Dawn of a new era for investment protection in South Africa - draft investment law to replace protections offered under investment treaties published for public comment

On 1 November 2013, the South African Department of Trade and Industry (DTI) has released its new "Promotion and Protection of Investment" bill (PPI Bill) for public comment (for a copy of the PPI Bill, see here).

The PPI Bill follows South Africa's publicised plans to review its bilateral investment treaties (BITs), in particular those entered into right after the end of the apartheid era. The majority of those BITs have been, or are in the process of being, terminated by the South African government. As part of the DTI review, the South African Government has already issued cancellation notices to various European countries, in respect of its BITs with, amongst others, Belgium, Luxembourg and Spain (to see our previous blog post on this, see here), and most recently, Germany and Switzerland. Existing investors are still entitled to rely on the protections found in those BITs that have been terminated and remain able to do so for a period between 10 to 20 years after the BITs termination, depending on the relevant BITs sunset clause.

The PPI Bill, when passed as law, is intended to regulate the protection of all investments in South Africa in place of BITs.

The following key provisions in the PPI Bill and their implications are discussed further below.

• Definition of an "investment".
• Absence of a fair and equitable treatment (FET) provision.
• Definition of "expropriation" and new principles of compensation for expropriation.
• Dispute resolution mechanism.

Definition of an "investment"

Section 1 of the PPI Bill contains a definition of "investment" and provides a list of assets typically held by an investor in South Africa considered to be an investment. This is not unusual and is substantially similar to the classes of assets listed in BITs entered into by South Africa with, for example, the United Kingdom (Article 1(a)), or Canada (Article I(f)).

However, the list is qualified by the requirement that the investment "relates to a material economic investment" or "significant underlying physical presence in the Republic, such as operational facilities" and excludes commercial contracts for the sale of goods or services and extension of credit in connection with such transactions.

This new requirement is concerning as it is not clear whether the Government has specific thresholds in mind in respect of the materiality of an economic investment or significance in physical presence. This calls to mind the annulled decision on jurisdiction in the ICSID case of Malaysian Historical Salvors Sdn, Bhd v The Government of Malaysia, which does not consider the claimant's investment to be a qualifying investment, on account that it did not contribute to the respondent's economy in a significant or material way.

Given that these uncertainties could lead to threshold issues such as jurisdiction and applicability of the investment law to a particular investment, this requirement is something which should be clarified by the Government, or removed if possible. Given that the PPI Bill is intended to be an omnibus law on the protection of all forms of investments in the state, we would think that a wider definition of investment is preferred.

Absence of an FET provision

The BIT between South Africa and United Kingdom (SA-UK BIT) contains an undertaking that investors shall at all times be accorded fair and equitable treatment (Article 2(2)). This is a provision which, under international investment law, provides investors with the ability to sue their host states for any new legislation or government action which alters the conditions under which their investments are made in an unreasonable or discriminatory way. It is a common protection found in BITs and not limited to the SA-UK BIT.

The PPI Bill however does not contain any such provision. Moreover, Section 10 of the PPI Bill contains an express provision empowering the Government to take measures to, amongst others, "redress historical, social and economic inequalities", "promote and preserve cultural heritage and practices, indigenous knowledge and biological resources related to national heritage" and "achieve the progressive realisation of socio-economic rights". This is a provision that may be anticipating claims arising from measures undertaken pursuant to South Africa's Black Economic Empowerment (BEE) Policy, and which would amount to a breach of the fair and equitable treatment standard under most BITs.

Definition of expropriation

The PPI Bill also contains a narrower definition of expropriation than is found in South Africa's BITs and explicitly excludes any measures “aimed at protecting or enhancing legitimate public welfare objectives, such as public health or safety, environmental protection or state security” or "which results in the deprivation of property but where the State does not acquire ownership of such property provided that there is no permanent destruction of the economic value of the investment or the investor's ability to manage, use or control his or her investment in a meaningful way is not unduly impeded".

In addition, should expropriation occur, the PPI Bill does not guarantee that an investor will receive the full market value of their investment as compensation. Instead, the PPI Bill mirrors the language of the South African Constitution, providing only that compensation must be “just and equitable”. Any compensation awarded to an investor must reflect an equitable balance between the public interest and the interests of those affected, having regard to the following factors:

• the current use of the investment;
• the history of the acquisition and use of the investment;
• the market value of the investment; and
• the purpose of the expropriation.

