Political Risk Management in Natural Resources Projects (with Elizabeth Eljuri) - OGEL by Yanal

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Political Risk Management in Natural Resources Projects in the MENA and the Latin American Regions by E. Eljuri and Y. Abul Failat

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Political Risk Management in Natural Resources Projects in the MENA and the Latin American Regions* Elisabeth Eljuri and Yanal Abul Failat**

Introduction

In the last decade or more, events in the Middle East and North Africa (“MENA”) region as well as Latin America (“LATAM”) has brought political risk faced by International Resources Companies (“IRC”) and the stability of the countries in which they operate in to the forefront of their concerns. The Arab Spring, the Sunni and Shia conflicts in Iraq and Syria, Iran’s rising tensions with Israel, its role in supporting the Assad regime, sectarianism and civil conflicts, seem to have become a trend in the MENA region that can only affect the stability sought. On its part, populist politics and resource nationalism characterise the policies of LATAM countries such as Bolivia, Ecuador and Venezuela. More specifically, severe economic measures such as exchange control regimes currently in force in Argentina and Venezuela, as well as continuing expropriation and forced contractual negotiation, make it even more difficult for IRC’s to decide whether or not it is worth the risk investing in these countries.

As recent events in Venezuela and other LATAM countries such as Argentina and Ecuador show, states are becoming increasingly more sophisticated at using national law and coercive state power to the detriment of foreign private investors. Therefore, developing and enhancing risk management tools to allocate or transfer risk effectively must be a top priority, particularly when contracting with oil rich states, state agencies, or state-owned companies.1 Also, the rise of

* This article is partially based on a previous article of Elisabeth Eljuri presented at the Special Institute on International Mining and Oil and Gas (Law Development and Investment) Rocky Mountain Mineral Law Foundation (RMMLF) 15 – 17 September 2013. ** Elisabeth Eljuri is a partner of Norton Rose Fulbright and Head of Latin America globally. She can be reached at Elisabeth.Eljuri@nortonrosefulbright.com; Yanal Abul Failat is a consultant at LXL LLP and can be reached at yaf@lawxl.com.

resource nationalism, a growing trend in LATAM, Africa, the CIS and South East Africa has led to a substantial rise in premiums that has made political risk insurance prohibitively expensive in certain countries.2 With all these on-going conflicts and transitions in various regimes in the MENA and LATAM countries, a rise in political risk in the years to come should be expected in these regions. Nevertheless, it so happens that countries such as Iraq and Venezuela which hold the highest levels of political risk, still attract IRCs due to the proven oil reserves which rank among the largest in the world. For this reason, IRCs who are willing to face such political risks and invest in countries of high risk have to be mindful of the legal techniques that are available to help them mitigate and manage these concerns.

Regardless of the nature of the host government contract that grants mining or petroleum rights, there are numerous measures that IRCs can take to minimise contract and country risk. Most of these measures are preventive measures that need to be addressed in advance but others are responses to specific threats that an educated IRC needs to be mindful of. In the area of natural resources, the battle of resource sovereignty versus contract sanctity is ever present and policy decisions may change fairly rapidly. A prepared IRC is usually in a much better position when those threats appear. When an IRC decides to invest in a foreign country, it must assess the commercial feasibility and the expected return from a project whilst considering both the investment environment and regime.3 All investments come with some degree of risk, usually, the higher the potential return, the higher the possible risks.4 To be clear, IRCs are willing to take geological risk; that is their business. Apart from the common investment and market risks, IRCs must take into account the risks that are inherent to energy projects due to the unique features of

Eljuri, ‘Political Risk Management in Latin American Natural Resources Projects: The Toolbox’ (2013) Special

Institute on International Mining and Oil & Gas Law, Development and Investment), Rocky Mountain Mineral Law Foundation, 2013. 2

See Peter Apps, ‘Political Risk Premiums Rising in Response to Resource Nationalism’ (Insurance Journal,

November 2009); available at: http://www.insurancejournal.com/news/international/2009/11/05/105102.htm accessed 3 January 2009. 3

H. Lax, Political Risk in the International Oil and Gas Industry (Springer, 1983) 89.

J. Berkley, Leadership Handbook of Management and Administration (Baker Books, 2008) 116.

the investments and the sector as a whole.5 Such projects lack stability due to the economic, financial and political risks that they encounter.6 These investments usually are based on a negotiated separate corporate-host investment agreement that enables them to address their subjective needs.7 The real concern of IRCs when using such contracts is not the possibility of host governments having a strong bargaining position leading to favourable terms but rather the possibility of being subject to political processes and current events which may hinder the achievement of their goals and operations.8

Political Risk in the Natural Resources Sector

There are many reasons why IRCs are more vulnerable to political risk than companies in other sectors. Firstly, natural resources projects have features that are exclusive: the investments themselves are unique transactions between IRCs and host states.9Apart from the technical difficulties that are specific to natural resources projects, the capital-intensive nature and the lengthy duration of these investments, usually over twenty years, render geological, commercial, and political risks inevitable.10

Secondly, the sector holds significant political and economic value; this is supported by the fact that natural resources are the prime source of income for a number of producing States. In such countries it is also the public who is highly interested in revenues for the simple reason that higher royalties from energy contracts for instance, mean higher salaries, better education and general wellbeing.11 Accordingly, this public awareness is directly linked to governmental 5

R. James and J. Mauel, `an Integrated Approach to International Energy Investment Protection`, in Proceedings of

the 58th Annual Oil and Gas Law Conference, Institute for Energy Law (Centre for American and International Law, 2007). 6

M. Erkan, International Energy Investment Law: Stability Through Contractual Clauses (Kluwer Law

International, 2011) 21. 7

Lax (n 3).

Ibid.

Erkan (n 6) 27.

T.W. Waelde & G. Ndi, `Stabilizing International Investment Commitments: International Law versus Contract

Interpretation`, (1996) 31 Tex. Int`l L J 216, 220. 11

Erkan (n 6) 27.

elections and with a view to be voted, politicians may take measures or behave in a manner which satisfies the public but negatively impacts the foreign IRC.12 This is based on the fact that "an action regarded by one IRC as discriminatory 'intervention' may be perceived by other observers as an appropriately imposed differential treatment by an intelligent government.”13

Thirdly, energy investments are long term fixed investment and are `quasi-irreversible`; although possible, it is not financially or technically feasible to do so. Theodore Moran notes that IRCs cannot in the short term `pack up and leave`, or in negotiations with host officials convincingly threaten to do so.14 As a result, the host government, which is aware of its strong bargaining power, may behave in an opportunistic way which detriments the IRC.15Such behaviour is further motivated by today`s high energy prices, sensitive global politics and state companies which encourage host governments to seek flexible agreements, larger profits and more sovereignty over their natural resources.16 Thus, it is crucial for IRCs to be alert and well informed on the nature of political risks and to be particularly prepared to mitigate those risks that are intrinsic to the energy sector.

An overview on Political Risk:

Political risk is broadly defined as "the risk or probability of occurrence of some political event (s) that will change the prospects for the profitability of a given investment."17 Similarly but in a wider manner, Shell defines political risk as “the probability of not maintaining the described contract during a ten-year time span-in, the face of changing economic and political

J.Valera, `Political Risks for International Oil Companies Investing in Latin America` (2006) 1 OGEL, 6; available

at: www.ogel.org/article.asp?key=2142 accessed 06 August 2013. 13

James (n 5) 6.

T. Moran, `Political and Regulatory Risk in Infrastructure Investment in Developing Countries: Introduction and

Overview`, 5(6) (a) Draft Paper 06 March 1999 CEPMLP (2000); available at: http://www.dundee.ac.uk/cepmlp/journal/html/vol5/article5-6a.html accessed 06 August 2013. 15

Erkan (n 29).

James (n 5) 4.

