Increasing international construction and projects activites
Recent years have seen an increase in the amount of cross-border activity in the construction and engineering sector, particularly in projects in developing economies. In 2012 PwC noted that “infrastructure spending has begun to rebound from the global financial crisis and is expected to grow significantly over the coming decade” and predicted that “some regions, particularly emerging Asia, are projected to enjoy a bigger boom in infrastructure development than more advanced economies.”[1] This was soon reflected in the market. Almost half of the major construction and engineering firms surveyed by KPMG in 2013 indicated that they planned to expand internationally by targeting projects in new locations, most commonly in Africa and Asia, and particularly major infrastructure projects in the energy, mining, rail and water sectors.[2] This increased international activity was observed by UNCTAD in 2014; it estimated that the amount of foreign investment for the construction of greenfield projects in developing economies had jumped from $22 billion in 2013 to $42 billion in 2014.[3]
Many of the locations for these new projects have traditionally been perceived as jurisdictions with higher risks, including concerns such as greater political risks, less-predictable policy or greater exposure for foreign investors. To address these concerns in order to attract foreign investment (both in the construction sector and generally), many States have committed to protect incoming investors and their investments against expropriatory, unfair or discriminatory treatment by public authorities within their territories. These protections are commonly agreed in international investment treaties between capital exporting States and capital importing States wishing to attract investment.
By structuring investments carefully at an early stage, contractors involved in cross-border projects can often benefit from these commitments and may secure important protections from harmful interferences by the State where the investment is made. This article examines how contractors and investors can structure their cross-border projects to access such protections.
International investment agreements
A Bilateral Investment Treaty (“BIT”) is a treaty between two States by which each State grants rights and protections to investors from one State investing into the other. Multilateral investment treaties apply ("MITs") apply similarly between multiple States. A key feature of BITs and MITs is that they commonly give investors, including contractors and developers, the right to bring a claim directly against the State into which their investment is made (known as the host State), before an international arbitral tribunal for violations of investors’ rights under the BIT without the need for investors to conclude a direct contract or arbitration agreement with the government. International arbitration under a BIT can provide an alternative neutral forum to the domestic courts of the host State. A notable proportion of investment arbitrations involve international construction and engineering projects.
There are more than 2,500 BITs in operation worldwide. Many tax effective jurisdictions such as the Netherlands, Belgium, Luxembourg, and common investor hubs such as the USA, the UK and Germany, have a broad range of BITs with other States, and particularly with developing economy States which are attracting increased construction projects.
A contractor’s right and ability to bring an arbitration against a host State arises from three fundamental pillars found in almost all BITs/MITs:
- First, the qualifying gateway criteria as defined in the BIT: whether the contractor itself qualifies as an "investor" of the home State and therefore benefits from the host State's obligation to protect investors of the home State; and also whether the contractor’s foreign project investment into the host State similarly qualifies as a protected "investment". This article examines these two gateway criteria by which international construction projects may benefit from BIT protections offered by host States.
- Second, the protections offered by States to foreign contractors and other investors which create actionable obligations for a host State as towards investors and investments from the other State. A breach by a host State of its BIT obligations may give rise to liability towards an investor, and thereby a potential cause of action for an investor which may be determinable by arbitration.
- Third, the host State's offer of arbitration to resolve a dispute arising from an alleged breach of its protective obligations. The host State's offer to arbitrate is a unilateral open offer made in the BIT to any qualifying "investor" from the other State which has made a qualifying "investment". Contractors and investors value the opportunities for redress which is made available through international investment arbitration, particularly where concerns may exist as to the neutrality or fairness of a host State's local court procedures.
Protections offered to investors by a host State
Some of the most common protections offered by host States to contractors and other investors and to their projects or other investments under BITs are as follows:
- not to expropriate or nationalise investments except for a public purpose, on a non-discriminatory basis and on payment of prompt, adequate and effective compensation;
- to accord fair and equitable treatment to the investments of investors of the other State;
- not to take unreasonable or discriminatory measures against those investors;
- not to treat those investors or their investments less favourably than the host State’s own investors and their investments (known as “national treatment”), or those of any third country (known as “most favoured nation” status);
- to provide full protection and security, or protection by the State from interference by third parties, and the provision of a secure environment; and
- to observe any obligations entered into with respect to the investments of investors of the other State party (also referred to as an “umbrella clause”).
These protections are particularly valued when investing in countries and industries where there is a high risk of governmental or regulatory interference or when investing in high profile assets. When the host State (including its organs or agencies such as regulators, police, ministries, local authorities, licensing authorities etc.) carries out activities that negatively affect the value of the project, these protections may be breached. Such actions generally fall within the broad category of extra-contractual actions involving the exercise of State power which cannot be exercised by a contractual counter-party. For example, such actions may include seizing a contractor’s assets, cancelling an ongoing project, taking control of a contractor’s business, demanding a share in the profits, imposing a windfall tax on a development or withdrawing a concession to operate a development.
