The Investment Treaty Arbitration Review: Legal Defences to Claims

I Introduction

A claimant investor may submit an investment treaty claim based on a number of legal grounds from the relevant treaty or customary international law, or both. Yet, just as the claimant investor can choose among various grounds for making a claim, the respondent host state may also have resort to multiple layers of defences. While a host state's strategic planning will inevitably focus on objections to jurisdiction when a dispute first arises, it is also very important to consider at an early stage what defences could be raised against the merits of the claims.

In response to an investor's claim that the host state has breached an obligation under the treaty or international law, the host state may deny the occurrence of the alleged breach. Alternatively, the host state may raise legal defences, effectively arguing that the acts or omissions complained of were justified. This chapter will focus on a host state's legal defences to investment treaty claims.

Legal defences to investment treaty claims can be based on various grounds. Those that have been recognised under customary international law include force majeure, distress and necessity. These customary international law defences are often incorporated into the provisions of investment treaties, along with exceptions to investment protection standards applicable to laws and regulations of the host state enacted for reasons of security, public health or public order.

II The 'necessity' defence

Among the defences based on customary international law, 'necessity' arguably presents the most intriguing issues and challenges in the context of international investment disputes. A respondent host state may claim that its acts are justified on the ground of 'necessity' when there is an irreconcilable conflict between an essential interest of the host state on the one hand, and an obligation of the state on the other.2 Necessity differs from force majeure in that it does not concern an uncontrollable situation that prevents the host state from fulfilling its obligations, but is rather a defence that applies where the host state has deliberately taken a measure that may appear to be in breach of an obligation.3

While the necessity defence is well established in international law, it was not invoked in international investment disputes until relatively recently. The judgment of the International Court of Justice (ICJ) concerning the Gabčíkovo-Nagymaros Project (1997) is known to be the first judgment in which the defence of necessity was pleaded and reviewed by an international dispute settlement body.4 In that case, the ICJ confirmed that the state of necessity is a ground recognised by customary international law.5 However, the ICJ noted that necessity as a ground for precluding wrongfulness can only be accepted on an exceptional basis where the specified requirements are satisfied, and that the host state is not the sole arbiter of whether those conditions have been met.6

The required elements of a state of necessity are generally understood to be set out in Article 25 of the International Law Commission's Draft Articles on Responsibility of States for Internationally Wrongful Acts adopted in 2001 (the ILC Articles). In order for a state of necessity to be recognised, the host state must establish the following elements: (1) the existence of a grave and imminent peril, (2) that threatens an essential interest of the respondent state, (3) the state's act is the only way to safeguard that essential interest, and (4) the state's act should not seriously impair another essential interest. Also, the plea for necessity is excluded if (5) the international obligation in question excludes invoking necessity, or (6) the state has contributed to the situation of necessity. According to the accompanying ILC commentary, 'necessity' concerns 'exceptional cases' for which conditions are 'narrowly defined' under Article 25.7

The defence of necessity was one of the core issues in investment treaty disputes arising from Argentina's economic crisis in the late 1990s.8 Among these, CMS v. Argentina (2005)9 and LG&E v. Argentina (2006)10 were the first two cases that reached different decisions on Argentina's necessity defence. Both cases concerned Article XI of the Argentina–United States bilateral investment treaty (BIT) (1991), which provides that '[t]his Treaty shall not preclude the application by either Party of measures necessary for the maintenance of public order, the fulfillment of its obligations with respect to the maintenance or restoration of international peace or security, or the protection of its own essential security interests'.

Both tribunals took the view that economic peril qualifies as an 'essential security interest' within the meaning of Article XI.11 However, while the tribunal in the CMS case was persuaded that the situation was difficult enough to justify the government taking action to prevent the danger of total economic collapse, it did not agree that the measures adopted by Argentina were the only steps available.12 Finding also that government policy errors had contributed significantly to the crisis, the tribunal in the CMS case ultimately declined to accept Argentina's defence based on necessity.13 In reaching that decision, the CMS tribunal applied not only Article XI of the BIT, but also the customary international law standards for necessity as set out in Article 25 of the ILC Articles.

