1. China invests abroad
Chinese outbound direct investment ("ODI") reached new heights in 2012, as Chinese companies invested approximately US$77.2 billion overseas – an increase of nearly 3,000 per cent compared to the 2002 figure of US$2.5 billion. The upward trend in outbound investment flows suggests that outbound investment may soon match, or even exceed, the flow of foreign direct investment ("FDI") into China. As China's economy has matured in the past decade into a major source of ODI, Chinese companies have made significant investments and strategic acquisitions around the world.
The European Union is the primary recipient of Chinese capital investment, with over US$12.6 billion invested during 2012. Other major destinations for Chinese ODI are North America, South America, Australia, and Africa. Chinese companies have also broadened the industry scope of their investments, which were historically made to support China's vast manufacturing capacity. Today, China is investing in sectors ranging from natural resources to services, information technology, consumer brands and intellectual property. More than half of China's total outbound invested capital – US$243 billion – is in natural resource extraction projects.
2. What is the need for investment protection?
The raw numbers tell a dramatic story of economic expansion, driven mostly by Chinese government policies that encourage Chinese companies, particularly including State Owned Enterprises, to invest outside of China. As with any investment, foreign investment poses risks, many of which will be unfamiliar to enterprises that are new to investing abroad. Obvious risks of injecting capital into foreign states include currency fluctuations, unfamiliar regulatory systems and employment laws, tax, and the inherent challenges of working across cultures. A lesser-known, but equally potent, risk is unlawful governmental interference, which can impair or destroy the value of the investment. How can Chinese companies take advantage of legal protections against unlawful interference by host state governments?
Governments wield sovereign powers, including the power to make and change laws. The legislative framework in which an investment is made can have significant effects, either supporting the business or making it harder for businesses to succeed. Legislative instability is a risk for any business, but can be particularly acute for foreign investments. In order to foster a predictable and positive legal climate and attract foreign investors, many States have entered into a multi-layered network of international investment protections. These protections, often implemented through reciprocal treaties between two or more states, provide foreign investors with legal rights under international law. China has one of the world's most extensive networks of investment treaties, which operate both to protect Chinese investors when they invest in certain foreign States, and to protect investors from those States when they invest in China.
3. Bringing claims against host states
International investment arbitration
International investment arbitration is an effective method of resolving disputes between investors and host States. Historically, the doctrine of sovereign immunity meant that a foreign national had no direct remedy against a State that had expropriated its investment or taken some other action that violated the foreigner's rights. Before international arbitration provided a direct remedy against the State, injured foreign nationals had to seek protection from their own State, which enjoyed complete discretion to "espouse" the claims of its injured nationals at the international level.
Now, though, in many cases a foreign investor may bring claims directly against host state governments for breaches of international obligations, by commencing an investment arbitration. The basis of jurisdiction for investment arbitration tribunals to hear such claims directly against sovereign states is consent. States consent to resolve disputes with investors through arbitration in a number of ways:
- Bilateral Investment Treaties ("BITs")
- Investment Chapters of Free Trade Agreements
- Multilateral Investment Treaties
National Investment Laws
- Unilateral declaration by a State of consent to arbitration over certain disputes
Contracts (Investment Agreements)
- Frequently seen in extractive industries, in which States partner directly with foreign investors
What protections are generally available?
Fair and Equitable Treatment
- Fair and Equitable Treatment ("FET") is the treaty protection that is most frequently-invoked by Tribunals to find that a State has breached its international obligations.
- Nearly every Chinese BIT contains a formulation of FET1, but international jurisprudence on the content of the FET standard is not consistent, largely because of variations in treaty drafting – for example, some investment treaties tie the FET standard to the minimum standard under customary international law (as in the NAFTA), while others appear to provide for an autonomous FET standard. Most Chinese investment treaties do not refer to a particular body of law or standard to aid with interpreting the content of the FET provision.
- The location of an FET clause in an investment instrument may impact its legal effect. If it is in the "treatment" article, it may be interpreted to only apply after an investment is made, and not apply to the admission of the investment into the host state. The placement of the FET provision in Chinese investment treaties varies.
- One of the dominant elements of the FET standard that has emerged in investment treaty jurisprudence is the protection of the investor's "legitimate expectations".