D. Haendel, `Foreign Investments and the Management of Political Risk`, in Westview Special Studies in

International Economics and Business (OPEC publishing 1982) 5.

circumstances.”18 Political risk refers to ‘the risk of probability of some political event(s) that will chance the prospects for the profitability of a given investment.19 These definitions outline the consequence of political risks but fail to explain the source and the motive behind such occurrence. Restrepo et al. define political risk as “the risk associated with the effect that actions of agents pursuing political objectives may have on the value of the assets of agents.”20 Such definition is preferable as it is neutral and is conclusive of the originators of political risk that commonly pursue political objectives; namely: governments, political activists, military or terrorist groups amongst others.21

What the above definitions have in common is the question of probability, the probability of governmental interference in energy projects in a sector where changes are of no surprise.22 Although the definitions above do not specifically refer to host governments as the source of political risk; most authors agree that whether on a national, regional, or local level, it is host governments that are the main drivers of political risk.23 Whether it is Venezuelan seizure of foreign operated facilities, Algerian and Peruvian revised and renewed tax assessments, Bolivian adoption of a new hydrocarbon regime with varied royalties and the uncertainty on the legality of contracts in the Kurdish region in Iraq24 it is the host government in every case that has created

C.A. Gebelien, C.F. Peason, & M. Silbergh, `Assessing Political Risk of Oil Investment Ventures` (1978) 30 (5)

JPT 726. 19

See Dan Haendel, Foreign Investments and the Management of Political Risk: Westview Special Studies in

International Economics and Business (1983) 5. 20

D. Restrepo, R. Correia and J. Poblacion, `Political Risk and Corporate Investment Decisions`, (2012) Working

Paper 04, Business Economic Series 03, University of Carlos III of Madrid (2012) 4; available at: http://hdl.handle.net/10016/13114 accessed 03 August 2013. 21

Ibid.

Erkan (n 6) 23.

Restreppo (n 20) 2; S. Gurien, A. Kolotilin and K. Sonin, `Determinants of Nationalization in the Oil Sector: A

Theory and Evidence from Panel Data`, 27 J L Econ & Org (2009) 323; See, M. Busse and C. Hefeker , `Political Risk, Institutions and Foreign Direct Investment 23 (2) EJPE (2007): 397; M. Tomz and M. Wright `Sovereign theft: Theory and Evidence about Sovereign Default and Expropriation`, in the Natural Recourse Trap: Private Investment without Public Commitment. W. Hogan and F. Sturzenegger eds. (MIT Press, 2010). 24

P. Cameron, International Energy Investment Law: The Pursuit of Stability (Oxford University Press, 2010) 12.

such risks. This does not however, at least in theory, negate the possibility that other players from within the industry can cause political risk and harm IRCs.25

Types of Political Risk

Generally speaking, political risk can be divided into two categories (1) instability risks and (2) risks which derive from the deliberate actions of a host government regardless of the legitimacy of the conduct.26 The former may include sabotage, labour strikes, rioting and civil wars and is best exemplified by the Arab-Spring which consisted of governments being overthrown, civil wars, protests, sustained civil disorder and protests amongst other related events such as the Amenas Siege in January 2013 in Algeria or the Egyptian Gas pipeline in Egypt which has blown up over thirteen times since the revolution in 2011.27Another example of instability risk in LATAM would be Venezuela, which with the death of late President Hugo Chávez, held recent elections in the midst of political and economic uncertainty. The second category of political risk falls under what Howard Lax calls political risk events28 and include: legal and regulatory interference; confiscation, nationalisation or creeping expropriation; currency instability; adverse contract measures, or even restriction on access to international arbitration.29 The nature of such events can be classified both as a one-time event or a continuous occurrence due to the fact that their characteristics are not mutually exclusive. In most cases, political risk events are a "materialisation of a process that has been brewing for a 25

Erkan (n 6) 24.

E. Eljuri and C. Trevino, `Political Risk Management in Light of Venezuela`s Partial Nationalism of the Oilfield

Services Sector`, (2008) 28 (2) Journal of Energy and Natural Resources Law (JENRL) 377; See generally E. Eljuri, `Venezuela's Exercise of Sovereignty over the Hydrocarbon Industry and Preventive Protections to be considered by Investors` (2008) 2 OGEL; available at: www.ogel.org. 27

Mohamed Arezki Kimeur, 'In Amenas Siege: Is Algeria's Economy under Threat?' (BBC 25 January 2013);

available at: http://www.bbc.co.uk/news/world-africa-21186272 accessed 04 June 2013. 28

Lax (n 3) 92.

Ibid, 92; S. Anderson, `Exploration, Nationalisation and Risk Management` 6 (1) Oil & Gas Review (2008): 20; T.

Hallmark, `Political Risk in West Africa: a Comparative Analysis` (1998) 11 OGLTR 399 cited in O, Rewane, `International Business Transactions: What are the Principal Risks to Foreign Investment in Oil and Gas Projects in Developing Countries?` 11 CEMLP Internet Journal (2004) http://www.dundee.ac.uk/cepmlp/car/html/car8_article6.pdf accessed 27 August 2013.

long time."30 This may result in a one-time isolated event as was the case when Colombia expropriated the oil company `Chiquita`; or continuous events resulting from an evolving political process, as was the case in the gradual nationalisation of the energy sector in Bolivia and Venezuela.31

4.1.

Change of Law: Expropriation

The most insidious legal risk is the risk of a discriminating or unfavourable change of law.32 The introduction of new laws, decrees or regulations could hamper and negatively affect the IRC`s legal and economic operating conditions under an agreement already concluded with the host government.33 On the one hand, the host government could enact legislation that nationalise or expropriate the natural resources sector or specific assets.34 On the other hand, the host government may employ contemporary methods of regulatory expropriation in which a combination of taxation, regulation and similar governmental acts substantially eliminate the value of the IRC`s stake.35 Most actions of adverse change of law result in different forms of expropriation; an action which in its classical sense is defined as “an official taking by a sovereign state of the tangible property of alien corporate ownership with a view toward the continued exploitation of that property for the public utility of the expropriating state.”36

4.1.1. Direct Expropriation Direct expropriation is amongst the most flagrant types of political risk, usually justified by national interests, a host government takes hold of an international energy company`s development rights, facilities, or products for their own use and benefit.37 In other words, the 30

Restrepo (n 20) 2.

Ibid.

R. Pitchard `Safeguards for Foreign Investment in Mining`, in International and Comparative Mineral Law and

Policy: Trends and Prospects. E. Bastida et al. (eds.) (Kluwer Law International 2005) 80. 33

Eljuri (n 26) 378.

Ibid.

J. Truitt, `Expropriation of Foreign Investment: Summary of the Post World War II Experience of American and

British Investors in the Less Developed Countries`(1970) 1 Journal of International Business Studies 24. 37

Anderson (n 29) 20.

host government may employ nationalisation, which is the `evil twin of expropriation`38, by taking charge of an energy company by expropriating its shares or assets either wholly or partly.39 What states sometimes forget is expropriation needs to be accompanied by fair compensation. On a larger scale than the Ecuadorian expropriation faced by Occidental Petroleum in 2006,40 the nationalisation that was conducted in a similar fashion by both Bolivia and Venezuela serves as a common example of such events in LATAM.41 In 2006, the Supreme Decree No.28701 was issued in Bolivia requiring international oil companies to surrender the production of hydrocarbons to the Bolivian national oil company, namely, Yacimientos Petrolíferos Fiscales Bolivianos ("YPFB").42 A year later, Decree No. 5200 was issued in Venezuela, with a threat of expropriation, the decree required international oil companies in the Orinoco belt to renegotiate contracts with the State.43 As a result, Petróleos de Venezuela S.A ("PDVSA") expropriated the properties of both Exxon Mobil and Conoco Phillips and became the operator of most private companies in the Orinoco belt, which under a mixed company arrangement held a minimum share of 60% in every project.44

4.1.2 Indirect Expropriation Many of these governments, due to the increase of oil prices and their specific ideologies and policies, were tempted to try to benefit from the windfall, regardless - in many cases - of prior rights of investors. In this context, in very general terms, it can be said that oil-producing countries have usually taken legal measures or de facto measures to increase government revenues; whether those measures are lawful in each case is an entirely different matter. For 38

Ibid.

Eljuri (n 26) 378.

Anderson (n 29).

Daniel Yergin, the Prize: The Epic Quest for Oil, Money & Power (Free Press, 1993) 389; J. Forero, `Bolivia

Epitomizes Fight for Natural Resources`(New York Times, 23 May 2005); available at: accessed 08 August 2012. 42

J. Hamilton, O. Garcia-Bolivar & H. Otero, Latin American Investment Protections: Comparative Perspectives on

Laws, Treaties and Disputes for Investors, States and Counsel (Martinus Nijhoff Publishers 2012) 57. 43

Anderson (n 29).

