This is the first in a series of articles delivering practical knowledge to international businesses on how to protect capital investments made abroad and what recourse is available when these investments are jeopardized.
Los Angeles, CA (Law Firm Newswire) May 13, 2013 - Your company is international in scope. You conduct business abroad, enter into international business transactions, and make investments in foreign countries. You understand that there are many risks to doing business abroad, especially in developing countries where the legal and political landscape can change quickly. Perhaps you believe that there is nothing to be done about these risks, and that you must simply suffer them as a cost of doing business on an international scale. Perhaps you’ve heard of Foreign Investment Protection as a concept, but think it is not relevant to your particular business, either due to its size or specific activity. Or, perhaps you did not even realize that an international framework of free legal protection exists for businesses like yours that invest abroad.
A Little-Known Safeguard to the Risks of Doing Business Abroad
The term Foreign Investment Protection refers to the proper structuring of a company’s (or individual’s) foreign investments to get the most out of a host of legal protections and guarantees available under an important, but largely unheard-of international legal framework. Given the sustained rise of global inbound and outbound investments, surprisingly few companies think of their international business activities as a foreign investment, much less think about protecting their business as such. Yet, proper Foreign Investment Protection is an absolutely business critical task – as essential as structuring an investment for tax benefits, or choosing the right corporate form for a business. What is more, it is a relatively easy and cost-efficient exercise, especially when compared to the significant risks involved. Indeed, Foreign Investment Protection can be thought of as business insurance for your company’s foreign investments. In this article, we will discuss the basics of Foreign Investment Protection, whether your business qualifies, and how your business can avail itself of such legal protections.
Protection From What, Exactly? The Myriad Dangers of Doing Business Abroad
It’s no secret that companies that engage in business abroad, especially in developing countries, run higher risks due to the political, judicial, economic and legal environments present (or lacking) in these countries. Such a company may expose itself and risk losing its investments due to unanticipated adverse acts by the country (called the “Host State”) where the foreign investment is made.
Adverse acts by a Host State can be extremely broad in range and form; they may be acts or omissions, overt or subtle, intended or unintended. Often, companies do not even realize that a Host State has taken an illegal adverse act against their foreign investment. Examples include:
- The conversion or transfer of a company’s investment assets, such as seizure of a factory, company, or bank assets. This includes expropriation or nationalization of assets, as well as “creeping expropriation” through incrementally adverse Host State actions which, on the whole, amount to an expropriation;
- Unfair, inequitable, arbitrary, or outright discriminatory acts, including, for example: the cancellation or forced renegotiation of contracts by a Host State (or a Host-State entity); cancellation of concessions or licenses, such as import/export licenses; discriminatory regulations or taxes; and a host of other administrative or regulatory actions or inactions that adversely affect a company’s investments in the Host State; and
- Political risks that include, for example, poor or discriminatory government administration, lack of administrative or judicial due process, and other arbitrary government actions.
These examples are not exhaustive by any means. The manner and form of an action or omission that can qualify as an adverse act by a Host State (and that would entitle a qualified foreign investor to Foreign Investment Protection and legal recourse) must be considered on a case-by-case basis.
Your Company May Be Protected Under International Treaties
Notwithstanding (or perhaps because of) these risks, Host States (especially those with developing economies) are eager to attract investors. In order to encourage foreign investment, a Host State may promise to refrain from undertaking adverse acts towards foreign investors, and guarantee fair recourse to those investors for losses incurred as a result of any adverse acts taken.
These guarantees and protections are typically contained in an international investment treaty entered into between two countries, called a Bilateral Investment Treaty (a “BIT”). BITs are legal agreements between two countries that establish such reciprocal obligations and guarantees, in order to encourage and protect foreign investment. (Investment guarantees and protections may also be contained in multilateral treaties between more than two countries, a famous example being the North American Free Trade Agreement, or NAFTA.) There are currently over 3,000 BITs in force worldwide; the United States alone has entered into more than 40 BITs in force that could be relied upon by a qualifying investor. Taken as a whole, BITs provide a dynamic international legal framework of protection for foreign investment.
