Freeport vs Indonesia: In defense of public welfare

From its inception in Indonesia, Freeport’s primeval priority has always been securing the continuity of its mining operation, not swindling the investorstate dispute settlement system to reverse the course of a nation’s legislation and extract billions of dollars.

Over the course of the saga of US mining giant Freeport versus the Indonesian government, both sides have made tit-for-tat threats to take the protracted dispute to international arbitration. The critical question we have to ask is whether international arbitration constitutes the most appropriate mechanism available for reaching the best solutions for both parties.

Illustrating the arbitration, the center of gravity of the first stage will focus on the question of whether the arbitral tribunal has jurisdiction over the breach of contract allegedly committed by Indonesia. This issue stems from the government’s issuance of a new regulation requiring mining companies wishing to continue exporting copper concentrates to terminate their Contract of Work (CoW) and convert them into a special mining license (IUPK).

In the business sphere, foreign investors employ techniques to protect their investments from the risk of legal uncertainty. One of them is signing a contract with the host state. However, despite Freeport’s investment being protected by the CoW, this protection is not powerful enough due to the fact that is not covered by the Bilateral Investment Treaty, under which the second layer of investment protections are usually placed. Another reason is because the CoW designates Indonesian laws as the governing law, rather than international law.

These factors consequently delimit Freeport’s ability to dress up the claim of breach of contract as a breach of treaty under the umbrella clause. This is an advantage for Indonesia as it is generally accepted that a breach of contract per se by the host state does not give rise to direct international responsibility. It could dissuade the arbitral tribunal to accept jurisdiction over the case.

Nonetheless, since the arbitration system lacks predictability and proliferates a heterogeneity of interpretations, Freeport will likely delocalize the contract by referring to customary international law and like-minded arbitration awards.

The subsequent stage will involve “judging” the government’s attitudes toward Freeport’s investment. This is when, on one axis, the host government asserts its right to make a bona fide legal change to advance its public interests, but on the other, the investor deems such change as a deprivation of its investment.

Its analysis devolves into two frontlines. The first line will find the answer to a question whether the government’s unilateral act to terminate the CoW and oblige the divestment of 51 percent may constitute creeping and partial expropriation (indirect expropriation) under customary international law and national law.

Such expropriation may be interpreted not only restrictively as taking solely the property and titles thereof but also indirectly involving near-total deprivation of an investment.

However, it is generally believed in international law that such regulatory taking is justifiable if it is designed to protect a legitimate public welfare objective, is nondiscriminatory, proportionate or includes compensation.

Theoretically, a state cannot bind itself not to amend its laws in the future as such power is an inherent part of sovereignty. Giving up that power will mean surrendering its status as a sovereign state. A state contract, treaty or customary international law can constrain, but never remove the legislative authority of a state.

This pro-state approach shapes international arbitration, as since 2000 there has been a consistent trend in favor of differentiating justifiable regulatory taking called “police powers” and indirect expropriation. Indonesia, in this case, is exercising the former, not the later.

The second frontline will possibly revolve around the analysis of whether the Indonesian government’s change of regulatory taking that allegedly eviscerates Freeport’s investment may breach fair and equitable treatment (FET) under customary international law. Ordinarily, an arbitral tribunal employs transparency, stability and a legitimate expectations test in probing the FET standard.

The stability and predictability of legal and business frameworks are indispensable for foreign investors. Such a climate is sustained if the host state can furnish transparent, stable and predictable regulations governing the foreign investor’s investment.

Transparency and stable in this sense refer to circumstances that allow the foreign investor to be cognizant beforehand about any regulation and goal that will govern its investments. Meanwhile, the legitimate expectations cannot be construed that the state will “freeze” the legal framework, but rather investors must be protected from “unreasonable” modifications of that legal framework. This suggests that the government still reserves policy spaces.

In a plethora of arbitrations, modifications in the legal framework for foreign investment are driven by the fact that foreign investment sometimes takes a disproportionate share of national resources, and with reasonable elucidation, it is defeasible for the government to correct the situation through regulatory intervention in advancing local and national development. FET standard hedges this state’s right in a way that it does not substantially decapitate foreign investor’s businesses.

If we look the development of regulatory footings that govern the mining industry in Indonesia, it adduces axiomatic evidence that they do not infringe the FET standard. The Indonesian government has been exercising its regulatory power with transparency as it allows all mining companies to be aware of every one of the government’s regulatory changes by enabling the aggrieved parties to negotiate.

In the new regulation, the government does not dispossess the legality of Freeport’s operation, but provide a fully-fledged license as a “passport” to constantly export its product. It means the new mining industry regulation is predictable, indiscriminate and within the corridor of law and good faith.

Indonesia’s recourse to change the mining regime in defense of public interests is in line with international law, but it is not riskfree. When Indonesia is “sued” in international arbitration, the paucity of Freeport’s investment protections at the international level and the major “pro-state” interpretations that are starting to shape current arbitration cases will put Freeport under the upper-hand of the government.

Undoubtedly, international arbitration will clarify some legal puzzles and render an enforced award for the losing party. But, the economic, political, social, security and diplomatic costs prior, during and post that process may be cataclysmic for both sides.

From its inception in Indonesia, Freeport’s primeval priority has always been securing the continuity of its mining operation, not swindling the investorstate dispute settlement system to reverse the course of a nation’s legislation and extract billions of dollars. For now, let see how that priority works over the next 120 days.

The writerDimas Kuncoro Jati   is a member of Young International Arbitration Group (YIAG) based in London and LLM candidate in international dispute resolution at The Dickson Poon School of Law.