1.1 Foreign investors invest in projects in host states in the hope and expectation of success and a reasonable return on their investment. However, it is unfortunately a relatively common occurrence for foreign investments to be damaged or completely destroyed by measures taken by the host state. These measures range from outright expropriation of the investment to a unilateral change in the regulatory, royalty, pricing and tax regimes, which undermine the economic basis on which the investment was made. In such cases the investor’s losses may not be recoverable because the investor is limited to bringing an action in the domestic courts of the host state, or instituting a domestic arbitration, where obtaining a fair hearing against the government of the host state is often not possible.
1.2 However, there is a solution to this problem, which is to structure the investment in such a manner so as to ensure that there is a bilateral investment treaty (BIT) in place (containing a dispute resolution clause) between the investor’s home state and the host state into which the investment is made. Foreign investors are increasingly looking to structure their investments to take advantage of BIT protection.
1.3 This article considers the basics of BITs, and explains how investors can structure their investments so as to ensure that they are protected by a BIT.
2. Our Experience
2.1 Steptoe & Johnson has acted for over 30 investors in arbitrations against states pursuant to BITs. In 2009 we obtained the first award issued against Zimbabwe in an ICSID arbitration for breaches of the Netherlands-Zimbabwe BIT (Funnekotter & Ors v Zimbabwe). The award arose out of one of the largest programmes of nationalisation since the end of the Second World War. In 2009 we also obtained the second largest award to be issued in a NAFTA arbitration (Corn Products International v Mexico). Our lawyers remain at the forefront of acting for investors against states in Africa, Latin America and around the world.
3. BITs – an overview
3.1 BITs are treaties, i.e. agreements between states governed by public international law, which provide that nationals (corporates or individuals) of each state when investing in the other state, will, together with their investments, be accorded certain rights and protections. BITs only bind states once they have been ratified (as opposed to merely signed). Conduct deemed to be that of a state includes the conduct of all of the organs of the state (the Executive, the Legislature and the Judiciary), together with the conduct of all persons and entities empowered to exercise elements of governmental authority (the latter group, depending on the circumstances, may include state companies and their officers). Therefore the conduct of the state that is covered by BITs is very wide.
3.2 The most common protections that host states promise under BITs include fair and equitable treatment, full security and protection, treatment at least as good as that provided by the host state to its own nationals (national treatment), treatment at least as good as that provided by the host state to nationals of third states (most favoured nation treatment), repatriation of investments and returns, no expropriation unless against prompt, adequate and effective compensation, and a promise to observe obligations with regard to investments (known as “umbrella clauses”).
3.3 Importantly, in the event of a dispute between the host state and the investor, BITs invariably provide for a standing offer by the host state to submit the dispute to binding international arbitration, which may be commenced by the investor. A breach of a BIT entitles the investor to damages to a level that would wipe out the consequences of the breach.
3.4 BITs are unique in that they are international agreements between states that give enforceable rights to corporates and individuals. Furthermore, BITs provide protection to covered investors, whether or not the investor has a contractual relationship with the host state.
4. There must be an “investor”
4.1 In order to be an “investor” covered by a BIT, the investor needs to be a national of one of the contracting states to the BIT on which it seeks to rely. A company will be a national under many of the model BITs if it is incorporated in the state of which it asserts nationality.
5. Treaty shopping
5.1 In many instances there may not be a ratified BIT between the home state of the investor and the host state into which it wishes to make, or has made, the investment. However, in many instances this problem can be easily solved. Take for example the situation where a British investor wishes to invest in Zimbabwe. There is no ratified BIT between the United Kingdom and Zimbabwe. However, there is a ratified BIT between the Netherlands and Zimbabwe. In order to obtain the protection of the BIT between the Netherlands and Zimbabwe, the British investor need only incorporate a subsidiary company in the Netherlands and ensure that the Dutch company owns the investment in Zimbabwe. Such a structure will entitle the Dutch company to bring a claim under the BIT in the event that a measure is taken by the Zimbabwean Government which damages the investment.
