like common commercial arbitration, the jurisdiction of investment arbitration is also based on the consensus of the parties to submit the investment dispute to arbitration. “Consent” may be rendered by the following means: first, the investment destination country and a foreign investor may directly set forth in their investment agreement that the investor may submit any dispute arising out of the investment agreement to arbitration; secondly, an investor may submit a particular investment dispute to arbitration as it is provided for in the laws of the investment destination country; thirdly, it may be agreed upon in the bilateral or multi-lateral investment treaties signed between the investment destination country and the home country of the investor that the investor may submit a particular investment dispute to arbitration.

Currently, in international practice, the bilateral and multi-lateral investment treaties may serve as an important basis on which an investor initiates investment arbitration. The statistics of the Ministry of Commerce indicate that, China has entered into bilateral investment treaties with 105 countries, including 56 countries along the Belt and Road. In addition, China has concluded multi-lateral investment treaties with ASEAN and other regional integration cooperation organizations. The negotiation of the investment treaties with the EU is under way. All of these investment treaties contain the clause that allows an investor of the parties thereto to refer a dispute to investment arbitration.

The investment destination country government will directly or indirectly participate in a cross-border PPP project, generally as a party to the project contract. The investor should endeavor to incorporate investment arbitration as a means of dispute resolution in negotiating the project agreement, so as to be properly protected. If there are no provisions in the project agreement setting forth that the investor may initiate investment arbitration to resolve a dispute, the PPP project investor may initiate investment arbitration only in reliance of bilateral or multilateral investment treaties in general.

II. Types of investment arbitrations

Investment arbitrations consist of two categories:

First, ad hoc arbitration. An ad hoc arbitration refers to the form of arbitration under which the parties concerned refer their dispute to the tribunal chosen by such parties in accordance with the arbitration agreement.  An ad hoc arbitration may not be administered by any institution, and the tribunal will determine the case independently. Ad hoc arbitration is more flexible for the parties concerned in terms of appointment of arbitrators, arbitration procedure, arbitration efficiency and arbitration expenses.

Ad hoc arbitration has been adopted as an investment dispute resolution means in early bilateral investment treaties concluded between China and other countries. In such treaties, neither arbitration organization nor the mandatorily applicable arbitration rules have been agreed upon by the partied thereto. In most cases, only several arbitration rules are set out for the reference of the parties concerned.

For example, it is set forth in Clause 7 of the bilateral investment treaty executed by China and Malaysia in 1988 that “the said international arbitration tribunal shall be set up by the following means: …. The tribunal shall structure its arbitration procedures with reference to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States signed on 18 March 1965 in Washington D.C. or Arbitration Rules of the United Nations Commission on International Trade Law.”

Secondly, institutional arbitration. Although ad hoc arbitration has its own advantages, it has many problems, such as highly arbitrary decisions, irregular procedure administration, lack of transparency, lack of consistency in arbitration award, as it lacks explicit arbitration rules and unduly relies on the autonomy of the parties concerned. In recent years, institutional arbitration is set out as the preferred dispute resolution means in the bilateral or multi-lateral investment treaties by many countries, in order to avoid the said problems. Among the arbitration organizations, the International Center for Settlement of Investment Disputes (ICSID) is the most important one.

ICSID is an arbitration organization specially set up for resolution of international investment disputes based on the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (“ICSID Convention”). In accordance with the ICSID Convention, ICSID has jurisdiction over any legal controversy which arises directly out of investment between a state to the Convention and the national of another state thereto and is referred to ICSID upon written consent of the parties.

China executed the ICSID Convention in 1990 and approved such execution in 1993. Since then, more and more bilateral investment treaties have incorporated the investment dispute settlement mechanism under the ICSID Convention into the bilateral treaty framework^[6]. For example, it is set forth in Clause 9 of the bilateral investment treaty executed by China and India in 2007 that “if both the home state of the investor and another state to the treaty are parties to the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States and the investor agrees in writing to refer the dispute to the International Center for Settlement of Investment Disputes, the dispute shall be referred to the ICSID.”

