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Home >> TII EDIT
Vodafone and international arbitration
By D P Sengupta
Jun 29, 2018

RECENTLY, the Delhi High Court has rendered an important decision [2018-TII-33-HC-DEL-INTL] covering a number of issues involving the controversial Bilateral Investment Protection Agreements (BIPA) that India and other developing countries had entered into for attracting foreign investment.

In the case before the Delhi High Court, initially, a Dutch subsidiary of the British Multinational group Vodafone, Vodafone International Holdings BV (VIHBV) served a notice on the Indian government under the India-Netherlands BIPA, claiming that VIHBV being a company constituted under the laws of the Netherlands, was an 'investor' as defined under Article 1(d) of the India-Netherlands BIPA and that under the said agreement, the Indian government was obliged, amongst other things, to:

  • accord fair and equitable treatment to investors;
  • provide full protection and security;
  • not breach the legitimate expectations of investors in making investments;
  • not deny justice or breach previously provided assurances; and
  • not take steps to indirectly expropriate the investment.

To briefly recount the dispute, British Multinational group, Vodafone had entered the then lucrative telecom business in India through the acquisition of the business of Hutchison of Hong Kong that had a license to operate in some telecom circles in India. The bone of contention was about the tax on capital gains arising from the transactions. The liability was, of course that of Hutchison but Vodafone having refused to withhold the requisite tax before making the payment to Hutch was caught in the vicarious liability as stipulated in the Indian laws. Vodafone maintained that the investment for the acquisition of shares and other rights in the telecom business were in the form of acquisition of shares of a Cayman Islands company. The issue of capital gains was therefore to be determined on the basis of the domestic law since India did not have a DTAA with Cayman Islands and the revenue believed that the transaction was taxable in India.

The action for recovery of the tax from Vodafone was challenged in writ before the Bombay High Court, which held in favour of the tax department. However, this was overturned on appeal by the Supreme Court that decided that as per the existing law there was no liability to capital gains in respect of the transfer of shares since according to the Supreme Court the shares and the company are different and transfer of shares of a holding company abroad did not amount to transfer of the underlying Indian assets. Having lost in the Supreme Court, the government decided to make some 'clarificatory' amendments and one such amendment was to define the use of the word 'through' as was used in section 9(1) of the IT Act that governs the non-resident taxation in India. It was clarified that a transfer of assets in India could be through the transfer of a share.

Since, the government persisted with its action of recovery from Vodafone by virtue of this amendment, Vodafone gave notice to the government of India to invoke the BIPA agreement between India and the Netherlands. Although the government of India initially refused to join the proceedings and still maintains that taxation matters are not covered by the BIPA, it ultimately agreed to the appointment of an arbitrator and the matter is still pending with the arbitral tribunal.

In the meantime, Vodafone group also gave notice to the government of India under the India-UK BIPA on the ground that the indirect investment of its British subsidiary in India was also adversely affected by the action of the government of India and its intention of recovering the tax from Vodafone. While the government of India raised objection to such second arbitration and refused to join proceedings and appoint arbitrator, Vodafone went ahead and requested the International Court of Justice to appoint an arbitrator. In January 2017, it served a notice of arbitration on the government of India. The government of India was of the opinion that the second notice involving identical facts and issues was an abuse of process and corresponded in this regard with the President, ICJ, who informed the government of his intention to proceed with the designation of an arbitrator in accordance with the applicable rules. Vodafone apparently claimed that it had filed the second arbitration in view of the objection raised by the government under the first arbitration proceedings under the Dutch treaty.

Thereupon, the Government of India filed a civil suit before the Delhi High Court seeking a declaration that the Notice of Arbitration under India-United Kingdom BIPA and the proceedings initiated thereunder were an abuse of process and was null and void. The government also expressed apprehension before the High Court that the President ICJ might proceed with the appointment of an arbitrator in case the government persisted in its decision not to participate in the proceedings. The Court thereupon passed an interim injunction restraining Vodafone from taking any further action under the notice of arbitration under the BIPA. India had also raised objection before the arbitral tribunal already constituted under the India-Netherlands BIPA alleging that exactly similar issue was raised under the India–UK BIPAA. That Tribunal dismissed the argument on the ground that under the arbitration proceedings it is the tribunal that determines its competence and India was to raise its objection, if any, under the tribunal to be constituted for India-UK BIPA.

Vodafone had also filed SLP against the interim injunction issued by the Delhi High Court and the Supreme Court allowed the constitution of the arbitral tribunal and nomination of the Chairman but observed that since the matter was coming up before the High Court, the arbitral tribunal shall not commence hearing before the final hearing by the High Court. It is in these circumstances that the Delhi High Court delivered its final order. The High Court took note of the fact that, in the meantime, the government itself had agreed to participate in the proceedings and nominate an arbitrator and also the fact that Vodafone apparently had expressed its willingness to consolidate the proceedings before one arbitral tribunal. Therefore, the Delhi High Court vacated its interim injunction and also held that the arbitral tribunal is competent to determine its competence-under the so-called 'competence- competence' principle adopted in arbitration.

