The Caveat Investor Principle Analysis and Perspective

THE "CAVEAT INVESTOR" PRINCIPLE: THE "CAVEAT INVESTOR" PRINCIPLE: ANALYSIS AND PERSPECTIVE By Kashif Mir Zubair Recent controversies involving foreign investment in various sectors of the Pakistani economy (Riko diq lease in Baluchistan, Rental Power Plants, Huawei Telecom, are some examples) have put Pakistan at an increasing risk of being labelled a pariah State insofar as foreign investment is concerned. While such a label may be an unfair indictment, it nonetheless raises the question of whether international investors should be mindful of the unique dynamics of pluralistic and politically volatile countries like Pakistan. A necessary corollary to this question is the idea that the conduct of the investor, even outside the realm of the legal fiction created by complex investment treaties and contractual arrangements should be a factor incorporated into the dispute resolution process, and be part of the standard on which disputes are adjudicated. The mainstream view generally does not consider the question of whether investors should be held culpable if they fail to gauge the true nature of the political, cultural, economic and social realities in the countries they invest into. A more pertinent question of whether principles of international commercial law and dispute resolution, largely conceived in the West, are fit to be applied uniformly across all nations is also often discounted. This Article will aim to illustrate the efficacy of an unconventional theory of dispute resolution and dispute mitigation, specific to investor-state disputes. The overwhelming focus of academic, doctrinal as well as adjudicative development of international law in the area of foreign investment has been on standards of treatment that investors should expect from host States and as a consequence most risk management tools, which include various dispute resolution mechanisms, were developed with the objective of compelling host States to adhere to fair and equitable standards of treatment. Bilateral investment treaties have evolved over time to include an exhaustive exposition of obligations of States towards investors; failing which the investor has recourse to the protective measures contained in these treaties. Traditionally, "fair and equitable" standards of investor conduct have, however, been inexplicably ignored, despite the potential of such standards to mitigate risks and decrease the probability of disputes. In recent years however, decisions of arbitration tribunals do reflect a need for a more consolidated investor conduct doctrine and in certain cases, investors have been denied protection under these treaties due to the shortcomings found in their conduct and business practices. It is pertinent to mention that such standards should encompass a wide range of business practices and mandate that the investor be assiduous in its conduct from the very start. If standards of fair and equitable treatment are to become an inviolable tenant of investor-State relations in long-term contracts between foreign investors in host States, it is essential that investor conduct should be part and parcel of such standards. There is a fundamental need for an increased emphasis on investor conduct and it has become necessary develop a formidable doctrine that is inclusive of these standards. Ideally they should be at par with the overwhelming doctrinal, treaty-based and arbitral attention on the obligations of States. The lack of emphasis on the conduct of the investor acts as an impetus for States to disregard standards of treatment mandated by investment treaties and contractual obligations. Often times, these form the basis of not adhering to standards of treatment, as the tremendous focus on State conduct is perceived to be undercutting the sovereign right of the state to regulate economic activity within its borders. There is a plethora of arbitral awards concerning standards of fair and equitable treatment in relation to judicial and administrative actions of the State. Briefly, arbitral tribunals have interpreted standards of fair and equitable treatment contained in various bilateral and multilateral investment treaties as requiring States to extend such treatment to investor that is "reasonable, non-discriminatory, consistent, transparent and in accordance with due process" In relation to standards that the investor in natural resources must adhere to, the only jurisprudence is found in a select few arbitration awards and the principles contained therein can be best described as emergent. Peter Muchlinski has articulated the urgent need for the development of such a doctrine that he hopes can be termed as a principle of "caveat investor". His arguments, although mostly theoretical, . It is also pertinent to mention that they have been largely dismissed by a leading a renowned academic and one of the leading authorities on international dispute resolution, Thomas Walde, with what this author believes is a somewhat cynical exposition of an idea that holds immense potential to induce stability in investor-State relationships. He states that applying the 'caveat investor' principle would greatly undermine investment as such benchmarks are detached from reality and too high to achieve in practical terms. He further states that if "only 'perfect' investors were to be protected, there would be no need for protection at all." The idea of achieving impeccable standards of investor conduct may seem like a notion of utopia, if the aim is to achieve fair and equitable standards of investor conduct in absolute terms. However, the very presence of established benchmarks will help achieve equilibrium in long-term investor-State relations and may induce an increased emphasis on diligence and appropriate risk assessment on part of investors. Disputes are less likely to occur if the investor has been diligent enough to structure his investment, from the very beginning, in a way that shields it from politically motivated interference. Furthermore, a doctrine that focuses on standards of investor conduct is not as novel or unprecedented as is alluded to in Thomas Walde's criticism of it. Parallels can be drawn with established concepts in English common law relating to commercial contracts such as fairness and unconscionability of contracts that dictate that validity of contracts can be dependent upon a commitment to fair and honest conduct on the part of the claimant, as well as on the part of the defendant in a contractual dispute. Muchlinski's 'caveat investor' concept, however, is explained in a very restrictive way and he has not borrowed from established theories of corporate practice that have acknowledged of how transparency and corporate responsibility are good for business relations in the long run. Thomas Walde's criticism of it is perhaps justified to the extent that it is presented as something novel and only relevant in relation to balancing it with the expectations of 'fair and equitable conduct' that investors expect from host States. He focuses solely on finding legal justifications for these emergent principles in various arbitral awards and offers