There was a massive proliferation of bilateral investment treaties in the 1990s. A World Bank study stated that in 1994 there were over 700 such treaties. By the end of the millennium, the figure had moved towards 2,600 treaties. It has now exceeded that mark. Investment chapters are also included in free trade agreements. Obviously, states which participate in the making of these treaties consider them to be necessary for a variety of reasons, the most important being the belief that they promote the flow of foreign investment. The question whether they do in fact promote foreign investment flows has been subjected to considerable doubt in recent literature. Yet, the treaties continue to be made, though there is a decline in their numbers in recent times. Other reasons are advanced for their making. One is their signalling function. The making of such treaties is an indication that a state previously committed to certain ideological stances inimical to foreign investment has changed its policy and is now prepared to accept standards of protection of investment and international arbitration to settle investment disputes. The activity of China and Vietnam, erstwhile communist states wedded to a concept of public ownership of property, is illustrative of this signalling function. The former East European states, liberated from communist ideology, also signed many such treaties. But, such treaty activity is also explicable on the basis of the need of these countries to enhance their competitive positions.

The international law on foreign investment has witnessed an explosive growth since the last edition. The decade had witnessed a proliferation of bilateral and regional investment treaties, and a dramatic rise in litigation under such treaties. The attempt to fashion a multilateral instrument on investment within the World Trade Organization has given the debate on issues in the area a wider focus. This edition seeks to capture such developments.

In the course of the decade, I have had the good fortune of being involved actively in many facets of the operation of this area of the law. During such activity, I have acquired many friends who work in the area. My association with UNCTAD has brought me in contact with Karl Sauvant, Anna Joubin-Brett, Victoria Aranda and James Chan. It has also given me the opportunity to work with Arghyrios Fatouros, Peter Muchlinksi and Kenneth Vandevelde, the academic leaders of this field. They have added much to my understanding of the law. The many hours of arguments with them, in various parts of the world, have added to the pleasure of studying this area of the law.

The first edition was written while I was a visiting fellow at the Lauterpacht Centre for International Law, University of Cambridge. The successive Directors of the Centre, Professor Sir Eli Lauterpacht and Professor James Crawford, have continued to encourage my efforts in this and other areas of international law.

Consent of the parties is the basis of all arbitration. In contract-based arbitration, the consent is specific to disputes arising from the contract. It is usually expressed in the arbitration clause. In treaty-based arbitration, the consent of the state is said to be given to all present and potential investors who satisfy nationality criteria and whose investment is protected by the treaty in advance of the dispute. The rule can be so simply put. But, much dispute has arisen as to the jurisdictional criteria that have to be satisfied before an arbitral tribunal can proceed to the merits of a case. In virtually every treaty-based dispute that has arisen, the jurisdiction of the tribunal has been queried. So, it is necessary to examine the jurisdictional criteria that need to be established. Since most treaty-based arbitrations take place before ICSID tribunals, the rules are best stated on the basis of ICSID arbitration, which is likely to provide the standard for other types of treaty-based arbitration.

As may be realised, with an increase in the number of claims, states have invested much effort in exploring the methods of excluding jurisdiction, and have met with a measure of success. Cases are fought with tenacity, and states are resistant to the use of treaties for the imposition of responsibility. This, again, raises doubts as to the utility of treaties as an investment protection device.

If states were in agreement as to the norms that constitute the international law of foreign investment, it would have been possible to agree a multilateral agreement on foreign investment stating the substantive rules which apply in the area. The fact that no such multilateral agreements exist is due to the existence of conflicting approaches to the problem of foreign investment protection and the existence of contending systems relating to the treatment of foreign investment. Several attempts have been made at bringing about a comprehensive code on foreign investment, but they have resulted in failure simply because of the ideological rifts and clashes of interests that attend this branch of international law. Most drafts have been made with the objective of providing as much protection as is possible to foreign investment. These have been rejected by capital-importing states. The entry into the picture of non-governmental organisations (NGOs) further complicates the picture. They object to multilateral agreements which concentrate on investment protection exclusively without addressing issues relating to environmental degradation or the human rights violations associated with foreign investment. Some of these organisations take the view that the development interests of the poor are not addressed through such instruments, which seek only to protect the rights of rich multinational corporations. The entry of NGOs as major players in the area has further complicated the issue of making such agreements.

