By: Saurabh Tiwari
Globally, the issue of tax, investment, and dispute resolution in investment law is one that witnesses constant scuffle between the prominent players namely: the state and the investors. Jurisdiction of an arbitral tribunal plays a vital role in disputes between investors and state. States prefer the dispute to be resolved in their national courts as per their national laws while investors look for a forum which is favourable and just for them. Thus, the issue of jurisdiction of an arbitration court or tribunal takes prime importance.
Article 25 of International Centre for Settlement of Investment Disputes (hereinafter ICSID) provides for the jurisdiction of the court in cases where the dispute is between the contracting state and a national of another contracting state. Nationality is a core element of ratione personae jurisdiction of ICSID. The contracting states enter into Bilateral Investment Treaties (hereinafter BIT) and provide for treatment standards to the willing investors of one contracting state into the other contracting state providing protection and promoting investment.
Treaty shopping (also referred to as nationality planning) occurs when a juridical person structures his investment in such a manner that he gets the benefit of the most favourable existing BIT between two nations, which include a neutral forum for dispute resolution, tax benefits etc.
Treaty shopping can be done by an investor in two possible ways:
Firstly, by establishing a company in a state which has a BIT with the host state, and then use the newly established company as a channel to invest in the host state.
Secondly, by transferring his investment in an existing subsidiary in a country that has a favourable BIT with the host state.
Treaty shopping is an accepted practice in the international milieu and the establishment of companies so as to obtain benefits from domestic law and treaties is neither unethical nor illegal. It is a standard practice in international economic relations. Nationality planning has become as much a standard feature of diligent management as tax planning. The contracting states while entering into a BIT have the full autonomy and opportunity to structure and design the definition of investors in the BIT. If such states have chosen for a loose and wide definition of an investor in order to attract investment on a wide scale, they shall also bear the consequences of the same. This indicates that the contracting states do not object to the practice of treaty shopping. Hence, the investors may seek its legal protection under any scheme provided by the laws of the host state.
But it should also be noted that the BIT’s which are concluded between states that are not at equal bargaining pedestal either in diplomatic relations, in terms of experience, or in investment motivation. Consequently, the developing states, in order to fuel their development, have to conclude the treaty in unfair terms of the developed states in order to get foreign investments. Thus, the contention that the states have the full autonomy to design their BITs and hence justifying treaty shopping is rebutted to some extent.
It is argued that the concept of treaty shopping violates the principle of reciprocity as it offers protection to the investors of the host states which would not have been provided by the will of their home states. This is because the investment is not made directly from the home state into the host state, it is rather made through a shell company acting as a conduit for the investment and thus violating the principle of reciprocity.
With regards to the question as to whether treaty shopping has been allowed in a particular BIT, reliance is placed on the language used in the BIT. For instance, where the treaty language provides in clear and unambiguous terms the definition of investors and protected investors, the tribunals apply the same in the strict sense. In this respect, reference should be made to the decision of the tribunal in case of Tokios Tokeles v Ukraine, where the claimant was a company established under the laws of Lithuania whose 99% shares were held by investors in Ukraine, the claimants were completely under the definition of investors under the Lithuania-Ukraine BIT. The respondents contended that the ownership of the company was that of the Ukrainian citizens and thus they should not be given the benefit of the BIT. The tribunal held by the majority that the ICSID leaves sufficient autonomy for the states to draft their own BITs and determining the definition of investor’s nationality and the tribunal ought to respect the definition given by the states. Further, the claimant did not form the subsidiary to get the protection of BIT, instead, it was already in place for six years prior to the date on which the BIT was signed. However, chairman of the tribunal dissented in the case by stating that the ICSID mechanism and remedy are not meant for, and are not to be construed as allowing… nationals of a State Party to the ICSID Convention to use a foreign corporation, whether pre-existent or created for that purpose, as a means of evading the jurisdiction of their domestic courts.”
However, the above view was rejected categorically in Rompetrol Group NV v Romania wherein it was said that his dissent was not widely approved in the academic or professional literature, or generally adopted by subsequent tribunals.
ABUSE OF RIGHT AS A RELEVANT CRITERIA TO DETERMINE THE LEGITIMACY OF TREATY SHOPPING
The tribunals that choose to look past the treaty language, take into consideration the time of restructuring and the purpose of the same. It has been recognised that the principle of good faith is a general principle of law and a part of jus cogens, and hence the corporate restructuring that is not done in good faith has been dissuaded by the tribunals resulting in existence of principles of legality and good faith regardless of whether the treaty provisions expressly mention it or not.