This is far more limited that what is required under most of the BITs entered into by South Africa. For example, the SA-UK BIT requires "prompt, adequate and effective compensation" which amounts to "genuine value of the investment expropriated immediately before the expropriation" (emphasis ours). This certainly precludes the Government from discounting the value of the investment by reference to the purpose of the expropriation.

In addition, some investors may be covered by Article 28 of Annex 1 of the Southern African Development Community Protocol on Finance and Investment (Protocol), which South Africa ratified in June 2008 and came into force on 16 April 2010. The other contracting parties include Mauritius, Tanzania, Zimbabwe and Mozambique. Article 28 provides for full market value compensation for the expropriation of any investments made since this date.

Dispute resolution mechanism for investment disputes

One of the biggest changes is that the PPI Bill does not seem to provide investors recourse to international arbitration for disputes. Instead, the PPI Bill provides that investors can take their disputes to non-compulsory mediation facilitated by the DTI (Section 11(1)), the courts (Section 11(4)), or arbitration in accordance with South Africa's Arbitration Act of 1965 (Section 11(5)).

With respect to the reference to arbitration, this does not automatically entitle an investor to commence arbitration against the Government as there would still have to be an arbitration agreement, i.e. an agreement to refer disputes to arbitration, between the investor and the Government in the first place. As currently drafted, Section 11(5) certainly is unlikely to qualify as a valid arbitration agreement within the meaning of the 1965 Act as it simply states that an investor "may refer an investment dispute to arbitration" (emphasis ours). This is unlike most BITs which allow an investor (subject to certain preconditions such as cooling off period or consultation) to have recourse to international arbitration as a matter of course in respect of investment disputes. The impact of the PPI Bill on investors with existing contractual rights to initiate international arbitration but which do not have the benefit of the protection from a BIT or the Protocol also remains to be seen. If the PPI Bill is only intended to replace investment treaties' protection, the requirement to refer to arbitration in accordance with the 1965 Act should not affect investors' contractual rights to initiate international arbitration and should only apply to claims enforcing provisions of the PPI Bill.

Some commentators have put forward the argument that it does not automatically follow that the seat of the arbitration must be in South Africa or that only a South African court may resolve any investment disputes. It remains to be seen if the Government will clarify this in the final version of the PPI Bill. Given the express reference to the 1965 Act, recent commentary from officials regarding South African courts' competence to deal with investment disputes and their generally unfavourable view of foreign seated arbitrations, this does not appear to be an attractive argument.

Concluding observations

The European Union, South Africa’s largest trade and investment partner, has spoken out against South Africa's termination of its BITs, indicating South Africa should desist from cancelling its BITs with about 13 EU member states.

Although Mr Davies has dismissed the view that bilateral investment treaties are decisive in the decision to invest in any jurisdiction stating that "[t]here is no correlation between having a bilateral treaty and flows of investment", foreign investors will naturally be concerned and may consider the exclusion of a right to international arbitration as diminishing the security of their foreign investment.

More interestingly, for the next two decades or so, South Africa will have two parallel investment protection systems for investors of the same nationality while BITs are phased out and the PPI Bill replacing those takes effect. By way of example, German investors whose investments were made prior to the effective termination date of the BIT between Germany and South Africa (SA-Germany BIT) will be able to rely on the SA-Germany BIT for the next twenty years while German investors whose investments are made after the effective termination date cannot do so and will have to rely on the PPI Bill as enacted.

Investors and interested parties should consider submitting their views on the PPI Bill to the Director-General, Department of Trade and Industry. All interested parties have until 31 January 2014 to submit written comments on the PPI Bill.

More generally, and as good practice, investors should consider various methods of protecting their investments in South Africa. These include:

• the conclusion of a well drafted investment agreement with the government, incorporating stabilisation clauses and effective dispute resolution provisions;
• choosing appropriate future investment structures;
• reviewing existing investment structures;
• keeping fully appraised of the development of the PPI Bill and other developments.

For further information, please contact Matthew Weiniger, Partner, Gitta Satryani, Senior Associate, Hannah Ambrose, Professional Support Lawyer, or your usual Herbert Smith Freehills contact.