As the number of arbitrations under the investment treaties increases and the perception of their legitimacy decreases with conflicting decisions, states have responded in three principal ways. The first has been one of withdrawal from the system of investment arbitration. Some states have announced that they will consider not extending the life of their investment treaties after they expire. Others have sought to withdraw from the ICSID Convention. This response is a calculated decision based on the belief that the costs of arbitration and disputes outweigh the benefits that investment treaties bring to a state. Withdrawal and termination are matters of sovereign prerogative, but such a withdrawal has to be effected through the manner prescribed in the treaty. The effectiveness of withdrawal depends on its timing. Such withdrawal is not possible as to existing disputes or disputes that arose while the treaties were pending. The termination provisions in the treaties are relevant in determining such issues.

The second response is to change at lease future investment treaties so that there is an exclusion of certain sectors such as taxation from arbitration and the inclusion of exceptions to responsibility in the treaty itself. The third has been to argue new types of defences to liability. It is the third response that this chapter will focus on.

It is a relatively new phenomenon that there should be such defences to responsibility in a system which was thought of as providing a virtually unchangeable system of secure protection to foreign investors.

Unlike under the old law, there is now an increasing expectation, particularly among developing countries and non-governmental organisations (NGOs), that home states of multinational corporations should exert control over the activities of their corporate nationals operating overseas. These measures include not only the measures taken to promote the flow of foreign investment into developing countries, but also measures that seek to ensure that multinational corporations do not act to the detriment of host developing states. This chapter concentrates on the latter type of measure. The rationale is that developed states owe a duty of control to the international community and do in fact have the means of legal control over the conduct abroad of their multinational corporations. In moral terms, the activities of multinational corporations eventually benefit the home state's economic prosperity. The argument is that it is therefore incumbent on the home state to ensure that these benefits are not secured through injury to other states or to the welfare of the international community as a whole. The early law concentrated only on the protection of foreign investment through the diplomatic intervention of the home state. However, there is now an evolution of the notion that the home state has duties as well as rights in matters relating to foreign investment which require the home state to intervene to ensure that its multinational corporations act in accordance with emerging standards that require their accountability.

The right of a state to control the entry of foreign investment is unlimited, as it is a right that flows from sovereignty. The entry of any foreign investment can be excluded by a state. But, a sovereign entity can surrender its rights even over a purely internal matter by treaty. Some regional and bilateral treaties now provide for the right of entry and establishment of investments to the nationals of contracting states. Where such pre-establishment rights are created by treaty, the denial of a right of entry to any investor from one of the contracting states would amount to a violation of the treaty, unless it can be shown that his investment is not covered by the treaty. Where the treaty permits both the right of entry and national treatment after entry to nationals of the contracting states, the right of control over the investment on the basis that the investment was made by an alien is entirely lost to each of the contracting states. Where such a treaty applies to the foreign investment, the treaty completely extinguishes the right of control the state has over the foreign investment, except where the treaty itself provides exceptions to this situation. It may still be the case that, in circumstances of necessity, the treaty rights of the foreign investor could be suspended. Yet, it has to be concluded that such treaties diminish the right of control which the state has over the foreign investor.

