By: Aparajita Kaul
During the Covid-19 pandemic, the Indian government has taken steps on multiple fronts to safeguard the economy, ranging from releasing stimulus packages for small businesses, to introducing measures targeted toward Foreign Direct Investment (‘FDI’) from particular jurisdictions. The latter has come under heavy scrutiny because of the apparently targeted nature of the measure towards China.
On April 22, 2020, the central government notified an amendment to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 as a follow up to its Press Note reviewing the FDI Policy released on April 17, 2020, purportedly with the aim of “curbing opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic.” The FDI regime in India allows investments in three ways– automatic route, government approval route, and a hybrid of the first two based on the percentage of FDI sought to be invested. As the name suggests, the automatic route does not require specific approval from the government as a pre-condition to foreign investment. The categorization of routes is generally based on sectors, apart from specific provisions for Pakistan and Bangladesh.
The Press Note introduced a revision, as per which
“an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route [emphasis supplied].”
While on a plain reading it may seem innocuous, we must consider the event immediately preceding it. A few days before the release of this Press Note, the People’s Bank of China had purchased a 1.01% stake in HDFC Ltd. This move raised suspicion that Chinese investors may be taking advantage of the vulnerable situation India presently finds itself in.
China has pushed back calling the amendment discriminatory. This measure will have an impact on the investment relationship between the two countries that is presently governed by the China-India Bilateral Investment Treaty (‘BIT’). Although the BIT was unilaterally terminated by India in 2018, the presence of a sunset clause binds India to its treaty obligations for a period of 15 years from the date of termination, for all investments made or acquired before the date of termination.
WHETHER THE MEASURES GOVERNING THE ESTABLISHMENT OF INVESTMENT ARE COVERED UNDER THE CHINA-INDIA BIT
States have the sovereign right to exclude and regulate the entry of foreign investors. The FEMA (Non-Debt Instrument) Rules, 2019 and the FDI Policy regulate the entry of FDI into India. The amendment impacts the creation of new investments as well as activities relating to existing investments, for example, bonus issue, that could increase the investors’ pre-existing stake in Indian companies or, transfer of ownership of existing or future FDI that results in beneficial ownership (See Para 3.1.1(b) of the Press Note).
Bonus issue and transfer of shares will fall under the definition of ‘investment’ under Article 1(b)(ii) of the BIT, which includes “shares in and stock and debentures of a company and any other similar forms of interest in a company.” But, with respect to the creation of entirely new investment, the protection granted by the BIT to pre-establishment phase must be considered. This would depend on the language of the treaty. Article 3(1) of the China-India BIT states that:
“each Contracting Party shall encourage and create favourable conditions for investors of the other Contracting Party to make investments in its territory, and admit such investments in accordance with its laws and policy.”
This is a more general obligation than say, the 2012 U.S. Model BIT, wherein the National Treatment (‘NT’) and Most Favoured Nation (‘MFN’) provisions expressly extend protection to the establishment of investments.
FDI regulations that ensure ease of access (for example, by providing an automatic route of entry) for foreign investors to Indian markets will definitely be considered more favourable. However, if substantive rights with regards to the establishment of investment are read into Article 3(1), it could render any rules by India on screening and regulating FDI redundant and curb its sovereign right to control capital inflow. While interpreting an identical provision in the Australia-India BIT, the tribunal in White Industries v. India concluded that the obligation provided under Article 3(1) does not give rise to substantive rights for investors.
Chinese investors may seek to rely on the MFN or NT obligation provided in the BIT and challenge the FDI amendment. However, for the BIT to be applicable in the first place, the investment already needs to be “established”, as provided under Article 1(b). Article 3(1) provides for the admission of investments in accordance with the Host State’s laws, and not the BIT’s provisions. Treaties such as NAFTA that do cover establishment, expressly state so. Therefore, reading pre-establishment obligations into the China-India BIT should not be accepted and would unduly limit India’s sovereign right to regulate.
