In a recent blog post1, we examined the implications of Indonesia's notification that it will not renew its bilateral investment treaty ("BIT") with the Netherlands and reports that it was intending to terminate its BITs with 66 other states. Indonesia's motivations ultimately remain unclear, but some have speculated that Indonesia is reacting to the hefty claims brought against it by investors pursuant to BITs and now wishes to renegotiate its existing BITs.

In this newsletter we consider what these developments might mean for Japanese (and other international) investors in Indonesia and what steps Japanese investors may wish to consider.

Typical protections afforded by BITs

BITs establish protections for investments by nationals and companies of one state being made in another state (the "host state") against particular conduct by the host state.

The protection offered by different BITs varies greatly, but often they will:

  • guarantee that investors and their investments will be treated no less favourably by the host state than the host state's own investors (national treatment) or investors from other states (most-favoured nation treatment);
  • protect against expropriation of an investment by the host state without compensation; and
  • require the host state to provide full protection and security for foreign investments.

Importantly, BITs will typically provide investors with a means to enforce these protections – through international arbitration against the host state before a neutral tribunal (Investor State Dispute Settlement (ISDS) mechanisms).

BITs are therefore an effective way of encouraging foreign private investment between signatories and managing the sovereign risk for investors when investing in a foreign country. Before making a foreign investment, prudent investors will usually consider carefully the available investor protections, and structure their investment so as to receive the most favourable protections to be sought under BITs.

How might the termination of Indonesia's BITs affect Japanese investors?

With its growing economy, large consumer base and abundant natural resources, Indonesia remains a key target for Japanese foreign investment. In 2013, Japanese investors were the largest foreign direct investors in Indonesia by volume, with a total in excess of US$ 4.7 billion. Reports place between 1,200 and 1,300 Japanese companies operating in Indonesia and in 2013 Japan was Indonesia's largest export market, with bilateral total trade volumes for the year exceeding US$ 43 billion.

How will Indonesia's actions affect Japanese investors? Much will depend on the structure of the investments made.

Investments structured under BITs to be terminated

Investors commonly structure investments through special purpose companies incorporated in intermediary countries. This allows risk to be insulated and provides protection under specific investment treaties when investing in foreign countries.

For example, the Netherlands is often used for this purpose because of the breadth of protections offered by the Netherlands' BITs and the fact that they normally apply to investors of other states investing through Dutch incorporated companies. Japanese investors may find that their Indonesian investments are structured to benefit from one or more existing BITs that are reported to be terminated. However, the good news is that the impact of Indonesia's decision will likely not be immediate.

This is because BITs commonly only permit termination if notice is given prior to the end of initial or rolling renewal periods (often in the region of 10 years) or require fairly extensive notice periods before terminations become effective. Termination, however, is not usually the end of the protections; BITs will often include a "sunset clause" under which qualifying investments made prior to termination will continue to benefit from such protections for a set future period. Once this period ends the protections will fall away.

In the case of the Netherlands BIT, existing investments are protected for a further 15 years after termination under the sunset clause. Therefore, if the notice by Indonesia terminates the Netherlands BIT at the end of the current renewal period (1 July 2015), investments made prior to that date will continue to receive protection until 2030. For the Indonesia/Australian BIT – which has a renewal period ending in 2022 – protections will continue until 2037. The particular position will depend on the BIT through which the investment is structured.

Protections under the Japan/Indonesia Economic Partnership Agreement

The 2008 Japan-Indonesia Economic Partnership Agreement ("EPA") – effectively a free trade agreement – also contains protections equivalent to those in BITs, from which qualifying Japanese investors may benefit. These protections include full compensation for an investor in the event its investment is expropriated, the right to be treated no less favourably than domestic investors or investors from other states and full protection and security for investments. The EPA also provides access to ISDS mechanisms for investors through international arbitration.

In this regard, Japanese investors may be in a better position than certain other international investors – there have been no reports that Indonesia intends to terminate its free trade agreements or multilateral agreements that include investor protections, such as the EPA. Qualifying Japanese investors may therefore continue to seek recourse to international arbitration in respect of breaches by Indonesia of investor protections through the EPA.

Other protections available for Japanese investors in Indonesia

Even if Indonesia withdraws from its BITs, other routes may remain for Japanese (and other international) investors in Indonesia to benefit from investor protections. One way might be through structures benefiting from relevant multilateral treaty arrangements with Indonesia, such as:

  • The ASEAN Comprehensive Investment Agreement (ACIA), which provides investors incorporated in ASEAN nations with many protections offered by BITs.
  • Other ASEAN free trade agreements with Australia and New Zealand, China, Korea and India.
  • The Organisation of Islamic Cooperation (OIC) agreement for the protection, promotion and guarantee of investments entered into between various member states of the OIC.

Additionally, investors can potentially benefit from rights under the domestic Indonesian Investment Law and if the foreign investor is in a strong position, it may be able to negotiate contractual protections equivalent to those in BITs.

Conclusion

Whilst there may be no immediate effect on existing investments covered by BITs to be terminated and protections may continue for some time, we recommend that Japanese investors take stock now and consider how existing Indonesian investments are structured and whether they will continue to benefit from the best possible protection in the longer term. Even where sunset periods exist in BITs, these protections may not continue for the full anticipated duration of an investment. In addition, given the potential for change in the investment environment in Indonesia, investor protections may take on a new level of prominence. If concerns exist, it may be sensible to consider restructuring existing investments to achieve better levels of protection.

Japanese investors making new investments in Indonesia should also consider how to structure those investments to gain adequate investor protections, whether this is through the protections in the Japanese/Indonesia EPA, BITs with longer sunset periods, or one of the other protections identified above.

The structuring of investments to gain investor protections can be a notably complex topic.