SUMMARY NOTE ON MODULE 6

INTERACTION OF PUBLIC LAW FRAMEWORKS

Introduction – Interactions between legal frameworks governing foreign investment

The interaction between three key legal frameworks that investors, legal counsel, and
government officials must understand and use in planning, managing, and protecting investments
in foreign countries can be summarised as follows:

1. The national law-contractual framework interaction – this can also be referred to as the
interaction between the private and public law regimes on foreign investment.

2. The national law-international law interaction – this can also be referred to as the
interaction between the domestic and international public law regimes on foreign investment.

3. The contractual framework–international law interaction – this can also be referred to as

the interaction between the domestic and international private law regimes on foreign
investment

Each of these interactions create a dynamic, trilateral set of processes that influence how capital
flows from one country to another and the way it is used once it reaches its destination. Each of
these interactions may be summarised as follows.

1. Domestic Public Law and Private Law

The public-private legal interaction within this framework takes shape in multiple ways. First,
national law creates, gives meaning to, and enforces the contractual framework for investment
transaction. For instance, contracts that gave rise to the Dabhol Power Company in India and the
Kenana Sugar Company in Sudan were the products of national law of the respective host
countries. The contracts relating to the international movement of the capital to finance those
projects were also shaped by the national laws and regulations of countries that were the source
of that capital. It is again the national law that usually controls and regulates the negotiation
process, defines the scope of parties’ negotiating authority, and specifies the contents of relevant
contracts.

In addition to regulating investment contracts, national law may also provide for the use of
contracts with investors as a means to promote foreign investment. Thus, foreign investment
codes and laws may empower state investment authorities to enter into contracts that grant
investors a variety of incentives, such as income tax exemptions, duty-free import privileges, and
government subsidized inputs like electricity and water.

The legal regime governing contracts between private parties is often the subject of government
policy. The distinction in permitted contractual scope by the state is often the difference between
an economic system based on “public ordering” of economic transactions, in which state
agencies make fundamental investment decisions, and one based on “private ordering,” in which
decisions on major economic transactions are left to the discretion of private companies and
persons. The precise boundary between the domain of national law and the domain of contract in
particular countries may shift over time. Thus, countries that have changed national policy and
institutions toward state-dominated economies have tended to limit the domain of contract, while
those seeking to liberalize and deregulate economic life have expanded the role they grant to
contracts as devices for economic ordering.

It must be noted, however, that the interaction between national law and the contractual
framework is not uni-directional. Private investors can, by way of contracts, also seek to
influence the nature and application of national law or at least that part of national law that
affects their investments. Indeed, foreign investors commonly use contracts as part of their
strategies to protect assets from potential injurious actions by host governments. Thus, investors
conclude agreements with host governments that provide for “stabilization clauses,” which have
the effect of exempting their investments from negative future changes in laws and regulations,
and parties to investment transactions often enter into international arbitration clauses which
enable them to avoid the jurisdiction of national courts with respect to settling disputes relating
to their investments. Beyond that, investors may seek to avoid entirely the application of national
law of the host country by including a choice-of-law clause in their contracts that makes
applicable to the contract the law of another, usually more favourable, jurisdiction.

2. Domestic and International Public Law

The application of international law in organizing and protecting an international investment is

strongly influenced by national law and national legal institutions of both host and home
countries. In seeking the protection of international law with respect to investment transactions,
investors, their counsel, and host country officials must engage in a process of evaluating
whether an actual or proposed “measure” (whether an action or omission) by a host government
complies with relevant customary or treaty provisions of international law. Thus, the application
of international law to investment transactions is always a comparative process, comparing
whether the government’s treatment through its laws and regulations of an actual or proposed
investment does, or does not, meet the standards required by international law.

