To Due Diligence Or Not? A Case For Due Diligence As a Mandatory Precondition To Invoke Investor Protection

[Shamik Datta is an undergraduate student at NALSAR University of Law (India). He is particularly interested in investment treaty arbitration, commercial law and public international law.]

In recent years, the importance of the investor’s corporate social responsibility (‘CSR’) and environmental obligations has gained wide prominence in international investment law. This has resulted in several states explicitly including provisions mandating compliance with such responsibilities and obligations in their newly concluded investment agreements. As has been previously discussed, such provisions may potentially extend to imposing preconditions of complying with such provisions in order to invoke the protection of international investment treaties or agreements (IIAs). One such precondition discussed is the investor’s due diligence obligations.

Till now, unless expressly provided under the IIA as present in the 2018 Dutch Model BIT, the due diligence obligation of the investor has been limited to be simply one of the factors considered by a Tribunal, while assessing the legitimate expectations of the investor. However, this post argues that the importance of this obligation extends beyond this, as an implicit obligation arising under the IIA. Such an obligation applies at least to the extent of ensuring that the investment is in compliance with the law of the host state, which by necessary implication includes CSR and environmental obligations.

To demonstrate this, the post seeks to highlight the relevance of this implicit due diligence obligation in two types of IIAs: (i) IIAs that impose an explicit obligation to ensure compliance with the law of the host state and (ii) IIAs that do not impose such an explicit obligation. Following this, the post seeks to address a few potential issues associated with enforcing the implicit due diligence obligation or assessing its compliance, with a focus on the investor’s CSR and environmental obligations.

Due Diligence as an Implicit Precondition to Invoke Investor Protection under IIAs with “In Accordance With The Law” Provisions

Several IIAs explicitly mandate that investments must be made “in accordance with the law” of the Host State in order to invoke protection under the IIA. The purpose of these provisions is limit the parties’ consent to arbitrate to disputes related to investments made in compliance with the law of the host state. This can be through limiting the definition of an “investment” to “assets”, invested in “accordance with the respective laws and regulations of either Contracting State,” or “in conformity with the hosting party’s laws and regulations”, as included in the Germany-Philippines BIT and the Pakistan-Turkey BIT respectively. In such situations, ICSID tribunals, as in the case Fraport AG Frankfurt Airport Services Worldwide v. Republic of the Phillipines (ICSID Case No. ARB/03/25) have held that when “the BIT explicitly and reiteratedly required that an investment, in order to qualify for BIT protection, had to be in accordance with the host state’s law”.  

While such decisions reflect a post-facto analysis of whether the law of the host state was complied with, it is pertinent to develop a clear standard of ensuring compliance with such laws in light of the importance of these provisions as a precondition. In this regard, the due diligence obligation of the investor provides an appropriate standard for the investor to satisfy themselves that the investment is in conformity with the law of the host state. Such compliance with the law of the host state through due diligence would enable the investor to secure the protection of their investment under the IIA. This position is reflected in the decision of the ICSID Tribunal in Alasdair Ross Anderson v. Costa Rica (ICSID Case No. ARB/AF/07/03) (‘Alasdair’). In this case, while interpreting such an explicit precondition of being ‘in accordance with the law’, the tribunal held that “prudent investment practice requires that any investor exercise due diligence before committing funds to any particular investment proposal” and that “[a]n important element of such due diligence is for investors to assure themselves that their investments comply with the law“, which as the tribunal found was neither an “overly onerous” or an “unreasonable” obligation.

Through this, we can observe that the due diligence obligation of the investor would provide a suitable standard to ascertain the investor’s compliance with the IIA’s preconditions. Without any such due diligence to satisfy themselves of being in compliance with the legal regime of the host state at the time of making an investment, the investor’s claim for protection would inevitably be barred under the IIA. This becomes particularly relevant in cases when the legal regime itself mandates CSR or environmental obligations, such as conducting an environmental impact assessment before making any such investment. The standard of due diligence would extend to satisfying the investor with regards to compliance with such obligations. In light of this, the author argues that the due diligence obligation of an investor may be read in as an implicit obligation in all IIAs, mandating compliance with the law of the host state.

