Protect Outbound German Investment Through Bilateral Investment Treaty Planning

Executive Summary

• Making long-term investments in jurisdictions outside the EU in sectors that are heavily regulated by local and federal governments brings commercial and political risks, especially where those foreign investments are long-term and require significant up-front capital. 
• Germany has enacted over 100 bilateral investment treaties (“BITs”) designed to protect outbound German investment. These BITs usually protect direct shareholders in the underlying investment, as well as indirect (intermediary) shareholders, ultimate beneficial owners, and lenders. 
• BITs give investors significant international law protections, including protecting against unlawful expropriation, and requiring host States where the investments are made to treat the investments fairly and equitably and in a non-discriminatory manner both vis-à-vis local (national) investors and investors from other States. Additionally, many BITs give investors the right to arbitrate their disputes privately against the host State, instead of being forced to litigate in local courts that might favor the host State government. 
• German investors investing outside of Germany should therefore consider the benefits of structuring their investments to take advantage of BITs that Germany has ratified with host States all over the world. Where a German BIT is not in force, either because it has been terminated or was never ratified by either party, then investments may be made through a Special Purpose Vehicle (“SPV”) incorporated in a jurisdiction that has ratified a BIT with the target State of the investment. For example, Luxembourg, home to many investment funds, has 60 BITs currently in force. 
• Additionally, German investors investing outside of Germany but within the EU can consider routing their investment through an SPV incorporated outside the EU. The CJEU, German courts, and the European Commission have taken the position that intra-EU disputes under bilateral or multilateral investment treaties brought by investors of an EU Member State against an EU Member State are not arbitrable. Accordingly, German investors would have to “internationalize” their investments so that the intermediary SPV could arbitrate disputes under the applicable BIT against the EU Member State (albeit such BIT structuring will necessarily also have to take into account the broader implications of doing so, including the tax consequences of such structuring). If establishing an SPV outside of the EU is not appropriate (for tax reasons or otherwise), German investors may still be able to seek protections under national and/or EU laws. For example, the European Convention for the Protection of Human Rights and Fundamental Freedoms protects against unlawful expropriation of property and codifies the principle of due process in treatment by the government.

Investors Should Protect Their Outbound Investments Through Investment Treaty Planning

Germany currently has 114 BITs in force that protect outbound investment. Germany also has ratified the Energy Charter Treaty, which contains a chapter on investment protection.¹ German energy investors may be able to use investment treaties to hold foreign governments accountable through private arbitration should those foreign governments enact measures that adversely impact their investments.

Certain jurisdictions within the EU take the position that arbitration of disputes under investment treaties between an investor of an EU Member State against an EU Member State as the respondent is not permitted. Thus, German investors investing within the EU could consider (re-) structuring their investments through SPVs incorporated in jurisdictions outside the EU. The use of SPVs in this way may also be useful if the target destination of the investment is a State with which Germany does not have a BIT in force.

What are Investment Treaties?

Investment treaties are legal instruments entered into by two or more States to protect foreign investors possessing the nationality of one of the States and their investments when investing in the territory of the other State (the “host State”). While the content and scope of each investment treaty will vary depending on its specific terms, generally, investment treaties protect:

• Foreign investors, which typically include natural persons holding citizenship in the State of outbound investment (such as a German national) as well as companies incorporated or registered in accordance with the laws of that State (such as a company incorporating in Germany). 
• Investments made by those foreign investors, which often encompass “any kind of assets” held in the host State of the investment (the target of the investment) and, in particular, movable and immovable property, shares, bonds and claims to performance of economic value.

