A New Age for Chinese Bilateral Investment Treaties: Re-examining Expropriation
Under public international law, a state can exercise its sovereign claim over any property located within its territory, including foreign-owned private property. However, the prerogative of states to dispense foreigners of their property is not an absolute right. Indeed, customary international law holds that expropriation must be: (i) for a public purpose; (ii) non-discriminatory; (iii) in accordance with due-process; and (iv) compensated. Problematically, while states agree with these conditions in principle, they hold divergent views when it comes to interpretation. In particular, controversies are common on the construction of ‘compensation’. Difficulties also arise when states expropriate investments for legitimate regulatory purposes.
Bilateral Investment Treaties (BITs) supplement public international law in these respects by bringing certainty to the rules governing international investments. Through BITs, states are free to agree on the rules governing ‘compensation’ and ‘expropriation’ between themselves. Ultimately, the role of BITs is to create consistency to prevent disputes and ensure clarity to facilitate the settlement of disputes. In these ways, they give investors confidence in the security and potential of their investments.
How BITs coincide with Chinese interests
China’s inflow investment potential is sizeable. While it is the world’s largest economy, China accounts for only 4-5% of European investments abroad. In a similar vein, China’s outflow investment potential also remains largely untapped. This is indicated by its foreign direct investments (FDI) which represent less than 3% of FDI in the European Union. Outside of the EU, China is looking increasingly towards Africa, Latin America, and Central Asia for FDIs in raw materials.
Given these considerations, it is imperative that China draws a new road map for economic trade to replace the one it has used since becoming party to the World Trade Organization in 2001. Accordingly, modern BITs would allow Chinese financial potential to manifest in new streams of trade and investment.
The makings of a modern BIT
Although China’s legal framework has changed drastically in the past two decades, the legacy of its prior regimes continue to influence investment attitudes today. As such, fair and transparent BITs that assure the mutual protection of foreign investments in China and Chinese investments in foreign states would go a long way in boosting investor confidence. In part, this would require Chinese BITs to demarcate the boundary between different constructions of ‘compensation’ and resolve the inherent tension between ‘expropriation’ and ‘legitimate regulations’.
In the past, China embraced the Calvo Doctrine to assess compensation for the expropriation of foreign assets. The Calvo Doctrine highlights that the treatment of foreign investors should be ‘no more favourable than’ that accorded to national investors. Under this definition, foreign investors are not protected if a State’s domestic laws on compensation are intrinsically unfavourable.
Since around 2000 however, China has trended towards adopting a variation of the Hull Formula in assessing compensation. The Hull Formula better embodies the principle of just compensation as it prescribes that compensation must be ‘prompt, adequate, and effective’. In spite of this, the Hull Formula is inadequate per se as a method to determine compensation because it leaves open critical determinations such as the valuation date and interest terms. For example, the China-Chile BIT only requires that compensation ‘shall amount to the real value of the investment’ and the Sweden-China BIT simply declares that compensation should ‘place the investor in its original financial position’. Although these are prima facie just and reasonable terms, they do not delineate a consistent method to determine the actual compensation owed to an aggrieved investor.
This article suggests that the compensation provisions in Chinese BITs should pre-define the appraisal methods for both valuation dates and interest terms. For example, valuation can be explicitly designated as ‘immediately before expropriation was made public knowledge’ or ‘immediately before the expropriation took place’. The latter designation is reflected in the China-Peru Free Trade Agreement where compensation is held to be ‘equivalent to the fair market value of the expropriated investment immediately before the expropriation took place’. Similarly, interest could be defined as ‘the prevailing commercial interest rate from the date of expropriation to the date of payment’.
Direct expropriation, defined as ‘the mandatory legal transfer of property or its outright physical seizure’, is a rare phenomenon today. Instead, expropriation usually exists in an indirect form as ‘a measure that does not involve an overt taking, but that effectively neutralizes the enjoyment of the property’. Disputes on this front often hinge on the difference between lawful regulation and indirect expropriation because unlike expropriation, states are generally not liable for losses resulting from the good faith application of policy measures.
The tension between economic regulation and expropriation was explored in Tza Yap Shum v. The Republic of Peru, ICSID Case No. ARB/07/6. In Tza, the claimant was a Chinese national who owned a purchase and exporting company (the Company) in Peru. The question before the Arbitral Tribunal was whether interim measures imposed by the Peruvian taxing authority, which included a direction to Peruvian banks to retain any funds passing through them in connection with the Company’s transactions, amounted to indirect expropriation. In arriving at its decision, the Tribunal considered whether the interim measures ‘significantly interfered’ with the Company’s operations as well as the ‘arbitrary nature’ of the interim measures.
On the question of ‘significant interference’, the Tribunal found that the interim measures were a ‘strike at the heart of the operative capacity of [the Company]’. Since the Company’s business model used Peruvian banks to conduct its transactions, the interim measures ‘severely and substantially’ interfered with the Company’s operations. On the question of ‘arbitrariness’, the Tribunal found that the tax measures were arbitrary in nature because they did not comply with Peruvian taxation guidelines. The Tribunal held that, viewed in totality, the imposition of interim measures constituted an indirect expropriation of the claimant’s investment, thereby breaching the China-Peru BIT.
Tza is illuminative for setting out the default factors that determine indirect expropriation. More importantly, it highlights the importance of minimizing ambiguities in regulation-caused expropriation. To that end, this article recommends that Chinese BITs adopt a formula for indirect expropriation similar to the 2012 Model U.S. BIT. Under Article 4 Annex B of the Model U.S. BIT, factors such as: (i) the economic impact of the government action; (ii) the extent to which the government action interferes with distinct, reasonable investment-backed expectations; and (iii) the character of the government action, contribute to the determination of whether an action constitutes a legitimate sovereign act or indirect expropriation.
Towards stronger investment relations
Since signing its first BIT with Sweden in 1982, which provided very limited protection for foreign investment, Chinese BITs have evolved significantly. The emergence of ‘second-generation’ Chinese BITs in 1998, which offered much more substantive protection for foreign investment, transformed China’s FDI framework. However, China’s legal, political, and economic models have progressed immensely since that time. It should therefore embrace a comprehensive and anticipatory approach in its BIT negotiations and re-negotiations going forward. Such a transition would assist China in building its foreign investment capabilities.