Any comparative analysis must naturally begin with a sufficient understanding of the host state’s
domestic legal order upon which the state’s actions are based. On the other end, governments
contemplating entering into investment treaties or other international agreements affecting
foreign capital must carefully analyse existing legislation to be sure that it complies with the
treaty obligations they are to assume. National legal provisions that are contrary to contemplated
treaty obligations do not relieve a contracting state from its international obligation to abide by
those treaty commitments. If the provisions of a proposed treaty conflict with national law, three
options are open to the country concerned:

· to reject the proposed treaty,

· to negotiate exceptions to the treaty so as to alleviate the conflict, or

· to amend national law to conform to the new treaty standards

The interaction between the two public law frameworks is also visible in references to domestic
law within international legal texts. For example, many investment treaties provide that they
afford protection only to investments that are “made according to law,” a reference to the
national law of the host country. Thus, in order to determine whether an investment is protected
by a treaty, one must first determine whether that investment was made in accordance with the
requirements of a host state’s national law. If the investment is determined not to have been made
according to national law, the investment will not benefit from treaty protection. A similar
approach must also be taken in interpreting treatment standards contained in treaties like national
treatment and Most-Favoured Nation treatment.

Even if the applicable treaty contains no specific reference to national law, an arbitration tribunal
may nonetheless invoke it to deprive an investor of the benefit of international law if that
investor has violated national law in an egregious matter, for example by engaging in corrupt
payments and bribery of local officials to make an investment or has failed to comply with the
requirements of national law governing specific types of investment transactions.
3. Private Law and International Public Law

While the legal framework governing contracts is primarily the subject of national rather than
international law, there are various ways in which the private legal order interacts with the
international order. Foreign investors in certain instances may secure an agreement with host
states that their investment transaction is to be governed by international law. Courts and arbitral
tribunals have given effect to such contractual provisions and thereby “internationalized” the
investment contract concerned. Instead of applying international law generally to an investment
contract, the parties may agree that specific international law concepts, rules, and treaties will be
applicable to their relationship.

Thus, an investment contract may provide for the application of national law but may also
specify that all disputes between the parties shall be settled by arbitration under the auspices of
ICSID in accordance with the Convention on the Settlement of Investment Disputes between
States and Nationals of Other States (ICSID Convention). Indeed, through international
arbitration, the interpretation and application of investment contracts become subject to
international law procedures and processes. Conversely, applicable international law may impact
or invalidate provisions in certain contracts. For instance, agreements between investors and
governments providing for special treatment to specific investors may violate investment treaty
requirements of national treatment or MFN treatment, and state contracts requiring foreign
investment projects to operate in specific ways may offend prohibitions against performance
requirements in investment treaties.

A further interaction between international law and an investment’s contractual framework is

found in investment treaties that contain an umbrella clause, which elevates obligations entered
into by states with investors to the level of an international law obligation, and not a purely
domestic law duty that may be modified by domestic legislation. Even when a treaty does not
have an umbrella clause, the jurisprudence of various investor–state arbitration tribunals have
held that certain breaches of contractual obligations by states have constituted breaches of other
treaty standards such as “fair and equitable treatment” or “full protection and security” since, in
violating such obligations to investors, a state is frustrating the legitimate expectations of
investors.

Investment treaties and their impact on domestic law

An investment treaty limits the sovereign right of a state to subject foreign investors to its
domestic public law system. All the principal clauses that are included in a typical investment
treaty operate in various ways to define and narrow the types of domestic public law regulation
to which foreign investors must subject themselves. This is a response to investors’ concern for
the predictability and stability of the legal framework governing their investments. Foreign
investment treaties are based on the presumption that the guarantees provided to foreign
investors by the domestic public law system of the host country may be insufficient for the
special purpose intended by those treaties, which is primarily the creation of an investment-
friendly climate designed to attract the foreign investment desired by the host state.

The legal regime created by an international investment agreement is only one element among
many that states use to reach out to foreign investors, but it has become an important component
of such efforts. The impact on domestic public law that follows from the acceptance of such a
regime is normally perceived as a necessary consequence of an investment-friendly climate
rather than a negative aspect which should be avoided in principle. Thus, the priority of states
has shifted from sovereignty to attracting foreign investment.

