Do governmental measures taken to counter COVID-19 violate foreign investors’ rights
Authors: Oleg Alyoshin, Partner, Attorney-at-Law at Vasil Kisil & Partners, Energy and Natural Resources, International Arbitration, Agribusiness, Vsevolod Mazurenko, Associate at Vasil Kisil & Partners, Energy and Natural Resources, International Arbitration, Construction and Development
In February and March 2020, governments around the world adopted various restrictions to curb the spread of COVID-19. In many countries including Ukraine, the degree of interference in the economic and social freedoms was unprecedented.
Back in spring 2020, adoption of evidence-based decisions was nearly impossible, as the scientific community lacked consensus regarding the health risks and the nature of the virus. Choosing between immediate damage and multi-faceted long-term implications, most governments, quite understandably, opted for avoiding all too evident human costs. In France and the United Kingdom, for example, political leaders compared mitigating the risks of the virus with waging a war. Thus, initial responses by most governments were emotion-driven and addressed short-term dangers. This response made sense at the time, since the costs were all too evident, while thinking through the long-term economic and social implications required, among other things, expertise and global cooperation, all of which were manifestly lacking. Consequently, the rationale of the severity of the adopted measures consisted partly in the high social costs of inaction and partly in the insufficient understanding of the virus’ nature and factors that contributed to its spreading.
The world is now waking up to the realization that maintaining sweeping restrictions is too costly and counterproductive. By various estimates, in 2020 the global GDP will drop by around 6%, which the World Bank described as “the deepest global recession in decades”. In Ukraine, the National Bank estimates that the annual GDP will shrink by 7,7% compared to 2019. According to the International Labour Organisation (ILO) the industries hit hardest by the pandemic will include retail, manufacturing, real estate, construction, transport, arts, tourism, entertainment and leisure. Formerly rapidly-growing airline company SkyUp has stated that it is on the brink of bankruptcy. According to the World Bank, global per capita income has contracted by the largest fraction since 1870. Thus, the former approach of cracking a nut with a sledgehammer is no longer viable.
As the scientific data (and global consensus) are growing, they offer policy-makers less-interventionist yet workable methods such as testing and tracing, reasonable social distancing and clear and consistent official communication. Economic and social restrictions must be targeted, based on sound reasoning and applied in a non-discriminatory fashion. They should inflict no more economic harm than is strictly necessary in the circumstances. As the judge from the Constitutional Court of Ukraine recently noted, the implications of ill-thought-through restrictions – from limited physical activity to loss of access to medicine (to loss of income) – can be deadlier than the virus itself. If the Ukrainian government fails to meet these criteria, foreign investors can seek compensation for damage under international investment treaties. This article attempts to spell out the contents of these criteria.
2. Restrictions adopted in Ukraine
From early May, the Cabinet of Ministers of Ukraine adopted several resolutions that introduced restrictions on social and economic activities. Broadly, the restrictions that were relevant to business activities were as follows:
- ban on the organizing of sport, cultural, recreational and other social events with over 10 attendees;
- closing of shops, cafes and restaurants;
- restrictions on the carriage of passengers.
The restrictions above were first introduced under Resolution No 211 of 11 March 2020, Resolution No 392 of 20 May 2020 and have since been incorporated in other regulations adopted by the Cabinet of Ministers.
In early June, the Supreme Court of Ukraine applied to the Constitutional Court of Ukraine for a review of the governmental restrictions. On 28 August 2020, the Constitutional Court handed down a decision whereby the majority of the judges, disappointingly, avoided to address the lawfulness of the restrictions squarely. The judges did so on the ground that during the proceedings the regulations that were the subject of the review were repealed. This reasoning was too formalistic as the “repealed” provisions effectively migrated to other regulations and remained effective.
The minority judges issued dissenting opinions in which they held the economic restrictions unconstitutional. The judges did not spare the rod in calling out the state’s abuses. While, strictly speaking, their opinions are not legally binding, they carry a significant weight under both domestic and international law. Few of their observations merit quotations at length.