Investment treaties typically provide the following substantive protections to a foreign investor and/or its investment:

• National treatment: foreign investors should be treated no less favorably than domestic investors in like circumstances.
• Most-favored-nation treatment: foreign investors should be treated no less favorably than investors from third countries. This protection may be helpful should the government treat third-country investors more favorably by granting their permits on an accelerated basis or by offering their investments better tax or other economic incentives. 
• Fair and equitable treatment: the host state should respect the legitimate expectations of foreign investors at the time they made their investments, and should treat foreign investors and their investments transparently, consistently, with stability, and in good faith. 
• Protection from expropriation: the host state may not expropriate the investment or enact measures tantamount to expropriating the investment unless done for a public purpose, in a nondiscriminatory manner, in accordance with due process, and with the payment of prompt, adequate, and effective compensation.
• Free transfer of capital: foreign investors are entitled to freely transfer their investments and returns, including profits, dividends, and proceeds from the sale of investments.
• International arbitration: many investment treaties permit private arbitration of disputes between an investor and the host state, thereby taking the dispute out of the national courts, which may play favorites, and enables more straightforward means of enforcement in jurisdictions around the world where assets are located.

Investors Are Exposed to Geopolitical Risk

German investors making outbound investments should assess the risks of the host State where the investment is being made changing the economic rules of the game over the course of an investment's lifetime, which, in turn, could adversely impact the expected return on investment (“ROI”). For example, the host State may enact new laws and regulations that will change the key economic inputs used to calculate the investor's ROI, such as new tariffs, taxes, and royalties. Additionally, local authorities might fail to honor their end of the bargain such that a project will not be successful, such as by not approving environmental or exploitation permits in a timely manner or by denying them arbitrarily.

These risks are further heightened if the host State displays signs of governmental instability, which could lead to:

• Legal and regulatory uncertainty: frequent changes in government are often associated with shifts in legislation, regulation and policies that are difficult to anticipate. These shifts may impose new requirements or financial burdens on the investor, renege on commitments extended by a previous administration, or even nationalize investments in certain sectors. 
• Violence and unrest: political instability may also cause violence and public unrest, which may negatively affect investments, either through direct damage to property, or business disruption. 
• Currency volatility and restrictions: political instability may make repatriation of profits difficult where the host State's currency becomes volatile, which may cause convertibility issues and/or governmental restrictions aimed at preventing capital flight.

Investors Have Held Governments Liable for Regulatory Changes Impacting their Investments Through Arbitration Under Investment Treaties

German investors who find that the governments of the host States have taken measures that impact the value of their investments should consider whether to bring claims under investment treaties challenging those measures. Injured investors routinely bring claims under investment treaties. Examples include:

• El Jaouni v. Lebanon:² an arbitral tribunal found that Lebanon breached its obligation to accord fair and equitable treatment to German investors when Lebanon revoked their air operator certificates, thereby preventing them from operating private jets for charter and lease in Europe and the Middle East from Lebanon. The arbitral tribunal awarded the investors US$218.2 million in damages. 
• AES Solar v. Spain^:3 an arbitral tribunal constituted under the Energy Charter Treaty found that Spain had frustrated the legitimate expectations of German, Dutch and Luxembourgish investors in photovoltaic power plants to a reasonable return when it abolished its system of remuneration for photovoltaic energy through feed-in tariffs, upon which the investors had relied when making their investment. The arbitral tribunal awarded the investors US$100 million in damages. 
• Deutsche Bank v. Sri Lanka:4 an arbitral tribunal found that Sri Lanka violated its obligations under its BIT with Germany when it ordered the suspension of payments by the State-owned Ceylon Petroleum Company to Deutsche Bank under a hedging agreement. The arbitral tribunal awarded the investors the totality of damages claimed—US$60 million.
• Windstream v. Canada:⁵ an arbitral tribunal constituted under NAFTA found that Canada violated its obligation to accord fair and equitable treatment to Windstream's investments in Canada, following the passage of a moratorium on offshore wind farms which frustrated Windstream's agreement with the Ontario Power Authority to build an offshore wind power farm. The arbitral tribunal awarded the investor CA$25.2 million in damages.

Most BITs Protect Direct and Indirect Shareholders as “Investors”

BITs usually protect not only direct shareholders in an investment vehicle or company, but also indirect shareholders. This was the situation in Deutsche Telekom v. India,⁶ in which Deutsche Telekom qualified as an investor under the BIT on the basis that it indirectly (via a Singaporean subsidiary) held a 20% stake in the Indian company that operated in India and that had concluded the impugned agreement with India for the launch and operation of two satellites.

