On 26 March 2019, Australia and Hong Kong signed the Australia-Hong Kong Free Trade Agreement (A-HKFTA) and its associated Investment Agreement.

The Investment Agreement updates the investment rules in force between Australia and Hong Kong, which are currently contained in the 1993 Agreement between the Government of Australia and the Government of Hong Kong for the Promotion and Protection of Investments. The 1993 Agreement will be terminated and replaced by the new Investment Agreement upon entry into force of the A-HKFTA.

This article outlines some of the key differences between the two international agreements. In summary, the Investment Agreement is more modernised and aims to better balance the right of an investor to bring a claim with the right of governments to regulate in the public interest.

Most significantly, the definition of ‘investor’ excludes from its scope shell or mailbox companies owned by persons of a third country that do not have substantial business activities in the State. This change will have implications for investors seeking to structure themselves through a shell company to optimise investment protection. Whereas previously shell companies could be incorporated in (say) Hong Kong to take advantage of investment protections, the changes now deny protection to shell companies incorporated in Hong Kong without a substantial business presence there.

Finally, at a time when investor-state dispute settlement has its advocates and dissidents, it is interesting to note that the Investment Agreement provides investors from Australia and Hong Kong with access to an independent arbitral tribunal to resolve disputes.

Investor and Investment

The definitions of ‘investor’ and ‘investment’ are important to the scope of application of the rights and obligations of an international investment agreement.

Under the Investment Agreement, an ‘investor of a Party’ means ‘a Party, a natural person of a Party or an enterprise of a Party, that has made an investment in the Area of the other Party’.

A natural person is, for Australia, an Australian citizen or permanent resident of Australia and, for Hong Kong, a permanent resident of Hong Kong. A natural person who is both of these things shall be deemed to be a natural person of the Party with whom he or she had a predominant link taking into account (e.g.) the person’s permanent home, habitual residence and economic interests.

Critically, an enterprise of a Party must carry out substantial business activities in the area of that Party.

The new definition of ‘investor’ is significant. An investment must now be held by a company incorporated in Australia or Hong Kong that has substantial business activities in that State. The definition excludes shell or mailbox companies owned by persons of a third country that do not have substantial business activities in the State.

The phrase ‘substantial business activities’ is not defined. It will be a question of fact as to whether the business activities of the investor are ‘substantial’. Presumably if activities are undertaken as a commercial enterprise and for a profit, this will be sufficient.

The definition of ‘investor’ also needs to be read with the denial of benefits clause in Article 14 which permits the exclusion of certain investors from protection. It enables Australia or Hong Kong to deny the benefits of the Investment Agreement to an investor in certain circumstances. Such a clause is not uncommon in modern treaties, but Article 14 is a relatively narrow clause of this nature. It contemplates circumstances where the denying State has regulations in place that prohibit transactions with the investor.

The new definition of ‘investment’ is typically broad and has the now commonplace characteristics ‘commitment of capital or other resources, the expectation of gain or profit, the assumption of risk’. We see this expression in Australia’s free trade agreements with the US, Chile and Japan, for example. The definition also expressly excludes ‘an order or judgment entered in a judicial or administrative action’ (preventing a claim in respect of local decisions).

Substantial protections

The Investment Agreement contains the usual standards of protection including a requirement to pay compensation in certain circumstances when an investment is expropriated.

There is a difference worth mentioning here when considering the protection against expropriation of an investment. The 1993 BIT previously only used ‘deprivation’ language in its protection against expropriation clause, which is fairly atypical of investment agreements. Article 6(1) of the 1993 BIT required that investors ‘shall not be deprived of their investments nor subjected to measures having effect equivalent to such deprivation’. This language, which prohibits the ‘deprivation’ of an investment, is significantly wider than the language in the new Investment Agreement, which prohibits expropriation. The term ‘expropriation’ carries with it the connotation of a ‘taking’ of a person’s property with a view to transferring ownership of that property to another person (such as the State). By contrast, a “deprivation” can occur without a ‘taking’.

In addition, the Investment Agreement aims to better balance the right of an investor to bring a claim with the right of governments to regulate in the public interest.

