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Cost of Correcting Corruption – Does Cancelling 2G Licenses Constitutes Expropriation Actionable Under International Investment Law? by Shubhangi

About the Author: Shubhangi is a Law Student at Gujarat National Law University, Gandhinagar

ABSTRACT

While the Supreme Court’s decision in the case of Centre for Public Interest Litigation v. Union of India cancelling the 122 fraudulently issued 2G licences was considered by many as upholding the constitutional fundamentals of equality and equanimity, it has exposed the Indian government to actions under international investment arbitration for disregarding the very same principle of parity in context of their commitment to international trade.

The principle of international law on which such a claim will be based is failure of the Indian government to meet the necessary preconditions to invoking its right of expropriation through the above mentioned judgment. There was much speculation in the arbitration academia about the possibility of the same. Like all premonitions bad, it did come true with big conglomerates like Systemia Ltd. and Khaitan Pvt. Ltd. issuing notices of arbitration against the Indian government. Not surprisingly, the grounds for requesting such arbitration was unwillingness of the Indian Government to compensate the claimant for the losses arising out of its act of expropriation stemming from the SC judgment.

The tribunals would have to delve into the complex yet frequently visited conundrum of balancing the sovereign rights of a nation to regulate against the need of investor protection in international investment law. The article attempts to provide one of the first holistic picture of the possible jurisprudential arguments raised and the subsequent rebuttals that might follow in these arbitration proceedings.

INTRODUCTION

The 2G license scam is considered to be one of the many reasons for the potential undoing of the 10 year long UPA government in India. Summarily, the dispute revolves around the cancellation of the 2G licenses which were issued by the Department of Telecommunications, Government of India by the Supreme Court after intensive investigation carried out by the Central Bureau of India and much public outcry. This judicial conclusion of cancelling 122 licenses was arrived at through the Supreme Court judgment in the case of Centre for Public Interest Litigation v. Union of India[i].

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These licenses were issued in 2007-08. Post acquiring such licenses, many of the domestic companies entered into joint ventures with foreign companies and received investments from abroad each of which was governed under separate but similar Bilateral Trade Agreements. For the reference of this article, we could consider the BIPA (Bilateral Investment Promotion and Protection Agreement) under which Khaitan Holdings Ltd, the majority holder in the Indian telecommunications Co. of Loop Telecommunications, has filed the present notice of arbitration.[ii] Article 6(1) of the Agreement states herein:

Investments of investors of either Contracting Party in the territory of the other Contracting Party shall not be nationalised, expropriated or subjected to measures having effects equivalent to nationalisation except for public purposes under due process of law, on a non-discriminatory basis and against fair and equitable compensation.”[iii]

This is considered to be a wide expropriation clause in an investment treaty[iv] considering it includes the terminology “measures having effects equivalent to expropriation”.[v]  Fair and equitable compensation under the international investment law becomes due to the investor if the host country:

1. Expropriates or nationalises or takes any such measure which has the same effect as nationalisation or expropriation on the investment of the foreign investor.

2. For a public purpose

3. Under due process of law

4. On a non-discriminatory basis

The last three criteria laid down determine the legality of the act/regulation of the host country. The legality of the act determines the quantum of compensation where the award would be relatively higher if the same is found to be illegal.[vi] However, the issue that needs to primarily be determined is whether the regulation or law was an expropriation or not.

Therefore, for the claimants to successfully mount a case against the Government of India, they need to establish that the cancelling of the licenses was indeed an act of expropriation or one which had the same effect as that of expropriation.

A leading expert on international law had made an observation which is so unnervingly true today that one might as well refer to it as a prophecy; he had said that much literature and research would go into providing the paradigm that means expropriation in International Law and yet there would be little clarity on the subject.[vii] Truthfully enough, the author submits that disputes after disputes have deliberated on the issue and none have ended with an exhaustive definition of exactly what constitutes an expropriation.

To attempt to describe or comment exhaustively on a matter which has eluded the smartest and the most knowledgeable of authors and jurists in the field of international law would be a mountain too high to scale in mere ten pages. This article would therefore refrain from commenting on the issue as a whole and deal exclusively with the issue in hand – whether the cancellation of the 2g licenses constitutes expropriation as defined by the existing jurisprudence on the matter and whether an obligation to compensate arises.

