Investing in infrastructure?

Global investment in the infrastructure sector is on the rise, increasing at an average annual growth rate of 2.9 per cent, and with the global need for infrastructure investment reported to be likely to reach $94 trillion by 2040¹.

However, we live in an uncertain world, where the risk landscape for international investors, including in the infrastructure sector, has seldom been as challenging. Political and economic risk factors such as Brexit, import restrictions in the Middle East, the US-China "trade war" and the high profile use of financial sanctions are the daily fodder of the financial press.

It is perhaps because of the volatile political landscape that the number of investment treaty claims against states relating to construction and infrastructure projects is on the rise – the International Centre for Settlement of Investment Disputes ("ICSID") reported earlier this year that construction and infrastructure disputes represented 41 per cent² of the 55 new cases registered with it in 2018.

International investors are well advised to know about the protection offered by investment treaties, no matter whether the location of their investment is in a traditionally stable jurisdiction such as the UK or a country with a track record of political instability. However, this need to ensure investment protection comes at a time when investor-state dispute settlement (ISDS) is subject to increasing public criticism, giving rise to a shifting landscape in the nature and extent of the investment protection available. So, investors also need to know the potential limitations of the protection available.

This article considers some of the key global developments which have the potential to impact foreign investors, and the extent to which investors can mitigate against such risks by restructuring their investments to take advantage of investor protection rights and guarantees available under existing bilateral and multilateral investment treaties.

Traditional investor protection

Foreign investors have long sought to structure their investments so as to take advantage of the investor protection provisions included in bilateral and multilateral investment treaties.

Bilateral investment treaties (BITs), are public international law agreements whereby two states agree to provide reciprocal guarantees and protection for investments made by foreign investors within their jurisdiction. States typically agree that foreign investors and their investments will be afforded fair and equitable treatment, freedom from discrimination (judged against the treatment that the host state provides to both domestic investors and investors from third states), and protection against expropriation without adequate compensation. Multilateral investment treaties (MITs) often provide similar guarantees, but have three or more state signatories.

BITs and MITs typically provide investors with a direct means of enforcing their rights by allowing them to commence arbitration proceedings against the host state. This is particularly valuable as it dispenses with the requirement for a separate arbitration agreement between the investor and the state.

The type of arbitration provided for in BITs and MITs varies, but arbitration under the rules of the International Centre for the Settlement of Investment Disputes (ICSID, a World Bank entity), the Stockholm Chamber of Commerce (SCC), or the United Nations Commission on International Trade Law, (UNCITRAL) is common. Those rules typically provide for hearings to be held in private, and there is little public disclosure of details about the case, the parties' respective positions, and any awards rendered, although there have been a number of steps in recent years to promote transparent arbitration of investment disputes. There is also little scope for the parties to challenge or appeal unsatisfactory awards, which are enforceable globally under either the New York Convention or the Washington Convention (in the case of ICSID awards).

Importance for infrastructure investment

Infrastructure projects, which are typically long-term investments, will inevitably be exposed to a risk of policy changes over the life of their development. Those risks can be difficult to foresee at the time of initial investment. Brexit is a good example of such risks – even now there is no certainty as to what form Brexit might take.

Structuring (or restructuring) investments in the infrastructure sector so as to ensure treaty protection can be an effective way to manage the risks that can arise during the life of a project for several reasons, including the fact that:

• in case of expropriation, investment treaties typically require the payment of prompt, adequate and effective compensation. The purpose of compensation under international law is to "wipe out all the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed."³  This is a standard that is frequently applied by investment arbitration tribunals and may be higher than the compensation that would be available to an investor under national law;
• investment treaties also offer other protection that may not be available under national law (such as fair and equitable treatment and protection against measures that have an effect that is tantamount to expropriation). This means that the host state will not be able, without potentially attracting liability, to introduce measures (such as fiscal measures) which would destroy the value of an investment but would not be considered as expropriation as the investment has not been confiscated;
• investment treaties exist outside of national legal systems, which means that a new government (which may not share the policy objectives of its predecessor) will be unable unilaterally to alter the terms of the treaty, although it may be able to terminate it; and
• however, treaties normally contain "sunset clauses" that operate to continue to extend treaty protection for a period of time after termination, typically for 10 to 15 years.

In addition to providing recourse to international arbitration (should disputes arise), investment treaties can also be used as a means of lobbying host states against adopting adverse policy changes. The threat of potentially public arbitration proceedings (with the added risk of a significant damages claim) can be a significant deterrent.

The changing landscape

Over the past decade, there has been a significant increase in the number of claims brought by foreign investors against the states hosting their investments. Many of those claims have been against emerging economies with stretched budgets, and in respect of politically controversial projects. They have frequently resulted in states being ordered to pay hundreds of millions, if not billions, of dollars in compensation to multinational corporations. Many of those claims have arisen in the oil and gas, power and renewables industries. 

