Author: Utkarsh Khandelwal*
| Jurisdiction: India China |
Topics: Investment Disputes BITs Relief and Remedies in General |
INTRODUCTION
Amidst the growing border tensions between India and China, the Indian government on 29 June 2020 took a drastic step in banning fifty-six Chinese apps citing security and data privacy reasons.[1] The ban made India susceptible to international investment claims by these apps. This article discusses the investment arbitration recourse with Chinese apps under the India-China Bilateral Investment Treaty (BIT).[2] Although the BIT was terminated in 2018, Chinese investors can still rely on the sunset clause in the treaty to hold India liable.[3] While investments made post-October 2018 are out of its scope, the sunset clause keeps the treaty in effect until 2028. This article specifically analyzes the remedies available to Tik-Tok, arguably the worst hit among the banned applications. Under the sunset clause, Tik-Tok is eligible to bring a claim under the BIT as it was established before October 2018 in India. As Atisha Sisodiya and Smriti Shandil previously argued on this blog, a successful unlawful indirect expropriation claim against India is possible, primarily due to lack of due process and disproportionate nature of the measure[4]. They also attempted to ascertain the most appropriate calculation of damages and issues looming around it.[5]
COMPENSATION OR DAMAGES?
The general remedy for lawful expropriation in the BIT is “compensation” as per the genuine value of the investment. However, commentators argue that an unlawful expropriation is a breach of international agreement that must lead to a right to claim a larger sum than mere compensation as per the treaty standard.[6] The ILC’s Draft Code on State Responsibility paves way for such claims in the form of “reparation”.[7] The ICJ in the Chorzów Factory case, relying on Article 31 of the ILC Articles, held that any breach of a treaty involves an obligation to pay full reparation as part of the damages.[8] The tribunal in ADC v. Hungary applied the customary international law standard (the Chorzów full reparation standard) to calculate damages for unlawful expropriation, when the BIT did not address the issue directly.[9] The methods of calculating the market value of the investment in “reparations’’ and “compensation” would still be the same, i.e “genuine/fair market value”. However, what makes the change in the quantum of damages and applicable interest is the valuation date for calculation of damages – for compensation the effective date of expropriation is taken, while for damages the tribunals take the final date of award to ascertain the quantum of reparations made.[10]
THE MOST APPROPRIATE METHOD FOR CALCULATION OF DAMAGES
Most investment treaties do not mention the exact method to calculate the “fair market/genuine value.” The tribunal has the discretion to decide on the method considering the nature of the investment.[11] There are two types of computation methods: first, the forward-looking method looks at future profit-making propensities of the enterprise to ascertain its real value (the discounted cash flow method); [12] second, the backward-looking method establishes the value of the investment expenditure in the past, disregarding any claims for lost profits (the cost based value method).[13]
The potential difference in the quantum through each method is extremely high. For example, in Metalclad v. Mexico, the tribunal rejected the claimant’s discounted cash flow claim of US$90 million and awarded a cost-based estimate of US$16 million in damages pursuant to the loss of its actual investment.[14] Hence, it is imperative to give due deference to the business structure and earning model of the entity while attempting to determine its true value. The real value of Tik-Tok, for instance, can be argued to lie in its online presence including in-app purchases of coins, multiple advertisement formats, branded effects, hashtag challenges, and not merely in its physical assets or sunk costs.[15] In that case, a forward looking method needs to be employed in the calculation damages.
On the contrary, an argument against the discounted cash flow method can be made that the enterprise in question is a new entrant in the market lacking historical data on profits. Further, the predicted profits can be speculative or exaggerated without considering future market conditions.[16] In such cases, the tribunals will reject the forward-looking method for want of certainty of profits.
According to the World Bank’s Treatment of Foreign Investment, “going concern” is an enterprise that has sufficient historical data to ascertain assured future profits.[17] Tik-Tok, while having spent only two years in the Indian market, can still be considered as a “going concern” due to its rising popularity with 200 million users and earnings of rupees ₹25 crores in the last quarter.[18] Moreover, from a more practical perspective, reports show an increase in the time spent on social media (presumably including Tik Tok) by Indian youngsters during the pandemic.[19] Therefore, the high future profits urge for the adoption of a forward-looking approach.
DISCOURSE AROUND THE DISCOUNT RATE
The DCF method entails calculations of future cash flows compounded or discounted to the valuation date, by applying an appropriate discount rate to account for the time value of money and the specific risks associated with the business. These risks include factors such as market turbulence, country risk, and inflation-related adjustments. Any cross-border investment exposes itself to the socio-economic and political milieu of the host country, which begets a certain level of risk on the investment, called country risk.
Consequently, the actual level of country risk is one of the main points of contention between the parties. The host country would want to demonstrate an increased risk in order to decrease estimations of cash flows and future profits. India, to that effect, may argue that it has had a strained political relationship with China that includes recent border tensions[20] and possibly India’s hostility towards Chinese entities stemming from its resistance to China’s Belt and Road Initiative.[21] Against this backdrop, the risk of hindrance to operations (possibly even leading to expropriation) must add to the country risk discount factor.
