Effect of Bilateral Investment Treaties on Foreign Investment in China
As the world’s second-largest economy, China is one of the top destinations for foreign direct investment. Such success is partly due to China’s efforts to enter into bilateral investment treaties (BITs) with other countries.
Bilateral investment treaties are agreements between two nations for the reciprocal encouragement, promotion and protection of investments in each other’s territories by companies based in either country. China had already concluded BITs with more than 130 countries.
Evolution of China’s BITs
The nature of China’s BITs with other countries has changed significantly over the years. From 1982 when China signed its first BIT with Sweden until 1998, Sino-foreign BITs generally provided limited protection for foreign investments.
Most of China’s early (or “first-generation”) BITs before 1998 lacked or provided only limited provisions for the national treatment of foreign investments, reportedly to protect infant industries or state-owned enterprises from foreign competition. National treatment means the host country does not treat foreign investors less favourably than its own nationals.
First-generation BITs also typically either did not provide for disputes to be settled by international arbitration, or restricted such arbitration only to disputes over the amount of compensation arising from expropriation. The latter case implied the need for a Chinese court to determine whether an expropriation occurred in the first place, which the host state may argue did not, consequently limiting the scope of application of BIT provisions for international arbitration.
Since 1998 however, China has been signing “second-generation” BITs that offer greater protection for foreign investors because it has become a substantial overseas investor in its own right, although it continues to attract much foreign investment.
These second-generation BITs offer comprehensive substantive protection measures for foreign investors, such as broad definitions of investment, protection of investments from expropriation, fair and equitable treatment of investments, national treatment and a most-favoured-nation (MFN) clause.
Where provided for in the BIT, investor-state disputes can be submitted to ad hoc arbitration under the arbitration rules of the United Nations Commission on International Trade Law, or a tribunal established under the International Centre for Settlement of Investment Disputes (ICSID) convention.
While both first- and second-generation BITs may allow for international arbitration, second-generation BITs also differ in this aspect because they can include unrestricted arbitration provisions.
Unrestricted arbitration provisions do not require foreign investors to exhaust local legal remedies first before seeking international arbitration, allowing for faster resolution, in contrast to provisions in more restrictive BITs that do. They also allow investors to submit any dispute over a potential breach of the BIT to international arbitration, beyond only those concerning compensation amounts for expropriation.
Most Favoured Nation Clause
Generally, a foreign investor bound by a more restrictive first-generation BIT with China can invoke an MFN clause to “import” substantive rights covered in a more favourable second-generation BIT between China and a third-party country.
However, controversy remains over whether the investor can invoke the MFN clause to extend an international tribunal’s jurisdiction to arbitrate dispute types falling outside the scope of the dispute resolution provision within the first-generation BIT, assuming the BIT has such a provision.
There is currently a lack of information regarding an international tribunal’s ruling in the abovementioned context for Sino-foreign BITs. In 2011, a Malaysian company became the first investor to bring a claim against China at ICSID. However, the case was suspended shortly after, following an agreement by the parties.
Past non-China cases have shown that the international tribunal’s ruling over the scope of its jurisdiction to arbitrate investor-state disputes depends on its interpretation of the wordings of the dispute resolution provision and MFN clause within the BIT concerned. For example, the tribunal may decline to arbitrate if it interprets the MFN clause narrowly to only cover arbitration of disputes over compensation amounts for expropriation (if specifically provided for in the BIT) and not simply any investor-state dispute.
Previous cases have also shown that the tribunal’s interpretation may or may not follow that of other similar cases. However, the fact remains that the MFN clause still has the potential to improve the protection of foreign investors bound by first-generation BITs.
Special Purpose Vehicles
Due to the unpredictability of the international tribunal’s interpretation of the MFN clause, foreign investors bound by first-generation BITs with China may seek an alternative option in the form of Special Purpose Vehicles (SPVs) to increase their protection. Foreign investors whose home country does not have a BIT with China may also consider SPVs for the same reason.
By holding an investment through an SPV incorporated in a third-party state that signed a second-generation BIT with China, the two abovementioned groups of foreign investors can gain greater BIT protection in China, including favourable international arbitration provisions for settling disputes.