By contrast, the tribunal in the LG&E case accepted Argentina's necessity defence, holding that it was exempt under Article XI of the BIT from responsibility for the enacted measures during the state of necessity.14 Whereas the CMS tribunal had also considered the customary international law requirements for necessity, the LG&E tribunal decided the issue more narrowly based on Article XI of the BIT, which arguably prescribes a lower standard, and applied general international law only to the extent necessary and required for the interpretation and application of the treaty.15 Consequently, the tribunal rejected LG&E's contention that Argentina's economic measures were not the only means available to respond to the crisis, noting that Article XI merely refers to a situation where a state has no choice but to act.16

As other commentators have observed, it is troubling that the CMS and LG&E tribunals reached contrary conclusions as to the necessity defence based on the same factual matrix and available legal standards.17 For what it may be worth, the approach taken by the LG&E tribunal appears to represent the minority approach among investment treaty cases that have dealt with the issue of necessity.

More recently, in the case of Union Fenosa Gas v. Egypt (2018),18 the tribunal rejected Egypt's necessity defence pleaded under customary international law (i.e., under Article 25 of the ILC Articles).19 Deciding that the respondent state bears the burden of proving its defence of necessity,20 the tribunal found that Egypt's act of privatising domestic electricity was not the only way to safeguard Egypt's essential interests against a grave and imminent peril (i.e., social unrest or concerns that serious unrest might ensue in the aftermath of the Egyptian revolution).21

In light of the Union Fenosa Gas v. Egypt decision, it may be said with some confidence that where the customary international law standard for necessity as set out in Article 25 of the ILC Articles is applied, the respondent state will need to establish that the measure complained of was 'the only way for [it] to safeguard an essential interest against a grave and imminent peril', and that this can be very challenging in practice. It is probably because of the rather strict applicability of this and other requirements under Article 25 that the defence of necessity has not been invoked more frequently by respondent states. However, where the operative treaty can be said to apply a lower threshold for assessing a state of necessity, the LG&E case may still offer useful guidance to respondent states seeking to assert that defence.

As the effects of the covid-19 global pandemic continue to pose a serious challenge to governments throughout the world, it is widely expected that treaty claims alleging that counter-measures were adopted in breach of obligations under investment treaties will inevitably follow. When confronted with such claims, host states will undoubtedly want to explore the availability of legal defences based on force majeure or necessity in light of the facts and circumstances of each such case. While it is too soon to assess how host states will utilise such defences or the extent to which they will be accepted by tribunals, this is an area that merits close attention going forward.

III Defences based on exception clauses in the treaty

Many investment treaties contain exception clauses providing that the host state is not prevented from adopting or enforcing legislative or regulatory measures under certain specified grounds or in certain areas. From the perspective of a host state, the inclusion of such exceptions in investment treaties is an essential means for maintaining regulatory power with regard to foreign investors and for preserving regulatory flexibility in designated policy areas.22 It is also a way to avoid risk of getting awards that opt for a purely economic approach rather than taking into account public interest defences by host states.23

A typical example of an exception clause that has served as a model for similar clauses in BITs is Article XX of the General Agreement on Tariffs and Trade (GATT). Such clauses provide that nothing in the treaty prevents the state from taking measures necessary to protect values such as public morals, human, animal, or plant life or health, environment, national treasures of artistic, historic or archaeological value, etc. Furthermore, exception clauses often provide that a state is not prevented from taking any action that it considers necessary for the protection of its essential security interest. It is to recent developments surrounding such essential security interest clauses that we now turn.

