International Deal Structuring: Using International Structures To Protect And Enhance Foreign Investments

Friday, August 1, 2008 - 01:00

Around the world over 180 countries have entered into over 2,400 Bilateral Investment Treaties ("BITs"), specifically designed to protect foreign investments. BITs provide a new and potentially very powerful shield and sword to foreign investors whose investments are negatively affected by the activities (or inactivity) of states and state organs or entities (including central, regional and municipal governments, government departments and ministries, local councils, industry regulators, courts and government authorities and institutions).

A BIT is a treaty entered into between two states providing for the promotion and protection of the investments of the nationals of each state in the territory of the other state. They are usually entered into between capital-exporting nations and capital-importing nations as part of trade negotiations. The advent of international arbitration to resolve disputes under BITs in the last 15 years means that foreign investors can think beyond the dispute resolution options previously available to them (contract, tort, local or foreign courts or arbitration under the investment contract) to a new species of right and forum - international law rights enshrined in a treaty that provides for an international law arbitration. BITs and the rights enshrined in them will be particularly relevant when investing into developing and difficult countries or in valuable or high-profile foreign assets. States that act in breach of these BIT rights do so at their peril.

The usual preconditions to relying on a BIT are that: (a) the "investor" is a national of another country with which the host state has a BIT; and (b) the investor has made an "investment" in the host state.

"Investors" are usually defined in BITs as natural persons who are nationals of one party to the BIT or corporations incorporated in one party to the BIT. The United States has entered into 46 BITs and the United Kingdom 124 BITs. The UK's BITs are supplemented by the Energy Charter Treaty ("ECT") between 52 signatories including the member states of the European Union, most central and eastern European countries, Russia, Japan and Australia. Not only can investors rely on BITs entered into by their own home state, they can also invest via other states that have a BIT with the host state. This allows investors to channel their investments via an SPV or investment vehicle into the host state utilising tax-efficient locations that have BITs with them. This can be done even if the investor's home country has no BIT with the host state.

Two tax efficient western states, The Netherlands and Luxembourg, for example, each have signed the ECT and have nearly 100 BITs each with countries including China, Egypt, India, Indonesia, Korea, Malaysia, the Philippines, Russia, Saudi Arabia, Turkey, many western European states, most central and eastern European countries, most South American countries and many African states. In many cases a corporate investment structure incorporating a tax-efficient BIT state such as The Netherlands or Luxembourg will provide an international investor with significant tax savings and access to an invaluable bulwark against unwanted host state interference.

Most BITs include a broad definition of "investment." Typically they provide that every kind of asset may constitute an "investment" and provide examples such as property rights, shares, claims to money or performance under a contract and intangible rights. These definitions of "investment" will usually allow a foreign investor to claim compensation for the diminution in value of its investment in a local vehicle incorporated in the host state where a breach of the BIT's standards was the cause of that decrease in value. This effectively sidesteps the problems that shareholders usually have in bringing claims where the wrong was done to the company they invested in rather than to the investor itself.

If these preconditions are satisfied, a whole raft of rights and causes of action in international law may be available to the claimant against the host state and they usually allow foreign investors to initiate an international arbitration to claim full compensation directly from the host state's central government in the event of a breach of a treaty standard.

The standards common to most BITs and the ECT include an assurance that a host state will not expropriate foreign investments without paying the investor prompt, adequate and effective compensation for the devaluation or loss of the investment. This right often extends to "creeping" expropriation where the technical ownership of the investment is left intact but the investment is squeezed by changes in the host state's taxes, regulations or other changes in the law or in the state's practices.

BITs also usually include rights of a foreign investor to be afforded fair and equitable treatment. This standard allows an arbitral tribunal to assess the "fairness" of a host state's actions. In general terms this standard has been construed as requiring host states to maintain stable and predictable investment environments consistent with an investor's legitimate expectations and the host state's previous commitments. Such standards may often be supplemented by more precise prohibitions on, for example, "arbitrary or discriminatory" measures.

