Protecting Direct Foreign Investment Using International Investment Agreements

Protecting Direct Foreign Investment using International Investment Agreements

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Protecting Direct Foreign Investment using International Investment Agreements Making an investment into another state, known as foreign direct investment (“FDI”), generally carries a significantly different risk profile from investment in an investor’s domestic market. FDI may be exposed to greater risks arising from the political, regulatory and economic environment of the State into which investment is made. State measures may prejudice the investment or even lead to State expropriation of an investor’s assets.

Paddy Kelly Partner paddy.kelly@laytons.com +44 (0)20 7842 8018

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Protecting Direct Foreign Investment using International Investment Agreements

Protecting Foreign Direct Investment

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an entitlement to compensation where the host state breaches the protections available

The principal risks

The main forms of IIA protection include: The principal risks to which FDI is exposed include: • •

bilateral investment treaties (BITs): BITs are a form of

political risk:

agreement between two states by which each state

political instability risks policy changes which may alter

confers protections on investors from the other state

risk profile •

•

judicial risk:

•

multilateral investment treaties (MITs): MITs operate in

jurisdictions vary in their approach to judicial

much the same way as a BIT, but are made between

independence and due process

multiple countries; examples include free trade

discrimination:

agreements between multiple states and the Energy

governments may implement measures to confer

Charter Treaty for the energy industry

advantages on domestic businesses which prejudice FDI •

economic risk: economic instability may affect FDI

•

•

investment agreements entered into directly between the investor and the host state

civil unrest: may damage assets and prejudice FDI

Some form of protection may also be available from domestic legislation in the host state.

Protecting against FDI risks

A multi-layered approach, using a combination of these forms of protection, can maximise the protection available to investors.

It is not possible to protect FDI against all risks. Risks can, though, be managed by structuring investments to make use

Here, we consider the role of one of these management tools-

of International Investment Agreements (IIAs).IIAs establish

Bilateral Investment Treaties. Specifically, we contemplate the

a framework of rights and obligations designed to protect

practice of ‘Treaty Shopping’ that has become increasingly

FDI against such risks. Their purpose is to protect, and

prevalent over the last 20 years and its appearance in

thereby facilitate, FDI. They do so by putting in place investor

investor-state dispute settlement; to what extent it can confer

protections, based around rights including:

additional safeguards and, looking forwards, what options states are considering and implementing to deter the practice.

•

minimum standards of fair treatment and guarantees against state expropriation

•

a dispute resolution procedure, which permits rights to be enforced through international arbitration, rather than in the courts of the host state, when a dispute arises

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Protecting Direct Foreign Investment using International Investment Agreements

What is ‘Treaty Shopping’

How to ‘Treaty Shop’

Whilst there is no formal definition, ‘Treaty Shopping’ may be

Corporate (re)structuring is the main method used by

conceptualised as the legal practice or operation aimed at

corporate bodies to create a diversity of nationality (for

ensuring the most favourable treaty provisions are available

example by setting up a shell/mailbox corporation) and

to the investor in bringing an action at an international

therefore become eligible for the protection offered by the BIT

arbitration tribunal once a deemed breach of rights has

with the most favourable terms for their particular dispute.

occurred.

The first hurdle in investment arbitral proceedings is a The practice has faced questions of legitimacy, and it is

tribunal’s decision on its own jurisdiction and specifically the

questionable to what extent valid nationality planning

eligibility of the investor as a covered national under the

and the strategic use or change in nationality may be

investment agreement (Ratione Personae). Narrative on the

distinguished from ‘Treaty Abuse’. It is important to note

subject of nationality has considered whether a nationality

that whilst the general narrative on the practice has some

requirement needs to be continuous, or at what point in time

negative connotations, there is no universal prohibition of

the claimed nationality must exist in order to be opposable

Treaty Shopping. The practice raises many policy issues for

to the respondent state. No clear general guidelines have

international governments and international corporations

emerged and even after a broad spectrum analysis on case

alike.

law it seems clear that the subject can only be considered on a case-by-case basis.