POTENTIAL FET VIOLATIONS UNDER CHINA-INDIA BIT
For the investments that do fall within the BIT, there may lie a potential FET challenge. There are generally two possible interpretations of the FET standard that is provided in the China-India BIT: One approach equates FET with the International Minimum Standard (‘IMS’), which prescribes a high threshold for the FET provision to be violated, as was first stated in Neer v. Mexico. This is also the position taken by India in its Joint Interpretative Statements for BITs, which has not been signed with China. However, another approach believes that the FET standard is not rigid like the IMS, and evolves with time.
In the Indian context, the scope of FET was discussed in White Industries v. India and subsequently, Devas v. India, wherein the applicable BITs contained a FET provision identical to the one present in Article 3(2) of the China-India BIT. In both disputes, the tribunals noted that the purpose of the FET provision is to protect an investor’s ‘legitimate expectations’. This conception finds strength from a long line of cases endorsing it. Importantly, in Lemire v. Ukraine, the tribunal included the state’s ability to provide a stable and predictable legal framework within the determination of a FET violation.
There remains ambiguity in the FDI amendment that would require clarifications and further impact Chinese investors. This regulatory back-and-forth could violate the legitimate expectations of Chinese investors to a stable and conducive investment environment. It must be noted that the amendment does not prohibit investments but merely changes the route of approval. However, the government approval route is also more time-consuming and unpredictable, making the process of investment burdensome. A determination of the violation must be a balancing exercise, as was recognised in Saluka v. Czech Republic. The tribunal noted that a host state has the legitimate right to take regulatory measures in the public interest. Arguably, protectionist measures taken to safeguard the economy during the pandemic would be in the public interest.
Further, in Deutsche Telekom v. India, the tribunal concluded that a consensus in jurisprudence includes the protection from conduct that is “arbitrary, unreasonable…and lacking in good faith”, within the scope of FET. Chinese investors may contend that given the proximity between the HDFC share acquisition and the FEMA amendment, and the restriction to only neighbouring countries, the measure was targeted toward China, without any reasonable justification and violative of good faith. The lack of a clear nexus between India’s measure and its purported aim is explored next while dealing with its possible defence under the BIT.
INDIA’S EXCEPTION DEFENCE TO FET CLAIM
In case a tribunal finds a FET violation, by virtue of Article 14 of the India-China BIT, India’s measures are provided with an ‘exception’ for the protection of essential security interests or situations of extreme emergency. These measures must be “in accordance with its laws normally and reasonably applied on a non-discriminatory basis.” The provision does not give the state unilateral power to decide the existence of the exceptional circumstances. However, a UNCTAD report referred to an identical clause from the Hungary-India BIT and concluded that while such clauses establish objective criteria, the host state has the deference to determine what its security interests are. It must still show that the interest was ‘essential’.
While the Covid-19 pandemic and the looming economic crisis will probably be accepted as an extreme emergency, the measure must have a nexus with the achievement of this permissible objective. India has yet to provide an adequate justification for putting the restriction only on neighbouring countries to deal with the emergency. The threat of an ‘opportunistic takeover’ could exist with any other country as well, such as those which already account for significant FDI inflow. It is further unclear how FDI by neighbouring countries in every sector would qualify as threats to essential security interests of the country, even during the pandemic. A lack of clarity could potentially impede India’s successful defence against a BIT claim.
Apart from the aforementioned ‘exception’ defence available to India, it may also potentially invoke the ‘necessity’ defence under customary international law, though the threshold for the same is significantly higher. Moreover, as briefly mentioned earlier in the article, China may also consider a potential MFN or NT claim. The MFN and necessity defence arguments have been discussed here. While protectionism during a crisis is understandable, India must tread carefully in striking a balance between such measures and honouring its treaty obligations.
(Aparajita is currently a 5th-year student at NALSAR University of Law, Hyderabad. Her interests lie in international commercial arbitration and investment arbitration.)