But, of course, the impact of this paradigm change on the domestic public law of host states
remains to be examined, if for no other reason than because domestic rules applicable to foreign
investors must be adjusted to accord with the obligations imposed by the international treaty. The
scope of foreign investment treaties applies essentially to all economic activities of foreign
investors; this results from the broad definitions of the term ‘investment’ found in practically all
treaties. Consequently, almost every aspect of the host state’s public law system is potentially
affected and may be subjected to international review in accordance with the treaty’s system of
dispute settlement. It is clear that the host state’s sovereign right to legislate - not just in
economic matters, but also in such domains as environmental, tax, public health, and even labour
law - is placed under significant restrictions by clauses such as on indirect expropriation, and by
the uncertainties of their application by arbitral tribunals.

So far, states seem to have accepted - albeit sometimes grudgingly - the standard rules of
investment treaties, as well as their interpretation by tribunals, in a way that is leading towards
the creation of an emerging body of international public law. At one level, states have accepted
that the willingness to conclude investment treaties is recognized as the passport to the global
competition for foreign investments. While this recognition is accompanied by a partial loss of
national sovereignty, reformers in developing countries nevertheless see these investment treaties
as powerful tools for the modernization of the domestic public law system, providing effective
external checks as well as discipline on deficiencies which may be difficult to implement at the
domestic level.

The acceptance by states of the varied constraints to sovereignty is based on the acceptance of
the notion that international economic relations require internationally agreed rules, and that
these rules need to be enforceable. One cannot overlook the fact that while the law of
international investment still has its foundations in domestic rules applied by national public law
administrations, this domestic framework is continuously tightened by the decisions of
international authorities.
Investment Treaty Arbitration as Global Public Law

Four specific features that are present uniquely in the investment treaty regime (and by extension, in
investment arbitration) distinguish it from other forms of dispute settlement mechanisms.

· Investment treaty claims are commonly not subject to customary limitations that apply to
individual claims under other types of treaties, including the duty of an individual to exhaust
local remedies.

· Under investment treaties, investors can directly bring claims for damages, awarded as a
public law remedy (via the damages principle).

· Because investment treaties incorporate the procedural framework and enforcement structure
of international commercial arbitration, investors can directly seek enforcement of the awards
of arbitration tribunals before the domestic courts of a large number of countries, with limited
judicial supervision by domestic courts (also known as the principle of direct enforceability).

· Finally, investment treaties facilitate forum-shopping by investors, through the selective

establishment of holding companies, thus expanding the reach of investment arbitration as an
international mechanism of adjudicative review.

The cumulative effect of these features of the investment treaty regime is to subject the
regulatory conduct of states to control through compulsory international adjudication to an
unusual extent. And it is precisely because of the potential of these internationally generated
adjudicative norms and mechanisms to exert a strong disciplinary influence over domestic public
law programmes that investment arbitration should be seen to constitute a powerful species of
global public law.

The proliferation of investment treaties and arbitrations suggests that multinational enterprises
are increasingly prepared to use investment arbitration to resolve disputes with states, indicating
that investment arbitration has become an important method for foreign investors to resist state
regulation and seek compensation for the costs that flow from the exercise of public authority.
Moreover, the wide geographic coverage of investment treaties and the corresponding
availability of investment arbitration has established it as an international mechanism for
adjudicative review in the regulatory sphere. Thus, there exists a well-established international
regime, based primarily on investment treaties, that seeks to protect investors from certain
‘harm’ caused by the exercise of public authority, and whose key unifying feature is the use of
investment arbitration as an international mechanism of adjudicative review. This offers evidence
of a rapidly emerging regime established at the international level, and which has the potential to
form a distinct element of a public law system.

A key aspect of the investment treaty arbitration is that it transplants the private adjudicative
model of commercial arbitration into the realm of government, thereby giving privately
contracted arbitrators the authority to make what are in essence governmental decisions. This is
achieved because investment treaties incorporate arbitral mechanisms in order to provide an
institutional forum and procedural framework for investment arbitration. Investment treaties also
rely on arbitral mechanisms for the enforcement of arbitration awards by domestic courts. Thus,
when it came to the drafting of investment treaties, the previously established arrangements of
arbitral mechanisms were simply incorporated as part of the architecture of investment
arbitration. In the process, the procedural framework and enforcement structure of international
commercial arbitration that provided the basis for the use of a private model of adjudication was
extended to resolve regulatory disputes between individuals and the state.