The proliferation of Treaty Shopping has taken place against a backdrop of a legal paradigm shift from protection of a

Secondly the tribunals consider the scope of the protection

foreign investor under the provision of standard diplomatic

that may be offered to the investment thereof (Ratione

protection as part of customary international law, to a

Materiae). Tribunals have shown that usually ownership

multitude of Treaty arrangements creating a direct right of

of shares (occasionally a minority shareholding), portfolio

access for the foreign investor to international arbitration

investment, some indirect investments or investments that

against the host state.

may be structured through several corporate layers can qualify. Tribunals have only tended to find exceptions when

The practice has similar facets to issues that have arisen

stated explicitly in the Treaty language and attempts by

in international tax law whereby corporate structures have

respondent states to convince arbitral tribunals to dismiss

established themselves in more favourable tax jurisdictions.

claims on the basis that the claimant was not the ‘real’ investor have been met with little success. Tribunals have virtually

With the arguable exception of the EU, there has been little

uniformly recognised the independence of legal entities in a

supra-national impetus to develop any global framework for

corporate legal chain and have rejected arguments aimed at

IIAs; hence, conservative estimates suggest there are more

‘piercing the corporate veil’ whether these entities are host

than 3000 BITs in place throughout the world- potential

state or third state controlled.

shopping heaven.

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Protecting Direct Foreign Investment using International Investment Agreements

For States How to limit the dangers of Treaty Shopping

•

explicitly prescribe that protection under a BIT is not extended to mailbox/shell companies and set out the additional requirements an investor will need to fulfil for example requiring ‘effective management’, ‘substantive business activities’ or ‘real economic activities’ to be in

States are arguably free to enter into the terms of a Treaty as

place to qualify as a protected investor.

they see fit and according to their individual best interests, which of course may vary considerably over time. Where

possible claims being made against them.

For Companies How to plan initial and secondary market investments

States have various tools at their disposal to reduce the

There are important factors for corporate bodies to consider

impact of Treaty Shopping should they wish. Options to be

when planning their investment strategy in order that they

considered are largely political but could be:

have the best chance to minimise any risk factors. Care needs

global economic realities have resulted in an imbalance in bargaining power, there may be occasions where states look to limit the practice of Treaty Shopping and avoid as far as

to be taken to structure new investments in a way that permits • • •

increased uniformity in developing a multilateral

claims under the BIT. Where investors are looking to purchase

investment framework

existing assets in the secondary market which do not have

negotiate more new treaties without investor-state

existing Investment Treaty protection they will wish to look to

settlement clauses

restructure the investment to obtain treaty protection and this

rein in the ease of incorporation of shell companies

may involve treaty shopping to do so.

Should these prove unpalatable in the global market place,

At the time of planning how an Investment can be protected

states have the option to consider more carefully the drafting

by way of an Investment treaty Investors should plan how

of any treaties:

they might look to fund possible future Arbitration claims for breaches of the treaty by the host government. There are a

• •

•

•

creating standardised BITs and ensure revisions are

number of insurance products available in the market that will

possible as necessary

either give political risk cover, or there are insurances that can

have policies in place to ensure compliance with the

be purchased to fund the legal costs of making and enforcing

terms of the BITs to reduce the number of claims being

the arbitration claim. Investors should explore the options for

made

insurance cover from specialist insurance brokers.

make the best use of conciliation proceedings before arbitration stage where the same is practical and

It is vital to consider the case law and how it has been

politically expedient

interpreted. Corporate bodies should ensure they have a clear

use Denial of Benefits (DOB) clauses to deny the

understanding of treaty interpretation before considering a

advantages of the invoked treaty, usually in the

claim or when ‘shopping’ for the most advantageous Treaty.

case of mailbox or shell companies. These clauses potentially have scope to limit the extent of the

•

Look at the proposed and actual company structure.