Erkan (n 6) 309; M. Ghertman & C. Meard, Regulation, Deregulation, Reregulation: Institutional Perspectives

(Edward Elgar Publishing 2009) 48.

instance, legal measures have been taken to: (i) increase taxes and royalties; (ii) nationalise the sector or type of business by increasing state participation or imposing further limitations or controls on private participation; and (iii) modifying the terms and conditions of granting instruments.45 Direct or formal expropriation however, has become `anathema` for developing states.46 Indirect expropriation on the other hand has become the "single most important development in state practice for foreign investment integrity."47 Such approach involves legal (not implying here “lawful”) and regulatory measures that significantly and gradually deprive the IRC from using the value of their project.48 This is called `creeping expropriation`, a term which stands for actions of a host government whereby the value of a project is destroyed because of imposed measures which alter the economic equilibrium of an energy project.49 Such expropriation may occur in many forms including: increased regulations; confiscatory taxes; limits on repatriation of currency; unstable currency rates and re-investment requirements amongst others.50 On this note, alterations on the tax regime and exchange controls are amongst the most sensitive forms of creeping expropriation.51 To exemplify, in 2006 the Ecuadorian Congress enacted Law No. 2006-42 which under its 42nd Article essentially called for an unforeseen nor agreed surpluses from oil selling prices on international companies.52 While this meant that Ecuador could generate up to US$500 million in revenues as result of the tax change; harsh consequences affected companies such as Oxy, which was producing 100,000 b/d at the time.53Similarly, 45

E. Eljuri, C. Maduro, V. Clamens, ‘Update on Latin America’s Resource Nationalism’ (2012) 1 OGJLA 18.

R. Dolzer, `Indirect Expropriation: New Developments? `11 Environmental Law Journal (2002): 65.

James (n 5) 6.

G. Joffe et al., `Expropriation of Oil and Gas Investments: Historical, Legal and Economic Perspectives in a New

Age of Resource Nationalism`, 2 J World Energy Law & Bus (2009): 2. 49

Eljuri (n 26) 378.

C. Hill, `How Investors React to Political Risk` (1998) Duke J Comp & and Law 283.

Pitchard (n 32).

Burlington Resources, Inc. v. Republic of Ecuador (ICSID Case No.ARB/08/5).

OGJ, `Ecuador Raises Taxes on International Oil Companies` (Oil & Gas Journal 05 August 2006); available at:

http://www.ogj.com/articles/print/volume-104/issue-18/general-interest/ecuador-raises-taxes-on-international-oilcompanies.html accessed 08 August 2012.

Algeria has adopted Law No.05-07 dated 28 April 2005 (as amended by Ordinance No. 06-10 dated 19 July 2006) requiring the majority shares in an energy venture to be controlled by the national oil and gas company, Sonatrach, in all consequent projects and imposed an exceptional profits tax.54 As a consequence of the continuous increase in oil prices, the Venezuelan government also increased the royalty rate to 30 per cent; included a ‘special advantage’ in favour of the country in the new granting instruments, which is a special contribution (alike to an alternative minimum tax), according to which the State must receive at least 50 per cent of the joint venture companies' gross income. Additionally, in April 2008, in a bid to maximise income derived from the current high oil prices, a new windfall tax was created through the enactment of Special Contribution Law on Extraordinary Prices in the International Hydrocarbons Market. This windfall profit tax is applicable to producers, including mixed companies created in accordance with the Organic Hydrocarbons Law, who sell liquid hydrocarbons, whether natural or upgraded, as well as hydrocarbons derivatives to Petróleos de Venezuela and any of its affiliates.55

As to currency risks, they generally arise from significantly devalued currencies, inconvertible currencies, or prohibitions on international transfers. The latter means, that the host government would exchange local currency on `its books` but would not allow the money to leave the host country.56 Companies subject to such conditions are more vulnerable to political risks than other projects.57 Particularly in Brazil, this is a common problem for companies whose revenues collected in local currency but whose debts were accrued in dollars or other foreign currencies.58 In 2003, Venezuela enacted an exchange control regime that restricts the conversion of the

Mark Clarke, 'Resource Nationalism: A Gathering Storm?' (2012) 31 (6) IELR 220, 221.

Official Gazette No. 38.910 dated April 15 2008. This law was later amended in 2011 and 2013.

James (n 5) 8.

Ibid.

T. Moran, International Political risk Management: The Brave New World (World Bank Publication 2004) 68; J.

Guira, `Preventing and Containing International Financial Crisis; the Case of Brazil`, Law & Bus. Rev. Am (2001): 481; M. de Sa Ribeiro, `the new Oil and Gas Industry in Brazil: An Overview of Main Legal Aspects, ` (2001) 36 Tex Int`l J 164.

Venezuelan Bolivars Fuertes with foreign currency.59 The Commission for the Administration of Foreign Currency (“CADIVI”), now National Centre for Foreign Trade (“CENCOEX”), administers this and under limited circumstances can assist with the exchange, thus creating a rigid system that is difficult to bear by international energy companies.60Although the CADIVI system is the prime example of exchange control, other countries such as Argentina and Algeria have less drastic restrictions in place.

4.2.

Contract Risk

4.2.1. Contract Breach or Repudiation In the context of political risk, contract risk generally refers to a host government defaulting, breaching, or repudiating an agreement concluded with an IRC;61 resulting in a significant loss to the detriment of the IRC.62 This risk extends to the government`s refusal to arbitrate or failure to pay an award assigned to the benefit of the IRC or lenders respectively.63 To exemplify, in August 2007, PDVSA has suspended payments owed to a number of oilfield service companies leading to a US$12 billion in debt by May 2009.64 These debts were eventually and gradually recovered from PDVSA but in due course, the companies did not recover the full amounts owed to them as they have approved a number of significant discounts and rate reductions and some were in fact expropriated when they attempted to suspend services65 More recently, it has been announced that Egypt, who since the 2011 revolution overthrew their government, have been 59

See Currency Exchange Agreement No.1, Official Gazette No. 37.625 dated 5 February 2003 (corrected 19 April

2003, Official Gazette No 37, 653. 60

Ibid.

James (n 5) 7.

Ibid; See Generally, K. Lu, G. Verheyen and S. Perera, Investing with Confidence: Understanding Political Risk

Management in the 21st Century (World Bank Publications 2009). 63

R. Shanks, F. Jenney and J. Zitko, `Political Risk Insurance`, in International Lawyer`s Deskbook. L. Low et al.

(American Bar Association 2003) 72; P. Torrado, `Political Risk Insurance and Breach of Contract Coverage: How the Intervention of Domestic Courts May Prevent Investors from Claiming Insurance` (2003) 17 (2) Pace International Law Review 313. 64

B. Mander, `Chavez Seizures Fuel Venezuela Oil Fears` (Financial times, 11 May 2009); available at:

http://www.ft.com/intl/cms/s/0/b332e432-3d54-11de-a85e-00144feabdc0.html#axzz23Ajeixlo accessed 10 August 2012. 65

Eljuri (n 26 ) 380.

struggling with their currency reserves and meeting energy bills and owes over US$5 billion to IRCs of which over half is overdue.66

Repudiation and declarations of unenforceability however, are more common and may be considered distinct from non-performance of a legal obligation stipulated in the contract.67 When a change in circumstances occurs, the costs and benefits achievable by an IRC from their energy contract can either increase or decrease.68 Usually, breach of contract or repudiation is likely happen when the costs of respecting a contract are higher than the costs of abandoning it.69 Such costs as well as reputational costs are also measured in the context of social and political benefits whereby the host government is likely to gain from such action.70 When analysing the cost benefits of rejecting an agreement, the host government takes into account the cost incurred by resorting to arbitration tribunals or courts when an IRC is seeking to enforce a contract.71On the grounds that certain contracts violated constitutional norms, host governments in certain cases have justified contract repudiation.72This is in fact a political risk faced by IRCs who have concluded Production Sharing Contracts with the Kurdish Regional Government in Iraq. The central government has allegedly grounds to find these agreements unconstitutional and illegal and therefore null and void.73 This is particularly threatening as these Production Sharing Contracts have been concluded under the umbrella of the Iraqi Oil and Gas Law 2007 and the Federal Oil and Gas Law 2011 which are draft laws that has been subject to debate for over five years.74 In the short term companies such as Exxon Mobil who contracted with the Kurdish 66

Dmitry Zhdannikov, 'REFILE – Egypt debts to oil firms highlight subsidies struggle' (Reuters 12 April 2013);

available at: http://www.reuters.com/article/2013/04/12/egypt-oil-idUSL5N0CW4H620130412 accessed 11 June 2013. 67

James (n 5) 7.

