Trilateral Investment Agreement signed by China, Japan and South Korea

On 13 May 2012, China, Japan and South Korea signed the Agreement among the Government of Japan, the Government of the Republic of Korea and the Government of the People's Republic of China for the Promotion, Facilitation and Protection of Investment ("Trilateral Investment Agreement").  The Trilateral Investment Agreement is the first legal framework between the three East Asian nations regarding investment and once in force, aims to enhance and protect investments made trilaterally, whilst also paving the way for a potential Free Trade Agreement between China, Japan and Korea.  A copy of the Trilateral Investment Agreement can be found here.

In addition to the more common protections that are covered under bilateral investment treaties already in force between China, Japan and South Korea [1] ("Existing BITs"), such as fair and equitable treatment, most favoured nation treatment and protection against expropriation, the Trilateral Investment Agreement also promises improved government transparency, express protections for intellectual property rights and exceptions that will allow governments of the host State to take prudential measures to ensure the stability of their financial systems.  It also identifies international arbitration as the key dispute resolution mechanism for foreign investors.

The Trilateral Investment Agreement does not seek to supersede the Existing BITs, but rather allows investors to "shop and choose" when deciding which investment agreement is most favourable to their investment.

Key Provisions of the Trilateral Investment Agreement

1.    Investments

Article 1(1) of the Trilateral Investment Agreement defines "investments" as including every kind of asset that an investor "owns or controls, directly or indirectly".  A key feature that distinguishes this definition from the Existing BITs is that it provides for investments that are "indirectly" controlled by an investor.  Additionally, unlike the Existing BITs, the definition under the Trilateral Investment Agreement does not expressly require the investment to be made in accordance with the laws of the host State.  This is a departure from language that has been adopted in earlier BITs that has required investments to be made in accordance with the law of the host State.  This earlier language could be read so  as to exclude from protection investments that are considered to have breached even minor violations of the laws of the host State, but is notably absent from the definition under the Trilateral Investment Agreement.

 2.    Investors

Investors are defined in Article 1(2) the Trilateral Investment Agreement as "natural persons" or "enterprises" that make investments in the territory of another Contracting Party.

"Enterprises" as defined in Article 1(4) includes government-owned or controlled entities.  The express inclusion of government-owned or controlled entities affirms the view that Chinese State Owned Enterprises ("SOEs") are likely to qualify as "investors" under the Trilateral Investment Agreement.  Therefore SOEs are likely to also be able to rely on the protections of the agreement for any qualifying investments made in South Korea or Japan, provided that these investments are commercial in nature.

3.    Denial of Benefits

Although the definition of qualifying "investors" and "investments" is arguably wider under the Trilateral Investment Agreement, unlike the pre-existing China-Japan and China-South Korea BITs, the Trilateral Investment Agreement also includes a "denial of benefits" clause.  The denial of benefits clause in Article 22 of the Trilateral Investment Agreement allows a host State to deny the benefits of the Agreement to a foreign investor if the enterprise is "owned or controlled" by an investor of a non-contracting State and the enterprise has "no substantial business activities" in the country of the contracting State.  This provision is specifically targeted at non-Chinese, non-Japanese and non-Korean investors who plan to structure their investments through China, Japan or South Korea in order to take advantage of the protections offered under the Trilateral Investment Agreement.

4.    Intellectual Property Rights

Article 9 of the Trilateral Investment Agreement expressly provides that China, Japan and South Korea agree to protect intellectual property rights in accordance with their laws and regulations.  Each nation has also committed to establishing and maintaining "transparent" intellectual property regimes and to promote trilateral cooperation and communications in the field of intellectual property.  Express protections for intellectual property rights are not found in the Existing BITs, and although a welcome addition to encourage intellectual property protection, the protections fall short of the most favoured nation standard, as there is no obligation to afford treatment equal to investors of one contracting State, as that offered to another contracting State under a pre-existing international intellectual property agreement.  These measures are largely viewed as providing greater protection of intellectual property rights to Japanese and South Korean companies looking to invest in China.

5.    Transfers of Capital, the Right to take Prudential Measures and Temporary Safeguards

The Trilateral Investment Agreement expands upon pre-existing provisions in the Existing BITs that require each nation to allow the free transfer of capital inflows and outflows.  Under Article 13 of the Agreement, China, Japan and South Korea have agreed to allow these transfers to be made in "freely useable currencies" without delay, albeit the transfers are still subject to the laws and regulations relating to exchange administration of the host State in force at the time of the investment.

