Decoding India’s New Model BIT (I)

By Kavaljit Singh | Commentary | May 11, 2015

In 2013, India launched an official review of its bilateral investment treaties in the wake of public outcry over arbitration notices issued by several foreign investors. Since India negotiates BITs on the basis of a model, the purpose of the review was to revise the 1993 model treaty text in tune with the recent developments and to provide a roadmap for the re-negotiation of country’s existing BITs. In April 2015, the government released a new model treaty text which will replace the previous model text of 1993 and invited comments from public.

So far, India has signed bilateral investment treaties (BITs) with 86 countries. Apart from standalone BITs, investment chapters of India’s FTAs with Singapore, Japan and South Korea also contain investment protection measures.

It is important to note that India is not alone in reviewing its BITs regime. Currently, a number of developing countries are questioning the rationale of investment agreements as these are neither necessary nor sufficient to attract foreign investment. The growing number of investor claims against sovereign states challenging a wide array of public policy decisions and regulatory measures has evoked deep concerns about the potential costs associated with such treaties. In early 2014, Indonesia announced its plan to re-examine more than 60 bilateral investment treaties. Like India, Indonesia is also drafting a new template for its bilateral investment treaties. South Africa terminated its treaties with Germany, Switzerland and Spain based on a three-year review and decided to replace its BITs regime with a new domestic legislation which aims to protect investor rights while safeguarding domestic policy space.

The Review Process

In India, the review process was carried out by an inter-ministerial working group led by Ministry of Finance. What is perplexing is that no inputs from domain experts, think-tanks, NGOs, and business associations based in India were sought by the working group while preparing the model text. Even the state governments whose actions can be challenged and subjected to international arbitration were not consulted. The drafting of the new model text was carried out by bureaucrats in consultation with just four international institutions. There is nothing wrong with consulting foreign experts and institutions per se, but no explanation has been given why no inputs were sought from experts and institutions based in India. In contrast, the US and South Africa sought active participation of all relevant stakeholders from their society in the review process as well as formulating the new text. It is only after the draft text was prepared, the government sought views from the public.

A Major Departure

Undeniably, India’s new model BIT is a major departure from the 1993 model. It new model provides an innovative approach to deal with imperfections of the current investment treaty regime in India. The new model text does not include several controversial investment protection obligations such as most favored nation (MFN) treatment while new obligations on investors have been introduced to ensure a balance between investor rights and obligations. Besides, the framework of investor-state dispute settlement (ISDS) system has been substantially improved. Unlike the 1993 model BIT which espouses twin objectives of investment promotion and investment protection, the new model BIT confines itself to a treaty narrowly focused on investment protection only.

Some of the key provisions of draft text of India’s new model BIT (posted online in April 2015) are examined below.

Preamble

The Preamble provides an introduction to the long-term objectives and goals of an investment treaty. The Preamble of 2015 model BIT reaffirms the right of State Parties to regulate investments in their territories in accordance with their laws and national policy objectives. It asserts the right of Parties to introduce new rules and regulations on investments.

The Preamble of new model BIT broadens the objectives of investment treaties by adopting a development-centric approach. It seeks to align the objectives of investment with “sustainable development and inclusive growth of the Parties.”

Defining Investment and Investor

In a bilateral investment protection treaty, the definition of investment and investor is of paramount importance because it determines what kinds of capital flows and investors would be protected under its framework.

The 1993 model BIT uses an “asset” based definition of investment which includes “every kind of asset” such as moveable and immovable property, shares, debentures, financial contracts, intellectual property rights and business concessions. The “asset” based definition of investment was formulated way back in the 1960s by the capital-exporting (developed) countries to protect a wide range of assets of their investors in the capital-importing (developing) countries. As pointed out by Nathalie Bernasconi-Osterwalder and Lise Johnson, a major problem with an expansive asset-based definition is that any kind of asset (for example, a company’s goodwill or money lying idle in a bank account) could qualify as an investment and therefore is eligible for protections given under the BITs.[1] Whether such assets contribute to the development of host-country economies is highly questionable.

In contrast, India’s new model BIT adopts an “enterprise” based definition of investment thereby confining it to only one form of external finance, namely, foreign direct investment (FDI) in the host state. In a narrow manner, an enterprise is defined as one having “real and substantial business operations” in the host state with “substantial and long-term commitment of capital” and engagement of a “substantial number of employees in the territory of the host state.” It further requires an enterprise to have “assumed entrepreneurial risk” and made “a substantial contribution to the development of the Host State through its operations along with transfer of technological knowhow, where applicable.”

