Protecting foreign investment from political risk
Funds Law Update | June 2009
Protecting foreign investment from political risk
RICHARD J. HAY (rhay@stikeman.com) AND LEIGH NICOLL (lnicoll@stikeman.com)
International law permits countries to exercise complete control over persons and
property within jurisdictional reach. Given this rule many investors are surprised to
learn that tools for managing governmental risk can be inexpensively incorporated
into acquisition plans for potentially exposed assets.
This note reviews the use of investment protection agreements to reduce risks to
assets posed by rogue governments. These treaties are the key asset protection
strategy for international investment in emerging markets.
Investment protection agreements
The world has approximately 2,500 investment protection agreements designed to
safeguard the rights of cross-border investors against capricious government
interference. Emerging market countries in Latin America, Eastern Europe, Asia and
Africa – the main risk areas – generally participate actively in the treaty networks.
Bilateral investment protection agreements restrain, in reciprocal undertakings,
government actions which prejudice the rights of protected investors through the
exercise of governmental powers in an arbitrary fashion.
The treaties establish conduct and process standards for treatment of foreign
investors with explicitly enumerated protections for covered nationals. Where the
protections for invested assets are not observed foreign investors can arbitrate
against the host contracting state and secure enforceable compensation.
Investment protection agreements are mechanically similar to tax treaties. They are
negotiated and concluded on a government-to-government basis, conferring direct
benefit on private sector parties. Investors established in a country lacking an
investment protection treaty with the target investment state can also benefit by
structuring indirectly through a country which enjoys treaty protection.
Investment protection treaties follow a general pattern though they vary in subtle
but significant respects. Selection of the most favourable treaty will depend on a
number of factors, including:
– treaty definitions and restrictions, including those in any ancillary agreements
or protocols between the governmental parties;
– availability of most favoured nation protections and the implications under
related agreements;
– tax planning considerations in the contemplated investment structure;
– availability of treaty protections where the protected investor holds the target
assets indirectly; and
– prescribed formalities in the arbitral and compensation process, including
compliance with pre-conditions in asserting claims.
Available protections
Compensation rights under investment agreements arise in the event of:
– discriminatory expropriation;
– forced sale of property to the government at an undervalue;
– government imposition of foreign exchange controls inhibiting extraction of
profits or proceeds;
– licence cancellations or alterations to government concessions without due
process; and
– interference covered by expanded protections under "most favoured nation"
provisions.
Dispute resolution
Arbitrations are organised under the auspices of an international tribunal, generally
under UN rules or those of the International Centre for Settlement of Investment
Disputes (ICSID) supported by the World Bank. Investors are able to pursue claims
directly against the host jurisdiction in the event of breach without the requirement
for intervention or support by their home country government. Conduct of the
arbitration and enforcement process takes place entirely outside the host
jurisdiction for the investment.
Arbitration under an investment treaty is expensive and time consuming and
accordingly is most appealing when the investment is substantial. However, a claim
to such treaty protection is always a valuable bargaining chip in any negotiation and
often leads to favourable settlement without the need to litigate.
Enforcement
Compensation awarded by the arbitral tribunal is generally enforceable against the
commercial assets of the defaulting government in more than 160 countries
worldwide pursuant to the 1958 United Nations Convention on the Recognition and
Enforcement of Foreign Arbitral Awards. Arbitration and enforcement rights are
typically unaffected by cancellation of a treaty after rights have accrued. Specific
performance rights are unusual but are occasionally available.
Commercial applications for investment protection treaties
A number of claims have been brought recently in the Latin American context, in
particular, in Venezuela, Argentina and Bolivia.
This planning is particularly attractive for assets prone to government interference
such as natural resources, infrastructure and real estate. In today’s risk averse
environment investment protection agreements are also increasingly attractive to
protect pension and mutual fund investments. Protection under investment treaties
is generally inexpensive to implement and does not involve the ongoing costs
required to maintain insurance cover.
Using these treaties, political risk can often be effectively reduced in a discreet
fashion, leaving investors free to concentrate on the commercial attractions of
proposed foreign investment.