Investment arbitration clauses are also set forth in certain regional multi-lateral treaties signed by China. For example, Article 14 of the Agreement on Investment of the Framework Agreement on Comprehensive Economic Cooperation signed between China and ASEAN provides a detailed arrangement for dispute resolution through investment arbitration. It is agreed in Paragraph 4 of this clause that “…, it may be submitted at the choice of the investor: … (b) under the International Center for Settlement of Investment Disputes (ICSID) Convention and the ICSID Rules of Procedures for Arbitration Proceedings, provided that both the disputing Party and the non-disputing Party are parties to the ICSID Convention.” In addition, the negotiation of the bilateral investment treaty between China and the EU is under way. When the treaty is concluded, 27 members of the EU will be bound by the treaty^[7].

In additional to ICSID, it may be agreed in investment treaties to refer a dispute to a common commercial arbitration organization. Some internationally reputable arbitration organizations have also developed their own rules on investment arbitration. For example, the Investment Arbitration Rules formulated by Singapore International Arbitration Center (SIAC) has become operative since 1 January 2017; and China International Economic and Trade Arbitration Commission (“CIETAC”) has formulated its International Investment Arbitration Rules (Interim) in 2017^[8], which became operative on 1 October 2017.

The scope of application of these arbitration rules is similar to that of ICSID. For example, it is provided in the CIETAC International Investment Arbitration Rules that the Rules are applicable to “cases involving international investment disputes arising out of contracts, treaties, laws and regulations, or other instruments between an investor and a State, an intergovernmental organization, any other organ, agency or entity authorized by the government or any other organ, agency or entity of which the conducts are attributable to a State (hereinafter as“Government”, collectively).”

However, it is particularly noted that the investment arbitration award rendered by an overseas commercial arbitration organization is recognized and enforced in accordance with the New York Convention. If the investment destination resorts to commercial arbitration, there is certain uncertainty in recognition and execution of the arbitration award in the territory of the investment destination^[9].

III. Arbitrable matters in investment arbitration

Subject to their respective economic, social, and political environment, different countries in the same historical period, as well as the same country in different historical periods would agree to refer different matters to investment arbitration.

Take China for example. We have gone through around 50 bilateral and multi-lateral investment treaties signed between China and other countries, and categorized the investment arbitration clauses therein into two major classes: first, the parties agree that the investor may only refer to arbitration the dispute arising out of particular matters, such as the dispute over the compensation amount for expropriation and the dispute arising out of breach of a particular clause of the investment treaty (e.g. national treatment clause, most-favored-nation treatment clause, investment treatment clause, expropriation clause, loss compensation clause, etc.) by the parties to the treaties; secondly, the parties agree that the investor may refer to arbitration the dispute arising out of or relating to the investment.

As China’s economy has been growing and China is increasingly opening up to the world, it has improved its investor protection and considerably expanded the scope of such matters as may be submitted to investment arbitration set forth in the bilateral and multilateral investment treaties. China has gradually shifted its investment arbitration clause from limiting disputes to be submitted for arbitration to particular investment matters, to agreeing to refer any dispute arising out of or relating to investment to arbitration.

In international investment arbitration, the scope of arbitrable matters is often the focus of the dispute between the investment destination country and the investor. When an investment dispute arises, the investor often wishes the scope of arbitrable matters to be as broad as possible, while the investment destination country generally expects such scope to be limited.

One of the most controversial issues is whether the most-favored-nation treatment clause may be cited to amplify an arbitrable matter under investment treaties. In order to ensure fair treatment among investors from different countries, an international investment treaty often contains the most-favored-nation treatment clause, pursuant to which the treatment granted to a foreign investor and its investment shall not be less favorable than that to investors from any third-party country and its investment. It is controversial in practice of investment arbitration, though, whether such most-favored-nation treatment clause is applicable to substantive rules only or may be extended to cover dispute resolution and other procedural provisions. Some arbitration tribunals hold that, if the scope of application is not defined in the most-favored-nation treatment clause, the tribunal will allow the investor to cite the most-favored-nation treatment clause to choose the dispute resolution most favorable to the investor in view of protecting investor’s interest. However, some tribunals hold that, if the dispute resolution clause of the investment treaty has expressly defined an arbitrable matter, the most-favored-nation treatment clause shall not be cited to arbitrarily amplify the parties’ intention of explicitly defining dispute resolution in an investment treaty.^[10] The wording of the most-favored-nation treatment clause, the status whether it explicitly excludes the application of the most-favored-nature treatment clause to dispute resolution procedure or not, the background of signing the treaty, and even the arbitrators’ understanding of the purpose of the treaty may affect the tribunal’s determination of this issue.