For instance, judge Lemak V.V. in his dissenting opinion emphasised that: “even the justifiability and seriousness of the objective of protecting people’s lives and health, for which restrictions on the exercise of constitutional rights have been implemented, does not mean that such restrictions may be arbitrary and incompatible with the rule of law.”
3. Ukraine’s obligations under international treaties
To attract foreign investments, Ukraine has signed over 79 investment protection treaties. According to these treaties, Ukraine has committed to granting to investments standards of treatment that derive not from domestic but from international law. One of the implications of this is the fact that Ukraine may be held liable even if the measures at issue were regarded as legal under the domestic legal system. In this context, the dissenting opinions of the judges of the Constitutional Court would very likely be given serious consideration.
Investment treaties include the following most common standards of protection of foreign investments:
- minimum standard of treatment;
- fair and equitable treatment;
- full security and protection;
- national treatment;
- most favoured nation treatment;
- prohibition on the taking of measures that are arbitrary, unreasonable and/or discriminatory;
- prohibition of expropriation.
This article will treat Ukraine’s obligation to accord to foreign investments fair and equitable treatment as well as to avoid the adoption of measures that are arbitrary, unreasonable or discriminatory.
4. Standards of protection of foreign investors
a) Fair and equitable treatment: protection of legitimate expectations
The state’s obligation to accord to investments fair and equitable treatment (FET) is found in virtually all investment treaties. As the terms “fairness” and “equity” are open-ended, the effect of the FET standard continually evolves.
The landmark case Tecmed v Argentina interpreted the FET standard to include the state’s obligation to fulfil the investor’s legitimate expectations. The rationale of this obligation was expounded in Suez v Argentina thus: “[w]hen an investor undertakes an investment, a host government through its laws, regulations, declared policies, and statements creates in the investor certain expectations about the nature of the treatment that it may anticipate from the host State. The resulting reasonable and legitimate expectations are important factors that influence initial investment decisions and afterwards the manner in which the investment is to be managed. The theoretical basis of this approach no doubt is found in the work of the eminent scholar Max Weber, who advanced the idea that one of the main contributions of law to any social system is to make economic life more calculable and also argued that capitalism arose in Europe because European law demonstrated a high degree of “calculability.” An investor’s expectations, created by law of a host country, are in effect calculations about the future” (decision on liability, para 222).
While it is now widely held that states have a duty to ensure a stable legal and business framework, this duty is qualified by the state’s power to legislate in the matters of public interest such as protection of human life and health. In the words of the tribunal in Saluka v Czech Republic: “[n]o investor may reasonably expect that the circumstances prevailing at the time the investment is made remain totally unchanged. In order to determine whether frustration of the foreign investor’s expectations was justified and reasonable the host State’s legitimate right subsequently to regulate domestic matters in the public interest must be taken into consideration as well.” Thus, not all expectations are protected equally: they “must rise to the level of legitimacy and reasonableness in the light of circumstances” (Saluka v Czech Republic, para 304 of the award).
The degree of stability required from host countries depends on the level of their economic and institutional development. It is reasonable to expect that countries respond to a public health crisis differently, considering their financial or institutional capacities. Arbitral tribunals often accept that an investor should not be insured against risks that could be reasonably avoided or revealed through circumspection and due diligence. In Parkerings v Lithuania the state was not held liable for the adoption of measures that were not unexpected from a country that was transitioning from a planned to a market economy. In the words of the tribunal: “[i]n principle, an investor has a right to a certain stability and predictability of the legal environment of the investment. The investor will have a right of protection of its legitimate expectations provided it exercised due diligence and that its legitimate expectations were reasonable in light of the circumstances. Consequently, an investor must anticipate that the circumstances could change, and thus structure its investment in order to adapt it to the potential changes of legal environment” (para 333 of the award).
