Mitigating cross-border investment risk through investment treaty protections

By Joshua Paffey - Head of Arbitration & Natasha Suhadolink - Partner

With almost unprecedented levels of undeployed capital presently sitting as dry powder within companies and financiers across the world, international cross-border investment will form an almost inevitable component of the near to mid-term investment strategy for many investors.

But with a confluence of geopolitical trade tensions and the extraordinary use of pandemic-driven sovereign power, international investment – particularly in long-term capex-intensive projects – has never been riskier.

The risks of cross-border investment to investors are manifesting globally in a variety of ways. Authorities of the host country may assert their sovereignty against the investor’s contractual rights or adopt measures that otherwise impact the economic viability of the investment. Unlawful expropriation is an extreme example of that but there may be less overt ways in which government action can deprive a company of the economic use of its rights or the value of its assets – from withdrawals of industry subsidies, to discriminatory denials of permits required to conduct operations or arbitrary criminal proceedings against the company’s personnel, to name but a few examples.

When this occurs, recourse before a foreign country’s domestic courts may not provide a meaningful remedy for a range of reasons including a perceived lack of judicial independence and impartiality, an absence of adequate protections under the local laws and the application of sovereign immunity rules.

Australian companies and shareholders can reduce the risk of operating overseas by ensuring that their activities benefit from protections available under investment treaties.

Investment treaties are international agreements concluded between two or more countries which protect qualifying investors (from one country) against certain types of government conduct (in the other country). They include treaties that are dedicated exclusively to the protection of foreign direct investments (often called bilateral investment treaties or ‘BITs’), as well as free trade and other trade liberalisation agreements that include investment protection provisions. Today, there are over 3000 investment treaties in force worldwide and Australia is a party to several dozens of them, including with countries such as Indonesia, the Philippines, Papua New Guinea and Peru where significant Australian assets are located.

Investment treaties offer substantive and procedural protections. Substantive protections typically guarantee that the investor’s rights will not be nationalised or expropriated (either directly or indirectly) without just compensation, that the investor will not be treated less favourably than comparable domestic and other foreign investors or subjected to discriminatory, grossly unfair or arbitrary treatment, and that the investment will be protected from harm by government and private actors. Treaties may also contain other substantive guarantees, like the right to a free transfer of profits in and out of the host country. They may even protect the investor’s legitimate expectations about future matters that may come to impact the investment. These protections can restrict arbitrary conduct by host countries in the form of new laws and regulations or the application of the existing laws in a way which affects the value of an investment.

Apart from the substantive protections, many investment treaties offer important procedural advantages. They may enable the investor to claim damages, including lost profit, from the host country for alleged treaty breaches in front of a privately appointed, independent and depoliticised panel of arbitrators, without needing to resort to domestic courts first. Moreover, unlike under most domestic law systems, a claim for damages for losses sustained in respect of an investment may be made by the company’s shareholders, sometimes several levels up the corporate chain.

In this way, investment treaties can be a powerful tool for companies and shareholders wishing to reduce risks to their foreign investments. If an investment is impacted by conduct of the host state’s authorities, they can – and often do – provide leverage when negotiating with foreign governments, and if a settlement cannot be reached, recourse to an international tribunal may result in an award of damages enforceable against the host country in a range of jurisdictions where the country holds assets.

However, to benefit from investment treaty protections, investments must be structured in a way which enables access to the most favourable treaty. While a number of treaties contain similar broad guarantees, we increasingly see differences among more recent species of investment treaties. Some limit access to investor-state arbitration to claims for breaches of distinct treaty guarantees only, such as expropriation, or even exclude investor-state arbitration entirely. Others might exclude certain types of investments or investors from their scope, and some contain specific provisions that preserve the host country’s right to regulate in certain areas, even if to the detriment of the investor. Some have begun to impose obligations on investors.

The foregoing underscores the need to understand the full range of investment treaties that may be available to de-risk foreign investments. Without careful corporate and transaction structuring, Australian companies and shareholders may only able to benefit from a limited number of treaties to which Australia is a party. Where there is no investment treaty between Australia and the host country of the investment, obtaining the most favourable treaty protections may require the investment to be channelled through a corporate entity of a third country with which the host country of the investment has concluded an investment treaty, offering a greater degree of protection to the investor and allowing disputes to be resolved in a binding dispute settlement process. Maximising treaty coverage may even require spreading the chain of ownership across a number of different jurisdictions so that a larger number of investment treaties can potentially be available.

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It is important to bear these matters in mind early in an investment’s cycle. Restructuring after a potential dispute has arisen may be treated as ‘abusive’ and may ultimately disallow the investor(s) from relying on a treaty’s protections. To de-risk operations by reference to investment treaty, corporate, transactional and operational structuring must be considered prior to the time of making an investment.

Published 6 October 2021