This brings us to another pertinent question: should the risk of expropriation be factored into the country risk at all? There exist divergent views on this issue. In Gold Reserve v. Venezuela, the tribunal thought it inappropriate to increase the country risk premium to reflect the State’s propensity to expropriate in breach of BIT obligations, because this would give host states a unilateral right to systemically influence the political situation followed by a taking, plausibly to reduce the quantum of compensation to be paid.[22] On the contrary, in Venezuela Holdings v. Venezuela[23] and Flughafen Zürich A.G. v. Venezuela,[24] both ICSID Tribunals accepted the risk of expropriation as a component of country risk, noting that when the claimants decided to invest they were aware of the legal and regulatory risks that existed and the confiscation risk remains part of such risk, which must be taken into account when determining the discount rate. This will be one of the most pertinent issues that the tribunal will have to address, as it will affect the claim to a great extent.
DAMAGE MITIGATING FACTORS
Article 39 of the ILC Articles provides that “[i]n the determination of reparation, account shall be taken of the contribution to the injury by wilful or negligent action or omission of the injured State or any person or entity in relation to whom reparation is sought”.[25]
These claims of contributory negligence are usually raised during the merits stage, but even on failure of such claims, they can be cited to mitigate damages.[26] In Occidental v. Ecuador, the claimants failed to obtain certain necessary government approvals for a partial transfer of ownership ultimately leading to the cancellation of their petroleum exploration rights.[27] The tribunal accepted a claim of illegal indirect expropriation but also held that the claimants’ material failure had “provoked” this response, and reduced the award by 25%.
India could potentially make such claims during both the merits and damages stages of proceedings. While a ban could be considered a disproportionate measure, following an unsuccessful counterclaim in the merits stage, the damages could still be reduced. The Indian government’s claims could arise from the transgressions in the privacy laws as mentioned in the press release regarding the ban.[28] Additionally, a likelihood of cross-border transfer of data to the Chinese government, as alleged by the U.S. government, could also provide a ground for counterclaims.[29]
CONCLUSION
Other ancillary issues may also affect such claims to a large extent, like the exact number of relevant years of lost profits claimed. Predicting the years for which an entity like Tik-Tok will continue to make high profits, especially in the ever-changing topography of any internet-based market, would be challenging. Moreover, a claim for both sunk costs of the investment along with lost profits may also be a challenge, as many tribunals have rejected such claims to avoid double counting.[30] Reparations in international investment law come with its challenges, due to the lack of clarity by the investment treaties on the damages and compensation, which make it difficult to decide on the appropriate standard and other variables affecting millions of dollars’ worth of claims.
[1] Govt. Bans 59 mobile apps which are prejudicial to sovereignty and integrity of India, defence of India, security of state and public order, Press Information Bureau (June 29, 2020, 8:47pm), https://pib.gov.in/PressReleseDetailm.aspx?PRID=1635206.
[2] India-China Bilateral Investment Treaty, Nov. 21, 2006.
[3] Agnieszka Zarowna, Termination of BITs and Sunset Clauses – What Can Investors in Poland Expect? Kluwer Arb. Blog (Feb. 28, 2017), http://arbitrationblog.kluwerarbitration.com/2017/02/28/booked-22-february-polish-bits/?doing_wp_cron=1597504728.5656790733337402343750.
[4] Atisha Sisodiya & Smriti Shandil, India’s ban on Chinese apps: Could India face the fire of Investment Treaty Claims? Am. Rev. of Int’l Arb.(September 13, 2020), https://aria.law.columbia.edu/indias-ban-on-chinese-apps-could-india-face-the-fire-of-investment-treaty-claims/.
[5] Id.
[6] E.g., Siemens A.G. v. Argentine Republic, ICSID Case No. ARB/02/8, Award, ¶¶ 352–53 (Jan. 17, 2007), https://www.italaw.com/sites/default/files/case-documents/ita0790.pdf.
[7] U.N., Draft articles on the responsibility of international organizations, with commentaries 2011, Article 31, https://legal.un.org/ilc/texts/instruments/english/commentaries/9_11_2011.pdf
[8] Factory at Chorzów, Judgment, 1927 PCIJ (ser. A) No. 9 (July 26).
[9] International Centre for Settlement of Investment Disputes, ADC Affiliate Limited & ADC & ADMC Management Limited v. The Republic of Hungary, ICSID Case No. ARB/03/16, Award of the Tribunal (Oct. 2, 2006) para 504, https://www.italaw.com/sites/default/files/case-documents/ita0006.pdf.
[10] ADC Affiliate Ltd. v. Republic of Hung., ICSID Case No. ARB/03/16, Award of the Tribunal, ¶ 497 (Oct. 2, 2006), https://www.italaw.com/sites/default/files/case-documents/ita0006.pdf.
[11] Jonathan Bonnitcha & Sarah Brewin, Compensation under investment treaties, IISD Best Practices Series, Oct. 2019, https://www.iisd.org/system/files/publications/compensation-treaties-best-practicies-en.pdf.