Jeswald W Salacuse, `Renegotiating International Project Agreements` (2001) 24 Fordham Int`l LJ 1341.

Eljuri (n 26) 379.

B. Marsh, `Preventing the Inevitable: The Benefits of Contractual Risk Management in Light of Venezuela’s

Recent Oil Field Nationalization` (2008) 13 Stan J L. Bus & Fin 457. 71

Eljuri (n 26)379.

Ibid, 380.

Yanal Abul Failat, 'Iraqi Federal Oil and Gas Law 2011: Exploration, Exploitation and Expropriation (2013) 32 (4)

IELR 141, 149 – 150. 74

Ibid, 150.

Regional Government are already facing threats by the Iraqi central government that wants to ban these companies from operating in other regions of Iraq.75 Even though, Exxon Mobil continues to operate in the Kurdish Region, other companies such as Shell have withdrawn from negotiations with the Kurdish Regional Government.76

4.2.2 Forced Renegotiation Generally speaking, it could be said that IRCs may be willing to consider the renegotiation of an original contract in situations where the host government requests such action on the basis that investment conditions had been altered.77 In fact, at times such approach has delivered better and friendlier solutions when compared to arbitration or litigation.78 In other circumstances however, IRCs due to acts of coercion, duress, or rather force instigated by the host governments accepted the renegotiations. In LATAM, Bolivia, Ecuador and Venezuela were accused on several occasions to have forced contractual renegotiation on foreign IRCs.79Host governments may exercise such action by executing threats under key economic terms, repudiation or termination of the contract or more directly by nationalisation.80 In LATAM, Venezuela has established a pattern that was followed by other countries, by enacting in February 2007 when Decree-Law No. 5200 concerning the migration of the association agreements of the Orinoco Oil Belt and of the exploration at risk and profit-sharing agreements into joint venture companies, provided for the transfer of activities to the state of the association agreements for the Orinoco Oil Belt as well as the exploration at risk and profit-sharing agreements. Nevertheless, this law also provided that the above-mentioned agreements could be migrated into joint venture companies with state-equity participation of at least 60 per cent. The law, however, was silent on the topic

James Lukwey, 'Iraq Still Considering Exxon Bidding Ban (Reuters 2012); available at:

http://www.reuters.com/article/2012/03/22/us-exxon-iraq-idUSBRE82L0GG20120322 accessed 23 April 2013. 76

'Shell withdraws from Kurdistan negotiations after hours of Baghdad Threats' (Shafaq News September 2013);

available at: http://www.shafaaq.com/en/politics/3611-shell-withdraw-from-kurdistan-negotiations-after-hours-ofbaghdad-threats-.html accessed 02 May 2013. 77

Cameron (n 24) 87

Ibid.

Eljuri (n 26) 381.

of compensation.81

Peter Cameron divides the approach in three stages: 1.

The state adopts legal measures that illegalise the structure of existing contractual agreements. In these measures the host government stipulates a `legal structure` per se and sets a timeframe for transition that is subject to penalties if not met.

Despite the mandatory nature of the process, the second stage has been referred to as the `migration` whereby the renegotiations take place.

The third stage is where under less favourable terms, the majority of the IRCs accept both the new terms of the contract and relevant new domestic law.82

4.3.

Restriction to Arbitration:

Although in the 1990s most of LATAM countries had joined the ICSID, there has been a negative shift from this emerging regime with rigorous condemnation. The LATAM countries have stated that such departure is based on the fact that this mechanism provides a regime that suffers from investor bias, impartiality, and high costs and prohibits states from filing claims.83 Thus, it is perceived that this is an “attempt, by multinational corporations, to undermine the sovereignty of Latin American states.”84 For this reason, populist governments such as Bolivia, Ecuador, Nicaragua and Venezuela that are unhappy about the outcomes of arbitral proceedings dealing with energy investments;85 have created a further political risk in LATAM which must be considered by IRCs when approaching the region to invest in the natural resources sector. It is a risk of restriction on arbitration that generally involves the host state taking extra legal measures that limit or reduce access to international arbitration.86 This may be done in many ways, for instance, a host state may request from the IRC a waiver of the contractual clauses relating to arbitration or even threaten to terminate or reject future contracts with IRCs who 81

Eljuri (n 45).

Cameron (n 24) 264.

E. Chalamish, `Do Treaties Matter? On Effectiveness and International Economic Law`, 32 MIJIL (2011): 336.

A. van Aaekn and J. Jurtz, `Emergency Measures and International Investment Law: How Far Can States Go? `

(2010) 2009-2010 Y.B. Int`l Investment L. & Po`Y. 85

Cameron (n 24) 206.

Eljuri (n 26) 382.

resort to arbitration upon a dispute.87 The host state, in a more direct manner, could even denounce or terminate a BIT and thus eliminating access to arbitration in the first place.88

This is exemplified by Venezuela who in 2008 withdrew from the Agreement on Encouragement and Reciprocal Protection of Investment between (the “Venezuelan-Netherlands BIT”) so as to avoid ICSID jurisdiction over future disputes.89In a more direct approach, both Ecuador and Bolivia ha both denounced and withdrawn from the ICSID whilst other states are preparing for alternative regional dispute resolution forums.90 Venezuela followed suit in 2012 when the World Bank received a written notice of denunciation of the ICSID Convention,91 This is permitted by Article 25 (4) of the ICSID Convention that permits the contracting state to inform or serve a notice to the dispute resolution forum, most usually the ICSID, that the State no longer consents their jurisdiction to resolve disputes between the state and the IRC.92

Arbitration may also be restricted through amendments to national legislation such as those made the Bolivarian Constitution in which Article 366 of its 2009 amendment provides that “foreign courts and jurisdiction will not recognised and [foreign companies] will not be able to resort to international arbitration or invoke diplomatic protections.”93 It must be noted however, that such a trend is not extending to all of LATAM; in fact, on the basis of last decade evidence such 87

F. Carbera Diaz, `Ecuador Threatens Cancellation of Oil Contracts Unless ICSID Nixed as Arbitration Forum`

(Investment Treaty News 2008) http://www.iisd.org/itn/2008/08/29/ecuador-threatens-cancellation-of-oil-contractsunless-icsid-nixed-as-arbitration-forum/ accessed 27 August 2012. 88

Eljuri (n 26) 382; E. Eljuri, P. Saghy, BIT Termination and the Survival Clause. What does the concept of

protection of investments made prior to termination of the BIT actually cover? (2008) IBA conference material, Caracas. 89

L. Peterson, `Venezuela Surprise the Netherlands with Termination Notice for BIT` (International Arbitration

Report, 16 May 2008); available at: http://www.iareporter.com/downloads/20100107_27 accessed 27 August 2012. 90

Cameron (n 24) 185.

ICSID News Release, 26 January 2012; available at:

https://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=OpenPage&PageType=Announ cementsFrame&FromPage=Announcements&pageName=Announcement100 accessed 6 May 2014. 92

ICSID Convention, Article 25 (4).

The 2009 Constitution of the Plurinational State of Bolivia, Article 366 as translated by Hamilton (n 42) 58.

behaviour is unlikely in Chile, Colombia, Costa Rica, and Peru.94 Lastly, it can also be achieved simply by refusing to include international arbitration in any future host government contracts.

Mitigating Political Risk:

As noted earlier, energy projects endure for many years and so their operational environment is subject to many changes that may create political risks threatening the investment.95 To mitigate such risks, a number of practices and mechanisms have been developed through various contractual techniques, treaty arrangements and political risk insurance.96

5.1.

