China, national security, and investment treaties

Author: Luke Nottage

Peter Drysdale’s weekly editorial,  along with related postings to this blog and enormous media attention in Australia and elsewhere, focuses ‘on the continuing detention of Rio Tinto executive, Stern Hu, in Shanghai on allegations of espionage’. Drysdale signposts some future analysis of ‘the legal framework under which Hu’s detention has taken place’. He also emphasises that we need ‘a cooperative framework—bilaterally, regionally and globally’ for ‘China’s authorities to avoid damage to the reliability of markets and for Australia to avoid the perception of investment protectionism’.

A worker with the flotation cells in the concentrator at Oz Minerals Century Mine in Lawn Hill, Queensland, Australia. Photo: Reuters

The most pressing legal (and diplomatic) issues concern China’s criminal justice system, especially when ‘national security’ is allegedly involved. But we need to consider some broader ramifications, including investment treaty protections. Part of the backdrop to the Hu saga could be that nations retain considerable sovereignty when it comes to deciding on the operational ambit of foreign investments. Investment treaties – which may be bilateral or regional, stand-alone or folded into broader Free Trade Agreements – now often entrench substantive liberalisation. But these treaties maintain exceptions for national security or subject investments to national interest tests. So even if Australia and China conclude their current FTA negotiations making it broadly easier for firms from either country to invest in the other, that sort of exception could be invoked by Australia, for example, to block or restrict an investment like the now scuttled proposal by Minmetals to acquire Oz Minerals back in March 2009.

Explicit restrictions along these lines had diminished considerably since the 1990s, especially in developed countries like Australia, as competition for FDI burgeoned world-wide. But now they appear to be on the rise again. Concerns have grown about sovereign wealth funds, for example, as well as China’s push to secure resources directly (rather than through long-term contracts combined with smaller equity stakes, the longer-standing approach pursued by Japanese companies in Australia). And after an initial period where countries were desperate to attract funds after the GFC, those market collapses are perhaps forcing a rethink of (explicit or mostly implicit) models based on the merits of lightly regulated markets.

However, part of the recent shift may be due to the growing importance of investor-state arbitration provisions in investment treaties. Under these procedural rights, the investor can claim directly against the host state for breaching substantive protections (such as expropriations, or transparent ‘fair and equitable treatment’) for investments that have been made. Thus, for example, the NZ-China FTA contains an exception for certain ‘essential security interests’ (Art. 201) but also full investor-state arbitration provisions.

Even without such provisions, the foreign investor may be more likely nowadays to be able to get their home state to bring a claim in public international law (say before the International Court of Justice) against the host state, with any compensation obtained from the host state then passed on to the investor. This indirect means of protecting investors was less popular when states tended to temper economics with politics or broader strategic issues. But nowadays in the WTO, for example, they often sue each other over economic issues, with interested industries or firms egging them on (think of Microsoft and the US enforcing TRIPS obligations). And investment disputes, thanks to burgeoning arbitrations that are brought directly by investors against hosts, are increasingly seen as economic rather than political or diplomatic disputes, likewise resolved through a much more ‘judicialised’ procedure.

Either way, the indirect or increasingly direct threat of a claim about an investment that has been made provides an incentive for a host state to rely more on residual exceptions to allowing investments in the first place, such as the national security exception. If so, however, we are likely to see more cases like that involving Stern Hu. That is, the (more broadly frustrated) home state of a frustrated investor reacts – even in a later context – against what it may have perceived as over-eager invocation of the national security exception. The irony in this case, perhaps intentional, is that China is now using its own national security law against a citizen of Australia. But it would be particularly unfair to be making an example of an individual for the actions of his country, particularly when employed by a firm (Rio Tinto) not involved in Australia’s original invocation of the national security exception currently retained in its FDI legislation.

