Structuring project finance to maximise protections under BITs

Many large projects are realised through involvement of international stakeholders, whether via financing, construction and operations or ownership. Given the significant capital invested, foreign investors often seek to structure projects so as to take advantage of protections offered by investment agreements, and in particular bilateral investment treaties (BITs), in order to protect against adverse actions by the state in which they are investing.

Investors should forward plan to take advantage of any BIT, or other investment agreement, and this article seeks to assist with that planning by explaining the nature and scope of the investment protection offered by BITs and importantly, how foreign investors can seek to structure (or restructure) a project financed transaction to take advantage of BITs to protect themselves from in-country risk.

Key points

• An investor may choose to structure its investment via an intermediary company in a jurisdiction other than its own in order to take advantage of the protections offered under particular investment agreements or BITs.
• This may be necessary where there is no appropriate BIT or investment agreement between the investor’s “home” state, and the state in which the investment is made. In such circumstances, investors may invest via an entity which has the requisite nationality so that this entity may bring a claim under the relevant BIT or agreement.
• Investors may also seek the protection of multiple investment agreements or BITs by structuring an investment with layers of shareholdings in various jurisdictions and seeking protection via those indirect shareholdings.

What is a BIT?

A BIT is an agreement entered into between two states which governs the reciprocal treatment each “host state” will afford investors of the other state (home state) when investing in its jurisdiction. BITs generally operate so as to allow foreign investors to bring a claim directly in international arbitration against the host state in the event that the host state breaches its obligations under the BIT. In this way, they offer protection to foreign investors against adverse actions of the state in which their investment is made.

Each BIT is unique and will offer varying levels of protection to investors and apply differently to individual investment structures. There are around 3,000 BITs in force, and it is, therefore, important for any investor wanting to rely on the protection of a BIT to identify: which BIT might apply to their investment; whether their investment will fall within the scope of that BIT; and, what protections are offered.

There are often other investment agreements in place which may also be available to foreign investors. These include multilateral investment treaties (MITs), co-operation agreements and other trade agreements entered into between states with investment chapters. The broad principles set out in this article apply equally to these agreements.

What protections are offered?

Protections offered under BITs vary. Traditionally, BITs encompassed a wide range of protections. Recently, however, there has been a trend toward curtailing the protections provided to investors due in part to a perception that there has been an overly investor-friendly approach from arbitration tribunals in determining BIT claims. Whether this perception is supported by empirical evidence is debatable, but what this has meant is that investors need to be alert to jurisdictions which might be limiting their BIT protections when structuring their project.

By way of example, the Netherlands recently developed a new model BIT which is less favourable to investors than its predecessor and is renegotiating its existing BITs. Various states, including Ecuador, Bolivia, India, South Africa and Indonesia have either terminated existing BITs or have not renewed those which have expired.

It is important to note that where BITs have been terminated, they may continue to protect investments after termination by operation of ‘sunset clauses’ intended to provide investors with a reasonable expectation of certainty (protection for 10-15 years post-termination is not unusual).

Protections typically offered under BITs include:

• protection from expropriation without compensation;
• fair and equitable treatment;
• full protection and security;
• free transfer of investment and returns;
• most favoured nation provisions;
• national treatment provisions; and
• an umbrella clause which acts to guarantee that the host state will observe any contractual obligations with regard to an investment by the foreign investor.

As stated above, the precise protections offered however depend upon the terms of the particular BIT. It is, therefore, important for an investor to consider each potentially relevant BIT separately and ensure that the protections offered suit their particular investment. Investors should be aware of jurisdictions which might be susceptible to changing their investment policies and to ensure that any BIT relied on is still in force.

Structuring a project to take advantage of investor protections

For recourse under a BIT, the following must be established: (i) an investment treaty must exist between the host state and the investor’s home state; and (ii) the investor must be eligible to make a claim under the treaty by establishing that it is an “investor” of an “investment” pursuant to that treaty.

The application of a BIT can be straightforward in situations where State A and State B have an agreed BIT in force and an investor from State A invests directly in State B, meeting the definitions of both “investor” and “investment” without the need for more complex structuring.

