Phoenix Action Ltd. v. Czech Republic, ICSID Case No. ARB/06/5

(Originally published in 2011 in International Investment Law and Sustainable Development: Key cases from 2000–2010; republished on this website on October 18, 2018. Read more here.)

Award available at https://www.italaw.com/cases/850

Keywords

Abuse of process, definition of “investment,” good faith, investor obligations, jurisdiction, “Salini” test

Key dates

Request for Arbitration: 23 March 2006

Constitution of Tribunal: 8 January 2007

Award on Jurisdiction: 9 April 2009

Arbitrators

Prof. Brigitte Stern (president, appointed by the ICSID Administrative Council)

Prof. Andreas Bucher (respondent appointee)

Prof. Juan Fernández-Armesto (appointed by ICSID Administrative Council)

Forum and applicable procedural rules

International Centre for Settlement of Investment Disputes (ICSID)

ICSID Rules of Procedure for Arbitration Proceedings

Applicable treaty

Czech Republic–Israeli Bilateral Investment Treaty (BIT)

Alleged treaty violations

• Denial of justice
• Expropriation
• Fair and equitable treatment

Other legal issues raised

• Interpretation—reference to other bodies/principles of law
• Investor obligations—obligations to act in good faith
• Investor obligations—obligations to comply with domestic/international law
• Jurisdiction—definition of “investment”—bona fide and made in good faith
• Jurisdiction—definition of “investment”—compliance with host state law
• Jurisdiction—definition of “investment”—definition under the ICSID Convention

1.0 Case Summary

1.1 Factual background

In April 2001, Czech officials commenced criminal investigations of Mr. Vladimir Beno relating to tax and customs duty evasions. Mr. Beno fled to Israel, where he thereafter, in October 2001, registered a new company, Phoenix Action Limited (“Phoenix”). On 26 December 2002, that Israeli company, Phoenix, acquired all the interests in a Czech company Benet Praha, Spol S.R.O. (“Benet Praha”) and its corporate subsidiary, Benet Group, A.S. (“Benet Group”). Mr. Beno had been Benet Praha’s executive officer at the time he fled from the Czech Republic. Phoenix purchased those companies from Mr. Beno’s family members, and paid only nominal sums for the acquisition.

At the time of the purchase, both Benet Praha and Benet Group were involved in ongoing legal disputes—Benet Group with a Czech national over the ownership of its two subsidiaries, and Benet Praha with Czech authorities regarding their actions freezing Benet Praha’s accounts and seizing its documents in connection with the criminal proceedings against Mr. Beno.

On 15 February 2004, Phoenix submitted a request for arbitration at ICSID, alleging that the Czech Republic’s treatment of its investment in Benet Praha and Benet Group violated the bilateral investment treaty (BIT) between the Czech Republic and Israel.

1.2 Summary of legal issues and award

The Czech Republic objected to the Tribunal’s jurisdiction, contesting that Phoenix’s interest in Benet Praha and Benet Group was not a protected investment under either the ICSID Convention or the Czech–Israeli BIT. It argued that “Phoenix [was] nothing more than an ex post facto creation of a sham Israeli entity created by Czech fugitive from justice, Vladamir Beno, to create diversity of nationality” (para. 34).

The Tribunal agreed with the Czech Republic’s objections to jurisdiction on the grounds that the investment was not made in good faith and constituted an abuse of the ICSID system. Further, the Tribunal held that in view of the circumstances of the case, Phoenix should bear all costs of the ICSID proceedings (estimated to be US$356,000), as well as the Czech Republic’s legal fees and expenses (CZK 21,417,199.13).

2.0 Select Legal Issues

The Tribunal’s decision is important because it details criteria required for investments to qualify as such under the ICSID Convention. As explained by the Tribunal, in order to fall under ICSID jurisdiction, an investment must not only be covered by the applicable BIT or other relevant state–state or investor–state agreement, but must also meet the definition of an “investment” under the ICSID Convention (para. 74). Consequently, satisfying the elements of an “investment” under the ICSID Convention is a prerequisite to ICSID jurisdiction that cannot be waived in a BIT. States can “confirm the ICSID notion [of an investment] or restrict it [through their BITs or other investment agreements], but they cannot expand it in order to have access to ICSID….As long as it fits within the ICSID notion, the BIT definition is acceptable, it is not if it falls outside of such definition” (para. 96).

In assessing whether the Claimant’s investment was an “investment” under the ICSID Convention, the Tribunal emphasized two important conditions that must be met. The first requirement is that the investment must be made in accordance with host state laws and regulations; the second is that it must be made in good faith. The Tribunal’s reasoning and holding on this jurisdictional issue are discussed further below.

The Tribunal’s findings on the criteria of investment under the ICSID Convention emphasize the implications of selecting ICSID arbitration in BITs. A fundamental principle of arbitration is that for an arbitral tribunal to have jurisdiction over a case, the disputing parties must have consented to that form of dispute settlement. Often the parties issue their consent to arbitrate in a contract; states also make broad, general offers of consent to arbitrate investment disputes in their BITs. When the disputing parties opt to arbitrate the dispute under the ICSID system, the ICSID Convention imposes jurisdictional requirements that are separate from, and that must be satisfied in addition to, jurisdictional requirements set forth in the underlying investor– state contract, BIT or other arbitration agreement. Arbitration through other arbitral systems, such as ad hoc arbitration under the United Nations Commission on International Trade Law (UNCITRAL) arbitration rules, in contrast, does not impose such independent jurisdictional tests. As shown in this case, the ICSID Convention’s requirements for accepting jurisdiction can serve as a filter preventing arbitration of some disputes—a role that respondent states may find welcome.

