A Caution to Investors

Investors should carefully consider the extent to which their foreign investments will be protected through any applicable investment treaties. For example, through Bilateral Investment Treaties (BITs), countries offer investors basic guarantees in the hope of attracting foreign investment. These treaties often allow investors to directly bring claims against a country through arbitration when there is a violation of the treaty.

Many of the BITs under which investors bring their arbitration claims include a Non-Precluded Measures (NPM) clause, meant to limit a country’s liability in certain exceptional circumstances. Recently these clauses have been invoked by Argentina as a defense to drastic government action following its response to the economic crisis in 2001. Various International Centre for Settlement of Investment Disputes (ICSID) panels are reviewing and shaping the scope of these NPM clauses, and determining how they will be applied. The interpretation and application of NPM clauses will be critical to both host governments and foreign investors in determining government freedom to respond to exceptional circumstances, and to determining the scope of investment protections available under BITs.

The Example of Argentina

In 2001, Argentina’s economy collapsed as a result of a severe economic crisis. When the collapse occurred, Argentina attempted to stabilize the economy and to restore political confidence through various measures, including passing an Emergency Law on January 6, 2002. The Emergency Law eliminated the peso/dollar parity peg, and ordered public utility rates to be converted into pesos at a rate of 1:1. These actions imposed painful costs on foreign investors who had bought into privatized utility companies. Foreign investors harmed by the Emergency Law sought legal protection under various applicable BITs.

In response, Argentina invoked the NPM clauses contained in its BITs as a defense. NPM clauses allow governments to take actions otherwise prohibited by the relevant treaty when, for example, the actions are necessary for the protection of essential security, or for the maintenance of public order. As long as the host-government's actions are consistent with one of the exceptions specified in the particular NPM clause, acts otherwise prohibited by the treaty will not constitute breaches of that treaty.

The first four awards handed down by ICSID arbitration panels, out of the many cases brought against Argentina as a result of Argentina’s reactions to the economic crisis, have taken different approaches to the NPM clause of the US-Argentina BIT. On the same facts, three tribunals, in the CMS v. Argentina, Enron v. Argentina and Sempra v. Argentina arbitrations, found the NPM clause inapplicable and held Argentina liable for damages to investors in breach of the treaty. A fourth tribunal, in the LG&E v. Argentina arbitration, found Argentina's defense under the NPM clause justified and held that Argentina was not liable to investors for harm caused during a certain period of the economic crisis.

The four tribunals did agree on two key points. First, the tribunals interpreted the essential security and public order provisions of the US-Argentina BIT broadly enough to encompass economic emergencies — this could set a precedent in any future cases where arbitrations arise as a result of government responses to an economic crisis. Second, all four tribunals agreed that the NPM clause in the US-Argentina BIT is not self-judging. In other words, the government invoking the NPM clause cannot decide for itself whether that clause would be applicable in any given circumstance. All four tribunals decided that any emergency action taken by a government is subject to review by tribunals.

Although all four tribunals agreed that the NPM clause in the US-Argentina BIT was not self-judging, the LG&E tribunal was far more deferential than the CMS, Enron and Sempra tribunals. Those tribunals applied the customary law requirement of necessity, requiring Argentina to show that the actions taken were the only ones available to the government in response to the crisis. In contrast, the LG&E tribunal applied a level of scrutiny closer to a good faith review, affording Argentina some deference in reviewing its own determinations of the appropriate responses to the crisis.

An Annulment Committee under the ICSID Convention reviewed the award issued in CMS v. Argentina, and criticized the tribunal's handling of the necessity defense for failing to separately analyze the defense under the treaty as well as under customary international law. It nevertheless held that it did not have the authority to correct the tribunal's legal errors since it had not acted in manifest excess of its powers.

The Resulting Divide in Opinion

The troubling split in decisions by these tribunals has sparked an important debate on how NPM clauses should be interpreted. Some legal scholars have contended that the interpretation of NPM clauses as an equivalent to the necessity defense is problematic. It has been argued that reading the customary defense of necessity into the NPM clause violates the canonical rule of interpretation that each treaty provision must be given effect. Some scholars have claimed that the NPM clauses would serve no purpose if they merely referred to the necessity defense, since that defense would already be available in customary law. Therefore, the clauses would not meaningfully increase government freedom of action in exceptional circumstances. As a consequence, under the three tribunals’ interpretation, the risks and costs of government actions in exceptional circumstances would largely fall to the governments.

Those who advocate a deferential review of the invocation of NPM clauses contend that to refuse to do so could prevent a government from taking necessary action in the event of a crisis. Governments often face unexpected threats and crises. If they must bear the full costs of harms to investors caused by a response to a crisis, they may not be able to respond to a crisis in the preferred way. Some governments may not be able to afford their preferred policy in response to a crisis, due to fear of incurring significant liabilities.

ICSID tribunals have increasingly faced questions outside of traditional foreign investment issues, which have required them to review governmental policy, such as the legally permissible responses to a massive economic crisis. Yet, ICSID tribunals often lack the capacity to fully appreciate the context of government policies. Some legal scholars have argued that these tribunals may not be in the best position to undertake substantive reviews of essential governmental policies. Undertaking a good-faith review of these issues would allow ICSID panels to have a supervisory role, without taking away from host-governments the freedom to develop policy responses they deem appropriate.

There are others, however, who have advocated for a less deferential review of the invocation of NPM clauses, for the sake of protecting investors and securing continued foreign investment. These proponents argue that despite the benefits of a deferential review, many investors may perceive such reviews to be detrimental to their interests.

All sides agree that some level of review is necessary in order to balance government freedom of action with investor protection. However, it is important to ensure that when governments attempt to transfer the risks of government action to investors in extreme situations, they can do so only in legitimate and limited circumstances. Furthermore, nations that are deficient in rule of law, in the operation of their court system and in governance, generate the very risks that concern foreign investors. These risks, in turn, disproportionately expose such countries to investor arbitration claims. In many of these situations, it is plausible that a government might not follow its own laws. Moreover, if host-governments are able to invoke NPM clauses as a defense, subject to a very deferential review, foreign investors may not receive enough protection to outweigh the benefits of foreign investment, and foreign investment may decline significantly in countries greatly dependent on it.

Looking Forward

As this controversy has yet to be resolved, both host-governments and investors should pay close attention as ICSID panels continue to review and analyze the NPM clauses in investment treaties. The interpretation of these clauses can help both host-governments and investors to better understand the scope of their protections under relevant treaties, and will allow investors to better assess the costs and benefits of engaging in foreign investment.