- Other elements of the FET standard that are frequently discussed in investment treaty jurisprudence are the host state's obligations to (i) provide "Protection and Security"; (ii) to provide a stable, predictable, and consistent legal framework; (iii) to provide substantive due process and protection from measures which are "arbitrary or discriminatory"; (iv) to provide procedural due process and not deny justice; (v) to act transparently; (vi) to act consistently with the requirement of reasonableness and proportionality; and (vii) to act consistently with its national laws (the principle of legality).
- The National Treatment standard in most investment treaties provides that states will provide treatment to foreign investors that is no less favourable than the treatment provided to the host state's own investors.
- In contrast to the FET standard, the National Treatment standard is relative, and depends on the level of treatment provided to similarly-situated local entities.
- The majority of Chinese investment treaties do not contain a National Treatment obligation.
- China has been reluctant to include robust protections under the National Treatment standard. The Japan-China-South Korea trilateral agreement of May 2012 is an example: Article 3(2) carves-out pre-existing non-conforming measures which provide more-favourable treatment to investors of the host state as compared to foreign investors.
- China has insisted on this measure in order to protect its policies that subsidise and afford better treatment to State-Owned Enterprises ("SOEs"), although it applies reciprocally and means that Chinese investors may not be able to complain against the operation of pre-existing measures that favour investors of the host State.
Most-favoured Nation Treatment
- A corollary to the National Treatment standard, the Most-Favoured Nation ("MFN") standard requires a host state to provide treatment that is no less favourable than that provided to investors of any third state. In theory, this means that each investor covered by an MFN guarantee should be able to access the best standard of protection available under any of the host state's investment treaties, unless an express exception applies.
- Much like the evolution of China's own investment treaty practice, states frequently revise their investment treaties, and each is the product of significant bilateral negotiations. It may be possible that a host state has an investment treaty in place with a third state that provides better treatment than would be available under the applicable treaty with China, especially if the Chinese BIT was signed in the first or second generation.
- There is mixed jurisprudence about whether investors may use MFN guarantees to take advantage of more favourable dispute resolution clauses in treaties between the host state and some third state. This issue may be particularly important to Chinese outbound investors, as early Chinese BITs did not provide for investor-state dispute resolution through arbitration. Chinese investors should pay careful attention to the dispute resolution mechanisms available to their investments, and consult expert advisors to structure investments to obtain the best possible set of protections.
Protection of commitments made to investors ("Umbrella Clauses")
- Fewer than half of China's investment treaties have an "umbrella clause" that specifically provides protection for breaches of commitments made by a host state to a foreign investor.
- Those that do contain an umbrella clause typically follow a standard formulation, which requires contracting parties to observe all obligations/commitments they have entered into or assumed against foreign investors.
- The umbrella clause is often compared to an "elevator" that may transform breaches of obligations into treaty breaches, although the scope of the types of breaches that can be so elevated is not settled in practice.
- The question of whether a Chinese investor may use the MFN provision in a Chinese BIT to avail itself of an umbrella clause in a BIT between the host State and a third country has not been tested.
- All three of China's model BIT forms provided that a contracting party may expropriate foreign investments if the expropriation is (i) for a public purpose, (ii) carried out in a non-discriminatory basis and (iii) under domestic legal procedure, and (iv) accompanied by compensation.
- Under international law, both "direct" and "indirect" expropriation have been recognized. Direct expropriation typically involves a State physically seizing assets or transferring legal title. Indirect expropriation is less well defined, but usually measured by the extent to which a state's indirect measures have effectively "neutralize[d] the benefit of the property of the foreign owner".2
China's network of investor protections
Bilateral Investment Treaties and Multilateral Treaties
China's BIT program began in 1982, when China signed its first BIT with Sweden. Today, over 130 BITs are in force between China and other States, including many – but not all – of China's major economic partners. A full list of China's current BITs is at the end of this guide.
The "first generation" of Chinese BITs were signed between 1982 and about 1989. China introduced a revised Model BIT in the late 1980s, leading to the "second generation" of Chinese BITs between 1990 and 1997. In the late 1990s China further revised its Model BIT, and the modern generation of Chinese BITs began in about 1998. Over the decades of its program, China's practice in treaty negotiations has evolved significantly, and its modern investment treaties accord in most respects with international practice.
