Indonesia’s Perspective on Investment Agreement Review

Published in Investment Policy Brief, No. 1, Juli 2015 

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1. Introduction

Following the contemporary discourse surrounding International Investment Agreements (IIAs), Indonesia is currently undergoing a thorough review of its 64 Bilateral Investment Treaties[1] as well as 5 Investment Chapters under various regional agreements.[2] The review envisages a critical evaluation to the impact of the existing IIAs to Indonesian national economy and formulation of a new approach towards IIAs, which will be fine-tuned in favor of its interest in pursuing national development goals. In this regard, Mrs. Retno Marsudi, the Minister for Foreign Affairs of the Republic of Indonesia, specifically emphasized in her Annual Press Statement that economic diplomacy carried out by Indonesia will also aim at creating a new regime for investment agreements between Indonesia and other countries.[3] In light of this particular view, this Article tries to share the Indonesian experience in undertaking such an intention.

For this purpose, this Article will flesh out the rationales of the review. It will also explain how the review process is being undertaken. The challenges faced during the review process would also be an interesting subject of discussion in this Article. Last but not least, it will also attempt to present a set of critical outlooks to some substantives issues pertinent in IIAs.

2. Rationales of the review

The rationales for review conducted by Indonesia are essentially similar to the rationales for reviews undertaken by other countries. In Indonesia’s view, the following factors will be the upcoming points of discussion.

First, the review has been undertaken to strike a balance between investor protection and national sovereignty as indicated by Mrs. Retno Marsudi in her opening statement for the Regional Interactive Meeting on the Development of Investment Treaty Models hosted by the Ministry of Foreign Affairs of the Republic of Indonesia, International Institute for Sustainable Development and UNCTAD.[4] Most provisions of the existing IIA are outdated provisions as they grant extensively broad protection and rights for foreign investors, leaving the host state with little to no policy space to implement its own development goals. Indonesia also believes that the current regime of IIAs does not grant sufficient space for sustainable development. Therefore, a general modernization is needed to update the existing outdated IIAs in order to preserve the right for states to exercise their regulatory and policy space.[5]

Second, one of Indonesia’s greatest concerns regarding IIAs is the provision on the Investor-State Dispute Settlement (ISDS) which has increased Indonesia’s exposure to investor claims in international arbitration. To Indonesia, ISDS provisions seem to be problematic and their benefits are far from clear. They also create uneven playing fields between national and foreign corporations. It is also expected that the inclusion of ISDS provisions will be a highly contentious issue in the ratification process.

To date, Indonesia has been involved in at least 6 ISDS cases. In comparison to other ASEAN countries, Indonesia has the highest number of international arbitration cases.[6] The decision to go with the review was particularly encouraged by a billion – dollar lawsuit from UK-listed Churchil Mining, in addition to several unrelated threats of costly litigation from international companies. The case does indeed fall under the category of frivolous claim, or submissions which have no legal merit.[7] Due to this reason, Mr. Susilo Bambang Yudoyono, the President of the Republic of Indonesia stressed that the Government will not let those multinational companies do as they please with their international back-up and put pressure on developing countries such as Indonesia.[8]

Similarly, Jan Knoerich and Axel Berger in their seminal work:Friends or Foes? Interactions Between Indonesia’s International Investment Agreements and National Investment Law held that because the ISDS clause is being invoked by foreign investors with increased frequency, IIAs are beginning to have serious repercussions for developing countries, particularly for Indonesia[9]. To further worsen the situation, there is also the tendency for foreign investors to submit frivolous claims, or submissions that have little to no legal merit.[10]

Third, the provisions in IIAs may potentially override national legislations in addition to the decision of international arbitration that may possibly supersede the decision of domestic courts. These two rationales are well-founded considering that the current IIA regime has sometimes ruled supreme over the national law in force, which will raise questions of the law applicable for either the investors or the Host States.[11]

From the aforementioned rationales of the review, it can safely be assumed that Indonesia has not lost faith in IIAs in general. Indonesia merely intends to modernize and to renegotiate its IIA’s with a view to providing greater capacity to regulate in the public interest. For that purpose, excessive benefits to foreign investor that may prejudice Indonesia’s policy space needs to be re-examined. The new investment regime should aim at fostering investments that does not only reap benefits from the Host State but also contributes to the overall development of that particular Host State. Such review process also includes the need to place procedural and substantive restraints on foreign investors from lodging international claims against Indonesia.

3. Steps Taken

The review process is undertaken through three steps, namely the discontinuation of existing IIA’s, reassessing the provision of the existing IIA’s and developing a new treaty model of IIA. In pursuing those steps, the Government of the Republic of Indonesia also invites academicians, international/national lawyers, non-governmental organization, UNCTAD and experts from various countries and agencies to contribute their perspectives. Indonesia also envisages an intensive engagement with business sectors in the process.