Foreign investments in the construction sector have given rise to a significant proportion of the known investment treaty disputes. Claims have been brought under BITs in relation to the construction of major infrastructure works including highways,[4] canals,[5] hydro-electric projects[6] and pipelines[7] as well as smaller or individual projects and developments.[8]
Qualifying "investors" under a BIT
As noted above, the gateway jurisdictional issues for any claim brought under a BIT will be whether the contractor qualifies as an “investor” from its home State, and whether that contractor’s project in the host State qualify as an “investment” under the BIT in question. If the conditions for “investors” and “investments” under the BIT are not met, the contractor or their project will not be protected by the host State.
In general, investment treaties define “investors” as persons of a State party to the treaty, other than the State where the investment takes place. Typically, this includes a juridical person (i.e. a company) incorporated in the investor’s home State. While simple incorporation may be sufficient for certain home States, other States may require their BITs to define “investor” more strictly, for example also requiring a company to have its seat in the relevant home State and/or to carry out certain activities there in order to qualify as an investor of the home State.
It is often also possible to invest via other States which have a BIT with the host State. This allows contractors to channel their project investments via a foreign company or investment vehicle established in a third State into the host State even if the contractor’s own State has no BIT with the host State. The extent to which a BIT protects “direct” and “indirect” investments, structured through third States, will depend on the terms of the treaty.
These issues are best illustrated by examples. A State which has often not placed strict limits on the criteria for its qualifying "investors" is The Netherlands. Many Dutch BITs require only that an entity is incorporated within the jurisdiction to benefit from BIT protection. For example, the Netherlands - Czech BIT defines Dutch "investors" to be simply "legal persons constituted under the laws of [The Netherlands]"[9]. A non-Dutch contractor seeking to establish a project in the Czech Republic may benefit from the BIT’s protections by incorporating, and then routing its investment through, a Dutch special purpose project entity. Arbitral tribunals have accepted such project structuring where the relevant BIT wording is not limiting, refusing to pierce the corporate veil to look behind the shell company to the ultimate nationality of the investor.[10]
In contrast, other States prefer that only entities with genuine commercial activity within their territory may benefit from protective rights offered by other State parties to their investors. For example, Switzerland has entered into a number of BITs requiring Swiss investors to exercise “real economic activity” on Swiss territory. The Egypt - Switzerland BIT defines “investors” to be “companies, corporations, business associations and other organisations, which are constituted or otherwise duly organised under the law of that Contracting Party and have their statutory seat, together with real economic activities, in the territory of the same Contracting Party.”[11] A contractor routing project investments through a special project vehicle incorporated in Switzerland for tax purposes but without any real Swiss operations would not benefit from investment protections under such BITs.
These issues arise regularly in international arbitrations involving construction projects.
A number of disputes have arisen where the contractor is originally a national of a State which has a BIT with the host State, so no investment structuring is necessary. For example, in the case of Toto Construzioni v Lebanon[12] involving the construction of highway in Lebanon, the Italian contractor Toto directly brought an investment treaty arbitration against Lebanon under the Italy-Lebanon BIT. A foreign shareholder or a foreign party to a joint venture project may obtain BIT protections as a foreign "investor" even if its local partners may not. The case of Tulip Real Estate v Turkey involved the construction of a residential and commercial complex in Turkey. The foreign contractor Tulip Real Estate, a subsidiary of a major European contractor, held 65% of the shares of a local Turkish JV company which it had established for the project. Tulip brought an arbitration against Turkey by qualifying as an "investor" under the relevant BIT (its claim was limited to the proportional shareholding amount of the alleged damage suffered by the local JV company),[13] but Tulip’s local partners did not qualify for similar rights of recourse against Turkey.
Occasionally, a prudent contractor based in a host State may route its investments out of the jurisdiction and back in via a third State in order to qualify as a foreign "investor" of that third State, provided the BIT between the third State and the host State does not prohibit this. In Alpha Projektholding v Ukraine, a project involving a joint venture for a hotel in Ukraine, one of the joint venture partner entities was held to be a qualifying Austrian "investor" under the Austria-Ukraine BIT because it invested via an Austrian investment vehicle, although that entity was ultimately owned by Ukrainian nationals who would not have obtained BIT protection had they simply structured their project within Ukraine. The tribunal upheld the existing principle established in earlier awards[14] that if Austria and Ukraine had intended to prevent Ukrainian nationals from taking advantage of the protections offered by Austria in the BIT then the States would have included provisions to this effect, which they had not done.[15]
Qualifying "investments" under a BIT
Each BIT usually also contains its own definition of the “investment” to be made by the "investor" which would then qualify for BIT protection by the host State. Typically, the definition is broad and covers “every kind of asset”, including tangible and intangible property, shares, bonds, licenses, IP and concessions (e.g. to construct and operate an infrastructure project). However, a BIT may also impose conditions, such as that an investment must be approved by the host State, or must have certain characteristics such as the commitment of capital or other resources.
