Unravelling the Paradox of “Necessity” under Investment Arbitration

At a point in history when the entire world economies are struggling to stand upright and tackle this menace of COVID-19, we ought to step into the shoes of the governments that are forced to make decisions to protect the economic and social welfare of their citizens even at the cost of their foreign investors. A pressing concern that is being raised during these troubled times is whether or not the measures taken amidst this emergency will be insulated from future investment claims. Let’s rewind twenty years, in the wake of the 21st century, while many of the developed countries were generating wealth in abundance, Argentina was enveloped in one of the worst economic crises in its history. Between 2001 and 2002, the economic output plummeted by 20 per cent, the inflation soared and the government defaulted on its debts, which ultimately crippled the economy. In light of the preventive measures taken by the Government of Argentina during the crisis. The 2001 crisis revealed that international investment agreements have the potential to severely curtail the autonomy of a State to mitigate adverse effects to its economy. In light of this amplified significance and the pace at which the global commerce is being destabilised by the pandemic, growth of the international investment law jurisprudence to meet the contemporary investment crisis has become the need of the hour.

Following the World Health Organization (WHO) Directive that classified the COVID-19 outbreak as a global pandemic, a lot of anxiety and concern stirred across the globe. Over the past few months, despite the governments’ proactive measures and staunch leadership to guide their citizens through these dark and uncertain times, the global trade and commerce have been put on hold; companies have witnessed a drastic drop in their earnings; global stock market rates have plunged and widespread unemployment and hunger have become a common sight. In light of this, governments are doing everything in their reach to take measures to flatten the curve and ensure utmost protection to their citizens. These measures include travel bans, export-import restrictions, complete lockdown, and possible nationalisation of businesses in anticipation of an economic crisis that is to subsume the countries after the pandemic dies down. The emergency measures are bound to change the existing regulations in each of these countries and detrimentally affect the investments of foreign investors. This may result in a breach of the legitimate expectations of the investors to carry out their activities as assured under the bilateral investment treaties; potential discrimination between national and foreign companies; curtailment of investors’ property rights and, above all, a fundamental alteration to the existing investor-friendly environment.

While states may invoke force majeure under Article 23 of Draft Articles on Responsibility of States for Internationally Wrongful Acts (hereinafter ‘ILC’) or necessity under Article 25 of the ILC to justify their actions and preclude wrongfulness, we are aware that these defences may not always favour the states as seen in the multitude of cases that arose during the Argentina crisis in 2001. As seen in the cases of CMS v. Argentina, Sempra International v. Argentina, Enron Corporation and Ponderosa (U.S.) v. Argentina, and Continental Casualty Company v. Argentina, Argentina’s defence under customary international law was not sustained due to the stringent threshold that had to be satisfied. This serves as an apt indicator of the inadequacy of Article 25 of the ILC to accommodate a contemporary and unparalleled crisis, like the pandemic that the world is tackling at present. In this connection, although the necessity defence has been claimed more frequently than force majeure, the criteria that have to be met under Article 25 of the ILC make it nearly impossible to include economic necessity under its ambit.

Shortcomings of Article 25 ILC under Investment Arbitration

There are four criteria that greatly restrict the scope of operation of the necessity defence under Article 25 of ILC. Firstly, the Article provides that measures can only be taken to safeguard the “essential interest” of the state. There is no qualification as to what makes the interest essential or whether such interest is limited to traditional security concerns such as the outbreak of inter-state hostility.

Secondly, there must exist a “grave and imminent peril” against which the measure has been taken. However, when can an economic crisis become “imminent’? Or when can this culminate into a grave peril? Economic collapses typically take place over months, or years, so how will such subjective standards be quantified? Should the governments only take adequate measures once the entire state has gone bankrupt or will precautionary measures in the best interest of the economy lead to indemnifying the investors?

Thirdly, the chosen measure by the state must be the “only way” to meet the objective. This standard appears to be rather preposterous in light of an economic crisis where there often exists a multitude of ways to meet the objective and in such situations, the customary defence is simply unavailable.

And fourthly, the state should not be responsible for nor have contributed to the emergency situation. This may appear rather straight forward and reasonable, however, its application to an emergency situation that is complex and unclear maybe challenging. Let’s take the instance of an economic crisis, it can be argued that unemployment could have been reduced if better policy regulations were in place; if banks had higher capital, then the crisis would not have emerged in the first place and if governments would have interfered earlier then the crisis could have been contained pre-maturely. With this line of reasoning, states can be potentially responsible for any act by failing to anticipate or contain an emergency situation. What about a situation where there are various factors contributing to the emergency; banks, regulators, consumers, government, and other extraneous situations? What proportion of responsibility would then preclude the state from being able to rely on Article 25 of the ILC? When the global economy is rampantly moving at a fast pace and overcoming unprecedented obstacles, can a defence that is meant to safeguard and justify the actions of states be so ill-equipped and ineffectual? Perhaps, the origin of this exceptionally stringent test can be traced back to the plea of necessity surrounding the use of force in self-defence and it would be absurd to import such a robust standard into the realm of investment arbitration.

What needs to be understood in the realm of investment arbitration is that the preservation and protection of citizens’ welfare and the encouragement of foreign investments are parallel interests. Hence, excessive protection of foreign investments is not a guarantee to invite more investors but would rather cripple a government’s ability to preserve its national goals. In light of the investment claims that may arise during this pandemic, it is essential that the stringent thresholds are relaxed, in order to respect the genuine efforts made by the governments to alleviate the crisis.

Way Forward

The ILC Draft Articles have observed that the determination of the “essential interest” is dependent on all circumstances and cannot be narrowed to an objective standard. The term “essential interest” is not restricted to the existence and independence of a state itself, but also includes other ancillary interests, such as the preservation of the state’s social, economic and political stability, and its ability to provide for basic needs of its population. Further, the threshold for imminence must be made relative to a timeline appropriate to the emergency at hand as opposed to a complete collapse of an economy. According to the Draft Articles of the ILC, the “only option available” means that the defence cannot be invoked if a state has other lawful means to preserve the interest, even if those means are ‘more costly or less convenient.’ This exerts an unreasonable amount of pressure on developing third world economies that have a lot at stake, especially during a financial crisis. Hence, tribunals must also delve into the reasonableness and appropriateness of the measure taken by the governments after considering its pros and cons. Therefore, the standard under Article 25 of the ILC must strike a balance between ensuring that the states hold up to their commitments while simultaneously allowing sufficient flexibility to their sovereignty in determining in the best interests of their nation.

The tribunals that are yet to be constituted for the investment claims that have arisen during this pandemic have the opportunity to define the turning point in the history of investment arbitration to read Article 25 of the ILC more reasonably and progressively. This will help the states that are trapped in choosing between the competing interests of their citizens and investors in finally making a choice that is aligned in the best interest of their nations. In effect, this will also contribute to the growth and evolution of a more comprehensive and sophisticated doctrine of economic necessity, that is well-equipped to address the pressing concerns of the contemporary world.

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