Stabilisation Clauses

The term `stabilisation` in the context of international energy contracts refers to: [A]ll of the mechanisms contractual or otherwise, which aim to preserve over the life of the contract the benefit of specific economic and legal conditions which the parties considered to be appropriate at the time they entered into the contract.97

The emergence of such a clause was first witnessed in oil contracts with Middle Eastern host states and was the result of numerous state interventions that have occurred in LATAM.98 The traditional approach to stabilisation is to `freeze` clauses, in other words to shield them from any succeeding detrimental measures such as a change in the law which could affect the contract.99 The rationale behind this common feature is that “as a matter of private contract that this `lex specialis` will govern, wholly or partially,100 the rights and obligations of the parties under the contract, irrespective of the state`s exercise of sovereign powers.”101 94

Cameron (n 24) 206.

J. Dewar, International Project Finance: Law and Practice (Oxford University Press 2011) 95.

Ibid.

Cameron (n 24) 102.

Erkan (n 6) XVIII.

A. F. M. Maniruzzaman, `the pursuit of Stability in International energy Investment Contracts: A Critical

Appraisal of emerging Trends` (2008) 1 J World Energy Law & Bus 124. 100

Partial Stabilisation refers to a stability commitment that applies only to certain matter such as fiscal terms or

income tax or that exclude from its scope specific matters. 101

Eljuri (n 26) 387; Cameron (n 24) 70.

In the MENA, stabilisation clauses were used since the sixties.102 An example of such a clause is found in the Model Production Sharing Contract prepared by the Kurdish Regional Governments which provides that IRCs are exempted from any "change to the law, or by revocation, modification, or non-renewal of any approvals, consents or exemptions granted to the contractor, in order to maintain the contractor's financial interests under this contract reasonably unchanged."103

Further protection could be afforded to IRCs upon the internationalisation of the contracts whereby they are regulated by international law which prevail over national legislation.104 This allows for protection from existing laws as well as risks such as the uncertainty on the validity of the Kurdish Production Sharing Contracts. Muttitt illustrates this by noting Azerbaijan's 1994 Production Sharing Contract concluded for the Azeri-Chirah-Guneshli fields where in Article 23.2 which points at 'vague 'international petroleum industry standards and practices' at the time of signing the contract, and requires only compliance with Azerbaijan's laws on health, safety and environment if they are no stronger than those self-defined standards.'105

This type of classical and outright stabilisation clause may cause an imbalance between the interests of the state and the IRCs since the state`s exercise of its sovereign authority cannot be completely restrained and so more modern stabilisation techniques that do not `freeze` the rules 102

Clause 16 of the Amended Libyan Model Contract annexed to the text of the Libyan Law No.25/1955 on

Petroleum read “the concession shall throughout the period of its validity be construed in accordance with the petroleum law and the regulations in force on the date of execution of the agreement of amendment by which this paragraph (2) was incorporated in this concession agreement. Any amendment to or repeal of such regulations shall not affect the contractual rights of the company without its consent” as found in Instituto Della Enciclopedia Italiana, Encyclopaedia of Hydrocarbons (2005) Volume IV at 883 of Section 13.3; available at: www.treccani.it/export/sites/default/Portale/sito/altre_aree/Tecnologia_e_Scienze_applicate/enciclopedia/inglese/in glese_vol_4/879-900_x13.3x_ing.pdf accessed 4 January 2013. 103

Ahmad Al-Janabi, 'Oil and Gas Contracts in Iraq' (Who's Who Legal, July 2010); available at:

www.whoswholegal.com/news/features/article/28421/ accessed 9 May 2013. 104

Greg Muttitt, 'Nationalising Risk, Privatising Reward: The prospects for Oil Production Contracts in Iraq'

(Platform 2007) 16; available at: www.carbonweb.org/documents/nationalising.pdf accessed 04 June 2013. 105

Ibid.

of the game have been developed.106 For example, instead of freezing the law the national company may assume the obligation to compensate the IRC or rather the service contractor in this case for economic loss suffered as a result of change in the laws or regulations affecting the terms of the relevant agreement.107 The Strategic Association Agreement (“AA”) between PDVSA and major IRCs entered into for the development and production of the Orinoco Belt provides that PDVSA would compensate IRCs “for adverse economic situation resulting from adoption of governmental decisions or changes in the legislation which causes a discriminatory treatment of the AA or PDVSA’s partner.”108

Moreover, economic balancing can also be introduced in stabilisation with the objective to restore the economic equilibrium of an agreement in cases where it has been affected by unilateral state action.109 For example, the agreement could contain a formula tying the compensation to the oil price in the international energy markets.110 Of course these stabilisation techniques do not exclude the necessity of negotiating on matters such as automatic adjustment index to unanticipated events.111

Stabilisation clauses cannot stop state interference but proof of their breach can lower the burden of proof under international law in the realm of quantification of damages.112 In the decision of Saudi Arabia v. Arabian American Oil Co. in 1963 it was stated that: By reason of its very sovereignty within its territorial domain, the state possesses the legal power to grant rights to which it forbids itself to withdraw before the end of the Concession, with the reservation of the Clauses of the Concession Agreement relating to its revocation. Nothing can prevent a State in the exercise of its sovereignty, from binding 106

Eljuri (n 26) 387.

107

Ibid.

108

Marsh (n 70).

109

Peter Cameron, Stabilisation in Investment Contracts and Changes of rules in Host Petroleum Negotiators (AIPN)

2006. 110

Eljuri (n 26) 388.

111

Gurien (n 23).

112

Marsh (n 70).

itself irrevocably by the provisions of a concession and from granting to the concessionaire irretraceable rights.113

This has been reiterated in many arbitral proceedings including Texaco Overseas Petroleum Co Texaco & California Oil Co v. Government of the Libya Arab Republic.114 For this reason, choosing arbitration to resolve disputes is crucial when safeguarding the interest of an IRC. This is because an arbitration tribunal will offer the required neutral, commercial and technical expertise and thus analysing the stabilisation clauses objectively and subjectively.115 Moreover, local courts may naturally endorse arguments of a host state that may be preaching public interest and casting doubts on the impartiality of the proceedings.116

5.2.

Political Risk Insurance

Political Risk Insurance (“PRI”) is commonly used as a tool to mitigate and manage several types of risks or losses by IRCs contracting with states, state agencies or state owned entities.117 As part of the Marshall Plan, the notion of political risk insurance was the result of the United States Agency for International Development’s initiative to reconstruct Europe by providing insurance coverage for governmental acts of expropriation and war crimes.118 Despite its existence since the 60s and its continuous development, the range of PRI products has grown over the past decade in response to current global events, particularly events in the MENA region.119 As the Insurance Journal explains, events in the MENA have “brought PRI back to the 113

Saudi Arabia v American Oil Company 27 ILR (1963) 117.

114

Texaco Overseas Petroleum Co & California Oil Co v Libya Arab Republic, 53 ILR 349 at 490 (1975).

115

A. F. M. Manuryzzaman ‘some reflections on Stabilisation Techniques in International Petroleum, Gas and

Mineral Agreements (2005) 4 IETR. 116

Patson Arinaitwe, ‘Does inclusion of Stabilisation Clauses in Petroleum Agreements Insulate International Oil

Companies from Nationalisation’ (2012); available at: https://www.academia.edu/2611050/Does_Inclusion_of_Stabilisation_Clauses_in_Petroleum_Agreements_Insulate _International_Oil_companies_from_Nationalisation accessed 06 January 2013. 117

Anderson (n 29) 20.

118

Mohamed Stevens, ‘the Role of Insurance in Risk Minimisation: The Advantages and Disadvantages of Private

and Public Political Risk Insurance’ (2013) 16 CAR 5. 119

Michael Nolan, Federic Gilles Sourgens and Christina Totino, ‘Recent Trends in Public Political Risk Insurance

Coverage (2011) May/June Corporate Finance Review 13.

fore of global investors and markets.”120 Today, PRI covers many sectors and is widely sought by energy companies and has become a crucial investment consideration.

The most commonly insured political risks in the energy sector are events of expropriation, currency inconvertibility, transfer restrictions, political violence and contract repudiation.121PRI seekers may use public insurers such as the Overseas Private Investment Corporation (“OPIC”)122 or private insurers such as Lloyds, Chubb or AIG.123In many states, governmental or quasi-governmental insurers can offer their local companies PRI when investing abroad.124 In countries where this is not available, the Multilateral Investment Guarantee (“MIGA”) can offer investment guarantees for clients who are investing outside their home country.125 The World Bank’s MIGA who is a legal and financially independent entity was established with an objective to promote the flow of investments within emerging markets.126 Other multilateral providers of PRI include the Inter-American Development Bank and the Asian Development Bank.