In the light of this discussion, some of the key features of investment arbitration can be
delineated as follows –

1) Authorization of individual claims - Under investment treaties, states give a prospective – or

general – consent to the arbitration of future investment disputes. The state’s consent is
general because it is not limited to a specific investor, investment project, or dispute or series
of disputes arising from a defined historical event. Instead, the consent authorizes the
initiation of compulsory arbitration by any member of an indeterminate class of potential
claimants in relation to a very wide range of disputes. This, in effect, endows international
tribunals with general jurisdiction over disputes that may arise at some future date from the
state’s exercise of public authority. A state’s general consent to investment arbitration
commonly entails a broad waiver of the state’s customary immunity from suit before an
international tribunal or before a domestic court that is called upon to enforce an international
award.

Investment treaties define the scope of the state’s consent and the jurisdiction of international
tribunals in broad terms, generally apply international standards of investor protection to
virtually any sovereign act of the state and define ‘investment’ to include a very wide range of
assets. As a result, a wide range of regulatory disputes between investors and the state has
become subject to control through international arbitration at the instance of investors. Many
investment treaties limit or remove the customary rule that a foreign national must exhaust local
remedies before an international claim can be brought.

2) Use of damages as a public remedy - Investment treaties authorize arbitration tribunals to

award damages as a public law remedy. This is because awards of damages under investment
treaties are issued to compensate an individual, and to sanction the state based on a finding
that the state’s exercise of public authority was unlawful. Individualized damages claims are
very rare in international law. Damages claims by individuals are also the exception in the
field of human rights, despite the expanded protection of human rights law since 1945. Thus,
the ability of investors to claim damages under investment treaties is not only exceptional in
 the context of international law but is also much more extensive than under other international
mechanisms that allow individual claims for damages against the state.

3) Direct enforceability of awards - By incorporating the enforcement structure of the ICSID

Convention and the New York Convention, investment treaties allow investors to overcome
the resistance among national courts to enforce rulings and awards against sovereign states.
Investors seek enforcement of an investment arbitration award against assets of the
respondent state before the domestic courts of any state that is a party to these two treaties.
The coercive force of an investment arbitration award is supported by the authority of a large
number of states to enforce awards within their territory, based on treaties that authorize the
enforcement of foreign arbitration awards.

An investor does not, of course, always need to resort to domestic courts to enforce an
investment arbitration award since, in most cases, states voluntarily comply. But if a state still
refuses to comply with an award, the investor has two general options for pursuing enforcement.

First, investment treaties commonly require the states parties to recognize and enforce awards
under the investment treaty itself. This allows an investor to seek enforcement by domestic
courts in the states parties to the investment treaty, subject to the terms of the treaty and relevant
domestic legislation, on the basis that the respondent state’s ratification of the treaty constitutes a
waiver of its sovereign immunity from enforcement. Second, where the investment treaty
provides for enforcement under the ICSID Convention or the New York Convention, an investor
can seek enforcement of an award by a domestic court in any state party to either of these
treaties, based on the terms of the treaty and applicable legislation.

4) Forum Shopping - Investment treaties offer several opportunities for forum-shopping. They
establish varying levels of legal protection for capital flows between different states –
depending on whether a treaty is in place and on its terms – which, in turn, creates an
incentive for multinational enterprises to adapt their corporate structure to maximize their
legal security. Moreover, investment treaties facilitate forum-shopping on the part of
investors, thus establishing investment arbitration as a more generalized mechanism of
adjudicative review. In particular, investment treaties facilitate forum-shopping by defining
the term investor to include corporations, without imposing restrictions based on the
nationality of shareholders or minimum thresholds of foreign ownership and control. As a
result, a corporate investor with the nationality of a state party to an investment treaty might
be ultimately owned by an investor of a non-state party, or by an investor of the host state
itself.
Distinction between Investment Arbitration and Commercial Arbitration

Arbitration depends on the authority of the state to give force to arbitration awards. The state may decide
to override agreements to arbitrate for various reasons, such as to protect the interests of a weaker party,
third parties, or the public in general. Nevertheless, for the purpose of facilitating commerce, most states
have decided to limit their involvement with respect to private agreements to arbitrate. By agreeing to
arbitrate, parties give up one of the basic rights of citizens of any civilised community – that is, the right
to go to their own courts of law.