- China's most recent BITs were signed with Chad (26 April 2010), the Democratic Republic of Congo (11 August 2011), and Canada (9 September 2012)
- Treaty Protection coverage is extensive in Asia (76% of States), Europe (26 of 27 EU States, excepting Ireland), and Africa (over 60%).
- Notable Exceptions to China's investment treaty portfolio: The United States, Brazil
- China is known to be in negotiations with the United States
- European Union announced in May 2013 that it has formally asked its member states to agree to opening negotiations with China for the first EU-wide BIT
China has also signed several multilateral investment protection agreements, including:.
- China-ASEAN FTA signed in August 2009
- Trilateral Agreement between Japan, South Korea, and China in May 2012
What Substantive Protections are available to Chinese ODI?
Any Chinese company looking to invest overseas should consider the following key factors when structuring its investment:
- Does the host State have a treaty with China that covers investments?
- Does the host State have a national law to protect foreign investors?
- If a treaty or national law does provide legal protection, what substantive rights does it protect? Does it offer recourse to international arbitration against a host State to remedy violations of the investor's rights?
- Is there a contract/concession/license with the host State that includes consent to arbitrate disputes?
Key Protections under Public International Law
The substantive protections that apply under China's investment treaties are not all identical, and in some cases more favourable protections may be available under a national investment law, investment contract, or even a treaty signed between the host State and some third State. It is critical to examine the terms of each applicable investment protection instrument to analyse the substance of available legal protections.
Why do the protections afforded to Chinese investments vary under treaties with different States?
- There have been three different generations of Chinese investment agreements, beginning with the first BIT with Sweden in 1982.
The first generation of Chinese BITs, from about 1982 until 1989, included the typical protections of public international law, such as definitions of investment and investor, fair and equitable treatment, most favoured nation treatment, and expropriation and compensation. However, early Chinese BITs did not give investors the option to refer disputes to international arbitration, except for the limited purpose of determining the amount of compensation due for an expropriation.
- Many countries with which China signed first-generation BITs have since signed more-recent BITs. For example, The Netherlands signed its first BIT with China in 1984, and replaced it in 2004.
- The second and third generations of Chinese investment agreements introduced access to international arbitration, including arbitration for investor-State disputes under the auspices of the International Centre for Settlement of Investment Disputes ("ICSID"). These new Chinese BITs also introduced revised, generally more liberal, formulations of the substantive protections provided to covered investors.
- The launch of negotiations with the European Union is significant, as the EU has indicated that improved access to the Chinese market – through the reform of structures like mandatory joint ventures – is one of its key goals. That could mean extending National Treatment protection to EU investors in China, which China has traditionally resisted in order to protect legislative preferences for Chinese State-owned enterprises. The EU may wield sufficient economic influence with China to achieve this goal because it is China's largest trading partner, largest source of FDI into China, and largest destination of Chinese ODI.
4. Key questions for Chinese investors
What if the investment protection instrument that covers my investment is not as strong as a more recent Chinese BIT?
- Because Chinese investment treaty practice has varied so significantly, it is likely that more recent Chinese BITs offer better protections than older BITs.
- Analyse the available protections on a case-by-case basis, since the individual drafting of each treaty is of critical importance.
- Seek expert advice on how to structure and operate investments in order to maximise available protections and withstand challenges associated with structuring investments through third states.
Can I restructure an investment to gain more favourable treatment, either by coming under investor-state protections for the first time or by taking advantage of the provisions of a more favourable treaty?
- In many cases, yes – but consult an expert first. Investment tribunals have recognised a distinction between pre-dispute planning for investment protection (which is a legitimate element of corporate planning) and restructuring an investment to gain the protections of a treaty after a dispute has arisen (which has been rejected as an abuse of the arbitral process).
I am having a problem with a host government – how can you help?
- Herbert Smith Freehills has extensive experience advising investors on every aspect of obtaining and enforcing protection for investments under international law. Our expertise covers a variety of industries, including oil and gas, mining, major infrastructure projects and financial services in all parts of the world.
- Our team of public international law specialists includes professionals in offices across China, Asia and the rest of the world, and we frequently handle high-profile disputes that involve sensitive political or public-relations elements. In addition, we are one of only a handful of firms that frequently acts on behalf of sovereign governments, and many of our professionals sit regularly as arbitrators – giving us a well-rounded perspective when designing investment protection or dispute resolution strategies for our clients.
5. Chinese Bilateral Investment Treaties
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