Mitigating investment risk – treaty planning and damages claims against state entities

September 2018 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

September 2018 Issue

What do these three scenarios have in common? An investor is negotiating a contract with a state entity in a high-risk jurisdiction. An investor – an individual or a corporate entity – is considering how to structure its holdings in a tax efficient manner. An investor is facing potential asset nationalisation or breach by a state entity of its contractual obligations.

In each of these cases, the investor’s position can be vastly improved by considering which bilateral investment treaties (BITs) – and, in some cases, multilateral treaties – extend protection to its investments and therefore allow it to bring a damages claim directly against a state, often before the International Centre for Settlement of Investment Disputes (ICSID). This is even the case where the investor manages to negotiate a robust contractual provision for dispute resolution, as the public nature of ICSID arbitration may help deter detrimental state actions.

This article considers the increasing role of international arbitration in resolving disputes in the banking and finance sectors. It also addresses the use of investment treaties to bring claims against states, including by insolvency practitioners on behalf of companies in liquidation, and the use of corporate nationality planning to benefit from investment treaty protection.

While international arbitration – a private, neutral and flexible form of dispute resolution resulting in a binding and enforceable award – is widely used in the energy, construction and infrastructure sectors, and is on the rise in the technology sector, historically the banking and finance sector has instead largely resolved disputes through local court litigation.

As demonstrated by our 2018 International Arbitration Survey, in association with Queen Mary University of London, this appears to be changing. The findings of the survey draw from 922 questionnaire responses and 142 in-person or telephone interviews with private practitioners, arbitrators, in-house counsel, academics, experts and other users of international arbitration.

According to the survey, a majority of respondents (56 percent) anticipate an increased use of arbitration in the banking and finance sector. This is in sharp contrast to the results of the 2013 survey, which reported that 82 percent of respondents ranked court litigation as their most preferred form of dispute resolution for financial disputes. This latest finding can be read as a strong indication that financial institutions have a much greater interest in international arbitration than ever before. For example, the 2017 casework report of the London Court of International Arbitration (LCIA) notes that, in 2017, claimants were most commonly from the energy and resources sector or the banking and finance sector, with disputes from these two industry sectors each representing 24 percent of arbitrations referred to the LCIA.

Recent data shows that banking and finance disputes are also on the rise in the context of investor-state arbitration. ICSID’s 2018 caseload statistics report that of all new cases registered in 2017 (a total of 53), disputes emanating from the finance sector were the most frequent, representing 15 percent of new cases registered. This surpasses disputes in the oil, gas & mining sector, which represent 13 percent of new cases. A similar report from the United Nations Conference on Trade and Development (UNCTAD) reports that, of all known treaty-based investor-state disputes filed in 2017 (a total of 65), 17 percent of disputes relate to the financial and insurance services sector.

Importantly, BITs, of which over 2350 are in force between various states, and multilateral investment treaties, such as the North American Free Trade Agreement (NAFTA) and the Energy Charter Treaty, often allow investors to bring arbitral claims directly against states where the state has failed to treat foreign investors’ investments fairly and equitably or to provide adequate compensation for expropriation of an investor’s assets. For example, as of 2018, over 100 known arbitration claims have been brought under the Energy Charter Treaty, which applies to economic activity in the energy sector.

Indeed, over the past decade there have been some 50 known investor-state disputes involving financial institutions. For example, an ICSID tribunal constituted pursuant to the Germany-Sri Lanka BIT determined (by majority) in 2012 that Sri Lanka had breached its obligations under the BIT not to expropriate Deutsche Bank’s investments (arising from the suspension of payments under, and termination of, an oil hedging agreement) and awarded damages in the region of $60m plus interest, and $8m in respect of legal fees.

Equally, following ICSID arbitration under the Italy-Argentina BIT, in 2016 Argentina reached an agreement with about 50,000 Italian creditors holding $900m in defaulted bonds to settle the creditors’ claims. Other high-profile examples include a series of new ICSID claims (registered in 2017, and under various BITs) by banks against Croatia and Montenegro arising from the Swiss central bank’s decision to abandon exchange rate controls in 2015, and losses incurred from subsequent legislation compelling the conversion of franc-denominated loans into euros. Further recent examples include a claim by the managing director of a private equity fund against Kuwait in relation to accusations of fabricated criminal charges and a claim by a commodities trading firm against Estonia in relation to allegations of solicitation of bribes.

More generally, claims brought by financial institutions may also arise from interest in an investment (such as an oil, gas or mining concession) where the host state passes legislation nullifying or modifying the relevant contract, or interferes with performance of the contract or breaches it, or indeed where the state expropriates the investment in its entirety.

The ability to bring a claim against a state under an investment treaty is also of great relevance to insolvency practitioners, because they may be required to maximise the value of liquidated assets for creditors where a state has caused damage to the asset or even caused the insolvency.

A number of investment treaty claims have been brought against states on behalf of companies in liquidation. For example, in 2010, a tribunal constituted under the Germany-Thailand BIT awarded Walter Bau, a German company in liquidation, more than €30m in its claim (brought by its insolvency administrator) against Thailand over a tollway concession, finding that the Thai authorities failed to approve toll hikes as contemplated in the concession contract.

In a similar vein, a tribunal in 2015 upheld a claim against Hungary in relation to the local courts’ failure to properly follow domestic insolvency procedure. The claimant had invested in a Hungarian company that subsequently faced financial difficulties, leading to an application from its creditors for liquidation. The Hungarian Bankruptcy Court refused the application for a composition hearing with its creditors despite an express right to such a hearing under Hungarian law, and ordered the liquidator to proceed directly to the sale of the company’s assets. In the view of the tribunal, this refusal was “shocking” – it found that the claimant was denied an effective determination on the merits of the relief that it sought and which Hungarian law provided. The tribunal found that the state violated its obligations under the Hungary-Portugal BIT to accord fair and equitable treatment to the investment and not to impair by unfair measures the liquidation of the investment. The quantum award is not yet publicly available.

Further, currently pending investment treaty claims have been launched on behalf of liquidated companies against Slovenia (in 2013, in respect of a contract for the construction of a highway tunnel project) and against Italy (in 2015, in respect of tariff incentives for solar photovoltaic power plants). Such claims are not yet widely brought, but can give creditors a legal recourse for damages caused by a state.

In light of the above, it is important that investors assess the extent to which their (current or future) investments are protected under investment treaties. A first step is evaluating the location of the assets, the corporate structure that holds them and the place of incorporation of the relevant entities. Where individuals hold or control the assets, their nationalities should also be taken into account. The relevant treaties should then be compared to confirm they confer the necessary protections.

In some cases, the relevant treaties may not contain sufficient protection or the investors’ existing structure may not provide access to any treaty protection.

It may then be advantageous to consider whether the investor would have access to more robust protection by treaties by restructuring its investments, including via a holding company. Often such restructuring takes place in parallel with a review of the group’s tax position, dual taxation treaties and other commercial considerations. Tribunals have recognised that such restructuring is not uncommon and is perfectly legitimate, so long as it is done only in respect of future disputes and, under the doctrine of abuse of process, not in respect of pre-existing disputes. This means that investors must plan in advance to maximise their access to investment treaty protection and mitigate risk to their investments.

Dipen Sabharwal is a partner and Tomas Vail is a senior associate at White & Case LLP. Mr Sabharwal can be contacted on +44 (0)20 7532 1264 or by email: dsabharwal@whitecase.com. Mr Vail can be contacted on +44 (0)20 7532 2488 or by email: tomas.vail@whitecase.com.

Dipen Sabharwal and Tomas Vail

White & Case LLP