Investor-State dispute settlement under the Korea-Australia Free Trade Agreement

In brief

In a shift from the previous Australian Government's position, a free trade agreement between Korea and Australia, which was recently concluded by the new Coalition Government will include investor-state dispute settlement clauses. Partner Peter O'Donahoo, Senior Associate Hilary Birks and Lawyer Anna McMahon report.

How does it affect you?

• Australian investors in the Republic of Korea or Korean investors in Australia (foreign investors) may have a right to pursue an action against the host country under Chapter 11 of the Korea-Australia Free Trade Agreement (KAFTA) concerning a covered investment.
• KAFTA details the procedure a foreign investor must follow to commence a claim against the host country as well as particular jurisdictional thresholds that must be met. If not otherwise resolved, disputes may be submitted to arbitration.
• KAFTA includes broad carve outs limiting the scope of claims that a foreign investor may bring against the host country.
• Parties to arbitration under KAFTA should be aware of Article 11.21 concerning the transparency of the proceedings and its impact on commercially sensitive information.

Background

On 5 December 2013, Australian Prime Minister Tony Abbott and Minister for Trade and Investment Andrew Robb announced that Australia had concluded negotiations with the Republic of Korea for a free trade agreement. The terms of the free trade agreement were released on 17 February 2014, together with estimates of the extent to which Australia and Australian investors in the Republic of Korea will benefit from the elimination of existing tariffs on Australian exports and new market opportunities in industries including education, telecommunications and professional services.¹

The terms of KAFTA are significant in many ways.² In this article, our focus is on the inclusion of an investor-state dispute settlement (ISDS) mechanism for the resolution of disputes between foreign investors (non-parties to KAFTA) and either Australia or the Republic of Korea, as this has been a controversial issue in Australia since the previous Australian Government announced in April 2011 that it would not include ISDS in any future investment or trade agreements.³ With the change in government following the Australian federal election in 2013, came a change in government policy in relation to ISDS.⁴ The Coalition Government stated that it would consider the inclusion of ISDS on a case-by-case basis and, where adopted, would include limitations and carve outs to sufficiently protect a government's right to make decisions in the public interest. This is reflected in the terms of KAFTA.

KAFTA and ISDS: Chapter 11

Pre-conditions to submission of an investment dispute

The ISDS process is in KAFTA Chapter 11. Articles 11.15 and 11.16 specify the procedure to be followed for submitting an investment dispute to arbitration. These provisions are similar to those included in various free trade agreements to which the Republic of Korea is a signatory⁵ and to which Australia is a signatory.⁶

Chapter 11 does not apply to 'any act or fact that took place or any situation that ceased to exist' before KAFTA comes into force and, as such, limits a foreign investor's right to submit a claim.⁷

Further, a foreign investor may only submit a claim to arbitration if the foreign investor has suffered loss or damage by reason of, or arising out of, an alleged breach by a host state of:⁸

• an obligation under Section A of Chapter 11 (these include the familiar investment treaty obligations relating to national treatment, most favoured nation treatment and expropriation);
• an investment authorisation (as defined in Article 11.28); or
• an investment agreement (as defined in Article 11.28).

If the claim is based on an alleged breach of an investment agreement, the subject matter of the claim and the damages claimed must directly relate to the investment that was 'established or acquired, or sought to be established or acquired', in reliance on that investment agreement.⁹

A foreign investor is not permitted to submit a claim under the ISDS provisions in respect of an alleged breach of any obligations that do not otherwise fall within Article 11.16(1) including, for example, intellectual property rights specified in Chapter 13.

Prior to submission of a claim to arbitration under Article 11.16, the foreign investor and the host state are required to 'initially seek to resolve the dispute through consultation and negotiation'.¹⁰

Other criteria – 'investor' and 'investment'

A threshold question for investment treaty arbitration is whether the foreign investor satisfies the requirements for being an 'investor' and as having an 'investment'. These requirements are reflected in KAFTA through Article 11.16 read with Article 11.1 and Article 11.28.