This conceptual framework treats commercial arbitration as an autonomous system: so long as a dispute
exists within the private sphere, as delineated by the state, individuals are permitted to select an
alternative forum for the resolution of their disputes. In turn, the courts will show deference to
commercial arbitration, starting with the recognition of agreements to arbitrate and ending with the
execution of awards against the losing party. But this logic does not exist with respect to investment treaty
arbitration.

Although states incorporate certain aspects of commercial arbitration within investment treaties, the
authority for investment arbitration originates in the general consent of states, acting in a sovereign
capacity, to establish investment arbitration as a mechanism for the review of the regulatory conduct of
the state. When consenting to the use of adjudication to constrain government and thereby protect
investors, the action of the state is to be distinguished from that of upholding reciprocally consensual
adjudication within the private sphere. Here the state is acting in a sovereign capacity, and disputes
processed through arbitration flow directly from the exercise of public authority.

1) Consent - Equating investment arbitration with commercial arbitration is tantamount to

confusing public for private authority. The confusion is highlighted by the role performed by
the general consent in transforming international arbitration from that of a reciprocally
consensual method of adjudication between private parties into a mechanism to review and
control the exercise of public authority. A private party’s consent to commercial arbitration is
specific to the dispute, or to the private relationship within which the dispute has arisen. A
state’s consent to investment arbitration, by contrast, is an agreement to the compulsory
arbitration of future disputes with investors as a group.

Where consent is given after the dispute has arisen, the consent is specific to the dispute. Where
consent is given in advance, the consent is specific to the relationship between the parties. In
either case, the consent is limited either to a particular dispute or to a private relationship.
However, unlike private parties, states also consent generally to investment arbitration, in one of
two ways. First, the state can consent to investment arbitration by enacting a law that authorizes
foreign investors to submit any investment dispute with the state to compulsory international
arbitration. Secondly, the state can conclude a treaty that likewise provides for the compulsory
arbitration of disputes with foreign investors. In both cases, the state’s consent is general because
it authorizes the compulsory arbitration of future disputes arising from the state’s exercise of
public authority in relation to foreign investors as a group.

In making a general consent, the state is not acting in a private capacity. Rather, it exercises
public authority that the state alone possesses as an entity representing an independent political
group within the international sphere. When consenting by treaty to investment arbitration, the
state is acting in a sovereign capacity. Only the state can consent generally to arbitration because
only the state has the authority to regulate individuals in its territory and to authorize the
compulsory adjudication of disputes between the state and individuals who are subject to public
authority.

Where an investor consents to investment arbitration by seizing upon the opportunity afforded by
the general consent, the investor takes advantage of a governing arrangement that was
established by states. In this respect, investment arbitration based on the general consent is
analogous not to commercial arbitration but to domestic judicial review of state conduct.

2) Investment Arbitration as Public Law - By obliging states to arbitrate disputes arising from
sovereign acts, investment treaties establish investment arbitration as a mechanism to control
the exercise of public authority. For this reason, in particular, investment arbitration is best
analogized to domestic public law. In domestic public law, the primary subject of adjudicative
review is executive government. In response to an individual claim, the courts may review
sovereign acts of executive government to determine whether they were lawful and, if not, to
adopt an appropriate remedy. In investment arbitration, by contrast, the main subject of
adjudicative review is not executive government but the state as a whole. The international
principle of the unity of the state establishes state responsibility for acts of its constituent
elements, regardless of how public authority is allocated under domestic public law.

In effect, the state is equated to the executive branch in domestic public law and is subjected to
review by an international tribunal constituted as part of a bargain between states. By exercising
their adjudicative authority, arbitrators decide whether and how public authority may be used to
restrict capital transfers, tax business, establish standards, control land use, establish product
standards etc. For example, under NAFTA, claims have been launched against each state party in
disputes arising from various governmental activities, including a ban on the export of hazardous
wastes by the Canadian legislature, the creation of an ecological park by a Mexican state
government, and the conduct of a jury trial by a US court.

