Indonesian investments and international treaty law

Authors: Simon Butt, Luke Nottage and Brett Williams, University of Sydney

Indonesia’s new mining regulation requiring divestment of majority foreign investments is unlikely to generate many formal investor-state arbitration (ISA) claims against Indonesia, based on existing bilateral or regional FTAs, or investment treaties.

Avoidance of arbitration is primarily motivated by immediate pragmatic considerations. But considerable scope remains to use the international investment law framework further down the track and this may lead to complex adverse effects on cross-border investment, particularly in the rapidly evolving Asia Pacific region.

A conciliatory attitude toward the new regulation is still likely where the investor’s home state desperately lacks natural resources, such as Japan. This is one explanation for the lack of (direct) ISA claims by Japanese investors, despite Japan’s growing number of investment treaties around the world. These include the investment chapter contained within the 2006 Japan–Indonesia Economic Partnership Agreement, with its heavy focus on enhancing Japan’s energy security.

But Indonesia’s new regulation could still lead to formal ISA claims, or — more likely — it could frame renegotiations with foreign investors and possibly their home states, which may well be covered by investment treaty protections. Indonesia has reportedly only been subject to three ISA proceedings under the 1965 International Centre for Settlement of Investment Disputes (ICSID) Convention, to which Australia, Japan and the UK are also party. But a British mining company (Churchill) has recently announced it intends to bring ICSID proceedings against Indonesia for an earlier incident involving one of the world’s largest potential coal coking reserves.

Indonesia is also taking very seriously a highly politicised claim filed last year by a large UK-based investor in the financially troubled Bank Century. Rafat Ali Rizvi is alleging unfair treatment by the Indonesia authorities, including the judicial system, and expropriation after the Deposit Insurance Agency forced the bank into administration in 2008. On 4 April 2012 the tribunal (chaired by a former Solicitor-General of Australia) reportedly rejected Indonesia’s application, under ICSID Rule 41(5), for the claim to be dismissed on an expedited basis as manifestly without legal merit. A key issue — whether the claimant’s investment was properly ‘granted admission’ under the Indonesia–UK bilateral investment agreement — was found to be too complex to resolve under this preliminary procedure. Nonetheless, the arbitrators are likely to re-examine this jurisdictional objection at a later stage of proceedings.

Many investment treaties concluded by Indonesia, as well as several other ASEAN states, contain provisions requiring investments to have been ‘admitted’ in specified ways. For Australian investors potentially affected by mining investment divestment regulations and considering investment treaties with Indonesia, for example, the 1993 treaty between the two countries defines an ‘investment’ to be one ‘admitted by [Indonesia] in its territory in conformity with the laws, regulations and investment policies of [Indonesia] applicable from time to time’. It applies to investments ‘granted admission in accordance with the Law No. 1 of 1967 concerning Foreign Investment or with any law amending or replacing it’. (Indonesia’s current Foreign Investment Law is Law 25 of 2007.) The 2010 ASEAN–Australia–New Zealand Free Trade Area agreement (AANZFTA) defines a ‘covered investment’ somewhat differently: one ‘admitted by the host party, subject to its relevant laws, regulations and policies’.

Such provisions may create difficulties for foreign investors considering treaty claims against Indonesia. Post-Soeharto democratisation and decentralisation have generated an extraordinarily complex set of laws and policies affecting the admission and operation of foreign investments. But if such preliminary hurdles can be overcome, Australian investors seeking compensation or a better negotiating position might argue that the new Indonesian regulations breach the following substantive protections under international treaty law.

First, one avenue may be through AANZFTA, which, for covered investments, provides ‘national treatment’, namely ‘treatment no less favourable than that [which the host state] accords, in like circumstances, to its own investors and their investments’. But footnote 33 makes this commitment subject to a Work Program, with national treatment obligations only coming into effect along with schedules of reservations permitted under Article 12 of the agreement. Australia’s 1993 investment treaty with Indonesia does not provide for national treatment, but it does include ‘most favoured nation’ provisions, allowing Australian investors to claim the benefit of protections extended by Indonesia to third countries.

Second, foreign investors might claim compensation for ‘expropriation’ or its equivalent arising from the host state’s measures. This option is provided in both the 1993 investment treaty and AANZFTA.

Third, the host state commits to extending ‘fair and equitable treatment’ to Australian investors under both the 1993 treaty and AANZFTA. Both treaties also extend other protections, which Indonesia’s new regulations may well violate, such as a requirement for the ‘transparency of laws’. Some provisions may impact on future measures as well, such as proposed restrictions on foreigners holding key management positions in human resources departments.

Lastly, while the 1993 treaty only allows Australian investors to commence ICSID arbitration, AANZFTA adds several options designed for ad hoc proceedings. The former usually provides for greater transparency in proceedings, but AANZFTA allows the host state, for example, to make public all awards and decisions rendered by a tribunal. This is important for host states, given the greater public interests involved in ISA compared to inter-firm commercial arbitration.

The international law regime does not and cannot solve all disputes, even with the increasingly sophisticated drafting of investment treaties. Widely accepted legal interpretations are still evolving and ISA disputes tend to become quite fact-intensive, generating costs and delays. But international law provides additional mutually agreed understandings aimed at balancing a host state’s interest in maintaining appropriate regulatory discretion while attracting foreign investment, with the reasonable predictability foreign investors expect — particularly in the resources sector. The ISA mechanism is important in giving traction to substantive rights. Recent developments in Indonesia therefore provide another reason to reconsider the eschewal of ISA in all of Australia’s future treaties, a change in direction announced by the Gillard Government’s Trade Policy Statement in April 2011.

Simon Butt is Senior Lecturer at the Sydney Law School and acting Director of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS).

Luke Nottage is a Professor and Associate Dean at the Sydney Law School, University of Sydney, and founding co-director of the Australian Network for Japanese Law (ANJeL).

Brett Williams is Senior Lecturer at the Sydney Law School, and Public International Economic Law Program coordinator at the Sydney Centre for International Law.

A longer version of this article, including hyperlinks to further sources, is available here on the Japanese Law and the Asia-Pacific blog. The article draws on research for Luke Nottage’s project with Micah Burch and Brett Williams, ‘Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific’, supported by the Commonwealth through the Australia-Japan Foundation, which is part of the Department of Foreign Affairs and Trade.