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Article: October 2016: Structuring Foreign Investment to Ensure Treaty Protection

October 01, 2016
Business Litigation Reports

Although it is common practice for businesses to structure their investments abroad through jurisdictions that maximize tax and other advantages—such as the Isle of Man or the British Virgin Islands—investors less frequently plan to ensure that their foreign investments are structured so as to obtain protections from sovereign interference, such as regulatory takings or taxation. Often businesses are unaware that there is a network of treaties that protect investors abroad against abusive sovereign conduct. Taking advantage of that network can require advance planning.

These treaties include investment treaties between two States (bilateral investment treaties, or BITs), investment treaties between several States, which are typically related to a specific subject matter such as energy investments, or a specific region (multi-lateral investment treaties, or MITs) and free trade agreements (FTAs). BITs, MITs and FTAs typically contain substantive protections that allow foreign investors to bring claims against host States in specialized fora. But to obtain those protections, thought must be given to the holding structure for foreign investments so as to take advantage of an applicable and effective treaty.

Companies of all sizes and varieties that invest in foreign States often encounter difficulties with the foreign governments and their officials. Take, for example, recent fees and taxes levelled by Hungary on grocery stores that appear to have targeted major foreign grocery chains. In another well known example, international oil majors and mining companies operating in Venezuela have been struck by several rounds of nationalization in recent years.

Notably, interference with foreign investment, such as expropriations and regulatory takings, is no longer the sole province of governments in developing States. In the wake of the global financial crisis, developed States also took regulatory steps that had disproportionate impact on foreign investors. For instance, in recent years the Kingdom of Spain, a European Union Member State with over 40 years of orderly democratic transitions, has had more claims brought against it pursuant to investment treaties than any other State in the world, all in relation to regulatory actions it took towards renewable energy investors. Belgium too has been the subject of a recent action brought by Chinese insurance company Ping An over the State-led break up of Fortis Bank.

Because of scenarios like those described above, it is highly advisable for businesses investing abroad to structure their investments in foreign host States—irrespective of that State’s political risk profile—through States that have an effective investment treaty in place with the State hosting the investment. Below we provide background on those investment treaties and how businesses can structure their investments to obtain their protections.

What Are Investment Treaties? Investment treaties are public international law undertakings to protect and promote foreign covered “investments”. Covered investments include tangible and intangible property, interests in companies, rights under contracts, licenses and so forth.

BITs, MITs and FTAs treaties provide protection from political risk. Those protections include, amongst others, obligations on the part of a State to provide investments fair and equitable treatment; to refrain from expropriation without prompt, adequate and effective compensation; to treat foreign investments no less favorably than nationals of the host State; and to refrain from discrimination on the basis of nationality. Some treaties oblige host States to comply with contracts and other forms of undertaking given with regard to foreign investments.

States consent to arbitrate disputes concerning breaches of those obligations through unilateral offers to arbitrate found in BITs, MITs and FTAs. These disputes are ordinarily adjudicated before a facility created by the World Bank to specifically hear disputes between investors and states known as the International Centre for the Settlement of Investment Disputes (ICSID) or ad-hoc, using a set of rules created by the United Nations Commission on International Trade Law (the UNCITRAL Rules).

Structuring Investments to Ensure Investment Treaty Protection. To ensure protection of an investment through a BIT or an FTA, the first step is to identify the BITs and FTAs that the host jurisdiction has entered into with other States and that are in force. Occasionally States sign investment treaties, but for various reasons fail to ratify them such that the agreement does not come into force, or in other instances, a State has let the agreement lapse. There are several means of identifying the investment treaties to which a particular State is party and lawyers specializing in investment treaty arbitration can assist in pinpointing a treaty between the host State and another State that will contain the most advantageous treaty protections.

Once relevant investment treaties have been identified, they must be reviewed to determine that they (i) contain the necessary complement of investment protections; and (ii) allow investors themselves to bring claims against the host State. This review is essential, as not all investment treaties contain the full range of substantive protections and, in some cases, do not actually allow an investor to seek redress before an international tribunal for infringing upon those protections.

A review of potentially applicable investment treaties allows businesses to evaluate jurisdictions comparatively and identify one that both affords a company’s investment vehicle or holding company access to an investment treaty, together with a suitable tax and regulatory regime. Jurisdictions such as the Netherlands, Luxembourg, and sometimes the offshore territories of the United Kingdom, the BVI, Jersey, Isle of Man and Gibraltar, are popular jurisdictions in that they offer tax advantages and are also party to a broad network of investment treaties with substantive investment protections.

Following that step, a business will typically incorporate a holding company in the chosen jurisdiction and insert it into the chain of ownership so that it sits above the investment or any locally-incorporated special purpose vehicle. It is critical that advice be taken before structuring the investment to ensure that issues such as control are assessed and accounted for.

Importantly, corporate re-structuring to achieve treaty protection can also be carried out for existing 3 investments, not just those that are in the planning stages. Where a company has identified that one of its investments may lack coverage by an investment treaty, it can restructure its investment in order to obtain the protections of an applicable treaty. Crucially, this restructuring must occur before a dispute arises in order for the investment to receive treaty protection in that dispute.

Enforcement of Treaty Protections. Once a company has structured its investment through a jurisdiction that has an applicable BIT, MIT or FTA in place with the host State for its investment, it has the ability to bring claims against that State before ICSID or under the UNCITRAL Rules to seek relief for certain kinds of government interference.

Thus, by way of example, in 2009, a Canadian gold mining company that had invested in developing two mining concessions in Venezuela, found itself the victim of wrongful government interference when Venezuela suspended mining activities and ultimately terminated the company’s concessions, seized the company’s assets and occupied the project site. After bringing claims at ICSID under the Canadian-Venezuelan BIT, the Canadian company obtained $760 million in damages for Venezuela’s breaches of the BIT’s “fair and equitable treatment” standard. Venezuela to date has paid 50% of the award and has committed to paying the award in full.

There is historically a record of States complying with awards rendered through investment treaty arbitration. For instance, Venezuela, the subject of numerous BIT claims, has traditionally paid awards issued against it, including the award described above. Further, Argentina, a State that for years opposed paying out the numerous awards rendered against in the wake of the collapse of the Argentine economy from 1998 to 2002, has begun to settle those awards, albeit often at a discount. Another prominent example is Ecuador’s payment of a $100 million award to Occidental Petroleum in 2008.

Taking the above-described steps to ensure treaty protections are in place is necessary when investing in any jurisdiction. Such steps should be part of the routine due diligence efforts of any company seeking to make an investment abroad.