By way of PRI, IRC’s can now insure against political violence, expropriation and nationalisation in any of their forms. Although the public insurers have the ability to insure investments as long as twenty years and may assist and may mediate in cases of dispute, private insurers have been found favourable, as they are not restricted by any foreign policy 120

Alliant Issues New Report on Insurable Risks in 175 Countries.

121

For the most commonly insured political risks see generally Paola Morales Torrado, ‘Political Risk Insurance and

Breach of Contract Coverage: How the Intervention of Domestic Courts May Prevent Insurance from Claiming Insurance (2005) 17(2) Pace International Review 301. 122

Other public insurers include: The Export-Import Bank of the US, Nippon Export and Investment Insurance of

Japan, the Export Development Corporation of Canada and the Export Credits Guarantee Department. 123

Ian Bremmer and Preston Keat, the Fat Tail: The Power of Political Knowledge in an Uncertain World (OUP

2010) 104. 124

Anderson (n 29).

125

Multilateral Investment Guarantee Agency, ‘Guarantees Overview’ (2013); available at:

http://www.miga.org/investmentguarantees/index.cfm accessed 07 January 2013. 126

George Joffe and others, ‘Expropriation of Oil and Gas Investments: Historical, Legal and Economic Perspectives

in a New Age of Resource Nationalism’ (2009) 2 (1) JWELB 3, 12.

objectives.127 Private insurers however, do not necessarily compete with public insurers can complement them. In fact, in multifaceted transactions, energy companies tend to combine both public and private insurance to insure different risks, aspects and stages of the project.128

When there is no combination of low probability and high impact of the insured risk or when quantifying the risks and an appropriate premium is difficult, an IRC may find it difficult to find affordable insurance if at all.129 This is of course affected further by the relevant current state of the host country and other worldwide events. However, the rise of resource nationalism, a growing trend in LATAM, has led to a substantial rise in premiums that has made political risk insurance prohibitively expensive in certain countries.130For instance, recent unilateral action in LATAM has not only increased insurance premiums but also caused reluctance amongst many insurers to insure energy companies operating in the region, particularly Bolivia, Ecuador and Venezuela.131 This is because insurers may find that the requested coverage is no insurable due to the difficult in measuring the risk and accordingly in appropriating insurance premiums.132 Nevertheless, assessing political risk is a subjective exercise and the concept of PRI dictates that insurers will continue to cater for companies operating in countries that have high levels of political risks especially in developing markets such as Colombia, Egypt and Jordan that have high potential of reward.133 To exemplify, Apache who has significant upstream operations in Egypt maintained the viability of its investment despite the large sums of money owed to it by the Government.134 Apache who did not specify the amount owed stated to the press that “These insurance policies provide approximately US$1 billion of coverage for Apache for losses arising 127

Ibid.

128

M O’Brien, Balancing Covering Options (Latin France 2001) 42.

129

Alexander Van De Putte, David Gates and Ann Holder, ‘Political Risk Insurance as an Instrument to Reduce Oil

and Gas Investment Risk and Manage Investment Returns’ (2012) 5(4) 284, 288. 130

Apps (n 2).

131

John Cullen and K Praveen Parboteeah, Multinational Management (Cengage Learning 2013) 242; Apps (n 2).

132

Paola Morales Torrado, ‘Political Risk Insurance and Breach of Contract Coverage: How the Intervention of

Domestic Courts May Prevent Investors from Claiming Insurance (2005) 17 (2) Pace International Law Review 301. 133

Ibid 243.

134

Reuters, ‘Refile-Egypt debts to Oil Firms Highlight Subsidies Struggle’ (Reuters April 12 2013); available at:

http://uk.reuters.com/article/2013/04/12/egypt-oil-idUKL5N0CW4H620130412 accessed 02 January 2013.

from confiscation, nationalisation and expropriation risks, with a US$263 million sub-limit for currency inconvertibility.”135

5.3. Bilateral Investment Treaties as a political risk mitigating mechanism 5.3.1. Investment Structuring Structuring an investment has become a common practice for IRCs to enjoy protection available under investment treaties. An investment treaty in this context can generally be described as an agreement between two or more sovereign states which reflects the parties’ commitment to promote and protect investments made by a national of one of the parties on the territory of the other.136 These treaties that could be bilateral or multilateral essentially aim at protecting the IRCs against political risk.137 Bilateral Investment Treaties (BITs) usually afford nationals of a contracting state party specific protection specifically from expropriation or unjust treatment amongst others resulting from the actions of a host government.138 The investment treaty regime calls for a neutral form of dispute resolution settlement by international arbitration to be accessible to IRCs to resolve disputes with host states.139IRCs with access to a suitable investment treaty are afforded with increased leverage when negotiating with host states, possibly deterring the possibility of hostile state action.140 Unlike typical bilateral treaties, BITs `do not stand isolated in governing the relation between two states only, but rather develop multiple overlaps and structural interconnections that create a relatively uniform and treaty overreaching regime of international investment protection`.141 Since the conclusion of the first BIT in the 1950s, the use of such a mechanism has grown immensely reaching a figure of over

135

Ibid.

136

J. Voss, the Impact of Investment Treaties on Contracts between Host States and Foreign Investors (Martinus

Nijhoff Publishers 2010) 9; A. Sureda, Investment Treaty Arbitration (Cambridge University Press 2012) 26. 137

J. Salacuse, the Law of International Investment Treaties (Oxford University Press 2009) 26.

138

Dewar (n 95) 95.

139

Voss 9.

140

J. Mellmann, `Discussing Protection for Investors Affected by Resource Nationalism` (2012) Infrastructure

Journal Paper (2012) l; available at: www.wfw.com/Publications/Publication1034/$File/InfrastructureJournalResourceNationalism-March2012.pdf accessed 17 August 2012. 141

S. Scholl, International Investment Law and Comparative Public Law (Oxford University Press 2010) 30-31.

2,800 concluded BIT by the end of 2011.142 BITs have over the years given substantial certainty to legal framework of newly independent state in the field of foreign investment.143 This may be supported by the number of uniform principles of international investment protection commonly found in BITs.

A prime example of such a uniform principle is the protection from expropriation without compensation.144 This protection is at the heart of investment treaties, whilst not protecting IRCs from expropriation, they entitle an IRC who has been subject to either direct or indirect expropriation to prompt and effective compensation. Other uniform and common rights enjoyed by IRCs under BITs include: fair and equitable treatment, full protection and security, national treatment, and umbrella clauses.145 Moreover, it has become a standard that a uniform clause is included in BITs entitling IRCs to commence arbitration proceedings against host states in cases of expropriation or other actions of the states`.146 The main premise of such a right is to afford the IRC with a forum that ensures impartial justice.147 A major step could be said to have taken towards investment protection a step that BITs have took to a high level of success.148 It must be noted however, that unlike other uniform IRC rights consistently found in BITs, there is no uniform pattern for arbitration under different treaties.149 Normally, the IRC has the choice of referring a dispute to arbitration either under the International Centre for Settlement of

142

J. Zhan, `Statement`, UNCTAD World Investment Forum 2012 (2012) International Investment Agreements

Conference, Qatar 1; available at: http://unctad-worldinvestmentforum.org/assets/2012-forum-docs/WIF-IIA-JZSpeech_21-April-2012.pdf accessed 23 August 2012. 143

P. Bernandini, `Investment Arbitration under the ICSID Convention and BITs` in Global Reflections on

International Law, Commerce and Dispute Resolution, G. Aksen and others (eds.) (ICC publishing 2005) 91. 144

House of Lords, Any of Our Business?: Human Rights and the UK Private Sector First Report of Session 2009-

10: Vol. 2 Oral and Written Evidence (UK Stationary Office 2009) 320. 145

Scholl (n 141) 31.

146

K. Parlett, the Individual in the International Legal System: Continuity and Change in International Law

(Cambridge University Press 2011) 106 -107. 147

M. Sornarajah, the International Law on Foreign Investment (Cambridge University Press 2010) 217.

148

Ibid.

149

Ibid.