Another controversial issue is whether the investor has the right to refer to investment arbitration the contract dispute relating to the investment contract (or project agreement) to which the investment destination country is a party in accordance with the inter-state investment treaty.

It is commonly held that international treaties differ from investment contracts and domestic laws of the investment destination country in terms of source of law and legal system. Unlike an investment contract which sets out specific rights and obligations, an international treaty structures a separate set of standards for protection of investment and investors, such as just and fair treatment, principle of non-discrimination, etc. In an investment arbitration that an investor has initiated in accordance with the investment treaty, the provisions of the investment treaty shall apply in determining whether the investment destination country government has infringed on or deprived the investor of its legitimate rights and interests; while in an arbitration that an investor has referred to in accordance with the investment contract, the provisions of the contract and the domestic laws of the investment destination country shall apply. Therefore, an arbitration that an investor has initiated in accordance with the investment treaty only resolves a dispute arising from the investment destination country’s breach of the investment agreement, namely an international treaty, but excludes investment destination country’s solely breach of contract.

Some arbitration tribunals, however, include “contract dispute” in the scope of application of investment arbitration through amplified interpretation of related clauses in the investment treaties.

For example, where it is set forth in the investment agreement that an investor may refer “any dispute relating to the investment” to investment arbitration, some tribunals hold that, this clause applies to not only a dispute over the investment destination country’s breach of the treaty obligations under the investment treaty but also the contract dispute arising from the investment destination country's breach of the investment contract concluded with the investor.

In addition, some tribunals may cite the “umbrella clause” to include contract disputes in the scope of application of investment arbitration^[11]. It is provided in many investment treaties that, any party thereto shall honor its commitments regarding the investment by the counterparty investor in its territory. In other words, even though such investment treaties are executed by and between sovereign countries, they also protect the investors’ rights to the commitments of the investment destination countries. In a broad sense of interpretation of this clause, an investment destination country’s obligations under the commercial investment contract with an investor may be attributed to its obligations under the international treaty. As such, the arbitration clause agreed in such international treaty may apply^[12].

In practice, arbitrational tribunals hold different views toward interpretation of the umbrella clause. In some cases, the tribunals hold that, if the investment destination country government breaches the contract but does not breach other substantive clauses under the investment treaty, the dispute is “purely contract claim” and such breach does not constitute a breach of the umbrella clause; while some other tribunals hold that any breach of the contract with an investor by the investment destination country government constitutes breach of the umbrella clause of the investment treaty. Some tribunals have taken the middle way. They classify the investment destination country’s interference into“inter-state contract” conduct and “commercial contract” conduct. If the investment destination country’s conduct merely constitutes commercial breach under the contract without abuse of state power, it is not covered by the umbrella clause. If the investment destination country’s conduct involves act of state or abuse of state power, the umbrella clause shall apply^[13].

As a PPP project involves allocation of risks between public and private sectors and public services, an investor would generally sign a project contract with the investment destination country government or the platform company authorized by the government. For some PPP projects, concession shall be obtained from the government. Under the project contract and concession, the government assumes contractual obligations and enjoys contractual rights as a common commercial party on the one hand; on the other hand, it carries out administrative licensing, administrative regulation and service pricing activities as the administrative body.

In case that the administrative regulation, concession, and other administrative activities of the investment destination country government are performed in violation of the investment treaty, such as arbitrary revocation of administrative licensing, abuse of regulatory power, and other conduct suspected of violating principle of just and impartial treatment agreed upon in the investment agreement, it is not much controversial to consider such conduct as an arbitrable matter on the basis of the investment arbitration clause in most investment treaties which are broad.

In some PPP projects, when the investment destination country government fails to honor its commitments to the investors, it will take advantage of its domestic laws to liquidate or reorganize the project company or withdraw the concession by means of judicial procedure, or, even if the investor has obtained a favorable award through litigation or commercial arbitration, the investment destination country government may utilize its domestic judicial procedures to obstruct the enforcement of the award. Under such circumstance, although the administrative authority as a party to the project agreement is not directly involved, there is nothing controversial that the acts of the court and other judicial organs of the investment destination constitute acts of state in practice of investment arbitration. Unjust treatment of the investor in bankruptcy and reorganization procedures of the project invested by the investor or the court of the investment destination delaying in enforcement of the arbitration award may constitute an arbitrable matter under investment arbitration.