By using a private model of adjudication – commercial arbitration - to resolve what are quite
clearly regulatory disputes, investment treaties have radically transformed how adjudication is
used to review and control public authorities. Not surprisingly, the importation of a private
adjudicative model has generated tensions in relation to investment treaty arbitration. Of
particular importance are the issues that arise from the appointment of private arbitrators. In most
cases, arbitrators are practising lawyers or academics who compete for appointments in a market
for adjudicative services.

Unlike judges, arbitrators have a commercial interest to provide an efficient and economically
valuable service for clients and are not barred from political or professional activities
incompatible with their independence and impartiality. The business opportunities of arbitrators
are tied to the popularity of investment arbitration: the greater the utility of investment arbitration
to investors, the greater the number of claims will be filed, the greater the demand for arbitrators.

Conclusion - investment arbitration as global public law

Rather than being viewed as an offshoot of commercial arbitration, investment arbitration should
be treated as a unique, internationally-organized species of the public administrative law systems
of states. Some of the key reasons that have been identified in support of this position are -

· Not only is the regime of investment arbitration established by a sovereign act of the state, it
is also designed to resolve disputes arising from the exercise of public authority.

· The subject-matter of investment arbitration is a regulatory dispute arising between the state
(acting in a public capacity) and an individual who is subject to the exercise of public
authority by the state.

· Although most regulatory disputes are adjudicated by domestic courts in accordance with
domestic law, or by a specialized domestic tribunal subject to supervision by domestic courts,
here the general consent authorizes the adjudication of regulatory disputes by an international
tribunal. Whether resolved by resort to domestic or international law, this is intrinsically a
matter of public law.
The regime is therefore to be distinguished from reciprocally consensual adjudication, as
conventionally used to resolve international disputes between states, or commercial disputes
between private parties; it is not based on a reciprocal relationship between juridical equals but
rather engages a regulatory relationship between the state and an individual.

What makes investment arbitral tribunals a potent species of global public law is the fact that,
owing to their international dimension, tribunals established under the law of one state are
invested with the authority to resolve a regulatory dispute involving another state. Thus,
investment arbitration is both uniquely removed from the domestic legal system of the
respondent state, as well as uniquely integrated into the domestic enforcement structures of many
other states. As a result, the capacity of investors to make and enforce international claims under
investment treaties is unparalleled.

Adopting a strict definition of global public law – as a system similar to domestic judicial review
insofar it keeps public authorities within the bounds of legality and provides enforceable
remedies to individuals harmed by unlawful state conduct – investment arbitration would appear
to be the only case of global public law in the world today. Simply put, no other system of
international adjudication does what investment treaties do to restrain state action through
individualized claims, international review mechanisms, and effective remedial arrangements.

By examining investment treaty arbitration as an exemplar of global public law, it is possible to

map the disciplinary regimes that are emerging at the international level and to work through
their detailed implications. But there is also an additional benefit: by approaching the subject
from a perspective that is able to draw on universal values within the modern practice of public
law, we can highlight a number of issues about the way in which this regime has emerged. These
include:

· The manner in which the tribunals making such governmental decisions are constituted.

· The justification for removing such regulatory disputes from the jurisdiction of domestic
courts, and for supplanting the principle that local remedies should be exhausted before
international claims can be made.

· The justification for an extensive use of damages with respect to regulatory measures without
regard to the qualifications devised by courts for the use of such awards in a public law
context.

· The ability of such tribunals to effectively determine the extent to which their own decisions
will be subject to judicial supervision; the peculiarity of being able to make parallel claims
arising from a single dispute as to the legality of a sovereign act of a state; and the degree to
which the adjudicative process is able to consider and accommodate more general issues of
public concern.
All rights reserved. This document has been prepared purely for academic purposes, and should
not be construed as anything otherwise. No part of this document may be copied, reproduced, or
distributed in any form or by any means, whatsoever, without the explicit written permission of
‘O.P. Jindal Global University’ and ‘UpGrad Education Pvt. Ltd’. Breach of the condition is
liable for legal action. However, the permission to reproduce this material does not extend to any
material, which is explicitly identified as being the copyright of a third party. Authorization to
reproduce such material must be obtained from the concerned copyright holder(s).