The above does not mean that a state can rely on its own failings to justify violations of investors’ rights. As one judge of the Constitutional Court of Ukraine pointedly noted, “[d]uring the fight against the pandemic, the right to life and the right to health are most closely linked. Under Article 27(1) of the Constitution everyone has an inalienable right to life. Under Article 49(1) of the Constitution everyone has the right to healthcare, medical assistance and medical insurance. The link between these constitutional rights lies in the fact that insufficient, untimely and ineffective state measures in the area of healthcare in the context of pandemics may amount to a direct infringement on everyone’s right to life.” (Ruling of the Constitutional Court of Ukraine of 28 August 2020, dissenting opinion of judge Lemak V.V.) Notably, in spring 2020, the government of Ukraine (as indeed those of many other countries) set up a specially designated Fund for Fighting Covid-19. However, the government spent the vast majority of money not on medical equipment or similar purposes but on the construction of highways.
While in principle Ukraine can regulate mattes of public concern without breaching its obligations, measures that ostensibly aim at protection of public health must be adopted in good faith. In Saluka v Czech Republic, it was held that: “[i]t is now established in international law that States are not liable to pay compensation to a foreign investor when, in the normal exercise of their regulatory powers, they adopt in a non-discriminatory manner bona fide regulations that are aimed at the general welfare” (para 255 of the partial award). If the measures at issue are, for instance, knowingly ineffective, pursue an ulterior motive or do not result from good judgment, they may be considered as having been taken in bad faith.
Case law of arbitral tribunals indicates that secondary motives may undermine the legitimacy of measures that were adopted to protect public health. The ostensible goal of health protection should not be used to disguise such motives as protectionism, creation of competitive advantages or scoring political points. While the respective measures may succeed in achieving these illegitimate objectives, they would hardly be effective in improving the healthcare situation. For this reason, they may also be regarded as unreasonable or arbitrary.
A good example is the investment case Azurix v Argentina. The claimant (Azurix) won a tender for a concession contract for the supply of drinking water and wastewater treatment. After an unexpected algae bloom in one of reservoirs, the Governor of Buenos Aires accused Azurix of breaching the terms of the concession contract. He called on the residents of the metropolis not to pay the plaintiff’s bills and later, contrary to the terms of the concession contract, the local government refused to raise the plaintiff’s fees for water supply, after which it terminated the contract itself. Azurix filed a lawsuit against Argentina, claiming, among other things, that the government had breached fair and equitable treatment by adopting an unreasonable measure in breach of the fair and equitable standard in the agreement on mutual protection of investments between the USA and Argentina, claiming almost USD 700 million in compensation.
The tribunal held that the accusations of the poor quality of the drinking water and Azurix’ failure to comply with the terms of the concession agreement were motivated largely by political considerations. By accusing Azurix, the government indirectly blamed the previous government, who had awarded the concession agreement, for causing a threat to public health. In this way, the municipal government of Buenos Aires tried to reduce the level of political support for its opponent before the coming elections. The tribunal also decided that the government’s inaction partly caused the pollution itself and, in any case, the charges were exaggerated and occasionally unjustified. Thus, despite the declared purpose of terminating the concession agreement (protection of public health), the court found the purpose of the measures taken to be illegitimate as it was tainted by political motivations.
In Ukraine, the professed aim of social and economic restrictions adopted throughout spring and summer was the reduction of health risks, yet the methods adopted indicate bad faith. For instance, Chief State Sanitary Doctor of Ukraine stated that the government ordered to close parks spray roads “not to influence the epidemiological process” but to “induce a sense of anxiety in the public”. Regarding the restrictions on the use of public transport, the same official admitted that “in the case of public transport, the biggest problem was not the possibility of catching an infection in it. The risk was that people would travel to other places unnecessarily.” No explanation was given as to what travels were deemed as necessary.
Thus, on certain occasions, the government may have been manipulative and acted in bad faith. It admitted that the closure of public spaces and restrictions on the carriage of passengers had only a tangential connection with the spread of COVID-19. To the extent that these and similar measures caused businesses economic harm (such as, for instance, additional costs for transportation of workers and goods), they may not be regarded as a legitimate exercise of state’s sovereign powers under international law.
