India’s FDI Policy Distances Itself from Neighbours: Can China bring an MFN Claim?

[Smriti Kalra is a IV year B.A., LL.B. (Hons.) student at the National Law School of India University, Bangalore]

On 17 April 2020, the Indian government issued a press note which makes foreign direct investment (FDI) from “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 ” [emphasis supplied] subject to government approval. According to the press note, the amendment is aimed at “curbing opportunistic takeovers/acquisitions of Indian companies due to the current Covid-19 pandemic”. Accordingly, on 22 April 2020, the Government notified an amendment to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

Previously, India permitted FDI in several sectors under the automatic entry route (i.e., without the need for prior government approval), except for FDI from Pakistan and Bangladesh. Given this, and considering that the move comes immediately following the instance where People’s Bank of China raised its stake in HDFC Ltd., to 1.01%, it is being viewed as a disguised attempt to monitor and potentially restrict FDI flow from China to India. Such a move, described as discriminatory by the Chinese government, could hamper FDI inflow from China which is currently estimated to be over USD 6 billion and could also adversely affect the exits and transfers of investments, especially in the start-up sector. On the legal front, this amendment could expose India to potential investment arbitration claims by Chinese investors. The potential claim against India and possible defences are explored below.

States enter into international investment agreements (“IIAs”), such asbilateral investment treaties (“BITs”), aiming to promote and protect cross-border investments by providing foreign investors with certain rights, and allowing them to sue the host state before an international tribunal for any violations of their obligations under these instruments. India and China had entered into a BIT in 2006 and, although it was terminated in 2018, it continues to remain in force for a period of fifteen years from the date of its termination in terms of article 16.2 of their BIT.

Potential Claim under the India-China BIT 2006

Article 4 of their BIT contains the most-favoured nation (“MFN”) clause. This mandates that Chinese investors should be treated no less favourably than foreign investors from other countries, subject to specific exemptions for foreign investors from states part of a customs union and for taxation purposes under article 4(3). A potential MFN claim will succeed if, first, the MFN clause applies to the measure and, second, if it leads to less favourable treatment based on nationality. With regards to the first issue, the question is whether pre-investment measures – which seek to regulate the making of investments (as opposed to measures that regulate the treatment of an existing investment) – are within the scope of an MFN clause. India could argue that the MFN clause is inapplicable since an “investment” under the BIT is an asset that is already established or acquired in accordance with national laws (article 1(b), India-China BIT 2006), meaning that India can validly impose entry restrictions on future inflows without being subject to MFN obligations under the BIT. This argument is likely to succeed given that the general practice is that BITs do not cover pre-investment measures and only apply to existing investments (UNCTAD International Investment Agreements: Key Issues volume I, pages 90 and 195).

On the other hand, China could argue that the MFN clause should be read broadly to apply to pre-investment measures in light of the BIT’s preamble which encourages greater investment between the countries, and due to the lack of a specific exclusion of pre-investment measures (as found for instance, in article 10 (7) of the Energy Charter Treaty). This is unlikely to succeed because such a wide reading of “treatment” article 4 would render all entry restrictions on FDI such as sectoral caps invalid given that article 4 also prohibits discrimination between domestic and foreign investors. However, even though the MFN clause may apply only to existing investments under the BIT, India may still be exposed to a claim. An investor having a right to raise the investment’s stake (for example, by way of a call option on shares) could argue that this right falls under the definition of investment under the BIT (specifically, article 1(b)(iii) “rights … to any performance under contract having a financial value”). If the Indian government’s amendment also extends to restricting the exercise of such rights, it pertains to the treatment of an existing investment and hence, the MFN clause can be invoked to challenge the amendment.