Russia's annexation of Crimea in 2014 was followed in short order by the filing of investment treaty claims against Russia by Ukrainian investors. Since 2014, at least 13 separate investment treaty arbitrations are reported to have been initiated based on allegations that assets and investments were compromised by Russia's annexation of Crimea.24 These claims were filed under the BIT between Ukraine and the Russian Federation (1998). Although the Russian Federation initially denied the legitimacy of these proceedings and raised various jurisdictional objections over these claims, tribunals have been constituted and the cases have proceeded. Awards on the merits have been rendered in a number of these cases. For example, in an award issued in May 2018 in the case brought by Everest Estate and others, the tribunal found the Russian Federation liable for breaches of its obligations relating to expropriation under the BIT and awarded over US$130 million as compensation to the claimants.25 In an award issued in November 2018, the tribunal in the case brought by Oschadbank ordered the Russian Federation to pay damages in an amount equivalent to approximately US$1.3 billion for breaches of treaty obligations in relation to the expropriation of a branch of Oschadbank in Crimea.26 And in an award issued in April 2019, the tribunal in the case brought by Stabil and others ordered Russia to pay damages in the amount of US$34.5 million for breaches of treaty obligations in relation to the expropriation of petrol stations in Crimea.27

In May 2019, the Russian Federation purported to adopt a new defence strategy when its Justice Minister announced that claims would be dealt with at their 'early stages' before awards are made. This statement has been interpreted as a signal that Russia will adopt a comprehensive defence strategy in future, including not only objections to jurisdiction and admission, but also the assertion of factual and legal defences to liability and quantum, as well as challenges to enforcement.28

It will not have been lost on observers of the Crimea cases that this course change in defence strategy followed the issuance of a number of adverse arbitral awards in those cases. Yet a less obvious point that may also merit consideration in this regard is that the ability of the Russian Federation to respond more effectively to the Crimea cases may have been hampered by the fact that the Russia–Ukraine BIT does not contain essential security or other exception clauses.29 If the BIT had contained such clauses, it is not inconceivable that Russia may have adopted a more aggressive – and successful – defence strategy from the beginning.

In that context, we turn to consider another recent development involving Russia and Ukraine. That is, the issuance on 5 April 2019 of a landmark decision in a trade dispute between the Russian Federation and Ukraine in which a World Trade Organization (WTO) panel essentially accepted Russia's defence based on the 'national security exception' in the GATT. While that case was admittedly decided under a WTO trade agreement, it merits close scrutiny for the light it may shed on how host state defences based on national security exceptions in investment treaties are likely to fare in the future.

In a dispute settlement case commenced in September 2016 with Ukraine accusing Russia of undue restrictions on the transit of Ukrainian goods through Russian territory (Russia Traffic in Transit),30 Russia relied heavily on Article XXI (Security Exceptions) of GATT, which provides that 'nothing in this Agreement shall be construed . . . (b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests'.31 In essence, Russia argued (1) that it was authorised under Article XXI to assess its own essential security interests and to take the actions it considers appropriate for the protection of those interests; (2) that the measures at issue had been adopted in the context of a 'war or other emergency in international relations' within the meaning of subparagraph (b)(iii) of Article XXI; (3) that it had taken trade-restrictive measures for the purpose of protecting its national security; and (4) that the WTO Panel lacked jurisdiction to second-guess the measures it had adopted due to the allegedly self-judging nature of Article XXI.32

Although the WTO panel ultimately accepted Russia's national security justification, it did not accept all of Russia's arguments. In particular, the panel rejected the argument that national security exceptions under Article XXI are non-justiciable. The panel not only determined that actions taken under Article XXI are reviewable, but also found that the circumstances in which a member can invoke national security exception can be objectively observed, according to which the panel can determine whether the measures taken by the member are necessary to protect national security. In short, the panel decided that it can objectively review the context of the Russia–Ukraine case, and such observations led to the decision that the state of affairs between Russia and Ukraine rose to the level of 'war or other emergency in international relations', and that Russia's restrictive measures bore a plausible relationship with the emergent conflict.

