Unqualified Fair & Equitable Treatment Clause: It’s Time to Revamp

[Ameya Vikram Mishra is an associate at J. Sagar Associates, New Delhi and Nikhil Pratap an advocate practising in Delhi]

Recently, Cairn Energy plc filed a petition in the South District of New York to attach Air India’s assets. This action has been taken pursuant to an award by an arbitral tribunal (“Tribunal”) constituted under the Bilateral Investment Treaty between the United Kingdom and India signed in 1994 (“India-UK BIT”). The award, which was passed on 21 December 2020, found India guilty of violating the fair and equitable treatment (“FET”) provision under the India-UK BIT. The recent events have once again brought to light the unintended consequences of having unqualified FET clauses under international investment agreements (“IIAs”). The issue of unqualified FETs in investor-state disputes has been a longstanding one. In this post, the authors provide a brief background to the award passed by the Tribunal, highlight the issues arising from unqualified FETs, discuss some other well-drafted FETs and suggest a way forward.  

The Cairn Award

In 2012, the Indian Government passed an amendment to its income tax law which retrospectively taxed indirect transfer of capital assets by non-residents (“2012 Amendment”). Only a few years earlier (in 2006), Cairn Energy plc and Cairn UK Holdings Limited (together, “Cairn”) had carried out an internal corporate restructuring. In this process, Cairn had indirectly transferred its India assets to its Indian subsidiary, Cairn India Limited. After the 2012 Amendment, the Government of India demanded that Cairn pay taxes on the indirect capital gains from the 2006 corporate restructuring.

Cairn initiated arbitration proceedings, specifically alleging that India violated the FET clause (Article 3(2)) of the India-UK BIT by demanding aforesaid tax payment. The broadly-worded FET clause of the India-UK BIT reads as follows: “Investments of investors of each Contracting Party shall at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other Contracting Party.” [emphasis added] Thus, the principal issue before the Tribunal was whether India’s tax demand from Cairn, in pursuance of its 2012 Amendment, was in violation of the FET clause? To answer the question, the Tribunal had to first determine the ambit of protection offered by the FET clause.

India argued that the FET clause did not explicitly specify the applicable standards of protection and, therefore, the protection under the clause ought to be limited to the minimum standard of treatment under customary international law (“MST”). On the other hand, Cairn contended that the applicable FET standard must not be limited by the MST and should be autonomous, as there is no specific reference to MST under the FET clause.

The Tribunal rejected India’s argument and decided to interpret the FET clause independently from MST, by referring to ‘general principles of law’. It held that treaties and customary international law, which traditionally regulate state-to-state affairs, offer limited guidance in resolving disputes between an individual and the state.Thereafter, by relying on precedents from prior investment arbitration disputes, the Tribunal came to a finding on the scope and interpretation of the FET clause in the instant case. Applying these FET standards, the Tribunal then held that the 2012 Amendment violated the FET clause under the India-UK BIT. Therefore, the Tribunal effectively rejected a consistent international law standard of FET interpretation, and offered greater protection than the MST. Finally, the Tribunal held that India’s conduct breached the FET provision under the India-UK BIT, and directed India to pay more than $1.2 billion to Cairn.

The Cairn-India decision is a case in point for the varied problems associated with an unqualified and broadly worded FET provision, such as the FET clause in the India-UK BIT. In such cases, the tribunal is free to adopt a ‘general principles of law’ methodology of interpretation and has an unfettered discretion in deciding the scope of the FETs. The purpose of any IIA is primarily to ascertain the contours of protection of a foreign investment. When the Tribunal is allowed wide discretion in deciding the scope of FETs, a gamut of uncertainties open up for affected parties under IIAs. As such, general, broad and vague FET clauses go against the foundational purpose of any FET clause and often result in, inter alia, legal uncertainty and overbroad interpretations by arbitral tribunals. In fact, interpretation of unqualified FET clauses has been widely criticized as being “often selective, Western-centric, and expressed at a high level of generality”.

Rethinking FET Clauses

It appears that unqualified FET standard provisions are the most prevalent choice for FET clauses around the world. UNCTAD’s research conclusions indicate that out of a sample 2,575 IIAs, 1,985 IIAs have included unqualified FET standard provisions in one form or the other. Like in the case of the India-UK BIT, these FET provisions are characterised by minimalist and open language which do not provide any explanation or clarity on the expected FET standards. In order to mitigate the risks and problems associated with unqualified FET clauses, having an international minimum standard for protection of foreign investment, or listing out particular State obligations under FET provisions, seems to be the trend under the recent IIAs.