The primary focus of the definition of 'investor' under KAFTA is the place of incorporation. The definition includes Australia and the Republic of Korea (the Parties), State-owned entities and all other legal entities 'constituted or organised under the law of the Parties', regardless of form. This includes non-profit entities, corporations, trusts, partnerships, sole proprietorships, joint ventures, associations or similar organisations.¹¹

To reduce the potential for treaty shopping, KAFTA also includes a 'denial of benefits' clause allowing a Party to deny treaty protection to an investor in certain specified circumstances.¹²

KAFTA defines 'investment' broadly and includes 'every asset that an investor owns or controls, directly or indirectly, that has the characteristics of an investment, including such characteristics as the commitment of capital or other resources, the expectation of gain or profit, or the assumption of risk'.¹³ The definition of 'investment' also includes a non-exhaustive list of forms that an investment may take together with explanatory notes to clarify the scope.¹⁴

Safeguards

As the Coalition Government foreshadowed, KAFTA contains a number of safeguards to give the governments of the Parties greater certainty in the exercise of their discretion to regulate on 'public welfare' objectives. The safeguards are specified in different parts of KAFTA and include:

• regarding expropriation, an express provision that, except in rare circumstances, non discriminatory regulatory actions by a government that are designed and applied to protect legitimate public welfare objectives, such as public health, safety, and the environment, do not constitute indirect expropriations. KAFTA makes plain that this list is non-exhaustive, and that regulatory actions to protect public health include regulation, supply and reimbursement with respect to pharmaceuticals, diagnostics, vaccines, medical devices, health-related aids and appliances and blood and blood products;¹⁵
• reservations which allow each of the Parties to maintain or introduce certain non-conforming measures which will not be subject to some or all of the investment obligations in KAFTA relating to, for example, national treatment, most favoured nation treatment and market access;¹⁶
• reservations which allow each of the Parties to adopt or enforce measures, in a manner which would not constitute 'arbitrary or unjustifiable discrimination' or a 'disguised restriction on international trade or investment' and which are necessary:¹⁷
  • to protect human, animal or plant life or health;
  • to ensure compliance with laws and regulations that are not inconsistent with KAFTA;
  • for the protection of national treasures of artistic, historic or archaeological value; or
  • for the conservation of living or non-living exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption;
• a limitation on the scope of the most favoured nation clause to exclude investor-state dispute resolution procedures (for example, relating to the prerequisites for submitting a claim to arbitration or the selection of arbitrators);¹⁸
• the exclusion of investments which are subject to review under Australia's foreign investment policy;¹⁹ and
• procedural mechanisms that allow for expedited dispute resolution processes to determine whether, as a matter of law, a claim submitted is not a claim in respect of which an award may be made.²⁰

Transparency in the arbitral proceedings

Last year, we reported on the debate that there should be greater transparency in investor-state arbitration and the United Nations Commission on International Trade Law's (UNCITRAL) response through the adoption of new transparency rules.²¹

In this context, KAFTA provides that:²²

• the host state that is party to an arbitration must provide particular documents relating to the arbitration to the non-disputing state and also make them publicly available; and
• the hearings will be open to the public, subject to making appropriate arrangements for the protection of certain information that should not be publicly disclosed.

If a party to the proceedings seeks to maintain confidentiality over 'protected information' (which includes confidential business information),²³ it is the responsibility of that party to ensure that the protected information is clearly designated as such at the time it is submitted to the arbitral tribunal.²⁴ A party's claim that certain information is 'protected information' may be challenged and subject to determination in accordance with Article 11.21(4). Commercially sensitive information may be at risk in this regard.

Parties to the proceedings should be mindful of these requirements, in addition to those that may be imposed by the rules applicable to the arbitral proceedings under Article 11.16(3).²⁵

Comment

Subject to full implementation of KAFTA, for Australian investors in the Republic of Korea and Korean investors in Australia, the availability of ISDS is a welcome development. Such investors should consider structuring their investments to take advantage of the ISDS mechanism.

However, given the importance that the Parties to KAFTA have placed on negotiating the limitations of ISDS, foreign investors must carefully consider the impact of the safeguards and their scope and should also be mindful of the requirements for transparency in the event that arbitration is commenced.