[12] Anthony Charlton, Discounted cash flows – Part 2, valuation and the financial crisis, Kluwer Arb. Blog (Jan. 26, 2012), http://arbitrationblog.kluwerarbitration.com/2012/01/26/discounted-cash-flows-part-2-valuation-and-the-financial-crisis/?doing_wp_cron=1597470322.3656759262084960937500.
[13] MTD Equity Sdn. Bhd. v. Republic of Chile, ICSID Case No. ARB/01/7, Award, ¶¶ 240-41 (May 25, 2004), https://www.italaw.com/sites/default/files/case-documents/ita0544.pdf.
[14] International Centre for Settlement of Investment Disputes, Metalclad Corp. v. United Mexican States, ICSID Case No. ARB(AF)/97/1, Award (Aug. 30, 2000), https://www.italaw.com/sites/default/files/case-documents/ita0510.pdf.
[15] Julia Glum, Meet the Head of TikTok, a 35-Year-Old Who Makes Employees Do Push-Ups if Their Videos Don’t Get Enough Likes, Money (Jan. 10, 2019), https://money.com/how-tiktok-makes-money-tiktok-owner/.
[16] Compañía de Aguas del Aconquija, S.A. & Compagnie Générale des Eaux, v. Argentine Republic, ICSID Case No. ARB/97/3, Nov. 21, 2000, https://www.italaw.com/sites/default/files/case-documents/ita0206.pdf.
[17] World Bank Group, Report to the Development Committee and Guidelines on the Treatment of Foreign Direct Investment, Legal Framework for The Treatment of Foreign Investment Volume II, Report No. 11415, Sep. 25, 1992, http://documents1.worldbank.org/curated/en/955221468766167766/pdf/multi-page.pdf.
[18] Hemani Sheth, TikTok ‘targeting’ ₹100 crore revenue in India’ by September 2020, Bus. Line (Jan. 28, 2020), https://www.thehindubusinessline.com/info-tech/tiktok-targeting-100-crore-revenue-in-india-by-september-2020/article30673050.ece.
[19] Amandeep Shukla, Youngsters glued to social media amid lockdown, nearly half experience heightened stress: Study, Hindustan Times (May 19, 2020, 2:58 PM IST), https://www.hindustantimes.com/india-news/youngsters-glued-to-social-media-amid-lockdown-nearly-half-experience-heightened-stress-study/story-1qjnXkZkI38cP0yk5GSJ5I.html.
[20] Five things to know about the India-China border standoff, Al Jazeera (June 22, 2020), https://www.aljazeera.com/news/2020/06/22/five-things-to-know-about-the-india-china-border-standoff/.
[21] India will not accept project that violates sovereignty: MEA on OBOR, Business Standard (Apr. 5, 2018, 10:38 PM), https://www.business-standard.com/article/current-affairs/india-will-not-accept-project-that-violates-sovereignty-mea-on-obor-118040501227_1.html.
[22] Gold Reserve Inc. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB(AF)/09/1, Award ¶¶ 840–41(Sep. 22, 2014), https://www.italaw.com/sites/default/files/case-documents/italaw4009.pdf.
[23] Venezuela Holdings, B.V. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/27, Award ¶¶ 364–65 (Oct. 9, 2014), https://www.italaw.com/sites/default/files/case-documents/italaw4011.pdf.
[24] Flughafen Zürich A.G. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/10/19, Award ¶¶ 905-07 (Nov. 18, 2014), https://www.italaw.com/sites/default/files/case-documents/italaw4069.pdf.
[25] International Law Commission, Responsibility of States for Internationally Wrongful Acts art. 39 (2001), https://legal.un.org/ilc/texts/instruments/english/draft_articles/9_6_2001.pdf.
[26] See generally Martin Jarrett, Contributory Fault and Investor Misconduct in Investment Arbitration (2019).
[27] Occidental Petroleum Corp. v. Republic of Ecuador, ICSID Case No. ARB/06/11, Award (Oct. 5, 2012), https://www.italaw.com/sites/default/files/case-documents/italaw1094.pdf.
[28] Govt. Bans 59 mobile apps which are prejudicial to sovereignty and integrity of India, defence of India, security of state and public order, Press Information Bureau (June 29, 2020, 8:47pm), https://pib.gov.in/PressReleseDetailm.aspx?PRID=1635206.
[29] John Koetsier, Tik-Tok to Be Banned in USA, Trump Announces, Forbes (Aug. 1, 2020, 12:38 AM), https://www.forbes.com/sites/johnkoetsier/2020/08/01/tiktok-to-be-banned-in-usa-trump-announces/#4475f8a71d13.
[30] See, e.g., Himpurna California Energy v. PT. (Persero) Perusahaan Listruik Negara, Award (May 4, 1999) (an ad-hoc arbitration under the UNCITRAL rules; a case note is available at https://www.biicl.org/files/3931_2000_himpurna_and_karaha_bodas_arbitrations.pdf).
*Utkarsh Khandelwal is currently an undergraduate at Dr. Ram Manohar Lohiya National Law University. He is a Senior Contributing Editor of the RMLNLU Arbitration Law Blog. His areas of interest are International Trade Law and International Arbitration.