These sorts of issues are likely to become even more acute in light of some very recent developments in investment treaty arbitration practice (Investment Arbitration Reporter 2(11), 29 June 2009). In cases involving treaties with Russia and now China, tribunals have ruled that provisions that seemed to restrict arbitrations to quantification of compensation amounts should be read to extend arbitrability to the question of whether expropriation took place. Thus, even first- or second-generation investment treaties with China (including Australia’s dating back to 1988) may already apply far more extensively than almost everyone had thought (cf. e.g. Gallagher and Shan, Chinese Investment Treaties, OUP 2009). In any event, China is renegotiating such treaties or concluding ones with new partners (like NZ) that clearly allow arbitrability of all issues. The backdrop is that China is now a major FDI-exporter, whose investors are already beginning to bring claims abroad – although so far no investor (or law firm wanting to do other business in China) has risked claiming against China (see my paper with Romesh Weeramantry on this here [pdf]).

If these trends continue, namely direct investor-state arbitration provisions are concluded or reinterpreted to restrict the ability of home states to have second thoughts about foreign investments once they have been accepted, it seems to me that they will be more careful in allowing in FDI. But when they do, somewhere down the line, they may get a ‘Hu’ reaction from the frustrated home state. If so, then how Australia now reacts to China’s detention of Hu will be very important for the evolving field of investment treaties.

This post originally appeared on the Japanese Law and the Asia-Pacific blog

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  • I am an amateur economist and not a legal expert as Luke Nottage is. As a result, I would like to seek some clarifications from the expert on some of the points in this article, legalistic or otherwise. I hope that I can learn something useful from doing this.
    I find the following statements fascinating. Nottage says “… If so, however, we are likely to see more cases like that involving Stern Hu. That is, the (more broadly frustrated) home state of a frustrated investor reacts – even in a later context – against what it may have perceived as over-eager invocation of the national security exception. The irony in this case, perhaps intentional, is that China is now using its own national security law against a citizen of Australia. But it would be particularly unfair to be making an example of an individual for the actions of his country, particularly when employed by a firm (Rio Tinto) not involved in Australia’s original invocation of the national security exception currently retained in its FDI legislation.”
    Does this mean a link between the detention of Stern Hu by the Chinese authorities and an Australia’s invocation of the national security exception exists? On which ground or reliable information to prove that was the case?
    What does “unfair” mean there? Does it mean it is known for sure that the individual involved is completely innocent of those accusations by the Chinese authorities?
    Thirdly, while the firm (Rio Tinto) seemingly was not involved in Australia’s original invocation of the national security exception (I don’t know for which one), was that absolutely true that it didn’t involve in any undisclosed discussions with the government in relation to the matter? What would be Rio’s tactics in those discussions?
    Fourthly, didn’t the firm’s board short-change in the background the proposed investor and contribute to the collapse of the deal? Of course by no means I would argue that that should be used as an excuse to detain its employees without their violations of the laws.

  • Luke Nottage

    Thanks for these four good questions. Let me respond to each below, and add a fifth point for further discussion:

    1. I specialise in Japan, not China (although both countries are increasingly inter-linked), so I’m not qualified or particularly interested in whether in fact China’s detention of Rio’s Hu in fact turns out to be (more or less) “retaliatory” for Australia’s invocation of the national security exception in the earlier Oz Minerals case.

    I am making a more general argument, which implies that such scenarios are perhaps increasingly to be expected. That is:

    (a) States (including Australia, but also China,since the late 1990s) increasingly bind themselves to allowing foreign investors to claim directly against them as host states for illegally interfering with their investments (eg through expropriation, even indirect; or for lack of “fair and equitable treatment”.

    (b) This restricted room to manouevre AFTER the investment has been allowed in, to my mind, implies that potential host states will become more cautious in deciding whether to let in the investment in the first place. States often still retain broad discretion at that stage, eg ‘national security’ or ‘national interest’ – often through generic FDI legislation (applied by Australia in the Oz Minerals case), and even when an investment treaty has been concluded (eg the recent NZ-China FTA does not extend ‘national treatment’ to foreign investment regarding this ‘pre-establishment’ phase).

    (c) Extra initial screening like this risks the home state later “retaliating’.

    2. Measures like (c) seem “unfair” where the home state directs retaliation at a firm in the host state (like perhaps Rio) and especially a particular individual in that firm (perhaps Hu) not involved in the earlier situation (b).

