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21 November 2008

The impact of climate change regulation on bilateral investment treaties

Actions by governments to address climate change may present significant challenges to foreign investors. In particular, the implementation of environmental regulations, such as the Australian Government’s recently proposed emissions trading scheme, has the potential to trigger investor protections under international investment agreements, including bilateral investment treaties.

Bilateral investment treaties

Bilateral investment treaties (BITs) are agreements between two countries that are designed to protect and promote foreign investment. If an investor from one country makes an investment in the other country, then that investor may take the benefit of certain provisions in the BIT which protects its investment from certain actions by the host state, provided that certain procedural and substantive hurdles are met.

Where such provisions are breached by the host state, then the BIT provides mechanisms for the foreign investor to make a claim directly against the host state, usually by way of arbitration proceedings. In circumstances where an investor brings a claim against the host state, that claim will usually be determined as a matter of international law and will be subject to the language of the particular BIT.

Impact on environmental regulation

The implementation of climate change regulation by governments is typically required on a national level and may target carbon intensive industries, such as coal-fired electricity generators. Amongst the substantive features of climate change regulation is the obligation for carbon emitting industries to reduce their emissions by, for example, imposing an emissions trading scheme. In addition, governments have imposed arguably less onerous energy efficiency standards through initiatives such as abatement.

The ability of foreign investors to challenge environmental regulatory action through the use of international investment agreements is becoming increasingly significant in the wake of the implementation of a raft of environmental legislation following the commitment of many governments to reducing greenhouse gas emissions in line with such initiatives as the well-known Kyoto Protocol.

Expropriation

Amongst the protections offered by some BITs is the obligation that a host state cannot expropriate foreign-owned property, except on a legal, non-discriminatory basis for a public purpose and with adequate compensation. Notably, both direct and indirect deprivation of a foreign investment have been identified as an expropriation of property by international tribunals. Whether or not environmental regulatory action taken by governments amounts to expropriation has been the subject of debate within international tribunals. Some tribunals have identified environmental regulatory measures as a legitimate public welfare objective, affirming that “governments must be free to act in the broader public interest through the protection of the environment” (Marvin Feldman v Mexico, NAFTA Award, 16 December 2002, 18 ICSID Rev-FILJ 488 [2003], at paragraph 103) whilst others have narrowly considered only the effect, not the purpose, of the government action. This was the case in Compañia del Desarrollo de Santa Elena, SA v Republic of Costa Rica, Award, 17 February 200 5, ICSID Reports 153, where the tribunal held that:

“Expropriatory environmental measures – no matter how laudable and beneficial to society as a whole – are in this respect, similar to any other expropriatory measures that a state may take in order to implement its policies: where property is expropriated, even for environmental purposes, whether domestic or international, the state’s obligation to pay compensation remains.”

Fair and equitable treatment

Many BITs allow foreign investors to challenge the actions of the host state on the basis that the investor was not accorded fair and equitable treatment. The fair and equitable standard has previously been interpreted as a restatement of the customary international law principle that obliges host states to treat foreign investors in accordance with an international minimum standard. However this approach has led some tribunals to impart a higher threshold on behaviour that is not considered fair and equitable, requiring the additional element of “bad faith” (Genin v Estonia, Award 25 June 2001, 6 ICSID Reps 241). Other tribunals have not gone so far. In any event, it is clear that the standard is a high one and each tribunal may exercise a wide discretion in determining whether a particular action is fair and equitable.

The essence of this notion is unfairness, yet a tribunal may also have regard to the legitimate expectations of the investor and whether due process has been followed (Waste Management v Mexico (No.2), Award, 20 April 2004, at paragraph 98). Some tribunals have adopted an approach that is more favourable to investors, such as that applied in Tecmed v Mexico, Award, 29 May 2003, 10 ICSID Reps 130, where the tribunal went so far as to hold that the foreign investor is entitled to expect the host state will act in a manner that is totally transparent in its relations with the foreign investor and that the investor ought to know all the rules and regulations that will govern its investment. However this approach has been subjected to harsh criticism and it is unlikely to form the benchmark by which other tribunals will apply the fair and equitable standard.

Unreasonable and discriminatory measures

A further obligation that may be incorporated into BITs is the requirement that host states refrain from interfering with the foreign investor’s use, maintenance and enjoyment of its investment by unreasonable or discriminatory measures. The tribunal in Saluka v Czech Republic, Partial Award, 17 March 2006, stated that “reasonableness” required that the State’s conduct “bears a reasonable relationship to some rational policy”. Central to this concept is the notion that arbitrary and unreasonable actions by the host state, including those where the foreign investment is treated in a way less favourable to a domestic investment, may allow a qualifying investor to brings claims against the host state for breaches of the relevant BIT.

Implication for investors

If you are an investor who makes a qualifying investment in a foreign country to which your home state has entered into a valid BIT, you may have claims against the host government in the event that the host state implements environmental regulations that impact on your investment. In circumstances where a host state has not afforded a foreign investor adequate compensation for the impairment of their investment due to the introduction of environmental regulations, the investor may seek damages for any loss it has sustained in accordance with the relevant provisions of the BIT. Despite this, the process by which the investor may recover from the government is not by any means clear cut and remains an open question. This is particularly the case where governments make environmental regulations for a “proper purpose”. Some BITs have specifically identified that government regulatory action made for a legitimate public purpose may not be considered conduct amounting to expropriation. This approach was recently adopted in the Australia-Chile Free Trade Agreement that is discussed in more detail above.