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Allens Arthur Robinson

Focus: Nationality planning and foreign investment risk management

15 June 2009

In brief: Special Counsel Gordon Smith , Partner Stephen McComish (view CV), Lawyer Sam Luttrell and Law Graduate Caroline Spencer report on the significance of 'nationality planning' in connection with bilateral investment treaties in order to maximise foreign investors' rights in Asia.

How does it affect you?

  • With proper nationality planning, foreign investors may:
    • increase the protection of their investments in developing countries; and
    • avoid unfavourable dispute resolution procedures.

Our recent experience

Allens recently acted for a European investor in an 'investor-state' dispute arising out of a privately financed public infrastructure project in a developing Asian country. Our client alleged that the state party to the  project concession contract had failed to pay concession instalments or to provide adequate security. The investor claimed damages in excess of US$200 million. In the request for arbitration filed with the International Centre for Settlement of Investment Disputes (ICSID) in Washington, the investor alleged that the state had breached a number of the protection provisions of the bilateral investment treaty (BIT) with the investor's home state. 

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The BIT system

A BIT is an agreement between two countries under which each undertakes to promote and protect investments made in its territory by people and companies from the other country. Today, there are nearly 3000 BITs globally. In contrast to other international agreements, BITs are usually short documents. They tend to focus on establishing four simple rules; that:

  • neither contracting state will expropriate, nationalise, or otherwise take over, investments made by nationals of the other state in its territory;
  • each contracting state will treat investors from the other state just as it would treat investments of its own nationals;
  • each contracting state will extend to investors from the other state any greater benefit that it grants to an investor from a third country; and
  • each contracting state will accord investors from the other state fair and equitable treatment.

These key rules are generally backed up by a dispute resolution clause that provides for international arbitration. In a typical BIT, the arbitration clause will require that any disputes between protected foreign investors and either contracting state be resolved by arbitration under the auspices of one of two or three specified organisations; usually the ICSID, the International Chamber of Commerce in Paris or the Stockholm Chamber of Commerce. The advantage of ICSID arbitration is that it is a self-contained, independent system of dispute resolution that, unlike other forms of international arbitration, is not supervised by national courts.

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Nationality planning

'Treaty shopping' refers to a foreign investor seeking to acquire BITs' benefits in its actual or intended host state through third countries. The most advanced form of treaty shopping is 'nationality planning', where sophisticated corporate foreign investors plan their nationality in advance of their transaction in order to gain maximum protection under the BIT system. 

The principal method of nationality planning is to set up a company in a country that has a favourable BIT with the intended host state, and then use this company to channel capital into the host state. When an investor goes treaty shopping, the point of sale is the definition of 'national' (or 'investor'). These definitions are used to make it clear which entities are and are not protected, and fall broadly into two categories:

  • definition by reference to 'incorporation' in a contracting state, without other restrictions; or
  • less commonly, incorporation in a contracting state together with other restrictions, usually relating to control of the entity. The ASEAN Agreement, for example, requires both incorporation and effective management in the nominated state.

The purpose of specifying additional restrictions on nationality is to prevent treaty shopping. BITs that contain additional restrictions are unattractive because the foreign investor will not qualify as a protected national unless it actually conducts business through its capital conduit. However, the majority of BITs do not contain these types of limitations, and investors should look to one of these when they plan their nationality.

In our recent arbitration, we argued on behalf of the investor that the host state's failure to pay instalments due under the concession contract was a breach of the 'umbrella clause' of the relevant BIT. An umbrella clause is a provision in a BIT that makes the contracting states responsible for breaches of contracts they enter into directly with protected foreign investors, and, arguably, places breaches of these private agreements within the scope of the arbitration clause of the BIT. 

The BIT between our client's home state and the state respondent contained an umbrella clause; but even if it had not, it would have been open to our client to claim the benefit of an umbrella clause on the basis that the host state's other BITs contained them. This is because the umbrella clause creates a jurisdictional benefit, and, as such, can be brought into the host state's other BITs under their most favoured nation clauses. Obtaining the benefit of an umbrella clause from a different BIT in this manner is a form of treaty shopping.

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Which BIT should I choose?

The table below compares various BITs, and provides a useful guide for Australian companies considering investing in Asia and hoping to maximise the benefits of BITs.

BIT signatories Definition of 'national'/'investor' Arbitration mechanism Restricted submission Umbrella clause
Australia-China (1988) Incorporation ICSID, or ad hoc (with International Bank for Reconstruction and Development as appointing authority) Quantum of compensation for expropriation only Yes
Netherlands-China (2001) Incorporated and 'have their seat' ICSID or ad hoc Restricted – must exhaust local administrative review procedure Yes
UK-China (1986) Incorporation Ad hoc Quantum of compensation only Yes
Germany-China (2003) German: 'have their seat'
Chinese: incorporated and 'have their seat'		 ICSID or ad hoc Restricted – must submit to an administrative review procedure (three-month limit) Yes
Singapore-China (1985) Incorporation Ad hoc (Chairman of Stockholm Chamber of Commerce as appointing authority) Quantum of compensation for expropriation only Yes
Australia-Indonesia (1992) Incorporation ICSID Unrestricted No

Applying the criteria discussed above, the most favourable of the BITs shown in the table is the Australia-Indonesia BIT signed in 1992, as:

  • it bases its definition of 'investor' on incorporation alone;
  • it provides for unrestricted submissions to ICSID arbitration; and
  • although it does not contain an umbrella clause, other Indonesian BITs do contain one, and Australian companies could claim using the benefits of those umbrella clauses under the 'most favoured nation' clause.

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Conclusion

Our recent experience shows that foreign investors who undertake careful nationality planning will reduce the risks of their investment and find themselves far better positioned in the event of a dispute with their host state.

Published 15 June 2009

 

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