The WTO panel's decision in the Russia Traffic in Transit case has sparked considerable discussion and debate within the international community as the first WTO ruling dealing with the national security exception. Battle lines have been drawn around the issue of whether the measures adopted by Russia should have been subject to review by the WTO panel or whether the putatively self-judging nature of Article XXI should have rendered the dispute 'non-justiciable'. The United States – which is currently involved in a number of ongoing WTO disputes in which it has raised national security as a justification for imposing tariffs on steel and aluminium – predictably took the position that measures adopted under Article XXI are non-justiciable, whereas complainants in those WTO disputes, including the European Union, China, Canada and Mexico just as predictably argued that the WTO Panel had jurisdiction to review the measures adopted under Article XXI.33

The WTO panel's ruling may be understood as an attempt to curb the possible abuse of the national security exception while also recognising the discretion granted to each Member State under Article XXI of GATT. The panel acknowledged that each Member State is indeed entitled to define what it considers to be its own essential security interests, but also noted that such discretion was limited by 'good faith' and did not extend to elevating any concerns to essential security interests. Nevertheless, the ensuing debate over the justiciability of measures adopted for the protection of essential security interests reflects fundamental disagreements among states shaped by their respective national interests. Considering also that national security is increasingly viewed as inextricable from trade and economic matters, controversy surrounding the justiciability of national security exceptions seems likely in the investment treaty context as well.

As for general exception clauses, these have yet to gain widespread popularity with host states. One possible reason for this is the concern that adoption of general exception clauses in BITs will damage the host state's attractiveness as a venue for foreign investment. However, the covid-19 pandemic has forced most countries to implement more robust policies and measures for the protection of public health. In light of that experience, it seems likely that host states will assert available exceptions more aggressively when faced with investment claims, and that tribunals may have greater sympathy for the practical challenges faced by host states in preserving public health and welfare. It also seems possible that host states will consider the potential utility of general exceptions when negotiating investment treaties in the future. Thus, while current developments in the area of general exceptions are still limited, this is an area that merits close attention going forward.

IV Conclusion

In recent years there has been an increasing number of investor–state disputes lodged against host states. South Korea (where the authors of this chapter are based) is no exception. It is not unusual to find investors arguing that a single alleged act or omission of the host state constitutes a violation of multiple substantive protections under the treaty. For that and other reasons, investment treaty arbitration is often perceived as an investor-friendly battlefield.

Host state concerns about whether investment treaty arbitration can offer a level playing field are legitimate and must be addressed if the investor–state dispute resolution system is to be sustainable. In this regard, discussions focused on alternative solutions such as establishing an international investment court or encouraging greater diversity in the appointment of arbitrators are useful and should be encouraged. At the same time, the legal defences that are actually available to a respondent state require further attention and analysis. With greater attention to legal defences, investment treaty arbitration can gain renewed acceptance among host states as a sound means for investor–state dispute resolution in the long run.


Footnotes

1 Eun Young Park is a partner, Matthew J Christensen is a senior foreign attorney, Seokchun Yun is a senior attorney and Joonhak Choi is an attorney at Kim & Chang.

2 'Draft Articles on Responsibility of States for Internationally Wrongful Acts, with Commentaries', Yearbook of the International Law Commission, 2001, vol. II, part two, p. 80.

3 In practice, distress as a ground precluding wrongfulness is rarely if ever invoked in international investment disputes.

4 Gabčíkovo-Nagymaros Project (Hungary/Slovakia), Judgment, ICJ Reports 1997.

5 id. paras 50–52.

6 id. para. 50.

7 'Draft Articles on Responsibility of States for Internationally Wrongful Acts, with Commentaries', Yearbook of the International Law Commission, 2001, vol. II, part two, p. 83 ('[t]he term “necessity” (état de nécessité) is used to denote those exceptional cases where the only way a State can safeguard an essential interest threatened by a grave and imminent peril is, for the time being, not to perform some other international obligation of lesser weight or urgency. Under conditions narrowly defined in article 25, such a plea is recognised as a circumstance precluding wrongfulness.').