very little evidence on how these can reduce the potential for disputes in practical terms. Standards of investment conduct should ideally focus on internal organizational reforms that should translate into good behavior in the host-States where investments are made. It is almost universally acknowledged that reform in international law as well as international commercial practices in an incremental process, and the theoretical doctrines only become mainstream through the continuous process of evolution. It is therefore vital that the potential of the principle of "caveat investor" be explored in relation to its ability achieve efficient dispute management and dispute avoidance in the context of foreign investment in natural resources. An optimal standard of investment conduct should ideally be balanced with various legal and non-legal methods employed by international investors for risk mitigation. The over-emphasis on investor protection, especially in the face of an upward trend in the price of oil and other naturally occurring commodities is counterproductive. Investment agreements that seek to make use of extensive protective instruments are generally seen to be undercutting the power of the State to regulate the exploitation of their natural resources. Similarly too much discretion left in the hands of host States will make the investor vulnerable to adverse actions by the State, and eliminate any motivation for the State to seek an efficient resolution of disputes. A fundamental cause of investor-state disputes, as has been described earlier, is the perceived lack of benefit the host State derives from the exploitation of its natural resources. In this context, risk of politically motivated actions against the investor can be to a large extent mitigated if the investor is seen to be making contributions to the economic development of the host State and the local community where the project is based. Peter Muchlinski rightly points out that the actions of the host State government cannot be judged without reference to the conduct of the investor towards the community the State represents. The magnitude and intensity of investors-State disputes may be drastically reduced if the investor is obligated to properly assess risks before committing a large amount of capital over an extended duration of time in a country that has unstable conditions for investment. The rationale for this is sound. Muchlinski explains that it should not be part of the investors legitimate expectations to be able seek compensation for losses that can be attributed to their own inability to grasp the risks at the time the investment was made. While the investor should expect treatment as per the law prevailing at the time of the investment, it should not however, expect the state to tailor its domestic law to unreasonably favour the investor. Corporate practices in international oil companies, which are usually large investors in developing countries, are such that executives prioritize 'deal-making' with substantially little consideration of long-term risks. One of the most important aspects of the caveat investor principle is a duty to invest with adequate knowledge of all risks involved and a necessary corollary arising out of this duty is the principle that any losses as a result of inadequate assessment of risk or unrealistic expectations of profit should be borne by the investor. This has also been acknowledged in recent case-law dealing with the scope of investor protection offered under bilateral and multilateral investment treaties. In Maffaezi v. Spain for example, it was observed that investment treaties "are not insurance policies against bad business practices". Similarly, arbitration tribunals have held that the investor needs to be more conservative and prudent while investing in countries that are fraught with economic problems. Under the principle of caveat investor, the conduct of the investor should be judged in relation to the payment of taxes, contribution to national development goals and the observance of certain standards of treatment in relation to labour. If the investor is treated unfairly through any regulatory action by the host State, then evidence of sound investor conduct may bar the State from alleging misconduct on part of the investor. An arbitration tribunal may also take into account good investor conduct in order to assess whether State regulatory actions against it were proportionate. Standards of investor conduct should also mandate transparency in production and business practices as well as transfer of technology and a commitment to use locally manufactured machinery and goods whenever possible. International investors should also aim to make use of domestic dispute resolution where doing so would generate a more favourable outcome for both parties than international arbitration. Initiation of arbitration often takes disputes to the point of no return. Most investment treaties have omitted or expressly barred the use of local remedies for dispute resolution. In recent years, arbitration tribunals have expressed the desire that for certain types of disputes, such as clarification of tax matters; local remedies should be availed first. The hope for such a practice to become popular amongst international corporations however shall remain unfulfilled unless a major revision in international investment treaties is made. This exercise should exhaustively draw the parameters of when it is appropriate to use local remedies and for what disputes "delocalized," dispute resolution systems and arbitration should be the only available remedy. The caveat investor principle should also include an obligation on part of the investor not to use its bargaining position in order to coerce undue benefits from the State. This is a very prevalent practice in many countries where the governments are desperate for the influx of foreign capital. The regulatory authority of the State may also assert failure of the investor in achieving certain standards in its conduct as justifications for regulatory action. An objective standard therefore would constrain both the investor and the host States from certain actions or omissions that may result in disputes being adjudicated in national courts or arbitration tribunals. Recently, in a study it was observed that "the wisest and most committed foreign investors cannot rely entirely on external guarantees of property rights, whether they are reformed or not ultimately, security for most investors lies in how a particular project is perceived by its hosts-by government officials, but also in a democratic Third World by the press, labour, and nongovernmental organizations" Business ethics and corporate social responsibility are now emphasized in the top business schools and most managers and executives are trained in the subject. Adherence to excellent standards of corporate social responsibility can play an important role in dispute avoidance and therefore bring financial benefit to the investing company. The increased international co-operation in matters of environmental protection and climate change presents an opportunity for the more prudent