    It could be less unfair if the home state retaliated against the host state or even the firm involved in that initial situation (b). But we should debate whether any retaliation is appropriate. After all, the home state is simply exercising its sovereign rights based on discretionary standards (‘national interest’ etc) preserved by national legislation and/or investment treaties. And if retaliation occurs, it could lead to reciprocal retaliation, further incentives for the home state to exercise such discretions, or perhaps even steps away from including investor-state arbitration provisions in investment treaties. This would not be a good outcome for the world’s FDI system.

    Hu’s innocence or otherwise is secondary to these broader concerns.

    3. I haven’t heard anything about whether Rio somehow encouraged the Australian government to exercise its national security discretion to limit Minmetals’ bid for Oz Minerals. Let alone why it might want to do such a thing back in or before March. If it did, one could argue it is less “unfair” for China now to be retaliating against Rio – but what about an individual (like Hu) within Rio? And this still leaves my broader concern above about potential breakdowns not only in the bilateral relationship, but also the entire FDI system.

    4. Likewise, since it was the Rio board (and shareholders) who scuttled the Chinalco bid, why retaliate against the Australian government? And rather than detaining a Rio executive, it would seem fairer to retaliate by making it clear that China will be unlikely to consider any future investment proposals by Rio to be in its own national interest. But again, is this the sort of ‘tit-for-tat’ FDI system that we want to end up with, bilaterally and world-wide? Further, whether or not Hu did violate China’s laws is not the only issue: why was the prosecution brought at this juncture? (Prosecutors in all legal systems generally have considerable discretion.)

    5. Anyway, one well-known China watcher added this in the weekend’s Sydney Morning Herald (Hamish McDonald ‘China thought we wouldn’t care for Hu’, 25-6 July 2009, News Review p10, http://www.smh.com.au/opinion/china-thought-we-wont-care-for-hu-20090724-dw32.html):

    “There has been speculation the arrests were a payback for the failure of Chinalco’s bid to double its stake in Rio Tinto, and/or anger at the concerns about Chinese military power raised in Canberra’s Defence White Paper.

    The more that comes out in China, however, the more clearly the arrest is related to the iron ore negotiations, and a battle between State and Big Capital inside China itself.

    [reportedly] “the Rio Tinto affair is really a struggle between the market power of China’s steel companies and the political power of China’s government planners”.

    Stern Hu can look forward to up to 19 months’ detention, by recent precedent in State Security cases, before he is brought to court. He is entitled under a bilateral treaty to monthly consular visits by Australian officials, but not to a lawyer. Nor can a lawyer engaged for him carry out any investigation to prepare a defence.

    When the trial is held, family and media cannot attend, diplomats may or may not be allowed to observe, witnesses are not always called and the judges are subject to direction by a Party supervisor in the backrooms. Once charges are laid, an acquittal is unheard of: the best the convict can hope for is a lenient sentence for co-operation and an early deportation on “medical grounds”.

    What can be done? Not much use pointing out the failings of the Chinese legal system – best to convince leaders that their officials are inflicting massive self-damage.”

    If China’s judicial process is that grim, however, I am reminded by my colleague Chester Brown and UMelbourne’s Jurgen Kurtz that Australia might well have a “diplomatic protection” claim anyway against China, for “denial of justice” towards an Australian citizen. But this leaves other major questions. As a legal matter, can jurisdiction be secured, for example in the International Court of Justice? And especially as a practical matter, would Australia be willing also to escalate the dispute in this way given its interest in a FTA and other relationships with China?

  • Thanks, Luke.

    What I thought was there had been missing links in the whole drama of that detention. Each side has been left with speculations, misinformation and misunderstanding.

    Another point was that it was highly likely that Stern Hu was caught in Chinese wider measures to clean up its internal management issues and in that process Stern Hu was a party to some of those issues.

    There is more to be hoping for a better Chinese legal system we’d like to, and for the Chinese people too. It is them to bear that legal system much more than we Australians. The Stern Hu case, while being taken so seriously in Australia and with a lot of publicity, it is highly likely to a drop in the ocean in China as there are many more, much more serious cases that may be unfair from our point of view, or even may also be unfair within that complex and sometimes not clear legal system.

    Your colleague’s argument is impractical even to raise at a bilateral discussion. Even it could be done, probably there are always ways to bypass it, I am afraid.