There exists no debate that:

1. Investing in a domestic company of the host state constitutes an investment covered under a Bilateral Treaty Agreement.[viii]

2. Expropriation can be of intangible assets or property rights as well, thereby ensuring that licenses be considered assets which can be expropriated.[ix]

Based on the premise that neither of the above is contested by either parties to the arbitration, the possible legal grounds that the parties might resort to in order to prove the existence or the non-existence, respectively, of expropriation has been dealt with in the following sections.

CALCULATING THE LOSS: CLAIMANT’S APPROACH

Expropriation is an expansive term which has over the years been inferred and interpreted in an extensive manner. It originated initially as a safeguard against the “nationalisation drives” of the then conservative governments.[x] But as the international law became more sophisticated and the nations became smarter mavericks, it had to be interpreted widely to include indirect[xi], creeping[xii] and regulatory acts[xiii] of the government which had “an effect equivalent to expropriation”.

The line of argument that the claimant is likely to rely on is the “sole effect doctrine” evolved over the years through tribunal decisions like that of Tippets[xiv], Metaclad[xv], Phelpps Dodge[xvi] etc. The “sole effect” doctrine considers the economic effect of the government action/inaction on the investment as the sole criterion in determining whether there exists an obligation to compensate the investor. If the tribunal accepts the jurisprudence evolved though tribunal decisions like those stated above as the litmus test to decide if expropriation exists then the claimant has to simply establish that the cancellation of licenses was a government action that resulted in a considerable economic loss to the investor. What exactly the claimants have to establish is the existence of “wealth deprivation”[xvii] by the government of the host state without due compensation.[xviii]

It would not be surprising if the opening arguments of the claimants quoted the popular judgment in the case of Tippets case:

“The intent of the government is less important than the effects of the measures on the owner, and the form of the measures of control or interference is less important than the reality of their impact.”[xix]

There exists jurisprudence favouring an international regime which emphasizes on the protection of the investor’s economic interest over any other externalities which includes the good intentions of the host government. In the case of the Phelps Dodge International Corp v. Islamic Republic of Iran[xx], the tribunal went to the extent of acknowledging the need for the challenged law in light of the national interest of Iran and still ordered the respondents (Iran) to compensate the claimant.

Similarly, host states had to compensate the investor even when the contested regulations that were giving rise to expropriation were enacted or implemented with an intention to protect the environment against the blatantly environment harming activities of the investor in Metaclad case[xxi] and that of Santa Elena v. Costa Rica[xxii].

Through undertaking this extensive exercise in pointing towards this school of investment law, the claimants would attempt to influence the tribunal’s method of arriving at the conclusion of whether an expropriation exists in this particular case. If the tribunal was to accept this sole effect doctrine then the claimants would have successfully vitiated any need of entering into the raison d’être of the Indian SC judgment. This would be an important coup for the counsel of the claimants as now all they have to establish is that the cancelling of the license resulted in an economic loss to their client.

The next step in their argument would be to establish an economic loss or wealth deprivation. The claimants are bound to argue that in the present case a compulsory and direct transfer of property rights to the government has taken place as a result of the judgment given by the Supreme Court of India. In Tecmed v. Mexico[xxiii], an ICSID panel held that a failure of renewal of a land license was considered an act of expropriation to be compensated by the host state of Mexico. The claimant is likely to draw parallel to the above case law and suggest that the Indian judiciary’s action should be considered an act of expropriation even more direct than that of the Government of Mexico.

Similar jurisprudence which could perhaps be relied on during the course of their argument would be the case of CME v. Czech Republic[xxiv]. The dispute in the CME case[xxv] is perhaps going to be more relevant than the one cited previously as it was contested in the case that the Media Council, a statutory authority, had reversed its original position thereby forcing the local partner of the investor to agree to amendments which significantly reduced the value of the investment.[xxvi] The argument was held to be a valid one and gave a right of compensation to the investor. The tribunal reasoned that the expropriation of the investment was a direct consequence of the “actions and inactions of the government” and that there “was no immediate prospect at hand that the joint venture will be reinstated in a position to enjoy an exclusive use of license”.[xxvii]

