Fraport v. Philippines: ICSID Arbitration Tribunal refuses to hear merits of a $425 million dispute because the investment was made knowingly in violation of Philippines law
Summary and business impacts
On 16 August 2007, a Tribunal constituted under the Rules of the International Centre for the Settlement of Invesment Disputes (ICSID) held that German company Fraport's investment in Manila airport had not been made in accordance with the laws of the Philippines. Furthermore, Fraport was fully aware that it was in breach of domestic law. Since the protection of the German/Philippines Bilateral Investment Treaty (BIT) extended to investments which had been "accepted in accordance with the respective laws" of either contracting State, the project did not constitute an "investment" for the purposes of the BIT and the Tribunal denied jurisdiction to hear the case.
This decision is significant because it illustrates the fact that bad faith non-compliance with local laws at the moment when an investment is concluded is likely to prevent a dispute proceeding past the jurisdictional phase. Given that most BITs include an "in accordance with host state law clause" this case is potentially relevant to a wide range of investors.
From 1999, Fraport invested heavily in the construction of Terminal 3 of Manila airport. In particular, Fraport:
- acquired, through a cascade of companies, a majority shareholding of the company PIATCO which held a concession agreement with the Philippines Government; and
- assumed effective control of PIATCO through a series of confidential shareholder agreements with the cascade companies.
Fraport specifically chose to enter into these secret agreements as it considered control of the project to be "the only plausible way for its equity investment to prove profitable". However, Philippines Anti-Dummy Legislation prohibits foreign investors from assuming actual managerial control of a utilities company.
Under pressure of political and corporate lobbies, the Government annulled the concession agreement and Fraport initiated ICSID proceedings in September 2003.
Tribunal's findings: control and concealment
The Tribunal's denial of jurisdiction in this case centred on Fraport's acquisition of control of PIATCO in contravention of national law, but also, crucially, on its concealment of the shareholder agreements. In the Tribunal's view, this demonstrated bad faith, not least because local counsel had explicitly warned Fraport that "a particular structural arrangement would violate a serious provision of Phillippines law" and Fraport went on to conceal its illegitimate control from the Philippine authorities.
Interestingly, according to the Tribunal, an investor should be given the benefit of the doubt where the transgression of a host state law is a good faith error, since this could easily result from lack of understanding of the foreign law.
A further important distinction drawn out by the Tribunal was that a refusal of jurisdiction should be limited to cases where the investment was made illegally (assuming the host Government was not aware of the illegality when it approved the investment). Where violations occur in the course of an investment, this may prejudice a claimant at the merits stage, but it should not cause a Tribunal to refuse jurisdiction.
This case is the latest in a line of recent ICSID Awards considering the issue of compliance with the host state's national laws as a jurisdictional requirement. As such, it seems to indicate an important trend that future Tribunals are unlikely to ignore. However, this Award is particularly significant, being the first to clearly set out a Tribunal's remit to refuse to hear the merits of a case where there is non-compliance with domestic law. In particular, bad faith is likely to be a key factor, going forward, in any such case.
In the reasoning behind its decision, the Tribunal explained that "some reciprocal if not identical obligations lie on the foreign investor". This provides a warning for investors to respect the law of the place of the investment and to deal with one's host in good faith.