Sovereignty v. Foreign Investor Protection: Which is greater? Analysis of Vodafone and White Industries

Do bilateral investment treaties (BITs) go beyond investor protection, and potentially dilute or impinge upon the sovereignty of India?

BITs are investment treaties entered into between two countries, with a view to protect the investment made by investors of both countries in the corresponding country. BITs are primarily investor-friendly fiscal and monetary measures taken by the two contracting countries, so as to encourage inflow of foreign direct investment (FDI) into each of the countries, from the other.

Clauses and conditions of BITs are aimed at controlling the regulatory behaviour of the host state, so that there would be certain limitations or restrictions put upon the host state from interfering with the rights of a foreign investor.

A growing criticism is that BITs impinge upon, and potentially dilute, the sovereignty of the host country, and give a foreign investor an unduly higher or advantageous position, than even the citizens of the host country.

As with any other contract, BITs have a dispute resolution mechanism built into them, primarily consisting of investor-state disputes being resolved by way of arbitration before an international arbitral tribunal. Through this, an investor can raise and file a dispute directly against the host country, and seek compensation/damages from such host country.

Understanding White Industries Australia Ltd. v. The Republic of India

The White Industries case is probably one of the first and earliest examples of an investor raising a dispute and succeeding against India in an international forum, by invoking the dispute resolution mechanism under a BIT.

White Industries, an Australian company, had in 1989, entered into a contract with Coal India Ltd. In view of certain disputes and differences between the two contracting parties, White Industries invoked arbitration against Coal India, in which White Industries succeeded in May 2002. Eventually, the matter reached the Supreme Court of India, where it remained pending for almost 10 years, and White Industries was unable to enforce the arbitral award.

Being aggrieved by such judicial delays, White Industries invoked the dispute resolution mechanism under the India-Australia BIT, and filed international arbitration proceedings against India.

In what is considered to be a brilliant legal strategy, White Industries invoked the Most Favoured National (MFN) clause of the India-Australia BIT. This meant that although a specific term or condition may not be stipulated in the India-Australia BIT, it could adopt and incorporate, through the MFN clause, a contractual term from another BIT – in this case being the India-Kuwait BIT.

White Industries asserted that judicial delays in India had not allowed it to have an effective means of asserting claims and enforcing its rights under a commercial arbitration award in its favour against Coal India Ltd.

The Investor-State Dispute Settlement Tribunal, by its award in 2011, held in favour of White Industries, thereby making India liable to make payment of over 4 million Australian Dollars.

Understanding Vodafone International Holdings BV v. The Republic of India

In 2007, Hutchinson Telecommunications International Limited, a Hong Kong entity (HTIL) sold its stake in a Cayman Islands entity to Vodafone International Holdings BV, a Netherlands entity (VIHBV), which indirectly held shares of Hutchinson Essar Limited, an Indian company (HEL). This transaction was for a consideration of USD 11.1 billion, which was paid to HTIL, which earned capital gains on the sale. The Indian tax authorities made a demand for about USD 2.2. billion upon VIHBV.

VIHBV challenged the demand. However, the Bombay High Court held in favour of the Indian tax authorities. In appeal, the Supreme Court, in January 2012, reversed the decision of the Bombay High Court, thereby quashing the demand of the Indian tax authorities in favour of VIHBV. This should have put the matter to rest.

However, in what can be interpreted as an intent to side-step the decision of the Supreme Court, the Indian Parliament passed the Finance Act 2012, which inter alia provided for the insertion of two explanations in Section 9(1)(i) of the Income Tax Act (2012 Amendment), which effectively meant that the decision of the Supreme Court was nullified, and retrospective effect was given to a tax law. In view of this, the Indian tax authorities once again renewed its demand for tax from VIHBV.

Aggrieved by such amendments and renewed tax demands, VIHBV directly invoked international arbitration against India claiming that such action on the part of India violated the ‘fair and equitable treatment’ guaranteed to Vodafone under the India–Netherlands BIT.

On 25 September 2020, the international arbitral tribunal held in favour of Vodafone, holding that the company is not liable to pay such tax in India.

Critical analysis of the two decisions

Delays and pendency in Indian Courts

The White Industries case brought to the forefront a commonly known and severe problem of judicial delays and backlog in India.

Despite knowledge of these delays, the decision of the White Industries case squarely puts the blame and fault upon India, as a country, for White Industries not having been provided with an “effective means of asserting claims and enforcing rights”.

The fact that a foreign company can get such special and greater legal standing through a BIT, which is not available to an ordinary litigant, impinges upon the sovereignty of India, and takes away from the most basic right of equality. This decision also implies that the Indian Judiciary would be accountable to another nation’s private entity with respect to its functioning in regular course, which ought not to be the case.

Vodafone case and tax sovereignty

Coming to the recent Vodafone case, it is a well-established legal principle and principle of international law that imposition of tax is the sovereign right of every country. Therefore, the terms of a BIT ought not to be able to override or supersede India’s sovereign right to tax.

The decision by Vodafone to agitate this issue at an international forum by directly invoking the India-Netherlands BIT, rather than exhausting domestic legal remedies first, has short-circuited and bypassed the due and proper legal processes which had in fact supported Vodafone.

Vodafone had a clearly available alternate and efficacious remedy of challenging the constitutional validity of the amendments, thereby seeking striking down of the retrospective amendment by the Courts in India. Especially since the Supreme Court had previously held in favour of Vodafone.

The decision of the Supreme Court in favour of Vodafone in fact showed that India has a robust and well-functioning judiciary, and that foreign investors should have full faith in our judicial system.

Conclusion

With due respect, it is stated that the decision in the White Industries case is incorrect. This is primarily because White Industries ought to have been reasonably aware of judicial delays in India, prior to initiating any dispute in India. A foreign investor invests in India knowing the general conditions under which the country is governed, and sees benefit of investing in India primarily due to lower costs. Therefore, such foreign investor cannot and should not be the recipient of only the benefits of transacting in India, without also accepting or dealing with its setbacks. Also, a private foreign investor, through a BIT, making the Indian judicial system accountable to it, in fact impinges upon the sovereignty of India.

On the other hand, with respect to the Vodafone case, the important questions that need adjudication are (i) whether an international arbitral tribunal, by enforcement of a BIT, can overrule or supersede the host country’s sovereign right to tax, and can strike down or dilute the decision of a country’s legislature and (ii) whether a foreign investor must exhaust all domestic remedies before invoking arbitration under a BIT.

In a recent article, it has been stated that Solicitor General for India Tushar Mehta has advised the Government of India to challenge the Vodafone decision on the following question of law “ …the power of an arbitral tribunal to virtually and substantially declare a parliamentary legislation of a competent Parliament of a sovereign nation to be non est and unenforceable…”

Therefore, it is suggested that India should challenge the Vodafone decision of the international arbitral tribunal, primarily on the grounds of lack of jurisdiction and availability and non-exhaustion of alternate efficacious domestic remedies, before invoking the BIT.

While investor protection is important, it is also important for India, as a country, to preserve and safeguard its sovereignty.