Much has been written both in the press and in academic journals condemning ISDS. Critics have derided ISDS for amounting to "hotel room justice", where arbitration hearings in politically charged cases take place in private, away from public scrutiny, in the conference rooms of luxury hotels. Having once justified such treaties as a means of encouraging foreign direct investment, a number of states are finding it difficult to quantify the economic benefits realised and to justify to their own citizens the benefits of remaining a party to BITs and MITs in their current form.

This fresh look at BITs and MITs is leading to policy decisions and legal, regulatory and political reform which could, in turn, adversely impact foreign investors. In May 2018, the United Nations Conference on Trade and Development issued a report noting that investment treaty making had reached a "turning point". It noted that the number of new investment treaties concluded in 2017 was the lowest since 1983 and that, for the first time, the number of effective treaty terminations outpaced the number of new treaties.

Changes in Europe

In Europe, it is perhaps in part because of such growing public scrutiny that the European Commission has taken steps itself to condemn bilateral investment treaties. In June 2015, the European Commission commenced infringement proceedings against Austria, the Netherlands, Romania, Slovakia and Sweden, asking them formally to denounce their intra-EU BITs (BITs concluded between EU member states) on the basis they were incompatible with EU law.

In March 2018, the European Court of Justice (ECJ) handed down its decision in the Achmea case⁴. That case concerned a Slovak-Dutch BIT, which had been invoked by the Dutch investor against the Slovak Republic in response to the Slovak Government's decision to change its health insurance legislation. The ECJ held that the BIT violated EU law because it infringed the ECJ's role as the final arbiter of EU law (as it permitted the investor to commence international arbitration proceedings in respect of disputes arising under the treaty, which would in turn involve an international tribunal determining matters of EU law).

Following that decision, in January 2019, all 28 EU Member States agreed to terminate their intra EU BITs. 21 Member States also declared that they would inform investment arbitration tribunals (whether constituted under BITs or under the Energy Charter Treaty – a MIT to which the EU itself is a contracting party) of the decision in Achmea and would request courts to set aside or refuse to enforce investment arbitration awards arising from an intra EU BIT. There have already been instances of EU courts refusing to enforce intra-EU investment treaty awards.

Treaty termination

The problem is not confined to Europe. A number of states have sought to amend their BIT and MIT obligations in recent years. Following up on his campaign promises, the current US President has succeeded in having signed the United States–Mexico–Canada Agreement (which is yet to be ratified by all 3 countries), which will eventually replace the North American Free Trade Agreement (NAFTA), the MIT that has regulated trade between Canada, Mexico and the US for around 14 years.

NAFTA is only one of the MITs to fall foul of Mr Trump's protectionist policies. The US withdrew from the Trans-Pacific Partnership (a MIT which would otherwise have involved countries responsible for 40 per cent of the world's economic output) in January 2017, with the remaining state parties continuing with the agreement but narrowing the ISDS provisions.

The US is not the only state looking to reduce the scope for investors' claims against it. A number of Latin American states, as well as India and South Africa, have terminated their BITs in recent years, many as a result of substantial arbitral awards obtained by investors against them. Some states, including Bolivia, Ecuador and Venezuela, have gone a step further and withdrawn from ICSID altogether⁵. The Netherlands has also published a new model investment treaty, which significantly restricts the protections afforded to investors under Dutch BITs. The Dutch Government intends to use the draft treaty to renegotiate its existing BITs with non-EU states.

Protectionist policies

Even in those states where treaties remain in place, the position remains uncertain for foreign investors. States are displaying increased reluctance to enter new treaties and to renew treaties that are due to lapse. Some have sought to amend their model treaties to "water down" the investor protection obligations they will take on in the future. India, for example, now requires investors to exhaust all local remedies before commencing arbitration proceedings (meaning that any foreign investment dispute will need to originate in the Indian courts, and thus that investors will be significantly delayed in getting their dispute before an international tribunal).

All of this presents a significant degree of uncertainty and unforeseeability for investors. Despite this, infrastructure projects will continue to attract investment as they offer the possibility of significant and stable returns (China's Belt and Road Initiative, for example, is expected to result in investments of more than £760 billion across three continents and over 60 countries). But the uncertain climate does raise important questions such as will investments currently benefiting from investor protection guarantees continue to do so in the future? Will the standards and level of protection currently offered remain the same? Is the level of protection likely to change in the future?

None of these questions can be answered with any degree of confidence. It simply is not yet clear exactly how the landscape will change and what the impacts of such change will be. What is clear is that we have entered a new period fraught with uncertainty. Investors are best advised to find out whether they are currently covered by investor protection and, if not, to consider whether they may be able to restructure their investments to ensure protection.