Finally, the concluding argument of the claimants with respect to the claim of expropriation could be that this act of the Indian judiciary is against the legitimate expectation that the investors had when investing in the joint ventures. In international investment law, the interests of the foreign investor are protected against unreasonable and unexpected change in policy of the government. Though in most cases a successful claim of violating legitimate expectation requires specific commitment of the government to the investor which had a pivotal role in the investor’s decision to invest in the host nation[xxviii], where exclusive licenses were granted, the expectation that the same would continue to exist can be considered a legitimate expectation of the investor even if no specific commitment was made.[xxix]

Relying on the Thunderbird case[xxx], the claimant is likely to claim that assuming that the issuing authority of the host state is competent is in fact one of the most rudimentary of all expectations that an investor can have.[xxxi] The obligation of the host state to meet the legitimate expectation goes beyond the possible prejudice that the implementation of the expectation could have against the nation’s interest. This line of argument was accepted in the case of MTD Chile v. State of Chile[xxxii] and the Tecmed[xxxiii] case. Every time an investor’s expectation of consistency and stability it opens the host state for a claim for restitution or compensation in investment law.

Drawing from these established precedents on the matter, the claimants are likely to argue that the cancellation of the license constitutes a denial of its legitimate expectation on the continuation of its rights as a license holder as well as amounts to expropriation under international investment law.

If these arguments leave us wondering if there, at all, exists another side to the story, it will imply that the claimant’s council has done a job well. But there is always two sides of a story and the government of India would most definitely have employed an equally eager, if not more so, legal team to present its side.

FOR THE GREATER GOOD: THE RESPONDENT’S APPROACH

As respondents the task of the counsel representing the Government of India in these arbitration proceedings need not be to out rightly deny that the judgment adversely affects the investors. If proved that the judgment falls within the category of state regulations which are equitable, reasonable, non-discriminatory and a necessity for the public interest of the country then there arises no need to compensate the loss which the claimant incidentally suffers in the process.

State measures which are, prima facie, in legal exercise of its power do not necessarily give rise to an obligation to compensate even if implementation of such measures will cause considerable economic loss to the investor.[xxxiv]

The tribunals have also recognised this as the effective law. In this respect, the respondents will be wise to quote the extremely apt and astute observation made by the tribunal in the Saluka case[xxxv] which reads as follows:

“[i]t is now established in international law that States are not liable to pay compensation to a foreign investor when, in the normal exercise of their regulatory powers, they adopt in a non-discriminatory manner bona fide regulations that are aimed at the general welfare.”[xxxvi]

Similar opinion was reiterated in the tribunal decision of Methanex v. USA where it was held that bona fide measures of the government which are enacted or come into being after due process of law and are not discriminatory do not give rise to any obligation to compensate an investor.[xxxvii]

To refuse a state its sovereign right to alter its policies merely because the same is adverse to the interest of a handful of foreign investors is attacking the most revered auspice of international law- that of self-governance. Therefore, while evolving the jurisprudence on expropriation the jurists actively ensured that the state’s right to rule for the benefit of national interest was not curtailed unnecessarily or in entirety.

It has been recognised by various tribunal decisions that a measure enforced in order to promote established principles of social welfare need not create an expropriation as the same is within the absolute right of the state to govern on.[xxxviii] There exist legislation and international documents that provide illustrations of those acts of the state which are widely accepted as within the purview of its police powers. A possible, though non exhaustive, list of such powers is provide in the Restatement (Third) of Foreign Relations Law of the United States[xxxix]. “It includes bona fide general taxation, regulations, forfeiture for crime or any such action of the kind which is commonly accepted as within the police powers of the state.”[xl]

In CPIL v. Union of India[xli], the Supreme Court has ruled that the procedure involved in the granting of the 2G licenses are arbitrary, discriminatory and therefore violates the fundamental right of equality[xlii] guaranteed by the Indian Constitution. There exists no role of the state which could overshadow its paramount role of upholding the nation’s constitution. This ensures that any measure taken in pursuance of this cannot give rise to expropriation that needs to be compensated under the international investment law.

