Resource nationalism and other adverse changes in national laws that substantially destroy the value of an investment present a significant business risk to resource-based companies. To guard against such risk, investments must be properly structured at the outset to take advantage of the protections offered by the thousands of bilateral investment treaties1 that exist today.
Signatories to a bilateral investment treaty agree to reciprocal obligations in respect of investments made by nationals of the other country within the host country's territory. Similar obligations are found in some free trade agreements. For example, Chapter 11 of the North American Free Trade Agreement2 contains investment obligations that are nearly identical to the model that Canada currently uses to negotiate new bilateral investment treaties (known in Canada as Foreign Investment Promotion and Protection Agreements).3
BITs provide a stable investment environment that is not dependant on a contractual relationship between the investor and the host country. They protect investors against risks arising from the unilateral exercise of governmental powers by the host country, and enable investors to have recourse against the host country in a neutral arbitration forum.
While investment treaties differ in how they define the "investors" and the "investments" to be protected, as well as the scope of the obligations owed by the host country, the treaties are generally based on a common set of obligations to investors. Canada's model FIPA incorporates the following core obligations:
- National Treatment and Most Favored Nation Treatment: imposes an obligation to treat investors and investments no less favourably than domestic investors and investors of a non-Party.
- Minimum Standard of Treatment: requires treatment of investors in accordance with the "customary international law minimum standard of treatment of aliens, including fair and equitable treatment and full protection and security." Canada's model FIPA specifies that the provision does not require treatment beyond that which is required by "customary international law," a standard which remains uncertain in its scope.
- Performance Requirements: prohibits the imposition of various performance requirements, including those pertaining to domestic content and requirements to export goods produced by the investment.
- Expropriation: prohibits the host country from taking measures that directly or indirectly expropriate/nationalize an investment or have an equivalent effect. The host country may only expropriate/nationalize an investment if the measure is:
(i) for a public purpose
(ii) in accordance with due process of law,
(iii) non-discriminatory, and
(iv) with payment of adequate compensation.
Canada's model FIPA clarifies that an "indirect" expropriation does not require a formal transfer of title or an outright seizure, and is a fact-based inquiry that considers economic impact, the reasonable expectations of the investor, and the character of the expropriatory measure. Non-discriminatory measures adopted in good faith to protect legitimate public welfare objectives generally will not be considered an "indirect" expropriation.
- Transfer of Funds: requires the host country to permit all transfers relating to an investment to be made freely and without delay into and out of the territory.
One of the key benefits of an investment treaty is that it permits the investor to file an arbitration claim for damages directly against the host country, rather than leaving the investor dependant on government to government dispute resolution or the host country's domestic judicial system. BITs normally provide the investor with a choice of venue for arbitration. The International Center for Settlement of Investment Disputes4 was created by the ICSID Convention, which establishes an arbitration system for the settlement of investment disputes. Since Canada has not yet ratified the ICSID Convention, its model FIPA allows for arbitration under the ICSID Additional Facility Rules. Similar to many other BITs, Canada's model FIPA also allows for arbitration under the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL).
Considerations When Making A Natural Resource Investment
The availability of BIT protection should be considered prior to making investment decisions to ensure that the investment is structured to take advantage of the treaties.
A threshold consideration is whether the country of intended investment has one or more BITs in force. The absence of BITs may signal a poor investment climate and higher risk. South Africa's decision last year to terminate its BIT with the Belgo-Luxembourg Economic Unit and to not renew a number of other BITs with European Union countries has shaken investor confidence in that country. Likewise, Venezuela's denunciation of the ICSID Convention and its expropriation of natural resource businesses makes investments in that country high risk. Venezuela's denunciation also underscores the importance of BITs, in that it does not affect Venezuela's consent to ICSID arbitration mandated by existing treaties, such that recourse to the ICSID Convention will still be available for investments covered by existing BITs.
If the host country is a signatory to several BITs, an investor should review the available treaties to consider how to structure the investment to take advantage of the preferred investment treaty. Most BITs give the investor standing to bring a claim for damages caused directly to the investor (e.g. parent company or shareholder), as well as standing to bring a claim on behalf of an enterprise that it has created in the host country (e.g. a special purpose vehicle). However, there is a wide divergence in BITs regarding the extent to which the ultimate investor who is located in a non-Party is permitted to benefit from a BIT by bringing a claim in the name of a related entity located in the country that is a party to the BIT. Some BITs have stringent "denial of benefits" clauses, which exclude investors from the protection of the BIT if the investor is owned by a non-Party and does not have substantial business activities in the territory of the party to the BIT.