Though the emergence of an international minimum standard for protection of investments can be traced back to the decision of the US-Mexico Claims Commission in L.F.H Neer and P. Neer (USA) v United Mexican States in 1926, it is important to note that 14 out of the 15 IIAs concluded in 2019 have incorporated a minimum standard of treatment of investments under customary international law or have clarified FET standards with a list of state obligations.

The inclusion of an international minimum standard (MST or otherwise) under FET clauses, or having qualified FET provisions specifying a list of state obligations, can go a long way in preventing over-expansive interpretations ascribed to FET clauses by arbitral tribunals. Well laid out minimum standards of protection provide the necessary guidance to the tribunals in interpreting the FETs. This, in turn, reduces the risks to both foreign investors and states from incurring unintended liability for a purported violation of the FET clause. The advantages of well-qualified FET standards is fortified by OECD data which indicates that states have “greater success defending claims under MST (minimum standard of treatment) FET provisions than under FET provisions that are interpreted as being autonomous”.

Having recognised the benefits of the prescribing minimum standards, various countries have included a list of state obligations under FET clauses. The Comprehensive Economic and Trade Agreement between Canada and the EU (“CETA”) signed in 2016, is a prominent example. CETA includesa clear, closed text which defines precisely the standard of treatment, without leaving unwelcome discretion to the Members of the Tribunal”. In line with this, the European Commission has explained that the intent is “to clarify the standard, in particular by incorporating key lessons learned from case-law. This would eliminate uncertainty for both states and investors.” Further, the EU-Vietnam FTA (2016) and the EU-Singapore FTA (2018) also provide an exhaustive, but expandable list. By use of qualifiers such as “manifest” arbitrariness and “fundamental” breach of transparency (for reference see Article 8.10 (2) of the CETA), the FET clauses in these EU agreements have been worded in a manner that only serious state violations against a foreign investment will qualify as a breach of FET standards. Other IIAs such as the UK-Colombia BIT (2014) and Japan-Colombia BIT (2011) include a list of state obligations along with an international minimum standard.

The FET provision under the France-Colombia BIT (2014), in particular, is an important example, especially in the backdrop of the Cairn Award. The FET emphasises that states are not precluded from amending municipal laws or adopting new laws in the context of the FET standard. The intent of the French authorities is clear from its proposal, addressed to the European Commission, wherein it has clarified that an investor cannot expect that “laws will remain unchanged and that they cannot rely on the concept of “legitimate expectations” to challenge a mere change of law, even if such a change caused a significant loss of profit.” Article 8.9 (2) of the CETA also adopts a similar approach in its FET which provides that modification of laws by the state which negatively impacts investment or investor expectations alone does not amount to a breach per se. This approach mitigates the state’s risks of incurring unintended liability under FET standards.

An expected criticism of the foregoing is that this will allow unfettered discretion to States to change their laws. However, such criticism is unfounded because flexibility to change laws does not necessarily mean that the state has a blanket right to regulate. To the contrary, the intent of the qualified FET clauses is to unambiguously indicate where such right to regulate ends and therefore provide certainty of outcome to the parties.

In any event, the purpose of citing the above examples is not to analyse the FET clauses with the aim of prescribing the right balance between the protection to the investors vis-à-vis the states. The authors believe that the content and contours of the FET clause and the level of protection may vary in each case, depending on the negotiations between the parties.

India’s Way Forward

India has been well-aware of the shortcomings of unqualified and broadly worded FET provisions. In 2016, India drafted a model BIT wherein the FET clause has been replaced with a customary international law standard of protection. The model BIT specifically protects foreign investments from denial of justice, fundamental breach of due process, targeted discrimination on manifestly unjustified grounds, and manifestly abusive treatment (such as coercion, duress and harassment). Therefore, the model BIT has attempted to provide textual guidance on the exact contours of the protection to foreign investment. However, the exclusion of an FET clause from the model BIT has its own set of problems. Firstly, investors have a legitimate expectation of protection from arbitrary state actions. Non-inclusion of an FET clause having well-defined protections may indicate a balance in favour of the state’s right to regulate and discourage foreign investment. Secondly, excluding an FET clause may also result in reciprocal disadvantages to Indian investment overseas.

The Cairn Award is an opportunity for India as well as other countries to draw important lessons and realise the value of well-defined and comprehensive FET clauses. Such a clause enables both the states and foreign investors to have greater certainty in the outcome of disputes and mitigate risks for both the parties. As such, both the states and foreign investors benefit from them. We are of the view that India will do well if it incorporates balanced and well-defined FET clauses, with international minimum standards of protection, in all future BITs.

Ameya Vikram Mishra & Nikhil Pratap

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