5.2 However, a word of warning: consider the tax position that may be created by adding the newly incorporated company to the structure.
5.3 Furthermore, it is essential that any structuring of this kind is done before the dispute arises, otherwise such arrangements are likely to be characterised as “forum shopping”, which is not permitted.
6. There must be an “investment”
6.1 Furthermore, a BIT only applies to “investments” made by foreign investors into the host state. The term “investment” is defined very widely in most BITs to cover “every kind of asset” including shares, concessions, debt instruments, land and moveable property. Very wide interpretations have been given to these definitions by arbitration tribunals. However, a one-off sale agreement is less likely to be deemed to be an “investment”.
7. Protections offered to investors under BITs
Access to international arbitration
7.1 Most BITs provide that a foreign investor may refer disputes between it and the host state, arising out of an investment, to international arbitration. This right is a fundamental right, because without it all of the other rights cannot be enforced by the investor. The vast majority of BITs provide for arbitration at the International Centre for Settlement of Investment Disputes (ICSID) (a World Bank arbitration forum). However, some BITs also have provision for other arbitration forums, such as the International Chamber of Commerce (ICC), and ad hoc arbitration.
7.2 Many BITs expressly take account of rights of subrogation. In any event, it is permissible for insurers to bring a claim in the name of the insured under a BIT.
7.3 Monetary arbitration awards rendered by tribunals constituted pursuant to the ICSID Convention are enforceable in each of the one hundred and forty-seven states that have ratified the ICSID Convention as if they were a final judgment of a court of the state in which they are to be enforced – there are no grounds for refusing to enforce the award for public policy reasons or otherwise. If the arbitration tribunal under the BIT was constituted other than under the ICSID Convention, then enforcement will be through the New York Convention. In any event, enforcement will be subject to the laws of sovereign immunity.
Fair and equitable treatment
7.4 Fair and equitable treatment is a very wide protection. It is impossible to give an exhaustive definition of the fair and equitable treatment standard. However, under the standard the investor essentially must be treated in a consistent manner, free from ambiguity, transparently, and in accordance with the investor’s legitimate expectations. The most common situation in which states are found to have breached the fair and equitable treatment standard is where the implementation and maintenance of a particular regulatory regime (e.g., relating to royalties, pricing, and taxes) is promised to the investor by the state before the investment is made, but is subsequently unilaterally changed by the state after the investment has been made.
Full protection and security
7.5 The right to full protection and security places an obligation on the host state to act diligently so that the investor’s investments are not damaged.
7.6 National treatment is the right to be treated at least as favourably as nationals of the host state. This limits the state’s ability to favour its “national champions”.
Most favoured nation
7.7 Most favoured nation treatment, or MFN, is the right of a foreign investor to be treated at least as favourably as the nationals of a third state. MFN clauses are a way of ensuring that the host state does not have distorting investment policies toward foreign investors of different nationalities.
Repatriation of investments and returns
7.8 Repatriation of investments and returns is the right of the investor to freely transfer out of the host state, without delay, the investment, and any returns on the investment (such as dividends), in a convertible currency.
Expropriation or measures having effect equivalent to expropriation
7.9 BITs usually contain a right stating that the foreign investor’s investment will not be subject to expropriation, or measures having an effect equivalent to expropriation, unless the expropriation is for a public purpose, is on a non-discriminatory basis, follows due process, and is against “prompt, adequate and effective compensation”. In this context “prompt” means soon after the expropriation; “adequate” refers to the quantity of compensation and is generally regarded as meaning the fair market value of the investment; and “effective” means compensation paid in a convertible currency, usually the currency in which the investment was made.
7.10 Umbrella clauses vary in their wording, but a typical umbrella clause states: “[The host state] shall observe any other obligation it has assumed with regard to investments in its territory by [foreign investors]”.
7.11 Some cases have held that umbrella clauses elevate pure breaches of contract into breaches of the BIT, thereby enabling the foreign investor to utilise the dispute resolution clause in the BIT.