Investment Disputes (ICSID) Convention150 or under the United Nations Commission on International Trade Law (UNCITRAL) Arbitration Rules; both of which provide a regime for private claims under BITs.151

As a part of the World Bank Group, ICSID is an independent arbitration institution that has over the time become the main mechanism for settling investment disputes between IRCs and host governments through conciliation and arbitration.152 As of April 2014, the Convention was signed by 159 states and was ratified by 150 states.153 The rise in the number of arbitration cases was in fact due to availability of a number of treaty instruments and BITs created by host governments offering the ICSID as an alternative dispute resolution forum.154 Simultaneously, a number of crises occurred around the world, many of which were in LATAM (Argentina, Ecuador and Venezuela`s financial crisis in the 1990s) that have contributed to this growth.155 In fact, as of December 31, 2013, ICSID had registered 459 cases under the ICSID Convention and Additional Facility Rules, of which 33% have occurred in LATAM.156 BITs have served as a premise to invoke 63% of total amount of ICSID cases to establish its jurisdiction.157 In 2013, 39% of the newly registered cases pertained to the natural resources sector of which 26% arose 150

The Convention on the Settlement of Investment Disputes between States and Nationals of Other States (1965);

International Centre for the Settlement of Investment Disputes ICSID Conventions and Rules, ICSID/15/Rev.1 (2003). 151

W. Park, `Arbitrator Integrity`, in the Backlash Against Investment Arbitration: Perceptions and Reality. M.

Waibel (ed.) (Kluwer Law International 2010) 220. 152

D. Johnson, International Business: Themes and Issues in the Modern Global Economy (Taylor & Francis 2009)

86. 153

ICSID, List of Contracting States and Other Signatories of the Convention, as of 5 May 2011; available at:

http://icsid.worldbank.org/ICSID/FrontServlet?requestType=ICSIDDocRH&actionVal=ShowDocument&language= English accessed 21 August 2012. 154

J. Willems, `the Settlement of Investor State Disputes and China: New Developments on ICSID Jurisdiction`

(2011) 8 (1) SCJILB 2, 1. 155

Ibid, 2.

156

ICSID, `The ICSID Caseload - Statistics` (2011) 7, 11; available at

http://icsid.worldbank.org/ICSID/FrontServlet?requestType=ICSIDDocRH&actionVal=ShowDocument&CaseLoad Statistics=True&language=English21 accessed 23 August 2012. 157

Ibid 10.

specifically from the oil and gas and mining sectors.158 Although the ICSID Caseload Statistics of 2013 fails to outline the success rate of state or investors, one commenter provides that upon his analysis of 43 cases in LATAM, it is revealed that States and claimants have obtained mixed results and outcomes from these cases.159 This shows that in many cases, investors have succeeded in obtaining recourse under investment treaties from state action creating political risk.

5.3.1. Treaty Planning (Legitimate Treaty Shopping) When investing in LATAM or in MENA, the IRC`s contract must ensure that it structures the investment in a way which ensures benefiting from the protection afforded by the applicable BITs.160 It is crucial to structure the investment before disputes actually arise which would become problematic. Investment structuring must be done in a manner that maximises the protection of investment by taking advantage of available tax benefits and assessing the dispute resolution methods offered by host states.161 When structuring an investment, it is vital to select a suitable treaty by way of `treaty planning` or rather `forum or treaty shopping`. Treaty shopping occurs when IRCs intentionally select a BIT of a third party state which may afford more protection than the target host state`s treaty when investing in foreign markets.162 An analysis of the different protections offered by different treaties must be conducted as treaties are not identical and hold subtle variations in their provisions that can lead to major differences in practice or even hold restrictions or limitations that may impede the possibility of arbitration or the process of the investment.163 158

Ibid 23.

159

J. Hamilton, `A decade of Latin American Investment Arbitration` in Latin American Investment Treaty

Arbitration: The Controversies and Conflicts. M. Mourra & T. Carbonneau (eds.) (Kluwer Law International 2008) 73. 160

Eljuri (n 26) 393.

161

E. Saunders Hastings, `the Asymmetrical Legalization of Investment Regimes in Africa` in Sustainable

Development in World Investment Law. M. Cordonier and others (eds.) (Kluwer Law International 2011) 475. 162

M. Skinner, C. Miles and S. Luttrell, `Access and Advantage in Investor-State Arbitration: The Law and Practice

of Treaty Planning` (2010) 20 (20) JWELB 1. 163

T. Tyler and R. Deutsch, `Protecting Energy Projects from Political Risks by Treaty Planning` (2009) 8 (2)

Energy Litigation 1; available at:

There are general approaches to treaty shopping; the first is what refer to the `back end’ of the investment which may be arranged even if a dispute has occurred (but not always free of risk). For instance, the company who is in dispute may `sell its distress` to a company who has a better BIT.

164

The other approach is the `front end `of the investment or rather `nationality planning`,

whereby a company is incorporated in a country with a favourable BIT with the target state and operate the investment through that entity.165 This not only provides the IRC with favourable provisions, but if well planned, will offer favourable procedures. For instance, instead of resolving disputes in a domestic ad hoc arbitration, the disputes may be heard by the ICSID.166 Moreover, it must be noted that nationality planning does not only originate from the need to achieve favourable terms but also from circumstances where a BIT between the foreign IRC`s home state and target state does not exist.167

A change of nationality for whatever reason requires satisfying the requirements for incorporation under both the laws of the new jurisdictions and any other possible requirements from the BITs.168 Even though this type of investment structuring is not welcomed by host states; the practice is legitimate and is not prohibited. For instance, the tribunal Aguas del Tunari SA v Bolivia stated: It is not uncommon practice, and absent a particular limitation – not illegal to locate one`s operations in a jurisdiction perceived to provide a beneficial regulatory and legal environment in terms, For example, of taxation of the substantive law of the jurisdiction including the availability of a BIT.169

http://www.velaw.com/uploadedFiles/VEsite/Resources/ProtectingEnergyProjectsPoliticalRiskTreatyPlanning2009. pdf accessed 24 August 2012. 164

Saunders Hastings (n 161).

165

Ibid 2.

166

Ibid.

167

Ibid.

168

Eljuri (n 26) 394.

169

Aguas Del Tunari SA v Bolivia, ICSID Case no, ARB /02/3 Decision on Respondent Objections to jurisdiction 21

October 2005, 330.

Similarly, the tribunal in Phoenix Action, LTD v The Czech Republic recently confirmed: International IRCs can structure their upstream investments, which meet the requirement of participating in the economy of the host State, in a manner that best fits their need for international protection, in choosing freely the vehicle through which they perform their investment.170

5.3.2. Denial of Benefits Clause Several BITs however, include a denial of benefits clause that allows the host government to deny the benefits of a BIT to IRCs that have incorporated their companies in a jurisdiction only to enjoy a favourable treaty.171 With a view against treaty shopping, states have imposed provisions in which many treaties require effective management instituted from the country of nationality in order to achieve corporate nationality.172 Modern treaties are worded in definite terms to ensure actual control which illustrates the state’s awareness of trends in international arbitration.173 To have standing and to put into effect the protection of an investment treaty, the IRC as a threshold matter must ensure that they meet the definition of `investor`.174 Interestingly, the ICSID Convention does not define or use this term but rather refers to `investments` which have been made by a `national of another Contracting State`, a term which for judicial purposes is defined as: [A]ny juridical person which had the nationality of a Contract State other than the state party to the dispute ion the date on which the parties consented to submit such dispute to conciliation or arbitration and any juridical person which had the nationality of the contracting State party to the dispute on that date and which, because of foreign control, the parties have agreed should be treated as a national of another Contracting state for the purposes of this Convention.175 170

Phoenix Action Ltd v The Czech Republic, ICSID Case no ARB/06/5, 15 April 2009, 94.

171

OECD, Foreign Direct Investment Policy and Promotion in Latin America (OECD Publishing 1999) 47.

172

Sornarajah (n 147) 329.

173

Ibid.