Investor protection – is restructuring an option?

One issue for consideration by foreign investors who do not currently have the benefit of treaty coverage (or who have treaty coverage that is likely to be eradicated or "watered down" in the near future) is whether the investment can be restructured so as to ensure appropriate treaty coverage in the future. For example, with the termination of intra-EU BITs, how can foreign investors revisit the nationality of their investment vehicle in order to secure the nationality of a state that retains appropriate treaty coverage with the host state?

Whether restructuring is necessary and appropriate will depend upon the foreign investor's current rights and how they are likely to change in the future. Most BITs do not expressly prohibit the restructuring of investments to gain treaty protection. Indeed, it has been held that the restructuring of investments through a holding company in a third country in order to gain treaty protection against a breach of rights by the host state authorities is a "perfectly legitimate goal as far as it concern[s] future disputes"⁶ and that "corporate groups are routinely restructured for a variety of reasons"⁷.

The key point is that treaty protection will be secured only where the restructuring was motivated by an aim to obtain such protection in respect of "future disputes". Arbitral tribunals have used the "abuse of rights" doctrine to decline to consider investment treaty claims where the restructuring has been motivated wholly or partly by a desire to gain access to investment protection in circumstances where a specific dispute exists or is foreseeable.

Most notably, in the Philip Morris case⁸, the Australian Government succeeded in arguing in its defence that the Philip Morris tobacco company had restructured its investment (so as to route it through Hong Kong) primarily for the purpose of gaining access to the ISDS provisions in the Hong Kong-Australia BIT once it became likely that tobacco plain packaging laws would be introduced, which it would want to dispute. As a result, the Tribunal held that Philip Morris was not entitled to rely upon the investment protection standards set out in the Hong Kong-Australia BIT.

Philip Morris is not the only case on the topic. Other tribunals have also provided guidance on the extent to which a restructured investment will be subject to investment treaty protection. The key question is whether the dispute was in existence or foreseeable at the time of the restructuring. If there was a very high probability of a specific future dispute, and not a mere possible future controversy, the restructuring to take advantage of a specific treaty will likely be held to constitute an abuse of rights.

While there is no system of binding precedent in public international law, publicly available investment treaty awards are often considered persuasive, if not de facto precedent. Together with the increased public scrutiny to which ISDS is subject, it is likely that arbitral tribunals faced with claims by companies that have restructured their investments will give careful consideration to the reasons underpinning any such restructuring and the abuse of rights doctrine.

What next?

Foreign investors should think carefully about their existing investments in infrastructure projects as well as any new commitments under consideration now or in the future. They should consider whether those investments are at risk. Do they currently benefit from treaty protection? Is legislative change likely in the future which will impact the investment? Is the investor reliant upon protective measures set out in a treaty that may now be considered unenforceable, or which may be terminated, in the future?

Restructuring may allow investors to position their investment under the protective umbrella of a different BIT or MIT, but they may fail in subsequent attempts to seek redress from the state hosting their investment if they restructure for the sole or dominant purpose of securing rights against the host state to pursue a foreseeable dispute. Early consideration of the factors likely to impact a foreign direct investment, and a careful approach to any restructuring, will be crucial if investor protection rights are to be preserved. Therefore, if restructuring is considered necessary, it should be conducted in a timely manner, long before any specific dispute arises or becomes likely. Properly documenting the reasons for the restructuring will also be key.

Being aware of the protection that exists under international investment treaties may also provide investors with a means of seeking assurances from the state, and/or of lobbying host state governments to reconsider intended policy. Either way, early legal advice should be sought to ensure that the steps taken do not undermine the investment and to ensure that the investor is properly able to seek redress against the state should it need to do so.

1.  Global Infrastructure Outlook: Infrastructure investment needs 50 countries, 7 sectors to 2040, Oxford Economics, 2017.

2.  Comprising construction (14%), Water, Sanitation & Flood Protection (2%), Electric Power & Other Energy (20%) and Transportation (5%). See: The ICSID Caseload - Statistics (Issue 2019-1).

3.  Case concerning the Factory at Chorzów (Germany –v- Poland), Jurisdiction, Judgment, 26 July 1927, P.C.I.J., Series A, No. 9.

4.  Case C-284/16, Slovak Republic -v- Achmea BV, Judgment of the court on 6 March 2018.

5.  For more on the implication of states terminating their investment treaties, see "Is the sun setting on BITs", published in our International Arbitration Newsletter in December 2017. 

6.  Mobil –v- Venezuela (ICSID Case No. ARB/07/27) (Decision on Jurisdiction).

7.  Philip Morris Asia Limited –v- The Commonwealth of Australia (PCA Case No. 2012-12) (Award on Jurisdiction and Admissibility).

8.  Ibid.