However while deciding as above, the High Court had also held that the jurisdiction of Indian Courts in the matter of arbitration proceedings under an arbitral tribunal is not ousted by the existence of a BIPA agreement. It may be recalled that Vodafone had taken the position that National Courts of India inherently lacked the jurisdiction to entertain any dispute arising out of a Treaty between two sovereign countries; that the obligations under such treaties were not subject to domestic laws and disputes arising out of such treaties were not subject to the jurisdiction of the National Courts. The Delhi High Court rejected this contention even though it allowed the international arbitration proceedings to continue. In this connection, the court made certain pertinent observations that are of significance in the context of the current debate regarding compulsory arbitration as stipulated in the OECD BEPS Action point 14 that has been overwhelmingly rejected by the developing countries.

As to the jurisdiction of the Court in cases involving BIPA, the High Court pointed out that the Vodafone group has made investment in the territory of India holding economic interests in India and from a reasonable and holistic perspective, it was working for gain within the jurisdiction of the court. The Court invoked the principles of a single economic entity that is available even under the English domestic law to hold that it had jurisdiction over the defendants in personal.

The High Court observed that the jurisdiction of the Civil Courts in India is all embracing except to the extent it is excluded by an explicit provision of law or by clear intendment arising from such law.

The Court also very pertinently referred to the 'Convention on the Settlement of Investment Disputes between States And Nationals of Other States, 1965'. This Convention sets up an International Centre for Settlement of Investment Disputes (ICSID). About 161 States have signed the ICSID Convention and 153 have ratified it till date. However, the Union of India has not signed it and the main reason is that the ICSID Convention completely negates the role of National Courts. Therefore, perhaps unlike in other countries, there is no threshold bar of civil courts in respect of investment disputes in India.

It may be recalled that BIPA provides for dispute settlement between states and between investor and the source sate through arbitration. In this connection, the Court observed that the subject matter of the dispute between an investor and the host State is not the same as any dispute that may exist between two States. The Court held that if the agreement to arbitrate between a private foreign investor and the host State is held to be a treaty, it would amount to 'lifting the status' of the private investor to the 'pedestal of a foreign State'. In fact, the assumption underlying the investment treaty regime is clearly that the investor is bringing up a cause of action based upon the vindication of its rights rather than those of its national State. In the BIPA Arbitration, a contractual obligation and a contractual right is involved and therefore, there is no bar as to the subject matter of the dispute or as to the jurisdiction of the court to hear the case.

The Court pointed out that even the Courts in the United Kingdom have not accepted the argument with regard to non-justiciability of unincorporated treaties in the context of a private investor and host State. Moreover, if the argument of lack of jurisdiction canvassed by the counsel for Vodafone is accepted, then the Court would be powerless to execute a BIPA award against the State, even if the foreign investor were to approach the Court for its enforcement and execution;

Therefore the High Court took the view that recourse to a Court, when and if permissible, would be to correct any error rather than to perpetuate or introduce one.

The Court also pointed out that while acceding to the New York Convention, India had made a reservation that it would apply the Convention "only to differences arising out of legal relationship that are considered commercial under the national law". In this connection, the Court held that investment arbitration disputes are fundamentally different from commercial disputes as the cause of action is grounded on State guarantees and assurances and are not commercial in nature. The Court also referred to another aspect holding that although under the International law, "the State" includes the national judiciary; but under the Indian Constitution the State excludes the judiciary because it is independent of the other organs of the State.

However, considering the fact that the intent of the BIPA is to afford protection to investors such a purpose is better served if the arbitration agreement is subjected to international law rather than the law of the State. That said, the court also pointed out that the National Courts in India do have and retain the jurisdiction to restrain international treaty arbitrations that are oppressive, vexatious, and inequitable or constitute an abuse of the legal process.

The Court observed that as a matter of self-restraint, a National Court would generally not exercise jurisdiction where the subject matter of the dispute would be governed by an investment treaty having its own dispute resolution mechanism, except if there are compelling circumstances and the Court has been approached in good faith and there is no alternative efficacious remedy available.

The fact that it may be inconvenient or expensive for the Union of India to litigate before the arbitral tribunal is not an issue that would justify a finding of oppression. This problem can, in the opinion of the Court, be overcome by either accepting appropriate undertakings or by passing a conditional order.