174

R. Thorn and J. Doucleff, `Disregarding the Corporate Veil and Denial of Benefits Clauses: Testing Treaty

Language and the Concept of `Investor` in the Backlash Against Investment Arbitration: Perceptions and Reality. M. Waibel (ed.) (Kluwer Law International 2010) 6. 175

ICSID Convention Article 25 2 B

The convention does not provide any mechanism or criteria to define or evaluate this nationality nor do treaties offer a uniform test. Modern BITs however, include a test for nationality which assess the place the investor`s incorporation and the identity of their shareholders.176 As to the former criterion, an assessment is required examining where the entity is actually doing business.177 For instance, the Argentine/Netherlands BIT of 1992 provides that the term `investor` shall comprise with regard to either Contracting Party: (i) natural persons having the nationality of that Contracting Party in accordance with its law; (ii) without prejudice to the provisions of paragraph (iii) hereafter, legal persons constituted under the law of that Contracting Party and actually doing business under the laws in force in any part of the territory of that Contracting Party in which a place of effective management is situated; and (iii) legal persons, wherever located, controlled, directly or indirectly, by nationals of that Contracting Party.178

The requirement of such a genuine or effective link between the IRC and the country granting the nationality in the form of residence or domicile found in BITs may be an influence of customary international law.179In the Nottebohm case, the ICJ held that whilst states may decide on their own premise in accordance with their national legislation on how and when to grant nationality to a specific person or an entity; they must find a genuine link between the state and the supposed national. In this regard, the court has that stated that: Nationality is a legal bond having as its basis a social fact of attachment, a genuine connection of existence, interests and sentiments, together with the existence of reciprocal rights and duties. It may be said to institute the juridical expression of the fact that the individual upon whom it is 176

C. Leathley, International Dispute Resolution in Latin America: An Institutional Overview (Kluwer Law

International 2007) 16. 177

Ibid 17.

178

Agreement on Reciprocal Protection of Investments between the Kingdom of the Netherlands and the Argentine

Republic of 20 October 1992, Article 1 (b). 179

See the Nottebohm Case, (LIRChtenstein v Guatemala) Second Phase, Judgment, ICJ Reports 1955, Rep 4; A.

Guzman and A. Sykes, Research Handbook in International Economic Law (Edward Elgar Publishing 2007) 218.

conferred, either directly by the law or as the result of an act of authorities, is in fact more closely connected with the population of the State, it only entities that state to exercise protection vis à vis another state, if it constitutes a translation into juridical terms of the individuals connection with the State which has made him its national.180

Nevertheless, in modern circumstances this test may pose a strict approach that would hinder the protection of many investors.181 This problem was recognised by the International Law Commission which in their Report on Diplomatic Protection has stated that: [I]t is necessary to be mindful of the fact that if the genuine link requirement proposed by Nottebohm was strictly applied it would exclude millions of persons from the benefit of diplomatic protection as in today`s world of economic globalization and migration there are millions of persons who have moved away from their State of nationality and made their lives in States whose nationality they never acquire or have acquired nationality by birth or descent from States with which they have a tenuous connection.182 Some BITs however, include two definitions that apply to the Contracting Parties individually.183 For instance, the US-Uruguay BIT defines a national as `for the United States, a natural person who is the national of the United States as defined in Title III of the Immigration and Nationality Act` and `for Uruguay, a national person possessing the citizenship of Uruguay, in accordance with its laws`.184 In other BITs there is no requirement for nationality but rather of citizenship as is the case in the Canada-Argentina BIT where the term ìnvestor ìs defined as àny natural person possessing the citizenship of or permanently residing in a Contracting Party in accordance with its laws.185 Thus, the test and the different definitions permit the local subsidiary to hold the 180

Ibid, 23.

181

OECD, International Investment Law: Understand Concepts and Tracking Innovations (OECD Publishing 2008)

11. 182

ILC, `Report of the International Law Commission on the Work of its Fifty-Eighth Session`, UN Doc A/61/10,

Chapter IV (2006) 33. 183

Ibid, 13.

184

United States - Uruguay BIT entered into force on 1 November 2006.

185

Canada-Argentina BIT, entered into force on 29 April 1993.

nationality of the parent company, foreign investor, and so enjoy the protection afforded by the BIT.186 Nonetheless, the ability to identify the shareholders nationality might be intricate when the parent company or holding company is publicly traded.187 For this reason, an IRC seeking protection under BITs must with `care` assess whether the relevant BIT defines ownership or control, particularly since this is usually undefined.188

Like with the term investor`, the term ìnvestment` is not uniformly defined nor the does the ICSID Convention provide any such delineation. The drafters of the Convention have intended such omission due to the difficulty of defining the term and also due to a fear of creating a strict or limiting test on this regard.189 In this manner, the lack of definition allows greater flexibility when determining whether a certain operation could be classified as an investment or not.190 This also òpened the way` for BITs to define the term with care in a manner which considered the limits, ratione materiae, of the protection that a Contracting States accords to nationals of other states when entering into a BIT.191Judge Jessup however, in his separate dissenting Opinion in Barcelona Traction, states that generally `there are two standard tests of the “nationality” of a corporation. The place of incorporation is test generally favoured in the legal systems of the common law, while the siege social is more generally accepted in the civil law systems`.192 Moreover, the OECD notes that BITs generally attempt to delineate certain criterions of which if two or more are met, the economic activity would be considered an investment including: the place of constitution; the place of incorporation; the country of administration seat amongst others.193 This is similar to the general definition of ìnvestment` in LATAM BITs, where it will broadly require an investment to include: every kind of asset invested by an investor of one contracting state in the territory of the other contracting state: movable and immovable property; rights derived from shares, 186

Leathley (n 176) 17.

187

Ibid.

188

Ibid.

189

Bernandini (n 143) 99.

190

Ibid.

191

Ibid. 100.

192

OECD (n 181)18.

193

Ibid, 19.

stocks, bonds and other kinds of interests in companies and joint ventures, title to money or to any performance having an economic valued; intellectual property rights, including technical processes, goodwill and know-how; rights (including concessions) granted under public law, including rights in relation to the exploitation of natural resources.194 In this sense, the jurisdictional decision in Fedax N.V. v. Republic of Venezuela illustrative.195 In that case, Venezuela issued promissory notes that were subsequently acquired by Fedax, a Dutch investor. When Venezuela refused to pay on the notes, Fedax initiated arbitration. Venezuela argued that the mere purchase of the notes did not constitute an ‘investment’ in Venezuela and did not fall within the ambit of the Venezuela-Netherlands BIT. The tribunal, however, found that the treaty's inclusion of the phrase ‘every kind of asset'’ demonstrated "that the Contracting Parties ... intended a very broad meaning for the term 'investment’” This broad meaning had indeed become the standard usage: "A broad definition of investment ... is not at all an exceptional situation... [It] has also become the standard policy of major economic groupings."196

5.3.3. Remarks Thus, the principles and the definitions sourced from primary and secondary sources reconcile the fact that long term natural resources investment or energy projects should fall within the definition investment in most investment treaties. The above illustrate however, that when structuring an investment it is crucial to identify and analyse the relevant BITs to ensure that the both the IRC and the investment apply to the criteria of the treaty in order to ensure the enjoyment of the protection offered by it. Thus, it may well be said that if conducted properly, treaty planning is a legitimate and beneficial approach to investment structuring whereas if not done with care, an IRC may not qualify for protection due to the possibility of being subject to a denial of benefits clause and thus rejection on the basis of jurisdiction by an arbitral tribunal. 194

Leathley (n 176).

195

Fedax N.V. v. Republic of Venez., ICSID Case No. ARB/96/3, Decision on Jurisdiction, (July 1, 1997) 37 I.L.M.

1378 (1998). 196

Steinberg A., Kotuby, C., ‘Bilateral Investment Treaties and International Air Transportation: A New Tool for

Global Airlines to Redress Market Barriers’ (2011) 76 J. Air L. & Com. 457, 459.

Moreover, when the IRC is assessing a BIT or is treaty planning they must be aware that in certain BITs an alternative form of arbitration may be available under the ICSID Additional Facility Rules as a recourse when and if the ICSID has no jurisdiction over a dispute on the basis that the economic activity does not qualify to be an investment.197 All in all, despite definitional uncertainties, the possibility that an IRC falls outside the jurisdiction of the ICSID or a host state action to restrict arbitration,198 the process under BITs have `emerged as the preferred method for resolving investment disputes and the ICSID Convention as the most widely accepted for of arbitration.`199

197

Bernandini (n 143) 103.

198

T. Weiler and F. Baetens, New Directions in International Economic Law: In Memoriam Thomas Walde

(Martinus Nijhoff Publishers 2011) 279. 199

Ibid 107.