As another example, in Wintershall v. Argentina,⁷ a German indirect controlling shareholder in a whollyowned local subsidiary brought a claim against Argentina challenging the government's change of its regulatory framework that negatively affected the subsidiary's hydrocarbon-production concessions and exploration permits. The German shareholder, who had sought USD 300 million in damages, prevailed against Argentina.

Intermediary shareholders (as opposed to the ultimate beneficiary or holding company) may be entitled to treaty protection in their own right, provided the chain of corporate ownership includes one or more intermediary companies in a jurisdiction that has ratified a favorable BIT with the host State. For example, in HeidelbergCement,⁸ a German cement company brought a claim against Egypt, together with three of its French and Italian subsidiaries under treaties concluded by Egypt with Germany, France and Italy, respectively. This case remains pending.

BITs May Also Protect Lenders as “Investors”

Lenders who are financing projects may also be protected as investors under BITs, depending on the language in the relevant BIT. In the Energy Charter Treaty, the definition of “investment” expressly includes “bonds and other debt of a company or business enterprise” within the definition of the term “investment.” In Portigon v. Spain,⁹ the tribunal upheld jurisdiction over claims brought under the Energy Charter Treaty by a Düsseldorf-based financial services company that had extended EUR 600 million in loans to renewable energy companies engaged in over 30 projects in Spain. The tribunal determined that debt capital qualifies as protected investment under the Energy Charter Treaty. The case on the merits remains pending. Moreover, the definition of the term “investment” in the German Model BIT includes “claims to money which has been used to create an economic value or claims to any performance having an economic value.” This language has been construed as including a broad range of financing instruments, including hedging agreements.¹⁰

Investors Should Structure Their Outbound Investments to Benefit from the Protections of Investment Treaties

Investors frequently route their investment through entities incorporated in other jurisdictions for a variety of reasons. Luxembourg, for example, is known to offer many regulatory and tax incentives, making it generally desirable to international investors. And with 60 BITs currently in force, Luxembourg offers a wide coverage of protections for outbound investments. Although the BITs concluded by Germany cover all but one of the states with which Luxembourg has a BIT in place,¹¹ not all investment treaties are equal in terms of scope and levels of protections afforded to foreign investors. Furthermore, there may be certain strategic advantages for a German investor to bring a claim against a host state through the Luxembourg entity rather than in their own name.

In recent years, European institutions have taken a stance against investment treaty-based arbitrations to decide intra-EU disputes, i.e., disputes brought by an investor of an EU Member State against an EU Member State. On March 6, 2018, the Court of Justice of the European Union (“CJEU”) determined that investment treaty arbitration to resolve disputes arising out of intra-EU BITs is incompatible with EU law, on the basis that the autonomy of the EU legal order would be undermined by arbitral tribunals interpreting and applying EU law, which is the exclusive competence of the CJEU.¹² Following the CJEU's determination, the German Federal Court of Justice has held that investment treaty claims lodged by German energy companies (RWE and Uniper) against the Netherlands,¹³ and another brought by an Irish energy company (Mainstream Renewable Power)¹⁴ against Germany, were inadmissible.

Further, the European Commission has launched infringement proceedings against several EU Member States for allowing intra-EU BITs to remain in force and has strongly encouraged member states to phase out intra-EU BITs. Consequently, Germany terminated all of its intra-EU BITs. Although BITs typically contain a “sunset clause” allowing investors to continue to rely on the terminated BIT in respect of investments existing at the time of termination, the risk in doing so for German investors is that the arbitral tribunal may decline to hear the case on the basis that such disputes are not arbitrable under EU law or that European courts will annul an award on the basis that the tribunal lacked jurisdiction.