The application of a BIT may not be as straightforward, however, in the following situations:

• a State A investor wants to invest in State B but a BIT does not exist between State A and State B;
• a State A investor wants to invest in State B, a BIT exists between the two States, but that BIT does not contain adequate protections for the investor; or
• a domestic investor seeks the protections 

given to foreign investors under a BIT its own home state has with other states.

In such circumstances, an investor will have to look for an indirect investment path in order to take advantage of the BIT on which it wishes to rely. BITs can in principle offer protection in these circumstances, although careful analysis of the definition of “investment” and the definition of “investor” is required.

Who is considered an "investor"?

Who is considered an “investor” will depend upon the definition under the relevant BIT. Ordinarily, an investor must qualify as a national of the “home” state. For many BITs, incorporation of a company in the relevant state is sufficient. Other BITs might, however, be more restrictive and, for example, require that the company is headquartered as well as incorporated in the relevant state, or, as in the new Netherlands model BIT, the investor must have “substantial business activities” in their home territory. It is, therefore, important to read the definition of “investor” in the applicable treaty carefully when structuring BIT protection.

In circumstances where the investor is not a national of the “home” state party to the BIT on which it wants to rely, one of the most common ways to structure the project is by investing via an entity which does have the requisite nationality so that this entity can bring a claim under the relevant BIT. If done carefully, this method of structuring can permit reliance on a BIT.

Investors do, however, need to be careful if choosing this way to structure their projects. Some BITs include “denial-of-benefits clauses” which are intended to prevent the nationals of third states from seeking to benefit, via shell companies, from provisions that the states party to the treaty did not intend to allow. Denial-of-benefits clauses also prevent domestic investors (ie nationals in the “host” state) from seeking to benefit from BIT protections by incorporating “mailbox companies” in order to claim against their “home state”.

Such a clause was successfully invoked by Bolivia to challenge the entitlement of a US entity to rely on the US-Bolivia BIT where the relevant entity was controlled by nationals of a third state. Bolivia successfully argued that the entity of the third state: (i) was not controlled by the company within the US; and (ii) did not have substantial business activities in the territory of the US to permit the US entity to bring a claim under the BIT.

What will amount to “substantial business activities” was addressed by the tribunal in Limited Liability Company AMTO v Ukraine. The tribunal said that business must be “of substance” rather than “of form” and that “substance” related to the “materiality and not the magnitude of the business activity”.

If a denial-of-benefits clause does not exist, tribunals will not imply one on the basis that if the parties had intended for a denial-of-benefits analysis to apply they would have included this explicitly in the BIT.

What is considered an "investment"?

Crucially, in order to be protected by a BIT, the investment itself must fall within the definition of “investment” under the relevant BIT.

Most BITs contain a broad definition of investment. Usually, “investment” is defined as “every kind of asset”, which is then followed by a list of “particular” assets which fall under such definition. Companies are advised not to place too much reliance on “every kind of asset” but rather scrutinise the list that generally follows. That list usually includes:

• movable and immovable property as well as related rights such as mortgages, liens and pledges;
• shares of companies and other kinds of interest in companies (which usually covers debt and equity investment);
• title or claims to money which have been used to create an economic value or claims to any performance having an economic value;
• intellectual property rights, which may include trademarks, patents and copy-rights. In some investment agreements this also includes “goodwill”, “technical processes” and “know how”; and
• business concessions under public law, including concessions to search for, extract and exploit natural resources.

A common way investors structure projects to secure protection from investment treaties is to have layers of shareholdings in various jurisdictions. This has been a successful way of widening the range of possible “investors” as tribunals have traditionally extended the interpretation of “investment” to include indirect shareholdings through an intermediate company or even to allow claims from the ultimate beneficial owners of a corporate structure.

An example of this might be an energy-from-waste plant in France with the ultimate parent company investor incorporated in Mexico. The parent company chooses to funnel its investment through a subsidiary company in Malta and another subsidiary company in Trinidad and Tobago. Each of Mexico, Malta and Trinidad and Tobago has a BIT with France which allows for protection in relation to indirect shareholdings. This means that if a dispute were to arise, the company potentially has three different BITs at its disposal in order to pursue a claim against France.