By incorporating these precise definitions of investment, India has followed the so-called ‘Salini test’ approach (by reference to the arbitration award in Salini Costruttori SpA & Anor v. Kingdom of Morocco) to determine whether a transaction qualifies as an investment. The four criteria followed by the arbitral tribunal in this case are: a contribution made by an investor; certain duration of the enterprise; an assumption of risk; and a contribution to the economic development of the host state. In other words, an enterprise which carries out minimal business operations in the host country will not qualify as an investment.

The new model BIT clarifies that the real and substantial business operations do not include business arrangements created for the purpose of avoiding tax liabilities besides passive holdings of stocks, securities, land and other property.

The new model explicitly states that an enterprise must be “constituted and operated in compliance with the laws of the host state.” This clause has been specifically added in the text to deny protections to an enterprise that has violated obligations related to corruption, disclosures and taxation (listed in Chapter III of the new model BIT). It is worthwhile to note that there are some recent cases (for instance, Inceysa Vallisoletana S.L. v. Republic of El Salvador) where the arbitral tribunals have rejected the claims filed by investors on the grounds that investments were procured by fraud and corruption.

The new model only recognizes those investors who directly own and control an enterprise, thereby precluding claims being brought by indirect or minority shareholders. Not long ago, multiple cases were brought by minority shareholders of companies against Argentina for implementing measures to mitigate its financial crisis of 2001. There are many other instances where foreign investors (irrespective of shareholdings) have submitted claims under the investor-state arbitration on the grounds that their shares constitute the investment.

The new model also adds criteria regarding ownership and control of an enterprise. According to the new model treaty, an enterprise would be considered as “owned” by the investor if such investor directly or beneficially owned more than 50 percent of the capital in the enterprise. On the other hand, an enterprise will be considered as “controlled” by the investor, if such investor has the right to appoint directors or senior management officials or to control the policy decision of an enterprise.

Additionally, the model treaty excludes following assets of an enterprise from the definition of investment:

  • Portfolio investments;
  • Any interest in debt securities issued by a government or loans to a government or government-owned enterprise;
  • Any pre-operational expenses incurred for the establishment of the enterprise in the host state;
  • Claims to money that arise from from commercial contracts;
  • Goodwill, brand value, market share or similar tangible rights; and
  • An order or judgement in any judicial, regulatory or arbitral proceedings.

Furthermore, a holding company will not qualify as an investment entity and therefore assets owned by such companies in an enterprise will not get any protection under the new model BIT. A holding company serves as an investment vehicle for investors to own shares in other companies rather than producing goods or services. A holding company does not engage in the day-to-day operations of the companies owned and controlled by it.

The new model BIT defines both natural persons and enterprises “conducting real and substantial business operations in the home state” as investors. The inclusion of requirement that investors conduct real and substantial business operations in the home state is intended to deny protection to so-called “mailbox companies” which have a minimal commercial presence in the home country. A 2006 report SOMO (Centre for Research on Multinational Corporations) estimated that The Netherlands hosts nearly 20,000 “mailbox companies” which do not have a substantial commercial presence.[2] India receives substantial foreign investments from such “mailbox companies” located in Mauritius, Singapore and The Netherlands.

The denial of protection to mail-box and similar kinds of companies is significant because in the present-day globalized world economy, investors can easily maneuver their nationality or establish a legal presence in the home state to take advantage of a particular investment treaty. In tax matters, the practice of so-called “treaty shopping” is widely prevalent in India as foreign companies often route their investments through Mauritius, Singapore, Cyprus and other low-tax jurisdictions to take advantage of India’s double taxation avoidance agreements with these countries. Mauritius, for instance, accounts for more than 40 percent of India’s FDI since 2000.

In sum, India has opted for a narrow definition of investment and investor besides interpretative clauses have been incorporated to clarify the meaning and intention of several provisions.

Defining Measures

The new model text defines measures as legally binding actions by a governmental body that directly affect an investment. However, it defines government to include only central and state governments in the case of India. Hence, measures taken by local governments and institutions (such as municipalities, gram sabhas and gram panchayats) have been explicitly excluded from the scope of the BIT. The 1993 model BIT does not forbid foreign investors from bringing claims against measures taken by local governments and institutions.

[1] Nathalie Bernasconi-Osterwalder and Lise Johnson, Commentary to the Austrian Model Investment Treaty, IISD Report, International Institute for Sustainable Development, September 2011, p.7.

[2] Michiel van Dijk, Francis Weyzig and Richard Murphy, The Netherlands: A Tax Haven?, SOMO, November 2006.

This is the first in a series of five articles that will analyze the new model text for Indian bilateral investment treaty.

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