Practically speaking, these treaties guarantee a level of protection to foreign investors from one country (the “Home State”) who invest in the other country, i.e. the Host State. It is useful to think of BITs as a “Foreign Investor’s Bill of Rights.” Different BITs include different guarantees and standards of investment protection. Some of the most common standards include:
- National Treatment Protection, requiring a Host State to treat a foreign investor no differently than it would treat its own domestic investors.
- Expropriation or Nationalization Clauses, which require prompt payment of adequate compensation for the expropriation or nationalization of a foreign investment. As briefly described above, expropriation includes not only an outright seizure of assets, but also adverse acts that substantially lower the value of a foreign investment;
- Fair and Equitable Treatment (“FET”), a standard which prohibits, at minimum, a Host State from taking arbitrary, discriminatory or fraudulent treatment vis-à-vis a foreign investor. The FET standard is the most common standard of protection that foreign investors invoke when seeking legal recourse for adverse Host State acts;
- Most Favored Nation (“MFN”) Treatment, requiring a Host State to treat a foreign investor at least as favorably as investors from other countries;
- Full Protection and Security, a still-developing standard of protection that includes protection from physical damage to an investment, and that may require protection from harassment even where physical damage does not exist (e.g., lack of due process in the Host State’s court system);
- Umbrella Clauses, which require a Host State to observe all obligations (including contractual or legal obligations) that may apply in a relationship with a foreign investor. For example, a Host State’s breach of a contractual obligations vis-à-vis a foreign investor may be elevated to the status of an obligation under an applicable BIT.
The specific guarantees and protections afforded to a foreign investor depend upon the applicable BIT(s). One of the key benefits of these protections is that they are afforded to foreign investors for free: indeed, your company may already qualify for such protections. The most important step is to recognize that these protections exist; armed with this knowledge, a company can then seek appropriate legal advice on how to best avail itself of such protections at each phase of the investment.
Arbitration Against a Foreign Government: An Essential and Powerful Right
One of the most important protections conferred by BITs is that they enable a foreign investor to (a) seek recourse directly against a Host State for its breach(es) of applicable BIT protections; and (b) to do so before a neutral international arbitral tribunal.
It is hard to understate how important this right is. The ability for a company to bring a claim directly against a Host State is an obvious advantage, especially as other existing legal avenues against a Host State are far and few between. Beyond this, the ability to bring such a claim before an international arbitral tribunal is absolutely crucial, because it is almost always much more effective than bringing a claim before the local courts of the Host State, or through diplomatic channels.
These investor-state arbitrations utilize the same familiar procedures available in international commercial arbitration. They can take the form of either ad hoc arbitrations, or institutional arbitrations under rules promulgated by well-known global institutions such as the International Chamber of Commerce (“ICC”), the American Arbitration Association (“AAA”), the London Court of International Arbitration (“LCIA”), and so on. Many BITs frequently designate that arbitrations will proceed under the rules of the International Centre for Settlement of Investment Disputes (“ICSID”), an arbitral institution run under the auspices of the World Bank that specializes in investor-state disputes.
If a foreign investor is successful in its claim against the Host State, it will receive a judgment that ordinarily takes the form of monetary compensation from the Host State. In the event the Host State does not comply with the judgment and fails to pay the compensation, the foreign investor can enforce that judgment against the Host State in over 140 different jurisdictions worldwide (i.e., wherever the Host State's commercial assets may be found).
The Fine Print: Does Your International Business Qualify as an Investment?
As seen above, strong international legal protection exists for foreign investors. However, not all foreign business activities will qualify for protection. First, you or your company must qualify as an “investor”, as defined in the applicable BIT. An "investor" is usually defined as a national of, or a company incorporated within, a Home State that has entered into a BIT with the Host State where the foreign business is located.
