WHO SHOULD READ THIS
- Companies looking to participate in inbound or outbound invest opportunities.
THINGS YOU NEED TO KNOW
- Even in relatively sophisticated investment destinations, investors are subject to the risk of government action such as legislative and other regulatory changes that diminish the value of an investment. These risks can be protected against by intelligent structuring of an investment so as to gain the protection of a bilateral investment treaty (BIT).
WHAT YOU NEED TO DO
- Talk to our team about proactively structuring your investments to enjoy the protection afforded by BITs.
International investment is an important driver of economic growth in Australia. In 2015, investment in Australia by foreign parties was over $3 trillion, largely from the United States and United Kingdom.1 In the same year, investment by Australian parties in overseas jurisdictions was almost $2.1 trillion, again primarily in the United States and United Kingdom, and also notably in Japan, China and Singapore.2 Even in these relatively sophisticated investment destinations, investors are subject to the risk of government action such as legislative and other regulatory changes that diminish the value of an investment. These risks can be protected against by intelligent structuring of an investment so as to gain the protection of a bilateral investment treaty (BIT).
Bilateral investment treaties
A BIT is a binding agreement between two states by which each assumes obligations in relation to investments made by investors based in the other state. A state in which an investment is made may be obliged, for example, to promote favourable investment conditions, to treat investors fairly and equitably, and to not undertake expropriation or nationalisation. The certainty and security provided by a BIT is intended to foster investment between the signatories to the treaty. Australia is a party to 21 BITs with countries in many regions of the world, including China, Hong Kong, Indonesia, India, Mexico, Papua New Guinea, and Turkey.
The obligations assumed by a state under a BIT are directly enforceable against the state by investors, by virtue of investor-state dispute settlement (ISDS) provisions. The provisions will stipulate the method of dispute resolution, typically international arbitration and often at the International Centre for Settlement of Investment Disputes.
Australia also has free trade agreements (FTA) with other significant trading partners, many of which include ISDS provisions, as in the FTAs with China, Korea, and Singapore. When in force, the Trans-Pacific Partnership Agreement will also provide an ISDS mechanism. Some agreements, as between Australia and the United States, do not provide for direct suit against by the investor, instead requiring the consent of both national governments.
Risks in international investment
Australia’s wealth of natural resources has generated considerable inward international investment. It is appropriate, then, to consider by way of example the potential that changes in environmental protection regulation have to give rise to a breach of Australia’s investment treaty obligations.
Changes in environmental legislation that cause substantial delays to a project and diminish the value of an investment may constitute a breach of Australia’s obligations under a BIT to, for example, provide fair and equitable treatment to investors and to not conduct expropriation. Subject to the precise wording of the applicable BIT, a claim under treaty protections could be instituted if a foreign entity owned or partially owned the mining project or owned an Australian subsidiary that was conducting the project. A minority shareholding would likely be sufficient, as in CMS Gas Transmission Company v Argentine Republic.3
Another example in the resources sector can be found where a change in legislation results in the cancellation of a mining licence. Such a change could devalue the company that held the licence and amount to an expropriation from its shareholders. In consequence, foreign investors in the company who are based in a BIT signatory country may be entitled to bring a claim for compensation against the Australian government.
Further, changes to legislation affecting the liability of directors or holding companies for the environmental impact of operations or for noncompliance with regulations may constitute a breach of the obligation to provide fair and equitable treatment to investors. This is especially the case where the legislation imposes additional liabilities with retrospective effect, which could not have been foreseen by the investor upon making the investment.
Similarly, the unforseen imposition of a tax on windfall profits, or the early termination of tax concessions granted to a particular industry, may breach a treaty state’s obligation to treat investors fairly and equitably. The undertaking not to conduct expropriation may be contravened where, for example, a treaty state issues unfavourable tax assessments against an investor and takes enforcement action, such as seizing the assets of the investor, without affording the company an opportunity to pay the amounts claimed.
Intelligent structuring to gain BIT protection
It is clear from the foregoing examples that foreign investment comes with some risk even in sophisticated and stable jurisdictions such as Australia. It is apparent, too, that a BIT has the potential to be an effective means by which international investors can protect their investments.
While Australia has concluded BITs with some important trading partners, many desirable investment destinations are not a party to such a treaty. For example, an Australian company may wish to invest in oil production in Russia, Kuwait, or the United Arab Emirates, none of which has entered into a BIT or FTA with Australia. Each of these countries has, however, implemented a BIT with India. Thus, to gain the investment protections afforded by a BIT, an Australian investor may be advised to establish a subsidiary in India, which makes investments in Russia on behalf of the Australian investor.
The use of a subsidiary to gain BIT protection has been upheld by the courts provided the subsidiary meets the definition of ‘investor’ under the treaty. For example, the India-Russia BIT would encompass any legal entity constituted in India pursuant to Indian law. Some BITs exclude companies which, though incorporated in a contracting state, are controlled by a company in a third country.
Investment structuring must be proactive
It is essential that the structuring of an investment to enjoy BIT protection occur at the earliest possible stage, and certainly before a dispute becomes foreseeable. The importance of proactive investment structuring is exemplified in the Philip Morris Asia Ltd v Commonwealth of Australia arbitration,4 following which an arbitral Award was handed down on 17 December 2015. Philip Morris International (PMI) was a US-incorporated manufacturer of cigarettes that were sold in Australia. Subsequent to the Australian Government’s announcement of its intention to mandate plain packaging of tobacco products, PMI underwent a restructuring of its operations. By this arrangement, PMI’s wholly-owned Hong Kong-incorporated subsidiary Philip Morris Asia (PM Asia) acquired 100% of the shares in Philip Morris (Australia) Ltd (PM Australia). PM Asia contended that its restructuring was done for reasons of tax minimisation and business efficiency.
PM Asia then brought arbitration proceedings against the Commonwealth of Australia for breach of protections against expropriation afforded by the Hong Kong-Australia BIT. The Asian subsidiary contended that it was an international investor in Australia within the meaning of the treaty because it was incorporated in Hong Kong and owned investment assets in the form of a shareholding in PM Australia. PM Asia alleged that the plain packaging measures diminished the value of its investment in PM Australia, amounting to an expropriation in breach of the BIT.
The arbitral tribunal found that the restructuring was calculated to gain the protection of the treaty. It was observed that the ‘main and determinative, if not sole, reason for the restructuring was the intention to bring a claim under the Treaty, using an entity from Hong Kong’.5 In consequence, the commencement of an ISDS process constituted an abuse of right or abuse of process. This was said to occur ‘when an investor has changed its corporate structure to gain the protection of an investment treaty at a point in time where a dispute was foreseeable. A dispute is foreseeable when there is a reasonable prospect that a measure that may give rise to a treaty claim will materialise’.6 It is important, then, for investors to adopt a beneficial structure at the outset of the investment.
Inbound and outbound foreign investment will undoubtedly continue to play a key role in Australia’s economic growth. Especially in the present time of increasing social consciousness and rapid industrialisation of less developed countries, there exists substantial risk of diminution in the value of international investments through legislative and other regulatory action. It is therefore essential that parties proactively structure their investments to enjoy the protection afforded by BITs. The Philip Morris case demonstrates the importance of obtaining expert legal advice at the outset of an investment, as courts and arbitral tribunals are likely to strike down any attempt to gain BIT protection after a dispute has become foreseeable. By bringing themselves within the scope of a BIT, investors may be able to obtain protection against the political uncertainties that characterise even the most sophisticated investment destinations.
Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.