In the preamble, both State parties recognise ‘their right to regulate’ and resolve to ‘preserve their flexibility to set legislative and regulatory priorities, safeguard public welfare and protect legitimate public welfare objectives’.

The Investment Agreement introduces a range of general exceptions to the investment protections offered therein, none of which exist in the 1993 BIT, to permit the host State to regulate in the public interest.

For example, both State parties are free to take measures (inter alia) that are necessary to:

  • ensure that investment activity is undertaken in a manner that is sensitive to the environment (Art. 15);
  • protect public morals or maintain public order (Art. 18); (in respect of the latter, only where a genuine and sufficiently serious threat is posed to a fundamental interest of society); and
  • protect human, animal or plant life or health (Art. 18).

ISDS

The Investment Agreement contains an investor-state dispute settlement mechanism, providing investors from Australia and Hong Kong with access to an independent arbitral tribunal to resolve disputes for breaches of the investment rules.

Critically, however, the ISDS mechanism cannot be used to challenge a State’s public health measures or tobacco control measures.

We saw a product-specific exclusion like this for the first time in the CPTPP. Against the backdrop of ISDS following the introduction of tobacco plain-packaging legislation in Australia, the CPTPP introduced a clause preventing tobacco companies making use of its ISDS provisions. A State party to the CPTPP could elect to deny the use of ISDS for claims challenging a tobacco control measure.

The A-HKFTA says that no claim may be brought in respect of:

  • measures comprising or related to the Pharmaceutical Benefits Scheme, Medicare Benefits Scheme, Therapeutic Goods Administration and Office of the Gene Technology Regulator”; or
  • a Party’s control measures of tobacco products (including products made or derived from tobacco), cigarettes, imitation smoking products, and other smoking products such as Electronic Nicotine Delivery Systems and Electronic Non Nicotine Delivery Systems including electronic cigarettes)”.

Importantly, the ISDS provision in the A-HKFTA includes ‘procedural safeguards’, some of which are common to investment agreements and some of which are relatively new in the context of international investment agreements. These are summarised below.

Prior to initiating proceedings, the investor must first endeavour to resolve its dispute with the State through consultations for at least six months, a period that is typical of consultation periods in investment agreements. The investor must initiate proceedings within three-and-a-half years from the date on which the investor first acquired, or should have first acquired, knowledge of the alleged breach (Art. 27(1)). This limitation period is also typical.

The notice of arbitration must be accompanied by a waiver, by the investor, of any right to initiate the claim before any other domestic or international court or tribunal (Art. 27). This requirement is intended to prevent the investor forum shopping. There is also scope for the tribunal to decide as a preliminary question, on an expedited basis, an objection that a claim is manifestly without legal merit (Art. 29(4)). This provides a mechanism to strike out frivolous or baseless claims. A related mechanism to discourage frivolous claims is the tribunal’s ability to award costs against the investor if the tribunal finds in favour of the respondent’s objection (Art. 29(6)).

The A-HKFTA has improved provisions that ensure transparency of the arbitral proceedings. The host State is required to provide all of the arbitral documents (including the notice of arbitration, pleadings, transcripts and the award) to the non-disputing State party and to the public, and hearings are open to the public (Art. 30). These requirements are subject to provisions for the protection of information that is in a State’s essential security interests.

What now?

The change in international relations will be important to many. Hong Kong is one of Australia’s most significant trading partners, representing Australia’s sixth largest source of foreign investment.

Over 600 Australian companies have a major presence in Hong Kong. Hong Kong represents an ideal location for Australian companies looking to expand into Asia, and its position as a Special Administrative Region of the People’s Republic of China also means that Hong Kong plays a significant role in Australian inbound and outbound Chinese investment.

Both countries will now follow the applicable domestic treaty making processes to ratify the agreements.

In Australia, however, it remains to be seen whether the forthcoming federal election will have any impact. First, any review of the treaty by the Joint Standing Committee on Treaties is not likely to be completed until after the election. But secondly, although the current Coalition government is said to support the inclusion of ISDS clauses, the Labor party has said that it “will review ISDS provisions in existing trade and investment agreements and seek to work with Australia’s trading partners to remove these provisions”.