The commitment to opening up the free transfer of capital flows between these three East Asian countries must however be read together with Article 20 of the Trilateral Investment Agreement that also allows each host State to take measures relating to financial services for "prudential reasons" to "ensure the integrity and stability of the financial system", notwithstanding any other provisions of the Agreement. 

Article 19 of the Trilateral Investment Agreement further provides that where movements of capital could cause serious difficulties for macroeconomic management, a host State can adopt or maintain "Temporary Safeguard Measures" even if these measures do not conform to its obligations regarding National Treatment (Article 3) or Transfer of capital (Article 13).

Similar carve outs have been adopted in other BITs (such as the 2012 US Model BIT), and are largely seen as a government response to ensure that BIT provisions do not impact on their ability to mitigate financial emergencies in the wake of recent global financial crises.

6.    Disputes

Unlike the China-Japan BIT that allows "any dispute" regarding "investment" between an investor and a host State to be settled according to relevant dispute resolution procedures, the Trilateral Investment Agreement defines "disputes" as only those relating to allegations of a specific breach of the Agreement by a host State (Article 15).  This therefore requires an investor to identify a specific alleged breach of the Trilateral Investment Agreement before commencing the dispute resolution procedures.

7.    Settlement of Disputes

Article 15 of the Trilateral Investment Agreement states that investors can submit a dispute to either:

(i)  a competent court of the host State;

(ii)  ICSID arbitration (if available);

(iii)  arbitration under the ICSID Additional Facility Rules (if available);

(iv)  arbitration under the UNCITRAL Arbitration Rules; or

(v)  arbitration under any arbitration rules agreed by the parties.

However, as with the China-South Korea BIT, two conditions must first be met before investors can submit the dispute to the above mentioned forums.  First, the parties are subject to a four-month cooling off-period from the time that the investor sends a written request for consultation.  Second, investors may be required (at the request of the host State) to go through a domestic administrative review procedure. This is generally understood to refer to domestic procedures under China's Administrative Review Law but notably, under Article 15(7) of the Agreement, the entire procedure shall not exceed 4 months from the date the application is filed. 

An investor wishing to initiate ICSID arbitration under the Trilateral Investment Agreement should also keep in mind that China has made an exception under Article 25(4) of the ICSID Convention.  This exception provides that China will only consider submitting disputes to ICSID arbitration if the dispute relates to compensation resulting from expropriation and nationalisation.  On one view, as the Trilateral Investment Agreement does not expressly reproduce, or refer to, China's reservation to the ICSID Convention, an ICSID tribunal constituted on the basis of the Trilateral Investment Agreement to hear a dispute involving China may be unaffected by the reservation.  However this position remains uncertain, particularly as the Trilateral Investment Agreement specifies that an investor can submit the dispute to ICSID arbitration at the request of the disputing investor "if the ICSID Convention is available".  Whether an arbitral tribunal would attribute these qualifying words to mean that China's Article 25(4) exception applies to disputes under the Trilateral Investment Agreement is unclear.

8.    Fork in the road

Once an investor has submitted the dispute to one of the forums listed in Article 15 of the Trilateral Investment Agreement, that choice shall be final and the investor is unable to submit the same dispute to another forum.  If the investor decides to submit the dispute to arbitration, then pursuant to Article 15(6) of the Trilateral Investment Agreement, it must also provide a written waiver of its right to initiate any proceedings in a court of the host State.

9.    Entry into force

Article 27.1 of the Trilateral Investment Agreement provides that China, Japan and South Korea are required to notify one another through diplomatic channels upon completion of their "respective internal procedures" required for the entry into force of the Agreement.  The Agreement will then enter into force thirty days after the latest of these notifications. 

Conclusion

The Trilateral Investment Agreement builds upon the more common protections offered under the Existing BITs and is a positive development for qualifying investors looking to invest trilaterally between China, Japan and South Korea.  Given the dramatic increase in foreign direct investment into China from Japan and South Korea in recent years, the Trilateral Investment Agreement, once in force, aims to create a more favourable and secure environment for East Asian investors, particularly as it provides more robust protections for intellectual property rights that is likely to appeal to Japanese and South Korean investors looking to make investments in China.