The previous chapters have indicated how efforts have been made through diplomatic means and through treaty means to bring about the protection of foreign investment. Diplomatic means are the older of the two. There are definite rules on the basis of which diplomatic intervention to protect the interests of the foreign investor could be made. They are the genesis of what some states regard as customary international law. Where diplomatic intercession fails, the same rules become the basis on which litigation could be brought against the recalcitrant state before an international tribunal or the International Court of Justice. There have been very few cases that have been brought before the International Court of Justice or its predecessor. Where a large number of foreign investment disputes arise from a single incident, states may choose to set up Claims Commissions to deal with them. In these circumstances, an international tribunal is established pursuant to an instrument akin to a treaty with clear means of enforcing the awards it makes.

Investment treaties, as has been seen, have also devised their own methods of dispute settlement. They usually enable the foreign investor to invoke remedies through arbitration at his own instance, the state being taken to have expressed its consent through the treaty provision. In a sense, an attempt has thus been made to create a regime of investment protection. But, in the absence of a multilateral treaty, such a regime will not come about.

All law involves a resolution of conflicting interests. But, unlike other areas of law, international law lacks a centralised authority which could resolve conflicts of interest. Whereas in a domestic system there are decision-making authorities which can resolve such conflicts, in international law the absence of such an authority means that conflicts will be protracted. This situation will exist until some adjustment of the conflict is made in the course of time, either through negotiated settlements resulting in treaties, or through practices resulting in custom. The adjustment will embody principles which receive a measure of acceptance by states. All these involve consensual processes. International law embodies a long series of adjustments made in response to conflicts. As the process of adjustment never ends, the law continually remains in a state of flux.

The international law on foreign investment is an example of this process of adjustment. Its lack of clarity in many areas results from the intensity of conflict of divergent interests. Essentially, the conflict relates to the nature of the control that could be exercised over the foreign investment. Host states argue for national control subject to a minimum of external constraints, whereas capital-exporting states argue for greater constraints on national control in the hope of ensuring the protection of foreign investment. Various other actors such as non-governmental organisations (NGOs) with a diversity of interests have come onto the scene, thus adding further to the existing uncertainty.

The usual cause of action in investment disputes has hitherto been the taking of property. Though, as was claimed, customary international law recognised an international minimum standard of treatment of a foreign investor, the violation of this standard outside the context of the taking of property was seldom discussed. The growth of such a customary law was dealt with in Chapter 4 above. It forms a prelude to the discussion here. That chapter dealt with the manner in which the creation of an international standard was effected and the conflicts which attended it. But, investment treaties have sought to iron out such conflicts and provide recognition of certain standards of treatment of investments as between the parties to such treaties. It is only with the spelling out of the different standards of treatment in the investment treaties that the breach of treatment standards has become a distinct head of liability distinct from the taking of property. In more recent disputes, the failure to provide treatment according to standards prescribed in investment treaties has become important, especially in the context of Chapter 11 of the North American Free Trade Agreement (NAFTA). The vigour with which disputes have arisen between the two developed-country participants in NAFTA, largely on the basis of treatment standards and novel theories of the taking of property, has opened up new possibilities in the field.

Compensation for nationalisation of foreign investment is a topic steeped in controversy. Opinions expressed as to the need for compensation have ranged from the payment of full compensation, a concept which includes consideration of future profits the investment would have made, to the payment of no compensation at all. The acuteness of the conflict was evidenced by the division that occurred within the academic and official quarters as to the statement of the rule on the standard of compensation in the American Law Institute's Restatement (Second) of the Foreign Relations Law of the United States and in the various awards of the Iran–US Claims Tribunal. The issue has remained dormant in more recent times, attention being shifted to issues such as the scope of taking and the meaning and extent of regulatory taking. Another feature is the attempt to shift the focus of the controversy by articulating standards of valuation. The topic will remain of great interest, despite the fact that there have been few spectacular nationalisations in recent times. The need for foreign investment and the inadequacy of foreign capital to supply this need keeps such activity dormant. Given this context, states will not seek to spoil their record of stability by engaging in any spectacular nationalisations. But, bouts of nationalism will occur in cyclical patterns in the history of nations.