investors in natural resources to identify themselves with goals of environmental protection and sustainable development in the developing world. Former Secretary-General of the OECD, Donald Johnston has expressed the need to integrate foreign investment in natural resources with environmental objectives and policies. If the investors in natural resources are seen to be raising the profile of the host-country in terms of achieving goals of environment protection and reducing carbon dioxide emissions, then the government will have an additional incentive not to antagonize the investor. The extent to which the investor can contribute to the reputation of a host State in terms of being environmentally friendly is dependent on the indigenous environmental policy framework of the State. It has been suggested, however, that transnational corporations should integrate a voluntary corporate environmental management framework as a significant part of their foreign investment in natural resources. Jan Adams, an Australian environmental consultant believes that international business associations should take the lead in prompting extensive environmental principles through guidelines and codes. These voluntary approaches should ideally go beyond the minimum standards of compliance with host state regulations. Such an approach is not designed to achieve just an altruistic objective, but is an essential tool for risk mitigation. An otherwise good history of business operations management on part of the investor will be rendered an exercise in futility if the relationship between the foreign investor and the host country are strained due to environmental disasters that cause widespread damage. The Bhopal disaster of 1984 in India is a good example of this. The colossal loss of human life resulting from an industrial unit operated by a foreign investor brought to light major shortcomings of the international dispute resolution system in cases environmental disasters. The subsequent disputes over allocation of liability and compensation of victims, in absence of a strong international regime in this context, were handled in a haphazard way, with the result that the victims were given a miniscule compensation after a prolonged period of litigation. Public sentiments were incensed against the very idea of foreign investment and as a result foreign investment in India was suddenly subject to grave uncertainty and politically motivated adverse action. The probability for similar disasters is high in exploration of oil reserves, mining and other projects financed and operated by international corporations in developing countries. International investors should therefore be more vigilant in making a quick and efficient settlement of liability disputes as part of the contractual arrangement. Ideally, they should work out an "insurance based strict liability" regime in this context with the host State before the project is initiated. Additionally, they should be prepared to provide some sort of compensation for any human or property losses related to their project in the interim until issues of allocating liability are resolved. The above enhancements of business practices and conduct can be supplemented by greater partnerships between international corporations and international financial institutions. Such an approach will further minimise the risk of politically motivated disputes in this phase of resource nationalism. The economies most developing countries are heavily dependent on sustained financial assistance from the international financial intuitions such as the World Bank, IMF and the ADB. Partnerships can be in the form of the financial institution being the " guarantor, lender, or investor" in the project In the construction of dams to harness a country's natural resource of water for various purposes, the projects have in the past been conducted under the auspices of the World Bank and it has been seen that such projects have been less susceptible to risk of disputes. (The Tarbela Dam and Water Reservoir in Pakistan, for example) Investors usually operate under the umbrella of the international financial institute and are technically sub-contractors. This approach with greater partnerships can be extended to foreign investment in oil and gas exploration, mining and in other natural resources under the banner of sustainable development goals for countries through an international financial institution. An enhanced reputation and credibility is an essential dispute avoidance tool and extremely effective when the investor is seen to be more socially responsible than what is required under domestic regulatory laws. Principles of investor conduct in natural resources transactions should be contextualized with established principles of corporate responsibility in way where the investor feel a greater sense of empowerment in seeking resolution of disputes with governments. This is only possible if local sentiments are not hostile towards the foreign investor and the host-State considers the role of the investor as an increment to their political capital. It is however important to keep in mind that the principles of fair, equitable and responsible conduct in the context of investor behaviour are emergent and have not been properly incorporated with "textbook" principles corporate governance. They should not be designed strictly to balance investor conduct with obligations put on host States, but in fact serve as an incentive for States to adhere to the treaty and contractual obligations to protect investors. International corporations investing in natural resources of developing States should collectively develop a more uniform and consolidated standard that binds the industry as a whole to certain standards. The mind-set of international oil companies may alter over time in such a way that dispute avoidance through their own conduct becomes a priority as opposed to relying on enforcing stabilisation clauses or treaty-based protective measures through international arbitration that is often to the detriment of the investor-State relationship. It is however essential to meticulously draw the parameters of this standard and carefully balance it with the obligations of host-states in way where investor-conduct and obligations of States compliment and not oppose each other. The onus for doing so largely lies on transnational corporations that regularly invest capital into developing nations and this should be done internally with the minimal involvement of the international law practice specialising in transnational dispute resolution. The legal practice relying heavily on arbitration has a vested interest in maintaining the status quo of adversarial arbitration as the chief paradigm of transnational dispute resolution. The emergence of a standard of "caveat investor", in the very least, has the potential to be the starting point for reform and can be an impetus for a fundamental reorientation of priorities of the host States and international investors and recognition of a common basis for a system of efficient dispute management. Bibliography 1. ANTHONY H. J. 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