The arbitral tribunal in the case of Gustav FW Homester refused to provide the protection of treaty to a party where it was found that the restructuring was done in violation of the international principle of good faith. Hence, the restructuring made for the sole purpose of being entitled to a treaty and not for performing an economic function in the country where the new restructuring has been done is not allowed and the same constitutes treaty shopping of the ‘wrong kind’.
The time of restructuring of the investment also plays a vital role in determining whether a treaty shopping is legitimate or not. The ruling on the issue of timing is that of landmark Phoenix Action Ltd v Czech Republic, in which a Czech citizen established a company in Israel and bought two of his own Czech companies and then invoked the Israel-Czech BIT. The tribunal emphasised that the investment made was not an investment aimed to engage in economic activity, but was a simple rearrangement made merely to gain access to the BIT to which he was not entitled to in the first place. Consequently, it held that such an action violated the general principle of good faith.
THE RELEVANCE OF TIME OF RESTRUCTURING OF A CORPORATION
In the case of Pacific Rim Cayman LLC v Republic of El Salvador, where a Canadian company applied for obtaining a license to mine gold and silver in El-Salvador, failing which the Canadian company claimed through its US subsidiary. It argued that the actions of El Salvador were inconsistent with its obligations under both CAFTA and El- Salvador’s investment law.
The tribunal was of the view that corporate restructuring in international commercial arbitration is limited by the principles of abuse of right. The tribunal further held that the restructuring done with a single gal of gaining access to ICSID jurisdiction constitutes legitimate treaty planning should such restructuring takes place before the dispute arises. Hence, the timing of restructuring becomes of prime importance. The tribunal in the same case laid down a test to distinguish between a legitimate treaty shopping and an illegitimate one, based on the timing of restructuring. The tribunal held that a “dividing line is visible when the relevant party can see an actual dispute or can foresee a specific future dispute as a very high probability and not merely as a possible controversy”. Overstepping this line would mean an abuse of procedure and this would render the practice of treaty shopping illegitimate. Thus, in reality, the dividing line between legitimate and illegitimate treaty shopping is a thin red line encompassing a wide grey area. facts and circumstances would be important role-players in such determination.
HOW TO PUT A CHECK ON ILLEGITIMATE TREATY SHOPPING
To inhibit the problem of illegitimate treaty shopping, ‘denial of benefit clauses’ can be incorporated in the treaty to act as a counterpoise to the wide definition of investors in the treaties. A ‘denial of benefit clause’ authorises the host states to proscribe the treaty benefits to a person who although fulfils the definition of an investor fails to have a meaningful and effective economic connection with its purported host state, thus putting a check on the illegitimate treaty shopping. The ‘denial of benefit clause’ is an embodiment of the mutual views of the parties regarding the circumstances in which the host state can deny treaty protection to purported investors by allowing the host state the authority to effectively carve out from the definition of ‘investor’ shell companies owned by nationals of a third-party state or the host state and companies owned by enemy aliens. Hence, the possibility on the part of the state to deny the benefits of the treaty to a particular set of investors, who are not entitled to the benefit of a treaty, balances the principle of reciprocity while disentitling the shell companies of the treaty benefits and protections.
 Christoph Schreuer, ‘Nationality of Investors: Legitimate Restrictions vs. Business Interests’ (2009) 24 ICISD Review Foreign Investment Law Journal 521.
 Hussein Nuaman Soufraki v United Arab Emirates ICSID Case No ARB/02/07.
 Tokios Tokeles v Ukraine ICSID Case No ARB/02/18.
 TokiosTokeles v Ukraine ICSID Case No ARB/02/18 Dissenting Opinion (Chairman Prosper Weil) 130
 Luke Eric Peterson, ‘Analysis: ICSID Open Where BITs Set Loose Nationality Tests’ (2008) 1 Investment Arb Rep 1.
 SAUR International S/A v Republic of Argentina ICSID Case No ARB/04/4.
 Gustav FW Homester GmbH & Co KG v Republic of Ghana, ICSID Case No ARB/07/24.
 Cementownia “Nowa Huta” SA v Republic of Turkey ICSID Case No ARB(AF)/06/2.
 Phoenix Action Ltd v Czech Republic ICSID Case No ARB/06/5.
 Pacific Rim Cayman LLC v Republic of El Salvador ICSID Case No ARB/09/12
 Mark Feldman, ‘Setting Limits on Corporate Nationality Planning in Investment Treaty Arbitration’  27(2) ICSID Review Foreign Investment Law Journal 293.
(Saurabh is currently a student at Dr. Ram Manohar Lohiya National Law University, Lucknow.)