Moreover, although Germany has ratified investment treaties with over half of all States all over the world, the coverage for German investors looking to invest globally has gaps. By way of example, the BITs between Germany and Israel and Timor Leste were never ratified, such that investments made in either country are not protected. Additionally, investments made in non-EU States that have terminated their BITs with Germany (as is the case for the India-Germany and Indonesia-Germany BITs) would only be protected for the remainder of the relevant sunset clauses in those treaties

Therefore, German investors who are making outbound FDI in European States or States that are not covered by a German investment treaty should consider whether it might be preferable to structure their investments through SPVs incorporated in jurisdictions that have entered into investment treaties with the host State where the investment is being made. In this way, depending on the terms of the specific treaty and the project structure, the SPV could serve as the claimant in any arbitration against the host State regarding acts that breach the obligations and protections afforded to investors under the applicable treaty.

In the event that structuring an investment through SPVs outside the EU is impracticable, whether for tax reasons or otherwise, German investors may be able to resort to certain basic protections existing under national laws and/or EU laws. Article 1 of Protocol 1 to the European Convention for the Protection of Human Rights and Fundamental Freedoms (also known as European Convention on Human Rights or “ECHR”) specifies that “[e]very natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by general principles of international law.” On that basis, the European Court of Human Rights in Strasbourg found Slovakia liable to compensate an investor in relation to the privatization of the Bratislava airport.¹⁵ Article 6 of the ECHR further guarantees that “everyone is entitled to a fair and public hearing within a reasonable time by an independent and impartial tribunal established by law.” On that basis, the Strasbourg Court upheld a complaint brought by an Italian company that had obtained a significant arbitral award against the Albanian government.¹⁶

Accordingly, in summary, the corporate structuring of an investment should include a thorough analysis by the German investor to answer these questions when routing investments through a third jurisdiction:

• What is the ultimate target destination (who is the host State)?
• With which third states outside of the EU has the host State ratified investment treaties?
• From that list of investment treaties between the host State and the third State, are there any other relevant considerations, such as whether any particular state is more tax-advantageous or has a preferable regulatory regime? 
• Are the treaty protections in those investment treaties sufficiently robust?

This (re-)structuring of the investment should ideally be done up front at the time of the investment. Otherwise, it may end up being too late if not done by the time a dispute materializes.

Footnotes

1. Germany has withdrawn from the ECT as of December 20, 2023. German investors' ability to commence arbitration proceedings survives for another 20 years following withdrawal, i.e. December 20, 2043.

2. Abed El Jaouni and Imperial Holding SAL v. Lebanese Republic (ICSID Case No. ARB/15/3)

3. AES Solar and others (PV Investors) v. Kingdom of Spain (PCA Case No. 2012-14)

4. Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka (ICSID Case No. ARB/09/2)

5.  Windstream Energy LLC v. The Government of Canada (PCA Case No. 2013-22)

6. Deutsche Telekom AG v. Republic of India (PCA Case No. 2014-10)

7. Wintershall Aktiengesellschaft v. Argentine Republic (ICSID Case No. ARB/04/14)

8. HeidelbergCement AG and others v. Arab Republic of Egypt (ICSID Case No. ARB/21/50)

9. Portigon AG v. Kingdom of Spain (ICSID Case No. ARB/17/15)

10. See Deutsche Bank AG v Democratic Socialist Republic of Sri Lanka (ICSID Case No. ARB/09/2) (finding that a hedging agreement was of direct benefit to Sri Lanka by reducing the state's exposure to oil price volatility).

11. The exception is Tajikistan, with which Luxembourg has a BIT in force and not Germany

12. See Slovak Republic v. Achmea B.V. (Case C-284/16). The CJEU's decision was confirmed on September 2, 2021, in Republic of Moldova v. Komstroy LLC (Case C-741/19).

13. See Press release regarding Decisions of the German Federal Court of Justice (Bundesgerichtshof), July 27, 2023 in Cases no. I ZB 74/22 and I ZB 75/22.

14. See Press release regarding Decision of the German Federal Court of Justice (Bundesgerichtshof), July 27, 2023, Case no. I ZB 43/22.

15. BTS Holding AS v Slovakia, ECHR case (Application no. 55617/17), June 30, 2022.

16. Case of Iliria s.r.l. v. Albania (Application no. 31011/09), March 5, 2024.

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.