What constitutes an act of taking of foreign property in international law was once clear but has now come to be befuddled with difficulty as a result of the progressive expansion of the concept of taking. In the past, the law was discussed in the context of outright takings of the property of the alien. There was no difficulty in characterising the act of physical dispossession as a taking. After colonialism came to an end, there was a spate of nationalisations intended to regain control of the economy from the companies of the erstwhile colonial powers. After the initial rush of nationalisations, there was a movement away from the wholesale takings of industrial sectors to the targeting of specific companies. Developing countries instituted changes regarding the manner of entry of foreign investment. There was greater administrative control over investment. The vehicle of foreign investment was often a mandatory joint-venture company incorporated in the host state. The company became a corporate citizen of the host state and thus more amenable to its control. The process of foreign investment itself came to be enmeshed in a host of regulations which directed it to economic development objectives and environmental protection. In this context, the notion of what constituted a taking had to change. The focus was on the manner of governmental interference with the contracts on the basis of which the original investment was made or on the running of the corporate vehicle through which the investment was made.

Few areas of international law excite as much controversy as the law relating to foreign investment. A spate of arbitration awards resulting from investment treaties has added much to the debates in recent times. These have been followed by massive literature analysing the law resulting from the treaties and the arbitration awards. Since the awards often conflict, the confusion has been exacerbated. Though the conflict in the awards is often attributed to the inconsistencies in the language in the treaties each tribunal had to interpret, the more probable explanation is that there are philosophical, economic and political attitudes that underlie the conflict which in turn reflect the underlying causes for the controversies that have existed in the area for a long time.

The law on the area has been steeped in controversy from its inception. Much controversy has resulted from the law on the subject being the focus of conflict between several forces released at the conclusion of the Second World War. The cyclical nature of the ebbs and flows of the controversy is evident. The ending of colonialism released forces of nationalism. Once freed from the shackles of colonialism, the newly independent states agitated not only for the ending of the economic dominance of the former colonial powers within their states but also for a world order which would permit them more scope for the ordering of their own economies and access to world markets.

This book was written while I was on sabbatical leave from the National University of Singapore. I thank the Vice-Chancellor, the Council and Dean of the Faculty of Law for the generous terms on which I was granted the leave.

I spent the sabbatical year as a Visiting Fellow at the Research Centre for International Law of the University of Cambridge. I thank Eli Lauterpacht, the Director of the Centre, for many acts of kindness in making this year a happy and productive one.

I am grateful to Professor James Crawford, Whewell Professor of International Law at Cambridge, who read and commented on an early draft of this work, to Professor Detlev Vagts, Bemis Professor of International Law at Harvard, who enabled me to spend a month of research at the Harvard Law School and to Robin Pirrie, Fellow of Hughes Hall, Cambridge, who was helpful with his advice. I remain responsible for any errors and omissions.

As always, Thanga has been an unfailing source of strength. Ahila, Ramanan and Vaishnavi have given up time that should have been theirs.

Since the second edition of this book, the international law on foreign investment has witnessed such enormous activity that a new edition is justified within five years. The number of arbitration awards based on investment treaties has increased, resulting in several books written solely on the subject of investment treaty arbitration. New works have appeared on several aspects of the law on foreign investment. This work has held the area of the law together without fragmenting it any further. The carving out of an international law on foreign investment itself may have furthered fragmentation in international law. Yet, the aim was to ensure that the base remained clearly in international law principles. That aim does not appear to have been preserved in many of the later works which sought to carve out further areas as free-standing ones. The original niche of this work remains unaffected. It seeks to establish the foundations of the law clearly in the international law rules on state responsibility and dispute resolution rather than approach it with the central focus on investment treaties and arbitration which seems to have attracted the practitioner more than the scholar.

It also has a focus that is different from that of the other works in the field. It is written from the perspective of development. The claim to neutrality of the works in the field cloaks the fact that they deal with an asymmetrical system of the law created largely to ensure investment protection.