BITs may also provide that the state will observe any obligations entered into in respect of the investment. The status of this so-called "umbrella clause" is currently a matter of some debate. However, put at its highest, it may elevate breaches of contracts by states or state entities into breaches of international law actionable before an international tribunal whatever the investment contract itself provides for.

BITs frequently guarantee treatment to investors that is not less favourable than that which the host state affords to investors of another country or to host state nationals (a "most favoured nation" or MFN clause). This extends to protections under BITs concluded between the host state and any third party states and can allow an investor to shop around the host state's BITs for the standard that is most favourable to it. This guarantee can be crucial in cases where the relevant BIT contains a lacunae.

As noted above, BITs commonly include the signatory states' consent to international arbitration before a neutral tribunal under widely accepted international arbitration rules in the event of a dispute arising, for example the UNCITRAL or ICSID arbitration rules. The standards detailed above will be delimited by international law, not by the national law of the host state. In this way, the potentially crippling outcome of having to seek legal redress against states or state entities before their own local courts or under their own laws can be avoided. BIT arbitration may be commenced concurrently with an action under any investment contract, thereby allowing the investor to maximise pressure and leverage on the contractual counterparty and the host state.

This international dispute resolution mechanism has become increasingly popular in recent years. There have already been over 250 arbitrations arising out of BITs. Recent examples of multimillion dollar claims made under BITs include claims against Argentina over measures taken during the 2001 economic crisis in that country, which resulted in significant devaluations to foreign investments, a claim against Poland that state entities stymied the privatisation of the state-owned insurance company, claims against the Czech Republic that the media regulator facilitated the breach of a number of investment contracts entered into with private counterparties, claims against Russia and South American states that they expropriated oil and gas investments in their countries by (in effect) nationalising them, a claim against Hungary for allegedly wrongful termination of an airport operating contract, and a claim against Tanzania over expropriation of a water resources management concession.

Increasingly the mere threat of a BIT arbitration by an aggrieved investor has been enough to bring a dilatory or recalcitrant host state's representatives to the negotiating table.

In circumstances where international investors are keen to invest in developing and difficult countries and to acquire high-profile or high-value assets, investors should consider structuring their investments in such a way as to take advantage of the protections afforded by BITs. Efforts to provide access to a BIT should also link in with the need to seek international tax efficiency. International lawyers experienced in international dispute resolution should have the experience and expertise to help foreign investors both to protect and enhance the value of their investments.

Case Study

A Middle Eastern sovereign wealth fund wanted to obtain oil and gas concessions in an African country. As part of the deal it was required also to acquire and operate a mobile telecommunications company in the African country. The mobile telecommunications company was valued in excess of US$250,000,000.

The negotiations about the allocation of a mobile licence, which was key to the operation of the telecommunications company, took place at a very high level within the Government of the African country and the Government of the Middle Eastern state. When those negotiations took place, elections were imminent in the African country and there was perceived to be a likelihood that a new Government would attempt to undermine the telecoms licence which was the basis of the investment, perhaps as a precursor to seeking a pay-off.

The investor was advised by an Eversheds international arbitration lawyer about the possibility of structuring the investment so as to allow it to utilise a BIT even though there was no BIT in existence between the Middle Eastern country and the African country into which the investment was to be made. The investment was structured via the Netherlands, which had in place a BIT with the African country. The structure had the additional benefit of substantial tax efficiency as a result of international tax treaties between the relevant countries.

The investor was advised as to how to bolster its position under the BIT by extracting helpful concessions/promises from the negotiators for and representatives of the Government of the African state and documenting them in an appropriate form. These documents and promises/concessions were designed to assist the investor in bringing any BIT claims in the future.

Subsequently, after elections in which the Government in the African country changed, the new telecoms regulator, at the instigation of the new Government, attempted to revoke the licence, and the Middle Eastern investor was able to raise the BIT in negotiations, which instantly increased its leverage in settlement negotiations as against the telecoms regulator and the Government of the African country.

Stuart Dutson is a Partner in Eversheds LLP's International Arbitration Group based in London and Paris. He specializes in international dispute resolution including international arbitration, litigation and negotiation/mediation.

Please email the author at stuartdutson@eversheds.com with questions about this article.