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
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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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