The first step taken by Indonesia is to discontinue its existing IIAs, which as of the date of the writing of this article has reached 18 out of 64 IIAs. It is important to underline that this discontinuation process is done gradually by means of discontinuing IIAs that are due to expire according to the period requirement set in the termination clause of the IIA, or commonly known as the ripe period.[12] Another option in this discontinuation process is to do so immediately if the IIA authorizes either Party to end the agreement at any time. Consequently, as Indonesia is in the process of reviewing and discontinuing its whole IIA regime, a moratorium policy is now in force to prevent the conclusion of any other new IIAs until the review process is ultimately completed.[13]

This gradual and cautious approach is taken to avoid any unwanted political implications and bilateral backlash that might potentially undermine Indonesia’s position. Indonesia believes that by ending the agreement “by-the-book” according to the provisions set in the agreement (which was of course agreed bilaterally), Indonesia need not be concerned about any such backlash.

However, during the review process, there has been an emphatic call to look at this approach again. As the ripe periods of many IIAs concluded by Indonesia would be many years to come such as the Indonesia-Russia IIA which will end in 2024, it has been suggested that Indonesia proposes an earlier discontinuation. If its counterpart disapproves the proposal, Indonesia may just officially notify its intention to terminate the IIA upon the expiration of the period of validity of the IIA. Such notification can be submitted although the period of validity of such IIA still remains to be in place for a long time.

The second step that Indonesia has taken completely relates to the fact that the core gravity of the review is the reassessment of existing provisions. Every single IIA is dissected to find the most problematic provisions such as the Scope and Definition of Investment, the Most Favored Nation principle, National Treatment, Fair and Equitable Treatment, Expropriation and ISDS.The result of this assessment is the ultimate goal of this review and will be put into the new treaty model text as Indonesia’s official position in future negotiations. South Africa and India used the same approach by developing a new treaty model which will give a greater degree of consideration for sustainable development.[14]Indonesia followed suit by starting the process of developing a new treaty model for IIAs.

The third step is the development of a Treaty Model. The purpose of developing a model is to set up a guideline for Indonesian officials in negotiating and concluding investment treaties. In developing the model, the Government invites relevant stakeholders for public consultations, such as academicians, lawyers, and NGOs. Based on the review itself, new elements were added in the model to envisage a balance between investor protection and the state’s policy space. The model will also ensure consistency in treaty-making practice, although, in the other hand, it may create less flexibility in negotiations.

4. Challenges of IIA Review

Conducting an all-encompassing review to the whole regime of IIA proves to be a very challenging endeavor. We have identified a number of challenges which ranges from the psychological factor of the review scaring-off investors to the more technical challenge of how to further address the survival clause issue. The complete breakdown of each challenges are as follows:

Fear of scaring-off investors

One of the main challenges is to overcome the unjustified fear that the whole review and discontinuation process is scaring off investors. The Government of the Republic of Indonesia has taken this challenge seriously. In the World Investment Forum 2014 in Lima, Mr. Mahendra Siregar, Chairman of the Investment Coordinating Board of the Republic of Indonesia, assertively assured that the review process shall not compromise the legal certainty and protection of foreign investment. All foreign investment continues to enjoy the same level of protection under the Indonesian National Law on Investment.[15]

It is a matter of fact that the review process does not really affect the foreign investment inflows to Indonesia. It can successfully cope with this apparent negative sentiment. In fact, 2014 was the year in which foreign direct investment to Indonesia hit a record high of 78.7 trillion US dollar, according to the latest data by the Indonesian Investment Coordinating Board (BKPM).[16]

Balance between protection of investors and preserving policy space for states

The second challenge that comes to the fore is the question on whether the review and reassessment will be able to achieve the right balance between investment protection and the furtherance of public interest. To this end, we need to recognize what the real balance should look like. In principle, it might be possible to strike the balance between the two interests. Yet, it is indeed a complicated task as the interest of investor protection and policy preservation seems to be irreconcilable.

The temptation to include broadly drafted clauses on public policy exceptions is very obvious among the policy makers. They maintain that the incorporation of a set of robust clauses that may effectively serve as important tools to safeguard public policy interest would provide additional comfort to the Government.

However, concerns were expressed about the possible abuse of such public policy clauses as they give too much power to the state. Business sectors may perceive that the existence of such clauses will potentially defeat the purpose of concluding IIA as an instrument in attracting higher foreign investment.

Nevertheless this concern has also been challenged on the basis of two strands of arguments. First, the assumption that IIA will increase foreign direct investment inflow in many countries, including in Indonesia is empirically disputed. Therefore, the existence of such clauses should not correlate with foreign direct investment. Second, the public policy clauses may be formulated in such a way to prevent their arbitrary invocation. Then, the real challenge would be how to draft such clauses in setting out legitimate regulations of the activities of the foreign investors without permitting unreasonable or unjustified treatment to them.