8 There were more than 30 ICSID cases filed by investors in response to Argentina's economic measures in the midst of the financial crisis.

9 CMS Gas Transmission Company v. The Republic of Argentina (CMS), ICSID Case No. ARB/01/8.

10 LG&E Energy Corp., LG&E Capital Corp., and LG&E International, Inc. v. Argentine Republic (LG&E), ICSID Case No. ARB/02/1.

11 CMS, Award, para. 360; LG&E, Decision on Liability, para. 251.

12 CMS, Award, paras 322–324.

13 id. para. 329.

14 LG&E, Decision on Liability, para. 257.

15 id. paras 205–206.

16 id. para. 239.

17 Christopher F Dugan, Don Wallace Jr, Noah D Rubins and Borzu Sabahi, Investor-State Arbitration, 2008, Oxford University Press, p. 158.

18 Union Fenosa Gas, S.A. v. Arab Republic of Egypt, ICSID Case No. ARB/14/4.

19 The Egypt–Spain BIT (1992) did not contain a clause addressing the defence of necessity.

20 Union Fenosa Gas, Award, para. 8.38.

21 id. paras 8.41–8.46.

22 Yulia Levashova, 'The right of states to regulate in international investment law: the search for balance between public interest and fair and equitable treatment', Chapter 2: international investment agreements and the right to regulate: an introduction, International Arbitration Law Library, Volume 50 (2019), p. 27.

23 Flavia Marisi, 'Environmental interests in investment arbitration', Chapter 4: treaty mechanisms addressing environmental concerns, International Arbitration Law Library, Volume 51 (2020), p. 117.

24 Nicholas Peacock and Olga Dementyeva, Inside Arbitration: Crimean Investment Treaty Arbitration claims: Recent developments at www.herbertsmithfreehills.com/latest-thinking/inside-arbitration-crimean-investment-treaty-arbitration-claims-recent-developments.

25 See case information at UNCTAD Investment Policy Hub, Everest and others v. Russia at https://investmentpolicy.unctad.org/investment-dispute-settlement/cases/631/everest-and-others-v-russia; Permanent Court of Arbitration Press Release, Arbitration between Everest Estate LLC and Others as Claimants and the Russian Federation as Respondent at http://pcacases.com/web/sendAttach/2325.

26 See case information at UNCTAD Investment Policy Hub, Oschadbank v. Russia at https://investmentpolicy.unctad.org/investment-dispute-settlement/cases/724/oschadbank-v-russia. On 30 March 2021, the Paris Court of Appeal annulled this award on the basis that the Ukraine–Russia BIT only protects investments made from 1992 whereas the Crimean branch of Oschadbank was open before that time. https://globalarbitrationreview.com/russia-overturns-billion-dollar-crimea-award.

27 See case information at UNCTAD Investment Policy Hub, Stabil and others v. Russia at https://investmentpolicy.unctad.org/investment-dispute-settlement/cases/654/stabil-and-others-v-russia.

28 Nicholas Peacock and Olga Dementyeva, Inside Arbitration: Crimean Investment treaty arbitration claims: Recent developments at www.herbertsmithfreehills.com/latest-thinking/inside-arbitration-crimean-investment-treaty-arbitration-claims-recent-developments.

30 Russia – Measures Concerning Traffic in Transit (WT/DS512/R – 5 April 2019) at https://docs.wto.org/dol2fe/Pages/SS/directdoc.aspx?filename=q:/WT/DS/512R.pdf.

31 William Alan Reinsch and Jack Caporal, 'The WTO's First Ruling on National Security: What Does It Mean for the United States?' at www.csis.org/analysis/wtos-first-ruling-national-security-what-does-it-mean-united-states.

32 Tatiana Lacerda Prazeres, Trade and National Security: Rising Risks for the WTO, World Trade Review, Cambridge University Press, Vol. 19(1), 2020, p. 139.

33 ibid.

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