The respondents are likely to highlight that segment of jurisprudence on expropriation which focuses on the purpose and nature of the measure as being the important criterion for determining whether an economic loss of an investor comes within the purview of expropriation. It is likely to highlight the recent tribunal decisions which indicate that for a claim of expropriation to be successful, the claimants have to establish that 1) there is an enrichment of the host state at the cost of the investor[xliii] 2) a deliberate targeting of the investor[xliv] and most importantly 3) lack of a proportional overriding public interest for which the measure was enacted or enforced[xlv]. Not every economic loss of an investor can be considered a masquerading expropriation; especially when domestic investors are facing similar losses.[xlvi]

As far as the argument of legitimate expectation is concerned, it needn’t necessarily act against the interests of the respondent in this particular case. A legitimate expectation on behalf of the investor includes a legitimate expectation and acceptance of possible risks that might arise in doing business in another nation; these risks are considerably higher when the sector in which the investment is made is as heavily regulated as the Indian telecom sector. To assume that a license fraudulently and arbitrarily granted will not be revoked and if revoked be compensated is a far-fetched as well as an unreasonable expectation. In Starett Housing v. Iran[xlvii], the tribunal considered even a possible revolution to be within the ambit of risks that a business has to undertake when investing in the nation. Clearly, the upturning of an administrative action as being contrary to the Constitution by the judiciary in a country plagued by corruption and one with a pro-active judiciary has greater likelihood of happening than a revolution. The respondent is likely to contest that if the latter is a reasonable risk that an investor is expected to agree to then it is absurd to argue that judicial activism and corrective justice do not fall within the ambit of potential risks that a host state need not compensate an investor for.

THE AMALGAMATING APPROACH AND A WARNING: THE POSSIBLE CONCLUSION

A tribunal while arriving at its decision needs to piece together not only the two sides of the dispute but also include that segment of the jurisprudence which was cleverly whitewashed by the competent counsels of either or both parties. In the present dispute as well, the tribunal need not necessarily follow either of the two doctrines enunciated by both parties and instead seek parity by combining the two.

The concept of proportionality between the purpose of the regulation and the extent of the economic loss of the investor already exists in the legal landscape though not as clearly evolved. The tribunal in Tecmed v. Mexico[xlviii] rightly reasoned:

“[t]here must be a reasonable relationship of proportionality between the charge or weight imposed to the foreign investor and the aim sought to be realized by any expropriatory measure.”[xlix]

As far back as 1962, Proffessor Christie had considered even severe government measures, which if undertaken for just as fundamental a public purpose, to not be considered an expropriation that should be compensated.[l] The wide acceptance of this test in the international forum can also be adjudged by the fact that many Bilateral Agreements that have been entered into in the past decade explicitly exclude a measure designed to protect legitimate public welfare from within the purview compensable expropriation.[li]

Some of the earliest and most vehement supporters of this test are the European Courts while ruling under the European Charter of Human Rights. In the case of James v. United Kingdom[lii], the Court considered the taking of property from one as a necessary evil if the same was done for the purpose of greater social justice. Similarly in Sporrong and Lönnroth v. Sweden[liii], the court recognised “that the States are entitled, amongst other things, to control the use of property in accordance with the general interest, by enforcing such laws as they deem necessary for the purpose.”[liv]

Authoritative authors of investment law like the revered Sonarajah have also recognised the need to combine the two approaches to arrive at a more weathered and tempered test to determine expropriation.[lv]

The most logical approach to reconcile the two opposite spectrums would be to follow a test that determines whether the degree of adverse effect of the measure on the investment was justified in light of the public purpose that the measure intended to serve. Accountability is the cornerstone of a constitutional democracy like that of India. Any measure taken to achieve the same cannot be restrained on account of the possible conflict with the profit expectancy that a foreign investor might have had from investing in the country. In light of the new wave of “people initiated justice” that the world is witnessing today, there is a greater possibility that the tribunal would sympathise with the mitigating circumstances that culminated into the disputed SC judgment.

Under important element that enables a better insight into the commitment of the investors in pursuing business with India is the fact that they refused to participate in the new allocation of licenses that was initiated by the Telecom Department. This non participation was despite the fact that the Government of India had reassured that the outstanding losses of the successful candidates would be balanced out against any future payments that they would have had to make after getting their licenses.