claims or enhancing the interpretative controls on the

This involves considering how the BIT has interpreted

requirements to comply

requirements for the scope of control i.e. whether legal/

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Protecting Direct Foreign Investment using International Investment Agreements

formal control should suffice or actual/de facto control should be. There is inconsistent jurisprudence as to

How can we assist?

whether the case of foreign control should require

Firstly, with new investment we can assist in providing legal

purely legal or rather effective control. It is usually the

and treaty planning advice, secondly in undertaking legal due

case that tribunals are happy to use the presumption

diligence and analysis at the pre-investment stage and thirdly

that majority shareholding implied effective control

in drafting the relevant investment agreements in conjunction

whilst a showing of effective control was required in the

with lawyers in the host country for the investment. Should

case of a minority shareholding.

a breach occur and litigation is required we have experience of advising on International Investment disputes. Arbitration

•

•

Awareness of any timing requirements or restrictions,

regarding Treaty Shopping is invariably complex and can

particularly looking at how the BIT treats pre-existing

be protracted; stakes in claims tend to be high with large

disputes- some investments may be made prior to an

sums at issue. Given uncertainty of arbitration decisions it is

IIA coming into force and there has been conflicting

more important than ever that the advice taken is measured,

treatment of the same at tribunal stage.

commercially appropriate and well informed.

If there is a DOB clause the usual effect will be most severe on corporations who do not have substantial business activities in the home state or other states

Brexit implications

party to the treaty. Whilst this may be considered a

With the UK set to leave the EU in March 2019 it is interesting

restriction on Treaty Shopping the case law through

to consider the implications for Treaty Shopping. The EU has

differing tribunals has had varying treatment of the

endeavoured to assert its supremacy over the member nation

situation in terms of whether the right to deny benefits

states, even suggesting that its Treaties and supranational

could have a prospective or retrospective effect. It is

jurisdictions will be superior to any individual BIT and over

important to take strategic advice on this matter given

time will progressively replace them. Investments into the

the uncertainty as to which approach the tribunal will

UK before the commencement of the Brexit process may be

take.

Investment Treaty protected and Investors should seek advice on whether the effect of Brexit upon their investment may give

•

Registration Requirements- care should be taken to

rise to Investment Treaty Claims.

check whether the Treaty requires registration of all investments, failure to do so may exclude access to the protections on offer.

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Protecting Direct Foreign Investment using International Investment Agreements

Expertise

Corporate & Commercial We provide a complete range of corporate and commercial advice and support for clients who extend from start-ups, individual entrepreneurs and family offices to multinational corporations.

Our teams focus on acquiring a deep understanding of the particular needs and objectives of our clients to deliver advice and outcomes that are tailored to those needs and objectives and which meet them swiftly and cost-effectively. The approach to technical problems is informed, insightful and proportionate, and we take pride in viewing problems from a fresh perspective to provide innovative solutions.

John Gavan

Esther Gunaratnam

Paddy Kelly

Partner john.gavan@laytons.com +44 (0)20 7842 8000

Partner esther.gunaratnam@laytons.com +44 (0)20 7842 8000

Partner paddy.kelly@laytons.com +44 (0)20 7842 8000

Robert MacGinn

Daniel Oldfield

Daniele Penna

Partner robert.macginn@laytons.com +44 (0)20 7842 8000

Partner daniel.oldfield@laytons.com +44 (0)20 7842 8037

Partner daniele.penna@laytons.com +44 (0)20 7842 8053

Johnathan Rees

Christopher Sherliker

Cameron Sunter

Partner johnathan.rees@laytons.com +44 (0)20 7842 8009

Partner christopher.sherliker@laytons.com +44 (0)20 7842 8015

Partner cameron.sunter@laytons.com +44 (0)20 7842 8036

Liza Zucconi Partner liza.zucconi@laytons.com +44 (0)20 7842 8092

8 | laytons.com

This information is offered on the basis that it is a general guide only and not a substitute for legal advice.

We cannot accept any responsibility for any liabilities of any kind incurred in reliance on this information.

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