Due Diligence as an Implicit Precondition to Invoke Investor Protection under IIAs Without an Explicit “In Accordance With Law” Provision

In several IIAs such as the Energy Charter Treaty (‘ECT’), there does not exist any such “in accordance with law” provision. In such cases, while there may not be a jurisdiction prerequisite to comply with the law of the host state in order to invoke the IIA’s protection, it has been argued that such an obligation still applies as a matter of general principles of law. A case that is relevant in this regard is the decision of the ICSID Tribunal in Plama Consortium Ltd. v. Republic of Bulgaria (ICSID Case No. ARB/03/24). Here, the tribunal noted that while the ECT does not provide for such an explicit provision, the lack of such a provision does not suggest that the protection of the ECT applies to “all kinds of investments, including those contrary to domestic or international law”. The basic obligation of ensuring that the investment is in compliance with the law of the host state therefore still applies. The extension of this obligation to conduct due diligence is evident from the decision of another ICSID Tribunal under the ECT in the case of Masdar Solar & Wind Cooperatief U.A. v. Kingdom of Spain (ICSID Case No. ARB/14/1). Here, even in the absence of an explicit provision, the Tribunal held that before investing in another jurisdiction, the investor must conduct the appropriate due diligence to at least “familiarize itself with the existing laws”.

Another potential argument in favour of the implicit obligation of conducting due diligence would be the doctrine of unclean hands. Having originally developed as a principle limited to ascertaining the state’s illegal conduct before bringing a claim against another, this doctrine has been extended to the realm of investment arbitration, and has been justified in the name of international public policy, good faith principles, and the duty to honor local laws. An example of this is the decision of the ICSID Tribunal in Inceysa Vallisoletana, S.L. v. Republic of EL Salvador (SCC Case No. 2013/153), where the tribunal held that “no legal system based on rational grounds allows the party that committed a chain of clearly illegal acts to benefit from them”. Moreover, an implicit application of this doctrine in the context of due diligence can be observed in the Alasdair case mentioned above, where the Tribunal barred the investor from bringing such a claim because it had failed to conduct the necessary due diligence to ensure compliance with the law of the host state.

Through this, the author argues that even if there exists no explicit provision in the BIT mandating compliance with the law of the host state, such an obligation nevertheless still exists and as argued above, requires the appropriate due diligence. Such a standard of appropriate due diligence would apply to the extent of at least satisfying a prudent investor that the investment is, in fact, lawful and would thereby form an appropriate standard to adjudge compliance, in both the types of IIAs as discussed above.

Enforcing the Due Diligence Obligation or Assessing its Compliance: CSR and Environmental Obligations

As highlighted above, regardless of the type of IIA in question, the standard of due diligence includes considering the laws of the host state, which includes the CSR norms imposed on the investor and environmental obligations. At present, certain states such as France and Finland have enacted legislation imposing mandatory corporate due diligence obligations on investors as a part of CSR, particularly with regard to human rights and broader Environmental, Social and Governance issues. In such cases, assessing the investor’s compliance with the standard of due diligence becomes uncontroversial and merely includes ensuring conformity with the legislation.

However, certain problems with regards to enforcing such a due diligence obligation may arise in cases when the CSR obligation is merely permissive in nature. An example of this may be found in the current EU landscape, which does not impose a mandatory corporate due diligence obligation on the investors. Even then, however, the European Commission’s recent proposal for a law on corporate sustainability obligations- the Corporate Sustainability Due Diligence Directive is reflective of a larger trend of obliging companies to carefully assess the social and environmental impact of their business initiatives. This transnational trend is further supported by evidence of similar proposals in Switzerland, Denmark and Norway. In light of this trend, even in the absence of a mandatory corporate due diligence obligation as a part of the CSR framework of the host state, there is little to suggest that potential investors may avoid assessing the social and environmental impact of their investments in the host state.

Moreover, while assessing the extent of the investor’s due diligence with regards to their environmental protection obligations ‘in accordance with the law’ of the host state, certain provisions under the IIA pertaining to environmental protection would come into consideration. These would include the inclusion of preambular clauses pertaining to environmental protection (for example, Myanmar-Singapore BIT (2019)), substantive IIA provisions directly related to environmental protection (for example, Belarus-Hungary BIT (2019) Art. 2(7)), and environmental protection as a ‘carve-out’ or a general exception from the standards of treatment under the IIA (for example, India-Kyrgyzstan BIT (2019) Art. 5(5)). These provisions would be particularly relevant in enforcing the standard of environmental due diligence in IIAs without an ‘in accordance with the law’ clause, as the treaty would be interpreted in a manner consistent with the aim of environmental protection as laid out in the preamble, or other provisions of the IIA. This would provide a relevant standard to assess the investor’s conformity with the law of the host state and the extent of due diligence conducted by the investor, pertaining to the environmental implications of the investment.