Quite a few foreign investors and their home countries have threatened to revert to the international forum for compensation of their losses. The strongest in expressing their opinions from the very beginning were Russia and Norway with the Russian conglomerate Systema already having served a Notice of Arbitration.[lvi] The government is worried of the possible costs that the exchequer would have to incur were these claims to be awarded in favour of the many claimants. If a single of these arbitration are ruled in favour of the claimant, it will create a domino effect where most foreign investors would employ the international dispute redressal mechanism to be compensated for any economic loss that they might have incurred.

This also highlights another trouble that has been simmering under the surface for the Indian government for a long time– the repercussions of hurriedly executed and ill-thought-of Bilateral Trade Agreements that the country has been committing to over the past decade. In its enthusiasm to prove its credibility as an investor friendly country, India has entered into more than 74 BITs with negotiations underway for another 22.[lvii] Perhaps it is time to improve the negotiations to an extent and deliberate on including such clauses which provide greater flexibility to the Indian state to legislate and rule on policy matters important to public welfare without making it vulnerable to possible investment litigations.

A caged bird is often the imagery that the romantics associate with India. We were under foreign rule for a century to be followed with another long term enslaved to our own corrupt politicians. As India awakens to a more conscious future, it is important that we should not be enslaved and wrapped in arbitrations and litigations for the coming decades merely because of our eagerness to establish ourselves as a sought after investment destination.

The 2G scam has acted as an effective eye opener to the pathetic condition of the domestic Indian polity. It might as well ignite a debate on India’s approach to its bilateral trade and prevent India from being held at the figurative gun point of possible costly arbitrations by

[i] 2011(2)ACR1912(SC)

[ii] Nanthan and Prasad, Loop Telecom investor KHML slaps $1.4bn notice on government, Economic Times, Oct 2, 2013, https://articles.economictimes.indiatimes.com/2013-10-02/news/42617622_1_khml-loop-telecom-arbitration-notice

[iii] Bilateral Invetment Promotion and Protection Agreement, Ind-Mauritius, Article 6.

[iv] Sylva and Pye, Expropriation clauses in International Investment Agreements and an appropriate room for host states to enact regulations: a practical guide for states and investors, The Graduate Institute, Geneva, https://graduateinstitute.ch/files/live/sites/iheid/files/sites/ctei/shared/CTEI/Research%20Projects/Trade%20Law%20Clinic/Expropriation%20clauses%20in%20International%20Investment%20Agreements%20and%20the%20appropriate%20room%20for%20host%20States%20to%20enact%20regulations,%202009.pdf

[v] Ibid.

[vi] Andrew Newcombe and Lluís Paradell , Law and Practice of Investment Treaties: Standards of Treatment, (Kluwer Law International 2009) pp. 394

[vii] Fortier and Drymer, Indirect Expropriation in the Law of International Investment: I Know It When I See It, or Caveat Investor, 19(2) ICSID Review 293 (2004)

[viii] I. Brownlie, Priniciples of Public International Law, 534 (5th ed., 1998)

[ix] M. Soranarajah, The International Law on Foreign Investment, 7 (2nd ed, 2004)

[x] Supra n. 6, p. 3.

[xi] P. Muchlinski, F. Ortino & C. Schreuer (eds.), The Oxford Handbook of International Investment Law, Oxford University Press, 407-458 (2008)

[xii] Ibid.

[xiii] Ibid.

[xiv] Iran-US Claims Tribunal, Tippetts, Abbett, McCarthy, Stratton v. TAMS-AFFA, 6 IRAN-U.S. C.T.R., at 219 et seq.

[xv] Metalclad Corporation v. Mexico. icsid Case No. ARB (AF)/97/1. 40 ILM 36 (2001), available at <https://www.worldbank.org/icsid/cases/awards.htm>. NAFTA Chapter 11 Arbitral Tribunal, August 30, 2000.

[xvi] Phelps Dodge International Corp. v The Islamic Republic of Iran, 10 Iran-US C.T.R., 130

[xvii]B. Weston, Constructive Takings’ under International Law: A Modest Foray into the Problem of ‘Creeping Expropriation, 16 Virginia Journal of International Law, 112 (1975)

[xviii] OECD , “”Indirect Expropriation” and the “Right to Regulate” in International Investment Law”, in  International Investment Law: A Changing Landscape: A Companion Volume to International Investment Perspectives, OECD Publishing, 43-72 (2005)

[xix]Supra n. xiv.