Vodafone had given undertaking to the court that if the government of India agrees, it will consolidate the two separate BIPA proceedings before the UK arbitral tribunal (to allay the fear that no relief is granted twice over and there is no conflict of awards). Expecting the arbitral tribunal to take this undertaking into account, the High Court vacated its interim injunction.

This decision of the Delhi High Court is significant because it also dwells on the aspect of the functioning of the international arbitration process and displays the unease with such a process of dispute resolution. In this connection, the court quoted extensively from a speech given by Mr. Sundaresh Menon, then Attorney General of Singapore and currently Chief Justice of Singapore on International Arbitration.

While appreciating the role of arbitration in commercial matters and noticing the phenomenal rise in the number of such cases, Mr. Menon also pointed out that the proliferation of such cases was largely due to the proliferation of investment protection agreements entered into by nations. Mr. Menon noted that this is a comparatively recent phenomenon, and its most significant impact has been that national governments have increasingly found their freedom to act in their own domestic space being curtailed by the interpretations placed by arbitral tribunals on investment treaties. By way of example, he referred to some cases including one from Argentina where after the economic collapse in 2001, the Government decided to allow the peso to decline in value against the dollar. By 2004, the peso had stabilized and the economy began to recover. But as a result of this decision, claims were brought against Argentina founded on the investment treaties it had concluded in the 1990s. By 2006, more than 30 claims were pending for a staggering estimated sum of $17 billion in claimed compensation, an amount equivalent to the entire annual budget of the national government. Of particular concern is the understanding amongst the arbitration practitioners that "indirect expropriation" in such treaties refers to any Government measure that has the effect of eroding the value of an investment, it is probably not settled whether legislative or policy changes, which have a legitimate public interest purpose, will also be caught by the principle.

According to Mr. Menon, the arbitrators, men and women often schooled and experienced in commercial law, find themselves having an unexpectedly weighty hand in shaping economic and monetary policy, tax incentives and perhaps even employment laws. From the perspective of the government, national policy and legislation will now have to be assessed for legality vis-a-vis the State's international treaty obligations, as interpreted by an autonomous, privately funded adjudicative body usually consisting of foreign nationals. This has the potential to constrain the exercise of domestic public authority in a manner and to a degree perhaps not seen since the colonial era.

As a result, several states had stopped signing such agreements. In April 2011, the Australian Government issued a Trade Policy Statement to announce that while it had included investor-state arbitration clauses in past international economic agreements, it would no longer do so in the future.

Mr. Menon is scathing in his comments about the arbitrators. Although couched in diplomatic language, it is worth quoting his following observation.

"But who are the arbitrators to whom such important tasks have been entrusted?

They tend mainly to come from a fairly small and select group of specialised and arbitrators principally from Europe and the United States with experience in commercial law rather than in policy making. They are often unlikely to be attuned to the nuances of domestic public interest of the countries affected by their awards.

This private model of international adjudication has allowed a select few individuals drawn from narrow specialities within international and commercial law to rule on issues of public policy and legality of state regulatory actions, with little or no accountability to the constituency. Such an adjudicative mechanism bypasses the traditional protections and the often delicate and carefully arranged balance of interests that are built into the domestic administrative law framework."

And again, "The threat of moral hazard is particularly great in the arbitration process. Arbitration has been characterised, somewhat uncharitably, as ultimately a profit-making venture, with arbitrators being in essence business people in search of appointments. In contrast to the traditional vocation of a judge, arbitrators do not have tenure, are drawn from the same ranks of legal professionals, and earn substantial fees for the cases that they handle. Their earnings depend on the amount of time they are engaged in cases. There is therefore an incentive to promote one's attractiveness as a prospective appointee. (…)

Specifically as regards investment treaty arbitration, there have been assertions either of a perceived pro-investor bias on the part of commercial arbitrators or perhaps less frequently, a pro-state bias on the part of some pubic international lawyers active in this field. In relation to the former, it is, after all, in the interest of the entrepreneurial arbitrator to rule expansively on his own jurisdiction and then in favour of the investor on the merits, because this increases the prospect of future claims and is thereby business-generating. This hints of a modern-day ubersophisticated ambulance-chasing plaintiff's' lawyer. The pro-investor attitude has even been cited as the reason arbitrators from the developing world often rule in favour of investors from traditionally capital-exporting countries, this being the "price" that has to be paid to gain credibility and access to the privileged club of elite international arbitrators."

The OECD led by the USA is pushing very hard the unwilling developing countries for introduction of compulsory arbitration in the Mutual Agreement Procedure in tax treaties. So far, the policy makers in India as also in other developing countries have withstood such pressure. But then there is a powerful lobby in India rooting for the same and in course of time, the government might capitulate. Policy makers in India need to be aware of the dark side of international arbitration as has been subtly brought out in the above order of the Delhi High Court.

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