Several judges of the Constitutional Court were emphatic on this point. Thus, Slidenko I.D. called the admissions above “shocking”. He held that “[i]n general, the scenario suggested by the state but poorly accepted by the people recalls the minutest details of anti-utopias, including “V for Vendetta”, where playing on people’s fear of the epidemic served as a method of seizure of power and a trigger to the establishment of an authoritarian dictatorship.” (Ruling of the Constitutional Court of 28 August 2020, dissenting opinion of Slidenko I.D.)
b) Prohibition on the taking of measures that are arbitrary, unreasonable or discriminatory
Neither Ukraine’s legislate to protect public health, nor the investors’ duty to conduct due diligence and have realistic expectations gives Ukraine a free pass to adopt measures that are arbitrary, excessive or discriminatory. Some treaties state so explicitly. For instance, investment treaty between Canada and Ukraine provides that measures that are necessary to protect human life or health must not be applied in an arbitrary or unjustifiable manner, nor constitute a disguised restriction on international trade or investment (Article XVII(1)(b) of Ukraine-Canada bilateral investment treaty).
Even absent an express qualification on the exercise of regulatory powers, the prohibition on the taking of arbitrary, unreasonable and/or discriminatory measures is widely accepted to be caught by the FET standard.
In AES v Hungary the tribunal held that: “[t]here are two elements that require to be analyzed to determine whether a state’s act was unreasonable: the existence of a rational policy; and the reasonableness of the act of the state in relation to the policy. A rational policy is taken by a state following a logical (good sense) explanation and with the aim of addressing a public interest matter. Nevertheless, a rational policy is not enough to justify all the measures taken by a state in its name. A challenged measure must also be reasonable. That is, there needs to be an appropriate correlation between the state’s public policy objective and the measure adopted to achieve it. This has to do with the nature of the measure and the way it is implemented” (paras 10.3.7-10.3.9 of the award).
Justification underlying a governmental measure is rational where it is based on science and is capable of achieving the professed goal.
Restrictions would be regarded as unreasonable if they are excessive, i.e. if the desired goal could be achieved by means that inflict less damage. According to the data published by Oxford University, during March-April 2020 Ukrainian government adopted some of the most restrictive COVID-19-related measures in the world given the ratio of the severity of the restrictions to the number of the detected infections.
A governmental measure is considered to be arbitrary if: (i) it inflicts damages on the investor without serving any apparent legitimate purpose; (ii) a measure is not based on legal standards but on discretion, prejudice or personal preference, (iii) a measure taken for reasons that are different from those put forward by the decision maker, or (iv) a measure taken in wilful disregard of due process and proper procedure (EDF (Services) v Romania, para 303 of the award).
A number of governmental measures that have been put in place since March 2020 would fail to meet that test. For instance, a month-long ban on the arrival of foreign tourists that took effect on 29 August 2020 harms airline companies, hospitality and entertainment industries without improving public health, as there is no evidence that foreigners, not Ukrainians, have contributed to the spread of COVID-19. As a matter of fact, during the month when the entry ban for foreigners was effective, Ukraine’s infection rate has increased by about 50%. Further, selective enforcement of restrictions (application of dissimilar standards in similar situations) amounts to arbitrariness or discrimination.
The World Health Organisation (WHO) estimates that during the next two years waves of COVID-19 will keep reoccurring. This might serve for the Ukrainian government as an excuse for imposing or maintain restrictions on economic activity. However, as time passes, sweeping restrictions are harder to justify as the requirements for their legality increase.
Informed and robust cost-benefit analysis, not emotions and short-termism, is the yardstick of the legality of measures that encroach upon most fundamental economic freedoms. While there was no consensus on the nature of the virus during the first months of the pandemic, today scientists publish their findings with an ever-increasing frequency. Governments should heed the recommendations of WHO and ILO. Experts around the world actively discuss measures that would minimize the risk of virus spread with the least economic loss, and their findings are available to policy-makers. If the restrictive measures do not pass the test of reasonableness and proportionality under international law, the Ukrainian government will hardly avoid claims from foreign investors.