Foreign direct investment (FDI) inflow into India is at an inflexion point. The future of big-ticket investments hinges on the way the Government settles the expropriation charges in Vodafone capital gains tax (CGT) case and Supreme-court ordered cancellation of 122 second generation (2G) cellular mobile telephony licences. The Government also runs the risk of facing charges of “creeping expropriation” from aggrieved unincorporated oil and gas joint ventures. They have so farcontended themselves with subdued arbitration under production sharing contracts (PSCs).

The foreign investors in all telecom cases have invoked respective bilateral investment promotion and protection agreement (BIPA) or similar such pacts to seek compensation for loss of investment that would result from cancellation of telecom licences.

The Government has set up Inter-Ministerial Group (IMG) to participate in arbitration process in 2G licence cancellations that have affected foreign giants such as Norway's Telenor and Russia's Sistema JSFC, Abu Dhabi's Etisalat and Bahrain's Batelco. Similarly, it has put on hold serving of fresh CGT notice on Vodafone.

However, the Government has so farnot constituted an arbitration panel in the Vodafone case. Following change of finance minister, the Government is doing loud thinking on reviewing retro taxation and restoring investors' confidence. Earlier, the Government had, termed as pre-mature Vodafone's notice for arbitration served in April 2012 under Indo-Dutch BIPA.

In the case of KG basin's D6 block that is owned by unincorporated joint venture between Reliance Industries Limited, the UK-based BP Group and Canada's Niko Resources,the Government has only now agreed to set up an arbitration panel. It has also given conditional approval to RIL-led JV's mega investment plan for KG basin D6 block and its satellite fields.

These initiatives are emerging only after RIL approached the Supreme Court in April for justice under PSC. The Government's reluctance to set up arbitration panel in the first place smacks of arrogance and arbitrariness, whose glare is visible in gas pricing under PSC.

The key issue is whether the Government's regulating pricing and marketing of natural gas, tantamount to ‘creeping expropriation'. The Government's case-by-case approach over pricing of both natural gas and coal bed methane gas goes against the grain of market discovery of prices and marketing freedom as provided by PSCs.

Before discussing these cases further, we need to briefly go back to basics to make the analysis meaningful. Expropriation is one of the major political risks that foreign investors face across the globe.The World Investment and Political Risk 2011 report published by Multilateral Investment Guarantee Agency (MIGA) in December 2011 defines expropriation as: “the loss of investment as a result of discriminatory acts by any branch of the government that may reduce or eliminate ownership, control, or rights to the investment either as a result of a single action or through an accumulation of acts by the government.”

The report says: “Regulatory expropriation, including “creeping” or “indirect” expropriation can come in many shapes and forms and includes renegotiation of concessions, changes in the terms of commercial agreements, discriminatory fees or taxes, or the failure of governments to enforce property rights. The challenge is to distinguish between legitimate and unlawful actions.”

The challenge is indeed unique for Indian Government especially in the case of 2G licence cancellations triggered by heady mix of civil society & judicial activism. Even some of the imminent cases of creeping expropriation in oil and gas sector have been triggered by activists of different hues.

The 2G licences cancellation is the country's first instance where expropriation process has been set in motion at the behest of Supreme Court. This would not be a politically motivated expropriation as happened in the past in the form of nationalization of oil companies, banks, insurance companies that affected both foreign and domestic investors.

India's erstwhile Foreign Exchange Regulation Act (FERA) also forced many companies to either dilute their equity holdings or sell them in distress in the seventies.

In the past, expropriation across the globewas driven by the national urge to get rid of colonial legacy, jingoism, despotism and leftism. In the recent years, it has been propelled by national resource nationalism and rebirth of leftism in certain countries and mid-stream changes in regulatory framework.

The latest instances in point are expropriation of oil and gas subsidiaries (YPF) of Spain's Repsol by Argentina and expropriation of certain energy and mineral multinationals by Bolivia.

After losing the Rs 20,300-crore CGT case against Vodafone Group Plc (VGP) in Supreme Court in January 2012, the Government retrospectively amended the Income Tax Act in May 2012 to levy CGT on VGP subsidiaries that acquired controlling stake in Vodafone India Limited from Hong Kong-based Hutchison Whampoa Limited (HWL) through certain tax heaven-based transactions. Even before Parliament approved retrospective amendment to IT Act through finance bill 2012, VGP served on Indian Government an arbitration notice.According to VGP release issued on 17 April 2012, “the Notice, served by the group's Dutch subsidiary Vodafone International Holdings BV (“VIHBV”), is the first step required prior to the commencement of international arbitration under the Bilateral Investment Treaty (“BIT”) between India and the Netherlands. VIHBV is a company constituted under the laws of the Netherlands and therefore an investor as defined under Article 1(d) of the Treaty.”