Companies looking to structure projects around BIT protection through layers of intermediary companies should, however, pay particular attention to the treatment of shareholdings under the definition of investment. As mentioned above, traditionally tribunals have extended the meaning of shareholdings to include indirect shareholdings and France’s model BIT explicitly includes indirect shareholdings. In 2012, however, an ICSID Tribunal in Standard Chartered Bank v United Republic of Tanzania denied standing to an indirect investor, finding that protection under the relevant BIT required that an investment be made by, not simply held by, an investor.

The Tribunal in this case had to interpret whether a loan held by a subsidiary might be considered an “investment” of the claimant. The relevant BIT defined “investment” to mean:

“... every kind of asset admitted in accordance with the legislation and regulations in force in the territory of the Contracting Party in which the investment is made and, in particular, though not exclusively, includes: ... (ii) shares in and stock and debentures of a company and any other form of participation in a company ... .”

The Tribunal concluded that, as the definition included the words “investment is made”, the claimant had to demonstrate that the investment was made at the claimant’s direction, so that the claimant funded the investment or controlled the investment in an active and direct manner. Passive ownership of shares in the investor company, which is not controlled by the claimant, was not sufficient.

Although this case is seen as somewhat of an anomaly and turned on the particular wording of the BIT and the facts of the case, it does serve as a warning for investors. As a general rule, when structuring a transaction so as to benefit from the provisions of a BIT, it should be borne in mind that the less direct an entity’s involvement in the management and control of the investment asset, the greater the risk that an investor might not have jurisdiction under a BIT.

Some BITs specifically include “indirect shareholdings” in the definition of investment. If, however, an indirect shareholding is not explicitly included within the definition of investment, there is a risk that any claim brought by way of an intermediary company will not succeed, depending upon the circumstances.

ICSID Convention

Most BITs provide for any disputes to be heard by arbitration and a vast number of BITs provide for the application of the International Centre for Settlement of Investment Disputes (ICSID) Convention (Convention).

If a BIT does refer to the Convention, an investor will not only need to satisfy the requirements under the BIT but it will also need to satisfy the separate criteria of “investor” and “investment” under the Convention.

To be considered an “investor” one needs to have the “nationality” of the relevant state. “Investment” is not defined, and tribunals are somewhat divided on what criteria must be met. It is generally accepted that the following are likely to be needed to qualify as an investment:

• a substantial duration;
• a certain regularity of profit and return;
• an assumption of risk; (iv) a substantial commitment of money; and
• be of significance for the host state’s development.

Other factors which have been considered include:

• were the assets invested in accordance with the laws of the host state; and
• was the investment made in good faith?

Tribunals have said that these criteria are not mandatory. However, it is generally advisable that investors take them into consideration if they are seeking to rely on a BIT which provides for ICSID arbitration. Generally, this means that short term contracts such as one-off sales contracts or supply contracts will not qualify as investments.

Timing

Structuring a project in order to gain BIT protection does not always happen at the time the investment is made. Restructuring a project is possible, however, investors need to be careful as to when such restructuring takes place. If 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, a tribunal might consider the circumstances of the restructure an abuse of process and deny treaty protection.

This was the case in Philip Morris Asia Ltd v The Commonwealth of Australia, where Philip Morris Asia, a tobacco company, carried out its restructuring with a view to challenging forthcoming Australian legislation which would require cigarettes to be sold in plain packages. While noting that the mere fact of restructuring to gain investment treaty protection was not illegitimate per se, the timing of that restructuring saw the claim dismissed for abuse of process – the key point being that there was a reasonable prospect that a measure which might give rise to a treaty claim would materialise at the time of the restructuring and this had motivated it.

It is, therefore, advisable for companies who want to restructure in order to take advantage of a BIT to do so well in advance of any dispute.

Conclusion

There are many issues to consider when structuring a project to take advantage of BITs or other investment agreements and, if done properly, the protections offered can provide valuable protection to foreign investors. It is advisable when considering how to structure such investments to think not only about the legal consequences, but also any tax implications. BIT protection may also form part of a package of risk management measures, including political risk assurance or direct host state guarantees.

The authors would like to thank Ghislaine Lawless for her assistance with this article.

This article was first published in the February 2020 issue of Butterworths Journal of International Banking and Financial Law.