Opinion | Use BITs to plan ahead for disaster

FDI Intelligence | 27 November 2023

Opinion | Use BITs to plan ahead for disaster

By Hogan Lovells counsel Mike Jacobson in Washington, DC and senior associate Orlando Cabrera in Mexico City

When investors seeking to invest abroad are looking to safeguard their investments, they should consider treaty protections. Investment treaties, also known as bilateral investment treaties (BITs) and sometimes contained within broader free trade agreements, can provide foreign investors with access to substantive protections under international law and neutral forums to resolve disputes through arbitration.

Arbitral tribunals can award monetary damages to compensate foreign investors harmed by a host government’s breach of investment treaties. This is now vital for investors, with the Russia-Ukrainian war likely triggering investment claims. It is also particularly pertinent for US investors under the United States-Mexico-Canada Agreement (USMCA). Compared with its predecessor Nafta, the USMCA provides US investors much weaker protections in Mexico and no investment arbitration rights in Canada.

Who and what is protected

Investment treaties between governments protect their investors when investing in the other country. Most investment treaties protect against harm caused by the host country’s government by guaranteeing non-discrimination, protection from expropriation, and fair and equitable treatment. The latter may include protecting investors’ legitimate investment-related expectations, ensuring due process and preventing arbitrary conduct.

Successful track record

Many companies have successfully structured foreign investments under investment treaties and received monetary compensation for harm. Investment structures can be a critical factor in the outcome of disputes, because tribunals must have jurisdiction to hear a dispute brought by a national of a qualifying state. This can be achieved via treaty planning, or so-called nationality planning whereby an investor structures its investment through a third country to ensure access to treaty protections. Some of the most recent examples involve investment funds investing abroad.

In 2022, investment manager Gramercy won a claim against Peru’s government regarding its agrarian bonds. Peru objected to the tribunal’s jurisdiction, alleging abuse of process based on the investors’ nationality planning. Gramercy had acquired the bonds through an entity it had incorporated under the laws of Delaware in the US, which allowed Gramercy to bring an international arbitration under the treaty. The tribunal held that Gramercy’s restructuring of its investment to protect from possible future disputes was legitimate investment planning, and ordered Peru pay damages in excess of $100m.

This year, US-based Elliott Associates successfully arbitrated a case against South Korea. The hedge fund alleged that South Korea breached treaty obligations by facilitating a controversial merger between Samsung and Cheil Industries. The government argued the claim should be dismissed because Elliott had restructured its investment in Samsung — from one made through swap contracts to one based on direct shareholding — to gain treaty protections at a time when the merger and dispute was foreseeable.

The tribunal ruled that Elliott was unaware of South Korea’s intended interference in the merger when Elliott Associates acquired additional shares to prepare for a potential proxy fight as a minority shareholder, and dismissed South Korea’s jurisdictional objection. The tribunal ordered South Korea to pay $108.5m in damages.

When is corporate restructuring impermissible?

Investors should consider structuring investments to take advantage of treaty protections at the outset, or at minimum before any harm is incurred at the hands of the host state. Restructuring at a later time is also possible, but tribunals have imposed limitations on this, depending on the timing and nature of the host government’s harmful acts.

Perhaps the best example is the 2015 landmark case between Philip Morris International (PMI) and Australia. The tribunal held that it had no jurisdiction to decide the claim because PMI had engaged in an abuse of process by changing its corporate structure — to benefit from protections in the Hong Kong-Australia investment treaty — when it foresaw that the latter’s government was going to pass a law which led to the dispute. Thus, investors should evaluate and adjust their corporate structure before a dispute is reasonably foreseeable.

Planning the corporate structure of foreign investments with an eye towards treaty protections is a critical step to mitigate possible disasters. If foreign investors ensure treaty protections are in place as early as possible, they will maximise those protections.