VGP perceives retrospective amendment as indirect move to expropriate investment as is evident from the release. It says: “Under the BIT, the Indian government is obliged, amongst other things, to: accord fair and equitable treatment to investors; provide full protection and security; not breach the legitimate expectations of investors in making investments; not deny justice or breach previously provided assurances; and not take steps to indirectly expropriate the investment.”

There are several Vodafone-type cases involving share transactions between foreign investors undertaken within the legal framework provided by tax havens.

The Government must resolve at the earliest the issue of retrospective recovery of CGT from Vodafone and other foreign companies through negotiations.

Whatever be the Government's ultimate decision, the delay in clarity over retro moves would force existing foreign investors to rush for insurance cover against direct or indirect expropriation of their investments.

One option is to secure insurance cover against expropriation and other non-commercial risks from the World Bank's MIGA. To quote MIGA's telecom brief issued in March 2012, “coverage against expropriatory risks protects against administrative or legislative actions by sovereign governments that are confiscatory, as well as against ‘creeping expropriation,' a series of acts that gradually lead to expropriation. The guarantees can also cover adverse regulatory decisions, such as the revocation or modification of licenses and decisions related to frequency allocations.”

In all the 2G licence cancellations, it is the Indian companies that secured the rights to operate mobile services in different territories called circles. After securing licences, all of them scouted for foreign partners. That is how Telenor partnered with realty firm Unitech to form JV named Uninor. Similarly, Etisalat joined hands with another realty firm DB realty to form JV named Etisalat DB Telecom Private Limited (EDB), which was originally known as Swan Telecom. Similar is the story of other foreign companies such as Sistema that invested in other JVs whose 2G licences are now being cancelled.

Most of these companies have represented their cases directly and indirectly through their Governments and or through their attorneys.Sistema's London-based attorney, White & Case LLP, for instance, has written at least twice to the Indian Government in February and April this year. It has invoked Indo-Russian BIPA which came into effect in August 1996.

Sources in Department of Telecommunications quoted Sistema's attorney as saying that “Sistema has sound cause of action against India”. The company intends to file a claim with an ad-hoc International arbitration tribunal set up in accordance with the arbitration rules of UNICTRAL (Conciliation Rules of the United Nation's Agreement on International Trade Law) and/or in any other available forum.

Telenorhas invoked investment protection provisions of India-Singapore Comprehensive Economic Cooperation Agreement (CECA) by virtue of the fact that it routed its investments through its Singapore subsidiary, Telenor Asia Pte Ltd. In its notice seeking arbitration, the company has pointed out that when a Party expropriates the assets of an enterprise which is incorporated or constituted under the laws in force in any part of its own territory, and in which investors of the other Party own shares, it shall ensure that the provisions of paragraph 1 and 2 are applied to the extent necessary to guarantee compensation as specified therein to such investors of the other Party who are owners of those shares.

Telenor Asia has also indicated its intent to submit the present dispute to international arbitrationunder the Additional Facility Rules of ICSID in accordance with Article 6.21.3(b) of the CECA, in the event that the differences cannot be resolved through consultations and negotiations.

ICSID is International Centre for Settlement of Investment Disputes set up under the international Convention onthe Settlement of Investment Disputes between States and Nationals of Other States. It operates under the aegis of World Bank group. India is not a signatory of this Convention.

Telenor, Etisalat and other foreign companies secured Government's specific approvals for equity participation in their respective J Vs. The Government never ever told these companies that their Indian partners had secured licences under questionable policy regime.

All foreign companies entangled in 2G licences cancellation are unintended victims of the Executive-Judiciary tussle over a policy issue, which is distinct from interpretation of a law.

The Government should have the humility to accept that the fault lies solely with it in this case. It should thus direct IMG to straightaway determine the value of compensation payable to these foreign companies. The sooner it does it, the better it is restore India's image as credible and certain destination for investment and doing business.

Coming back to oil & gas, the Government has empowered itself with expropriation through a judgment delivered by Supreme Court in 2010. The Court had ruled that the Government has the right to fix price of gas produced by Reliance Industries Limited by noting that the Constitution gives the Government right to regulate natural resources.

The judiciary's interpretation of the Constitution to trash certain provisions of New Exploration Licensing Policy (NELP) and 2G licensing policy has opened up a sea of uncertainty over the expanse of expropriatory powers that the Government can wield by changing regulations for natural resources mid-way. The Government needs to restore confidence of both foreign and domestic investors by enacting laws for each such policy and contracts signed under it.

Simultaneously, the Government should enact a generic law to safeguard foreign investments. Three official committees have recommended such a law over the last 20 years! The Government also ought to sign international Convention onthe Settlement of Investment Disputes, International Energy Charter and any other such treaty that might be conceived to protect foreign investments. These initiatives should be taken along with time-bound resolution of all telecom and oil and gas disputes to put expropriation apprehensions to rest forever.