Tribunals generally assess whether a project is an "investment" on the basis of its features or characteristics, and by taking into account the circumstances of the case. Features that may point to the existence of an "investment" include the allocation or contribution by a foreign investor of capital, an element of risk, a long-term duration, the expenditure of funds by a foreign entity for the expectation of profit in the host State, or a claim to money or the purchase of an asset.
The wide scope of these provisions would generally encompass international construction projects, but this is a question of fact and varies from case to case.
In the construction sector, arbitral tribunals have held that risk-bearing activities at various stages of a project may be "investments" qualifying for host State protection. These include investment activities such as the purchase by the claimant contractor of shares in a local construction consortium[16]; the grant of a long-term concession by a host State which "could have generated significant returns" despite the contractor not yet having made significant contributions; [17] a contractor's provision of know-how, equipment and personnel to a project, as well as the contractor incurring significant bank charges for providing bank guarantees equivalent to the value of the employer's advance payment;[18] a contractor’s supply of services and materials and the mobilisation of its resources for the performance of a construction contract;[19] an operator's two-year commitment to provide vessels and services for a dredging contract;[20] and a project company's claim to a share of profits or returns flowing from the right to operate a project following its construction.[21]
Ensuring a foreign project is protected under a BIT
In order to maximise the potential protections available under BITs, contractors are generally advised to consider this at an early stage in project planning, ideally before establishing project entities or making fund transfers. In this respect, the approach to investment structuring is broadly similar to the structuring of international investments to maximise tax efficiency. As awareness of the BIT protection regime grows, investment structuring and tax planning exercises are beginning to be carried out in tandem. As noted above, the most favourable jurisdictions for project vehicles are often those which are both tax efficient and have networks of BITs with other States.
It may also be possible for a contractor to take remedial steps to restructure an existing project in order to gain the protections afforded by BITs provided this is done sufficiently early before a dispute arises. An existing project may potentially be re-routed through a new company established in a third State which has entered into a BIT with the host State when a dispute appears on the horizon. However, determining whether or not a legal dispute has arisen can be challenging. Tribunals have in some cases accepted legitimate investment restructuring before a dispute arises even if early signs of a dispute may exist. After Venezuela passed legislation to expropriate foreign investments in the oil & gas sector but excluded projects within a particular location, an operator within that excluded location restructured its investment out of caution, expecting the exclusion to be withdrawn. In due course the exclusion was indeed removed and the project was expropriated. The operator brought an investment treaty claim against Venezuela, and the arbitral tribunal affirmed its jurisdiction over the disputes which had arisen after the operator had completed the reorganisation.[22]
Making this determination can also be essential because arbitral tribunals have rejected claims if they consider that the investor has restructured its project for the sole purpose of obtaining protection, at a time when a dispute was already very probable. For example, a tribunal rejected an attempt by a local investor to internationalise a pre-existing domestic tax dispute by transferring the shareholding of the local company being investigated for tax evasion to a foreign investment vehicle which was wholly-owned by the same local investor.[23]
Contractors and project investors looking to carry out investment protection risk assessments or analyses of existing and planned projects would generally examine some or all of the following:
- Is there a BIT in place that the contractor and the project could benefit from?
- Are the definitions of “investor” and “investment” met and any conditions under the BIT complied with?
- Does the BIT provide key relevant protections, such as protection from expropriation, fair and equitable treatment, protection from discriminatory or unreasonable treatment, etc.?
- Does the BIT provide the contractor with access to international arbitration for claims in respect of all relevant treaty standards? If so, are there procedural conditions that must be complied with before a claim may be made?
- Does the local law of the host State provide any additional protection, or impose limitations or conditions on protection?
Where sufficient treaty protection is not in place, it may be possible to identify whether remedial steps are available which would allow a project to become protected (for example, by restructuring the project investment through a third State). Where limited treaty protection is in place, that can be enhanced by restructuring or similar steps. As the volume of cross-border construction and engineering projects grows, it is becoming common to structure the projects to benefit from foreign investor protections offered by host States, whether this is carried out during the initial planning stage of the project or during the early lifetime of a project before a dispute arises.