The issue of denial of benefits recently arose in Pac Rim Cayman LLC v. The Republic of El Salvador, a multi-million dollar claim brought in part under the Central American Free Trade Agreement,5 arising from El Salvador's refusal to grant extraction permits for the El Dorado gold mine. The ultimate investor in the gold mine is a Canadian company, Pacific Rim Cayman LLC. After the permits had been denied, ownership of the mine was transferred to Pacific Rim's U.S. subsidiary Pac Rim Cayman LLC. The ownership change was motivated at least in part by the investor's intention to bring a CAFTA claim (the U.S. is a party to the agreement; Canada is not). In a ruling issued last summer, an ICSID tribunal dismissed Pac Rim's CAFTA claim on the basis of the "denial of benefits" clause, as the U.S. company had no employees, office space, or bank account at the time the investment was made. Other Pacific Rim companies in the U.S. did have substantial business activities, but ownership had not been transferred to those companies. Notably, the arbitral tribunal rejected El Salvador's argument that the ownership transfer in the midst of the dispute constituted an "abuse of process" due to the continuing nature of the breach, but observed that the structuring of an investment to take advantage of a treaty normally must occur "upstream," before a dispute arises.
If the investor has active operations in more than one country with whom the host country has a BIT, the investor should consider structuring ownership of the investment to take advantage of the most favourable BIT. What will constitute "the most favourable BIT" is fact-dependant. The definition of "investment" within the potentially applicable BITs may present an issue – if the intended investment does not qualify as an "investment" under the treaty, the investor cannot rely upon its protections. Canada's model FIPA defines investment more narrowly than some BITs by specifically excluding certain claims to money and "any other claims to money." By contrast, many other BITs, including some of Canada's older FIPAs, define investment to include"every kind of asset" and "claims to money or any other claim under contract having an economic value".
The choice of arbitral forum must also be considered. Even if the BIT defines the investment as a protected investment, the ICSID Convention imposes an additional requirement that the dispute arise out of an investment "within the meaning of the Convention." The ICSID jurisprudence has generally required the following elements for there to be an "investment": a contribution; a certain duration over which the project is implemented; a sharing of operational risks; and a contribution to the host country's development. If the intended investment would not meet these criteria, it may be preferable to structure the investment to take advantage of a BIT that provides the option to pursue arbitration under the UNCITRAL rules.
The scope of investment obligations agreed to by the host country is another consideration. For example, some BITs include taxation measures within the scope of the obligations, while others specifically exclude taxation. The carve out for taxation measures in the Canada-EcuadorFIPA created difficulties for Canadian oil company EnCana Corporation in its claim for arbitration arising out of Ecuador's refusal to refund $75 million in VAT payments made by the company in connection with its exploration activities. The carve out precluded EnCana from asserting any claims other than expropriation, which was exempt from the taxation carve-out. While the arbitral tribunal held that the claim to the VAT refunds constituted an "investment" capable of being expropriated, it found that Ecuador's refusal to pay the refunds did not constitute an expropriation.
In recent years, Canada has aggressively pursued the negotiation of FIPAs. There are 24 treaties currently in force, 8 awaiting ratification, and another 12 under negotiation. Apart from several ongoing claims by gold mining companies against Venezuela, Canadian-based resource companies have made infrequent use of FIPAs.
The investor-state arbitral provisions within NAFTA have had more use, though most of the claims have been against Canada. In 2012, three new NAFTA claims were brought against Canada by resource-based companies:
(i) Lone Pine Resources Inc. (relating to a Quebec
law that suspended oil and gas exploration),
(ii) Windstream Energy LLC (regarding an environmental moratorium imposed by Ontario on offshore wind projects), and
(iii) Mercer International Inc. (based on denial of access to favourable hydroelectric rates enjoyed by competing pulp mills).
In a decision rendered by an ICSID tribunal last Spring, Mobil Investments Inc. obtained a ruling that 2004 Guidelines promulgated by Newfoundland that required the investor to contribute millions annually to research and development in the province constituted an impermissible performance requirement and therefore violated Canada's investment obligations under NAFTA Chapter 11.
Among the most significant investment-related events in 2012 was the conclusion of the negotiations of the China-Canada FIPA, which awaits ratification. Given the number of resource-based claims under NAFTA, what may prove to be of greater significance is the conclusion of the Canada-European Union free trade negotiations in 2013. Drafts of the agreement include an investment chapter, and a leaked negotiating memorandum reveals that if the EU prevails, the obligations owed to investors will be broader than those found in NAFTA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.