Investment chapters under Free Trade Agreements (FTAs) or Economic Partnership Agreements (EPAs)

Another challenge is the problem of investment chapters under FTAs or EPAs. Given the legal nature of the investment chapter is essentially an IIA, the investment chapters should also be subject to the review process. Nonetheless, the review process of the investment chapters could not be conducted in the same manner as in the case of bilateral IIAs. As the FTAs or EPAs consists of various chapters which are integrated into a single undertaking instrument, a specific discontinuation of the investment chapter is not legally possible unless it is done altogether with all chapters of that FTAs or EPAs. Article 44 (1) of the Vienna Convention on the Law of Treaties clearly provides that a right of a state to denounce or withdraw from a treaty may be exercised only with respect to the whole treaty unless the treaty provides or the Parties otherwise agree.

It is true that the whole chapters of FTAs or EPAs can be technically terminated altogether in accordance with their termination clauses. The problem does not, however, lie in the technical context. Discontinuing the whole chapters of FTAs or EPAs will certainly require much more extensive consideration of wider bilateral and regional/multilateral relations as it may lead to more complicated implications. Consequently, so far, not much can be done with respect to investment chapters of FTAs or EPAs.

The lesson we can learn from this challenge is that the issue of terminating FTAs or EPAs should be wisely dealt with during negotiations. It is recommended that FTAs or EPAs should include a clause allowing partial termination of a chapter, particularly the investment chapter.

Survival clause

One of the most interesting notion in reviewing and discontinuing IIAs is that the IIA will not necessarily cease to have any effect to existing investments even after they are discontinued or terminated, due to a provision commonly known as the survival clause. This clause allows foreign investors, who have had their investments made or acquired prior to the date of termination, to enjoy prolonged protection for a certain amount of time (usually 10 – 15 years) even after the treaty has been terminated..

The clause – which some have called the zombie clause – has posed substantial challenge during the review process. It means that all possible legal risk posed by the discontinued IIAs will remain intact. Thus, the question of the survival clause needs to be further reviewed with a view to shortening the time period of such a clause, with a view to consider different survival clause durations for different sectors.

Challenge of drafting a treaty model

The review process envisages development of an IIA model which will serve as a basis for future IIA negotiations. The model will provide clearer guidelines in order to maintain coherence between one IIA to another. According to Jonathan Bonnitcha, the existence of a treaty model will substantially diminish the number of inconsistencies between existing IIAs.[17] That being said, once a treaty model exists, it will provide Indonesia with a strong and consolidated initial negotiating text that will

prove useful in the future negotiations.

Apart from the obvious advantage of having such a treaty model at our disposal, there are also a couple of potential disadvantages that have been pointed out. Firstly, due to the vast amount of stakeholders involved in drafting the model, it will demand a lot of time to develop a model. Secondly, by having a basic text, we are somehow reducing our flexibility in negotiations. Different counterparts will require different elements in their intended IIAs and a treaty model will somehow limit their options which will arguably hamper or slow down the negotiation to a certain degree. Hence, it is ultimately not the problem of developing a well-drafted treaty model, but how to actually defend the text in negotiation.

In addressing this challenge, Indonesia is now considering developing a set of basic elements of position that would be translated by an illustrative model treaty. Therefore, the illustrative model treaty in one way or another can be subject to negotiation, while the basic elements of position shall be strictly guarded and uncompromisable.

5. Most Outstanding Issues

From the explanation above we have learned that the review process has addressed almost all common provisions included in IIAs. Yet, the most outstanding issue in the review process is the ISDS. In spite of this, excluding ISDS provisions altogether might not be a wise approach. Therefore, Indonesia considers limiting the scope of application of the ISDS provision. The limitation would be substantive and procedural in nature.

Substantive Limitations

The definition of investment is very essential as it will determine the scope of the protection rendered under the IIA. The narrower the definition of investment will also narrow down the possible number of cases brought via the ISDS mechanism. Therefore, the review has led Indonesia to reform its position into a narrow and restrictive definition (a combination between an asset-based and enterprise-based approach which targets particular investments). Portfolio investment is certainly excluded from the definition. The “Salini Test” characteristic of investment has been considered to be part of the definition. By doing so, not all investments may enjoy benefits under an IIA unless such investments also contribute to the national development of the Host State.[18]

Furthermore, the current scope of the National Treatment (NT) clause also needs to be narrowed down. The current NT clause extends to the pre-establishment phase. Therefore, the clause will apply not only to investors who are already operating in Indonesia (post-establishment treatment) but also potential investors seeking to make investments. This kind of NT clause creates the so-called pre-establishment right (right to establishment). It gives potential foreign investors the right to enter Indonesia and make investments in any sector on the same terms applicable to domestic investors.[19] The clause provides both protection and liberalization undertaking. Having said that, the review process suggests that the NT clause should only cover the post – establishment phase. This new approach of the NT clause also considers excluding special treatment in favor of domestic small/medium enterprises, measures affecting certain sectors related to development needs, particularly natural resources and sectors which possess close ties to national security.