[xx] 10 Iran-US C.T.R

[xxi] Supra n. xv

[xxii] Compañía del Desarrollo de Santa Elena S.A. v. Republic of Costa Rica, ICSID Case No. ARB/96/1.

(February 17, 2000).

[xxiii] Tecnicas Medioambientales Tecmed S.A, v. The United Mexican States, ICSID Award Case No. ARB

(AF)/00/2.

[xxiv] CME (Netherlands) v. Czech Republic (Partial Award) (13 September, 2001) available at

www.mfcr.cz/scripts/hpe/default.asp.

[xxv] Ibid.

[xxvi] Id at pp 160-170.

[xxvii] Id at p. 171.

[xxviii] Elizabeth Snodgrass, ‘Protecting Investors’ Legitimate Expectations: Recognizing and Delimiting a General Principle’, 21 ICSID Rev—FILJ 1, 36 (2006).

[xxix] Kenneth J Vandevelde, ‘A Unified Theory of Fair and Equitable Treatment’, 43 New York Univ J Intl L & Pol, 69 (2010-11).

[xxx] International Thunderbirds Gaming Corporation v. United Mexican States, NAFTA Arb.Tr,, 2006.

[xxxi] Id, para. 37.

[xxxii] MTD Equity Sdn Bhd and MTD Chile S.A. v. Republic of Chile, ICSID Case No. ARB/01/7, Award, May 25, 2004 (hereinafter MTD), available at https://www.asil.org/ilib/MTDvChile.pdf.

[xxxiii] Supra n.23.

[xxxiv]Supra n.8.

[xxxv] Saluka Investments BV (The Netherlands) v The Czech Republic, UNCITRAL, Partial Award, para 307, (17 March 2006)

[xxxvi] Id at para 276.

[xxxvii] Kara Dougherty, Methanex v. United States: The Realignment of NAFTA Chapter 11 with Environmental Regulation, 27 Nw. J. Int’l L. & Bus. 735  (2007). https://scholarlycommons.law.northwestern.edu/njilb/vol27/iss3/27

[xxxviii] Lauder (U.S.) v. Czech Republic  (Final Award) (September 3, 2002) available at www.mfcr.cz/scripts/hpe/default.asp

[xxxix] “Restatement of the Law Third, the Foreign Relations of the United States,” American Law Institute, Volume 1 (1987) Section 712.

[xl] Ibid.

[xli]Centre for Public Interest Litigation v. Union of India, 2011(2)ACR1912(SC).

[xlii]The Constitution of India, 1949, Article 14.

[xliii] Eudoro Armando Olguín vRepublic of Paraguay. ICSID Case No. ARB/98/5 (1997)

[xliv] SeaLand ServicesInc. vIran, 6 IRAN-U.S. C.T.R., at 149.

[xlv]S.D. Myers, Inc. v. Canada, (November 13, 2000) Partial Award, 232. International Legal Materials, 408.

[xlvi]Marvin Roy Feldman Karpa (CEMSA) v. United Mexican States, ICSID Case No. ARB(AF)/99/1 (2002)  pp. 39-67.

[xlvii] Starrett Housing Corp. v. Iran, 16 IRAN-U.S. C.T.R., 112.

[xlviii] Supra n. xxiii

[xlix] Supra n. xxiii, para 122

[l] G.C. Christie, What Constitutes a Taking of Property Under International Law, 38 Brit. Y.B.

Int’l L. 307 (1962).

[li]For example see US-Singapore, US-Chile BIT.

[lii] James and others v. United Kingdom, (1986) 8 EHRR 123

[liii] Sporrong & Lonnroth v Sweden (1982) 5 EHRR 85)

[liv] Ibid.

[lv] Supra n. xvii.

[lvi] Sistema threatens arbitration in 2G case, Times of India, Feb 28, 2012

[lvii]Kawaljit Singh, Sistema Threatens to Invoke Bilateral Investment Treaty, https://www.madhyam.org.in/admin/tender/Sistema%20Threat2.html

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