Retrospective domestic measures and international investment protection

By Puneeth Ganapathy, Lakshmikumaran & Sridharan

In two cases in 2020, Vodafone and Cairn Energy, India lost significant arbitral awards. These awards followed retrospective measures imposed on foreign investments, despite bilateral investment treaties (BIT) that protect foreign investors from unfair treatment by host nations.

Puneeth Ganapathy
Principal associate
Lakshmikumaran & Sridharan

While the past is unalterable, states may frame laws governing past events or conduct, either to clarify legislative intent, or to regulate prior transactions. Retrospective measures thus either validate something that was earlier invalid, or invalidate an earlier understanding, on the basis of which prior transactions were conducted. These are attempts to change the effects of the past. Such measures may be beneficial, but may affect the certainty of regulation and the framework under which business is conducted. Recent international jurisprudence therefore tends to treat retrospective measures that cause adverse effects as illegitimate.

In the context of foreign investment protection, arbitral tribunals had held against retrospective measures even before the awards in Vodafone and Cairn Energy. In an arbitration between the EnCana Corporation and Ecuador, the tribunal unequivocally found that a law that retrospectively cancelled an accrued right to tax refunds was capable of being an act of illegitimate expropriation.

Even where states carve out exceptions to BITs, retrospective measures are not protected. Retrospective measures, seen as abusive actions, are contrary to the premise of good faith conduct by states.

The tribunals in Encana and in Yukos v Russian Federation thus held that states will not be able to rely on BIT exceptions allowing them unfettered powers in specified areas such as taxation, where the measures in question are abusive. Retrospective measures may deprive states of any immunity granted in the BIT and result in liability for damages.

In the context of enforcement of awards, a New York court in Commissa v Pemex, refused to recognize the decision of a court in Mexico that relied on a retrospective law to set aside an arbitral award. An award set aside by courts in the seat of arbitration will usually prevent enforcement of that award in other jurisdictions. However, the New York court enforced the award and did not accord the usual deference to foreign courts because the judgment of the Mexican court was based on adverse domestic retrospective legislation.

Therefore even prior to the awards in Vodafone and Cairn Energy, international law had treated retrospective measures as illegitimate, particularly in the field of taxation. It is perhaps no surprise that India lost both arbitrations, failing to justify its imposition of retrospective capital gains taxes on the transfer of shares in Indian companies. Besides defending its sovereign right to taxation, India took the position that tax measures were carved out from the BITs and were not subject to arbitration. These objections were evidently rejected.

In Nissan v Republic of India, an arbitration involving the retrospective denial of tax credits and refunds, the dispute was settled after several rounds of hearings. Perhaps the government sees some merit in the rule against retrospectivity, or pragmatically acknowledges the difficulty of defending such actions in international arbitration.

India has lodged an appeal against the Vodafone award and may argue that international tribunals discriminate in favour of investors from the developed world, and against governments of developing countries. One viewpoint is that tribunals give insufficient weight to the right of sovereign action, particularly in the field of taxation. Alleging a developed-developing world divide or an invasion of sovereign powers, however, misses the point. Retrospective measures that cause adverse effects are inconsistent with the certainty, equality and rule of law that developing nations usually promise foreign investors when encouraging them to invest. Domestically, a state may be free to legislate retrospectively; however, where its actions affect foreign investors protected by BITs, its domestic powers or exercise of sovereignty will be scrutinized for fairness and legitimacy.

Puneeth Ganapathy is a principal associate at Lakshmikumaran & Sridharan

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