11. Challenging Buy National Clauses under BITs

7 September 2009

The ‘buy national' clauses that numerous governments have included in their economic stimulus packages are causing growing concern. For many developing countries, bilateral investment treaties may be the best option for legal recourse against such provisions.

Despite their likely trade-distorting effects, buy national requirements appear to be consistent with WTO rules on trade in goods and services (the GATT and the GATS), although they may well breach commitments made under the plurilateral Government Procurement Agreement (GPA). The GPA, however, applies to signatories only, which leaves the many developing countries that have refrained from joining the agreement without a possibility for legal recourse. For emerging markets, such as Argentina, Brazil and India, this causes major distress.

Turning away from the multilateral trading system, about 2,800 bilateral investment treaties (BITs) that provide for investor-state arbitration in international fora, such as the International Centre for the Settlement of Investment Disputes (ICSID), might serve as a basis for legal challenges. It is conceivable that investors engaged in the importation of products manufactured abroad, possibly even directly involved in bidding processes for government procurement contracts, will challenge buy national clauses under bilateral investment agreements with reference to (i) the substantive assurance of national treatment and (ii) the general principle of fair and equitable treatment.

According to the non-binding OECD National Treatment Instrument that has served as interpretative guidance to various tribunals and BIT formulations, bilateral investment treaties generally cover government procurement unless it is explicitly notified as an exemption - an opinion largely supported by jurisprudence.

While many signatory countries of numerous BITs, including China, Germany and the UK, do not include such exemption provisions in their agreements, the US generally excludes public procurement. However, as the US Model BIT shows, the exemption typically refers to the provision of most-favoured-nation and national treatment only. Other assurances, especially the general principle of ‘fair and equitable treatment', remain excluded from the exemption.

National Treatment under BITs

National treatment provisions in BITs generally require domestic and foreign investors to be treated equally both in de jure and in de facto. While some commentators and arbitrators differ on whether legal analysis needs to consider ‘wrongful intent', it has been argued recently that impact, rather than intent, is decisive for proving discrimination.

Buy national clauses mandate that goods purchased by the government must be produced within the home country. There is no de jure differentiation between foreign and national companies; thus, requirements apply irrespective of the investors' nationality. However, it is assumed that domestic companies have their manufacturing sites within their own country while foreign companies also manufacture abroad. As the arbitrators in ADF v US phrased it: "Can a US steel manufacturer or fabricator be expected to want to source its structural steel requirements in Canada or China or Korea? Would it not be ‘natural' for a US steel manufacturer or fabricator to carry out the fabricating operations in the US, in its own plant if possible?" (ICSID, 2003, para 457). From this angle, a de facto discrimination is conceivable since only foreign investors would be affected by the buy national clauses.

Fair and Equitable Treatment

A challenge under the ‘fair and equitable treatment' (FET) standard may serve as a second, and maybe more promising, basis for legal challenge. Although considerable uncertainty exists amongst academics and arbitral jurisprudence on the precise scope of FET, jurisprudence seems to have established that FET encompasses the fundamental principles of good faith, due process, non-discrimination and proportionality, including transparency and stability, meaning the protection of legitimate expectations. The landmark Mondev v the United States ruling established that "a judgement of what is fair and equitable cannot be reached in the abstract [but] must depend on the facts of the particular case" (ICSID 2002, para 118).  It would appear however that certain elements, such as transparency and the notion of legitimate expectations, are particularly relevant in determining whether obligations under FET may have been breached. Yet it needs to be analysed whether this standard has become part of international investment law.

The tribunal in Tecmed v Mexico (ICSID 2003, para 154) held that, in accordance with the principle of good faith, an investment policy may not affect the investor's basic expectations. Further ICSID and UNCITRAL jurisprudence has clarified that concept by ruling that legitimate expectations are grounded above all in the legal order of the host state, which needs to demonstrate a certain extent of stability and transparency.

With reference to Metalclad and Tecmed, the Occidental v Ecuador tribunal concluded that "there is certainly an obligation not to alter the legal and business environment in which the investment has been made" (ICSID, decision on jurisdiction 2005, para 240). The arbitrators in Bayindir v Pakistan clarified the scope of this interpretation when they stated that "the general definition of fair and equitable treatment in Tecmed refers not only to all rules and regulations that will govern the investments but also to the goals of the relevant policies and administrative practices or directives" (ICSID 2004, para 191). This line of jurisprudence appears to support the view that the sudden introduction of far-reaching preferential treatment for nationally produced goods and services that substantially affect investors' economic activities would be in clear breach with most BITs.

Legal Challenges under BITs

Investor-state arbitration is generally characterised by high uncertainty. The wording and history of a BIT, the nature of the measures challenged and the precise circumstances are equally important for the tribunal's findings and the interpretative approach deployed. The feasibility of legal challenge of buy national clauses under BITs hence varies from case to case. This complicates the use of the procedure, especially for developing countries and their investors, who often lack the necessary legal capacity. Furthermore, since the investor-state arbitration largely depends on the activism of individual investors, only those countries with a strong private sector engaged in foreign investment will be able to challenge the buy national clauses under BITs. Investors will also need to consider carefully the economic feasibility of a claim: while the procedure has the advantage of being rather efficient, including the possibility for high damages and the enforceability of awards in almost all jurisdictions, it also requires considerable financial and human resources due to its private nature.

Since only governments can initiate cases at the WTO, the decision to do so usually involves highly political considerations and requires considerable political will. For instance, it has often been claimed that the lack of active participation of some developing countries in dispute settlement proceedings results partly from the fear that the targeted country may withdraw trade preferences or other forms of assistance, or take some form of retaliatory action. Since BITs allow private investors to take legal action against major trading nations without consulting their home governments severely limits this scope for balancing greater political considerations. On the hand, the procedure has the advantage that disputes with a high potential of damaging the investment climate are often resolved through extrajudicial agreement, possibly including a change in law.

It is hence expedient to examine the legal and economic feasibility of claims, and to follow developments closely since BITs offer a highly viable basis for challenging buy national clauses.

Marie Wilke is Dispute Settlement and Legal Issues Junior Programme Officer at ICTSD.

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