Second, the business carried out in the Host State must qualify as an “investment” as defined under the applicable BIT. The good news is that most BITs define “investment” in fairly broad terms. These can include the following examples:
- Your company has made foreign investments in the Host State in the form of a joint venture or shares;
- Your company has made foreign investments in the form of financing, such as loans, deferred payments, provision of working capital, etc.;
- Your company has made foreign investments in the form of property in the Host State, including such property rights as mortgages;
- Your company has made foreign investments in the form of a construction contract (e.g., for infrastructure projects), or in the form of concessions granted by the Host State (e.g., exploitation of natural resources, etc.); or
- Your company has made foreign investments in the form of intellectual property (patents, trademarks, technical processes, know-how, etc.).
The above list is not exhaustive, and a qualifying "investment" can take many forms, subject to the specific terms of the applicable BIT.
How To Maximize Protection of Your Business and Reduce the Risks of Investing Abroad
Hopefully by now, it is clear that there exists a wide range of protections afforded under international investment treaties, and that there is a potentially large upside in properly positioning your business to benefit from Foreign Investment Protection.
Foreign Investment Protection is best undertaken at the outset of a company’s foray into an international project or transaction. A good law firm with foreign investment experience can offer advice on how to benefit fully from available BIT protections. Indeed, an impending investment can be structured (or a current investment restructured) through “nationality planning.” This involves a thorough investigation into available BITs and their provisions before structuring a foreign investment.
For example, assume you are a US business intending to enter into a joint venture in Indonesia. The US does not currently have a BIT with Indonesia. However, Indonesia does have a BIT with Australia. Your company may be able to benefit from the protections afforded by the Indonesia-Australia BIT by creating an Australian subsidiary to enter into the Indonesian joint venture. Further, in this example, even if a BIT already existed between the US and Indonesia, there might also be a BIT with, say, the United Kingdom, that is more favorable. In that case, it might make sense to create subsidiary in the United Kingdom to enter into the joint venture.
Of course, nationality planning is one of many factors in structuring a project or deal; other concerns such as tax issues obviously play an important role. However, given the inherent risks of foreign investment, a company should always consider Investment Protection in the overall matrix of decision-making at the outset of a transaction or project.
Proper structuring of an investment is subject to the general caveat that once a dispute with a Host State has arisen, it is likely too late to restructure the investment. Of course, very often a company will find itself in an investment dispute without prior investment planning. In such cases, it is still crucial to discuss the issues with experienced counsel, as the investment may yet fall within the protections afforded by a BIT, allowing the company to bring a claim against the Host State in arbitration. Indeed, for companies that make extensive foreign investments, it is good corporate practice to periodically audit these investments to determine whether adverse acts have taken place, and whether potential investment claims exist.
Foreign Investment Protection is poorly understood, if at all, by the vast majority of companies making foreign investments. The relative few companies savvy enough to avail themselves of these protections tend to be very large multinational corporations with sizeable teams of sophisticated in-house and external counsel at their disposal. Yet, Foreign Investment Protection is available to companies of all sizes and activities (as well as individuals), as long as their international business activities qualify as foreign investments. Put another way, an investment loss due to an adverse act need not be in the billions in order to qualify for compensation under an applicable BIT. Further, with the recent trend of specialized boutique international law firms, the legal costs associated with proper investment planning and investment treaty disputes can be drastically reduced. The only remaining difference between a small to mid-cap company and an multinational oil or mining company is awareness of these protections and careful foresight to obtain advice from experienced counsel on how to structure and protect a foreign investment. Going forward, consider yourself and your company armed with that same knowledge.
Eric Z. Chang International Law Firm delivers advice to companies on Investment Protection issues and disputes. Foreign Investment Protection is a complex field and it is often difficult to determine whether an international business qualifies for such protection. The firm therefore provides complimentary initial assessments as to whether a company is eligible to benefit from Investment Protection, and/or has a viable investment treaty claim for adverse acts taken by a Host State. Managing partner Eric Z. Chang can be reached by filling out the firm’s Contact Form, by calling +1(415)300-0576, or by e-mailing [email protected]
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