Coming to the second issue, in the present case, it could be argued that the amendment accords less favourable treatment on the basis of nationality. States with which India does not share a land border do not face such discrimination at the time of making their investment, and therefore the amendment could give rise to a potential claim for violation of the India-China BIT MFN clause. Joint interpretative notes signed by parties to a BIT elaborate on the common understanding of certain BIT obligations and can be useful for clarifying the scope of their provisions. There does not exist a signed joint interpretative note for the India-China BIT, but even if there was and the same was along the lines of India’s joint interpretative notes with other countries, it would not be of much assistance in the present case. According to India’s joint interpretative note, assessing an MFN breach requires a fact-specific inquiry to ascertain whether “like circumstances” existed and, to this end, several factors to have been enumerated ranging from aim of the measures or laws in place to the effect of the investment on the environment and the local community. The amendment to the FDI policy is unclear on what differentiates neighbouring countries from other countries such that the circumstances are not like anymore, and fails to explain why the amendment should treat them differently in the context of Covid-19. Hence, the amendment is an investment-specific measure, falling under the scope of the MFN clause and, by treating neighbouring countries less favourably, it discriminates on the basis of nationality, thereby violating the MFN clause.  

Potential Defence under the BIT and Customary International Law

To defend an MFN violation, India is likely to rely on defences under the BIT and under customary international law (“CIL”). Article 14, the exceptions clause under the India-China BIT, states: “Nothing in this Agreement precludes the host Contracting Party from taking action for the protection of its essential security interests or in circumstances of extreme emergency in accordance with its laws normally and reasonably applied on a non-discriminatory basis.” [emphasis supplied] It is important to note that article 14 qualifies both grounds of exceptions with the caveat that the measures should be applied on a non-discriminatory basis and, therefore, should not be discriminatory. The term “essential security interests” has been broadly interpreted – for instance, in LG&E Energy Corp., LG&E Capital Corp. and LG&E International Inc. v. Argentine Republic (ICSID Case No. ARB/02/1), where measures imposed in the context of Argentina’s economic and financial crisis were found to be justified for invoking this defence; but, this is not a common trend. Further, even a broad interpretation may not save the amendment as it does not elaborate why investment specifically from neighbouring countries poses a risk even in non-sensitive sectors (unlike defence) and why foreign investment from other countries cannot constitute “opportunistic takeovers/acquisitions of Indian companies”, continuing to be permitted under the usual automatic route. With regards to the second ground under article 14, i.e., “circumstances of extreme emergency”, it is arguable that Covid-19 and its economic impact qualify as an extreme emergency. However, again the reasoning for why only investment from neighbouring countries is being treated differently is neither apparent nor specified by the government.

Further, based on article 31(3)(c) of the Vienna Convention on the Law of Treaties, the Indian government could arguably also rely upon CIL to justify its measures. Under CIL, a measure that is imposed must not only be necessary for the protection of national security or similar important concerns such as a public health emergency, but also proportionate. This means that the measure in place must be the least intrusive alternative to achieving the legitimate aim of the state in protecting its national security or in furtherance of public health. Additionally, the State must also not have contributed to the grave situation in any way for it to claim this defence under CIL. In the present case, the amendment does not appear to serve the aim of national security or public health. Even if such a rationale exists, the State will have to show that there were no alternate measures: for instance, permitting foreign investments under the automatic route subject to certain criteria being fulfilled on a self-declaration basis, restricting investment to certain sectors, introducing more stringent pricing restrictions to prevent “opportunistic” investments for all foreign investors, or excluding minority Chinese investments at least from this restriction. One could also argue that imposing this restriction on all Chinese investments, some of which are instrumental in the technology and telecommunication space, could go against the aim of protecting India’s economy at this time. This is not to suggest that the Covid-19 pandemic cannot be a ground to restrict FDI especially to protect domestic entities against distressed sales – in fact, countries such as Australia and Germany are introducing restrictions.  However, it is the singling out of neighbouring countries, purportedly to target Chinese investors, that could be problematic if it is brought before an investment arbitration tribunal. Interestingly, this restriction has been applicable to Bangladeshi investors under the Consolidated FDI Policy 2017, but there have been no reported instances of an investor state dispute on these grounds. One of the factors behind this could be the comparatively lower amount of FDI inflow from Bangladesh as compared to China.

In conclusion, unless the Indian Government issues a clarification ensuring that no existing investments under the BIT are affected, there exists a potential claim for a Chinese entity to bring an investment dispute invoking an MFN violation against the Indian Government under the India-China BIT. It might be wise for the government to analyse the potential investor-state dispute fallout of the same.

Smriti Kalra

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