In the case of solely commercial conduct of the government as a party to the PPP project contract, it is uncertain whether the investor may initiate investment arbitration in accordance with the investment treaty. In the event that the investment agreement specifies that any and all investment-related disputes may be referred to arbitration, and that there is an umbrella clause or most-favorable-nation treatment clause available, an investor may attempt to leverage such favorable clause to claim amplified interpretation of an arbitrable matter and include contract dispute in the scope of arbitrable matters.

It is noted that, in the case of solely breach of the PPP project contract by the government, if the investor has exhausted the domestic judicial remedies of the investment destination and is subject to miscarriage of justice, such breach may constitute a breach of the investment treaty by the investment destination country government. A solely contract dispute will hence become a treaty dispute, in which case the investor may refer to arbitration in accordance with the investment treaty.

In case of a PPP project contract with a platform enterprise authorized by the government, if the platform enterprise breaches its obligations under the project contract, it shall be considered whether the breach of the enterprise can be ascribed to the government (investment arbitration may only be initiated against the investment destination government). In practice, the threshold of ascribing an enterprise’s conduct to the government is high. The tribunal generally will take into account the following factors in determining the same, i.e., whether the enterprise can be deemed a stateorgan, whether the enterprise is authorized to exercise public power, whether the enterprise’s conduct is subject to the government of the state^[14].

IV. Investor identification in investment arbitration

The ICSID Convention governs only the dispute arising out of investment between the investment destination country and the national of another state. Therefore, it is a key issue subject to the examination of ICSID whether the party initiating investment arbitration satisfies the definition of “the national of another state” under the Convention. Similarly, investment arbitration rules of other arbitration organizations have also explicitly defined the status of the arbitration applicant. Therefore, it is an issue that an investor must address to initiate an arbitration whether such investor is a qualified arbitration applicant.

It is defined in the ICSID Convention and investment treaties signed by China with other states that “investors” generally include natural persons and legal persons of the state. A natural person can be identified as an investor when he/she simultaneously meets the following two conditions: (1) he/she has the nationality of the investment destination; and (2) he/she has the nationality of another state on the date of submission of the dispute to arbitration and the date of registration of the application pursuant to the ICSID Convention. In the case of a legal person, there is not a uniform standard to determine its citizenship. The same legal person may be a citizen of many countries according to different standards, such as the place of incorporation, the location of management center, domicile, the location of the natural person who controls the capital of the legal person, etc. Therefore, if the investment treaty does not contain further provision on the standard for determining the citizenship of a legal person, the arbitration organization and tribunal shall decide case by case. Generally, however, the citizenship of the legal person shall be determined based on its place of incorporation or the state of its management center.

It is also provided in the ICSID Convention that, the legal person that is subject to a foreign control can be deemed as a qualified “foreign investor” even if it has the nationality of the investment destination. As the ICSID Convention omits to provide a detailed standard for the definition of “foreign control”, the tribunal will weigh on the shareholding ratios of domestic and overseas shareholders, voting right, and status of directors of the legal person.

In order to fill the said gap in the ICSID Convention, definition of the citizenship of a legal person and “foreign control” are covered in some latest investment treaties. For example, in the investment treaty concluded between China and ASEAN, the legal person of one party to the treaty shall be (1) duly incorporated or organized under the applicable laws of a party thereto; and (2) has substantial business operation within the territory of such party.

In practice, the status of the investor may be quite complicated sometimes. For example, a natural person may obtain a dual citizenship and may be a permanent resident of a state to the treaty; and as for a legal person, there might be issues like special purpose vehicle (SPV), share transfer by the foreign shareholders, and change of citizenship. In the investment in an overseas PPP project, a complex investment structure will be designed for financing, taxation, or commercial purposes, such as establishing an off-shore company in a third country, establishing a project company in the investment destination, etc. In some cases, a company is incorporated as the investor in a third state which has entered into a more favorable investment treaty with the investment destination, in order to enjoy a more favorable treatment. It is common issue in practice of investment arbitration whether such company incorporated in a third country is an investor under the investment treaty and whether such company has the right to initiate investment arbitration pursuant to the investment treaties between the third state and the investment destination country. It should be taken into account in preliminary planning of the project how the investor makes use of the more favorable investment treaty to the extent possible to protect its legitimate rights and interest by setting up a reasonable investment structure.