Likewise, restricting the scope of Most-Favored Nation is also necessary for limiting the possible application of ISDS. The existing MFN clause seems to be too broad as it potentially allows a foreign investor to invoke provisions of any other treaties other than the one concluded between the Home State of the investor and Indonesia. This classic principle has been substantially modified to fit Indonesia’s current stance on IIAs. Some important exclusions incorporated to the new MFN clause, namely:

• exclusion for pre-establishment measures;
• any existing or future regional FTAs and EPAs;
• existing and future IIAs;
• ISDS provisions; and
• any preferential system for any least-developed countries.

The inclusion of the clause on Fair and Equitable Treatment (FET) has brought about a high degree of unpredictability, particularly with respect to ISDS. Of the seven decisions finding states liable, five found a violation of the FET provision.[20] The FET clause is initially introduced for providing literally a just and equal treatment to foreign investors as if they were domestic investors. However, due to its wide application, there has been a number of uncertainties and legal risks associated with FET. One of the most worrying concerns is the tendency for tribunals to interpret FET broadly in favor of foreign investors, particularly with respect to the notion of “legitimate expectation”. During the review process, we found that a vague and broad wording of the FET obligation carries a risk of overreach in its application.[21] This has led Indonesia to craft a new provision namely on Standard Treatment, which simply shifts the focus from investor rights to protection from denial of justice. In this newly formulated provision, assurances were made regarding the fact that investors shall not be subjected to denial of justice in criminal, civil or administrative proceedings. To augment this treatment, Indonesia also provides police protection from any physical harm to the investors and/or investment.

As far as expropriation is concerned, Indonesia still maintains the clause of direct expropriation with high threshold requirements. Direct expropriation shall only be made for the purpose of public interest and carried out with due process of law and followed by prompt and adequate compensation. Yet, the issue of indirect expropriation seems to be very problematic. Indirect expropriation in principle is measures that a state takes to regulate economic activities within its territory, even where such regulation is not directly targeted at an investment. In this case, legal title to the investment is not affected.[22] This has potentially reduced the Host State’s authority and policy space to implement development-oriented measures and/or policies. As its new approach to IIAs, Indonesia plans to exclude in whole the provision on indirect expropriation. It also means that any measures that have effect or consequences which amount to expropriation shall be excluded from the clause of direct expropriation. This is done to preserve a greater degree of regulatory space for Indonesia to pursue its development goals without facing legal risk of being complained through ISDS.

Procedural Limitation

Imposing procedural limitations should be the best way to minimize legal risk of ISDS. In most IIAs, the Host States have already given their consent that an investor may bring any dispute against the Host State to international arbitration without requiring further consent from the Host State. It is also the case in Indonesia’s IIA.[23] This approach has become a grave concern for Indonesia as it will pose great legal risk to the country. As a solution to this legal risk, Indonesia considers introducing separate consent requirement for the investor to bring a matter of the international arbitration. Therefore, an investor may bring a case to the international arbitration if the investor and the Host State have expressed their consent to settle the case to the arbitration. A special agreement to settle a dispute to international arbitration would be required on a case per case basis. This approach would be expected to cut down the number of ISDS claims in international arbitration. At the same time, it will also promote settlement of investor – State disputes through domestic court or alternative dispute resolutions.

6. Conclusion

Indonesia’s review of its IIAs was mainly triggered by the increased exposure to investor claims in international arbitration. The review itself has been manifested in several steps such as IIA discontinuation, reassessment of existing provisions \and the development of a new IIA model. The effort has met several challenges on whether the review will scare off investors, how to strike the balance between protection to investors and policy space preservation, problems of investment chapters in FTAs or EPAs, survival clauses and the development a new model of IIA. The review process focuses on how to limit the scope of application of ISDS provisions. In light of this, substantive and procedural limitations are envisaged. As far as the substantive limitations are concerned, there are at least five pertinent issues related to the definition of investment, national treatment, MFN, FET and indirect expropriation. For procedural limitations, the new IIA will require a special agreement between the investor and Indonesia for bringing a case to international arbitration. This review is a dynamic process and not a one-off event. Constructive input and suggestions from every stakeholder, including business sectors and in-depth analysis are still highly needed to further fine-tune Indonesia’s new approach which will be crystallized in the new treaty model.

Sumber : https://kadirjailani.wordpress.com/2015/07/16/indonesias-perspective-on-investment-agreement-review/