This is also a welcome ruling for states because it illustrates that investors may be effectively penalized for bringing improper claims. Although in a number of investor–state arbitrations tribunals have required the state to bear its own arbitration costs even when the case was decided against the investor at the jurisdictional phase, here the Tribunal ruled that the investor must bear the costs of the arbitration and the Czech Republic’s legal costs, as jurisdiction was denied in view of the investor’s misuse of the ICSID system.

2.1 Definition of “investment” under the investment treaty and the ICSID Convention

Pursuant to the ICSID Convention, ICSID tribunals can only accept jurisdiction over disputes arising directly out of “investments.” The Tribunal noted that ICSID case law had identified various criteria required to establish an “investment” under the ICSID Convention (para. 83). It began by revisiting the so-called “Salini” test, which sets out four criteria for an investment to qualify as such under the ICSID Convention: a contribution (1) of money or other assets of economic value, (2) for a certain duration, (3) with an element of risk, and (4) that makes a contribution to the host state’s development (para 83).[1]

ThePhoenix Tribunal also noted, however, that there were divergent views on the Salini test including, in particular, whether satisfying the fourth criterion was required (para. 84). Addressing that debate, the Tribunal concluded that “the contribution of an international investment to the development of the host State is impossible to ascertain—the more so as there are highly diverging views on what constitutes ‘development’,” and that, consequently, the Tribunal should employ a “less ambitious” approach “centered on the contribution of an international investment to the economy of the host State” (para 85) (emphasis in original).

The Tribunal did not find itself strictly bound by the Salini criteria and thus proposed its own rendition of the elements that must be taken into account for an investment to be protected under the ICSID Convention:

1. a contribution in money or other assets;
2. a certain duration;
3. an element of risk;
4. an operation made in order to develop an economic activity in the host State;
5. assets invested in accordance with the laws of the host State;
6. assets invested bona fide. (para. 114)

The Tribunal explained its reasons for requiring the fifth and sixth criteria of the above-mentioned requirements:

The purpose of the international mechanism of protection of investment through the ICSID arbitration cannot be to protect investment made in violation of the laws of the host state or investment not made in good faith, obtained for example through misrepresentations, concealment or corruption, or amounting to an abuse of the international ICSID arbitration system. In other words, the purpose of international protection is to protect legal and bona fide investments. (para. 100)

Applying each of the six criteria, the Tribunal found that it could not deny Phoenix’s purported investment on the first five. As is discussed further below, however, it rejected jurisdiction on the basis of the sixth criterion, the requirement that the investment be made in good faith.

2.2   The requirement of good faith in making the investment

The Tribunal found that the “protection of international investment arbitration cannot be granted if such protection would run contrary to the general principles of international law, among which the principle of good faith is of utmost importance” (para. 106). Consequently, accordance with international principles of good faith was required for investments to be covered by the ICSID Convention. Yet compliance with those international principles of good faith was not necessarily sufficient to satisfy this sixth criterion: According to the Tribunal, in addition to international principles of good faith, domestic principles of good faith were factors to be considered when determining whether a protectable “investment” was made (paras. 109–112).

Based on these considerations, the Tribunal then assessed whether Phoenix’s purported investment qualified as one under the ICSID Convention. The Tribunal noted that the relevant issue was not whether there had been corruption or deceitful conduct, but whether the investor made the investment in an attempt to misuse “the international arbitration mechanism of ICSID” (para. 113) (emphasis in original).

To determine whether Phoenix’s investment was a bona fide investment, the Tribunal looked at various factors including the timing of the investment, the initial request to ICSID, the timing of the claim, the substance of the transaction in which the investor purchased and transferred its investment, and the nature of the investment’s operations (or lack thereof ) (paras. 136–144). The Tribunal then concluded that “the Claimant made an ‘investment’ not for the purpose of engaging in economic activity, but for the sole purpose of bringing international litigation against the Czech Republic” (para. 142). It noted that the unique goal of the investment was to transform a pre-existing domestic dispute into an international dispute subject to ICSID arbitration under a BIT. The Tribunal held that this kind of transaction was not a bona fide transaction and therefore could not be protected under the ICSID system (para. 142).

In addition to being important due to its elaboration of the criteria necessary for an “investment” to be covered by the ICSID Convention, this decision is also significant because it reflects a certain degree of scrutiny applied by the Tribunal. Although the acquisition of the Czech companies by an Israeli company (Phoenix) appeared prima facie a covered investment, the Tribunal was willing to assess the overall facts to ensure that an abuse of access to the ICSID system had not occurred. It remains to be seen, however, whether and to what extent future ICSID tribunals will follow the Tribunal’s approach of implying a robust requirement of a bona fide investment together with the requirement to comply with host state laws and regulations, even absent such provisions in the BIT itself. It is also uncertain how future tribunals will approach the principle of good faith discussed as part of the general principles of international and domestic law.

Note

[1] In Biwater v. Tanzania, the Salini test was described as having five criteria: (1) adequate duration; (2) regularity of profit and return; (3) risk; (4) substantial commitment of resources, financial or otherwise; and (5) contribution to the host state’s development.