In the practice of investment arbitration, the tribunal generally is inclined to amplify interpretation of the definition of an investor in order to obtain jurisdiction over the case, subject to the ICSID Convention and investment treaties. For example, it is explicitly required in the China-ASEAN investment treaty that the legal person shall have substantial business operation within the territory of one party to the treaty. A shell company that has no substantial business operation is likely to be deemed ineligible as an investor under the investment treaty^[15].

In consideration of the above, the investor should fully consider how to utilize a favorable investment treaty as well as the specific requirements for an investor under the investment treaty, in setting up the investment structure, so as to prevent the circumstance that a shell company does not conform to the requirements under the investment treaty. In addition, in case of share transfer or the investor’s involvement in the operation of an overseas PPP project by share purchase during the long-term operation of the PPP project, it should be covered in the due diligence whether the investment treaty will continue to apply so as to make an overall risk assessment.

V. Investment arbitration and domestic procedures of the investment destination

As described above, the investment made by an investor is protected by multiple legal systems, including domestic laws of the investment destination and international treaties. In order to balance the investment destination’s interest and prevent the investor from seeking double remedies by way of both domestic procedures and international investment arbitration, some investment treaties require the investor to exhaust local remedies before initiating investment arbitration or elect to seek remedies by way of either domestic procedures or investment arbitration.

Exhaustion of local remedies is an important principle of international law, which requires the party concerned to exhaust all available administrative and judicial remedy procedures of the investment destination and fully and legitimately use up the remedies available in all applicable litigation and arbitration procedures under domestic laws before initiating arbitration. This principle requires the party concerned to not only exhaust all final administrative reconsideration and final judicial ruling, in terms of procedure, but also fully leverage specific remedies available under domestic laws, such as production of evidence and call for presence of witnesses.

Explicit provision on exhaustion of local remedies is not common in the bilateral or multi-lateral investment treaties executed by the Chinese government. Early investment treaties generally contain a local remedy clause with a fixed term, i.e., the investor should first bring the dispute before a domestic court of the investment destination. If the dispute cannot be resolved before the court within a period of time, the dispute may be referred to investment arbitration. In arbitration practice, however, this clause is often circumvented as the most-favored-nation treatment clause by the tribunal or interpreted as non-binding on the ground of unattainability and unfairness^[16].

In case of dispute between the investor and investment destination, it is often difficult for the investor to be treated justly and fairly by the investment destination country government. Not only are the remedies inaccessible through local remedy procedures of the investment destination, a large amount of time and money would also be wasted. Therefore, PPP project investors should avoid including such clause in the investment contracts as much as possible. If the investment treaty between the home country and the investment destination contains similar clause, the investor should not be limited to domestic remedies of the investment destination but consider submitting the dispute to investment arbitration by using the most-favored-nation treatment clause, fair treatment clause, etc., so that it will not be stuck in the mire of domestic procedures of the investment destination.

In addition to exhaustion of local remedies, some investment treaties may require the investor to choose between the domestic and international arbitration procedures. For example, it is agreed in the France Argentina bilateral investment treaty that, the investor may choose to bring the dispute relating to an investment before the domestic court of the investment destination or refer it to international investment arbitration; it is provided for in the North American Free Trade Agreement (NAFTA) that an investor may refer the dispute relating to the breach of NAFTA by a party thereto to investment arbitration only where it waives domestic remedies.

As described above, a contract claim is different from a treaty claim in theory. In case of dispute relating to the investment contract, some holds that the aforesaid provisions on selection of procedures may be interpreted as requiring the investor to fully waive the right to contract claims in the investment destination, but rather than waive the investor’s right to remedies in case of the investment destination country’s breach of treaty in the investment destination only (which will not affect the contract claim). Therefore, in case of any dispute relating to a cross-border PPP project contract, if the investment treaty contains the said requirement for procedure selection while the investor intends to seek remedies through investment arbitration, the investor, for the sake of prudence, shall avoid bringing contract claim in the investment destination, so that it will not be deemed waiving the right to investment arbitration.

VI. Conclusion

Investment arbitration plays an important role in the multi-level dispute resolution system and even works as the last resort for dispute resolution due to its transparency and publicity. Chinese enterprises going global should make full use of existing international investment arbitration system by including investment arbitration into their risk prevention system during preliminary demonstration and design of the project. They should fully demonstrate and justify the investment from the aspects of selection of investment treaties, establishment of the investment vehicle, and conclusion of an investment contract, so as to reduce procedural obstacles and effectively and timely safeguard their own investment rights and interests in case of dispute.