Protecting Your Investments in Emerging Markets

October 6, 2014

The wealth of opportunities in emerging markets attracts a significant amount of foreign investment.  Making investments in parts of Africa, Latin America, Asia and the former Soviet Union can pay off handsomely if successful.  However, those same investments are often exposed to significant political risk.

There are ways for investors in emerging markets to limit their exposure to such risk, and counsel can help to identify some of the more compelling options in this regard.  Political risk insurance is one well-known option.  Another option is to structure (or restructure) an investment, whether in a greenfield project or through an acquisition, to take advantage of the protections offered by a favorable investment treaty.  It is the latter option that is the subject of this alert.

What are investment treaties?

Investment treaties are legal instruments entered into by two or more states for the purpose of increasing investment flows between the state parties.  They accomplish this objective by offering foreign investors certain legal protections against adverse actions of the host state.  Investment treaties commonly contain the following protections:

• Prompt, adequate and effective compensation in the event of an expropriation;

• Fair and equitable treatment, which ensures that, among other things, the state does not undermine a foreign investor’s legitimate, investment-backed expectations;

• Full protection and security, which ensures that states exercise sufficient diligence to maintain the physical security and, in some cases, legal security of the investment;

• Non-discrimination, which ensures protected investors treatment no less favorable than that accorded to national investors, or investors from third states;

• The free transfer of capital, into and out of the host state, related to the investment.

Most importantly, the violation of any of these rights is directly enforceable against the host-state through international arbitration.  Generally, investment treaties will permit investors to pursue arbitration before the International Center for the Settlement of Investment Disputes, otherwise known as ICSID, which is a part of the World Bank system, or under the Arbitration Rules of the United Nations Commission on International Trade Law, otherwise known as the UNCITRAL Rules.  Resulting arbitral awards are final and binding on the parties to the dispute, and enforceable in most jurisdictions around the world, subject only to very limited grounds for annulment.

Of course, not all investment treaties offer the same type of protection for your investment.  For instance, the European Union is currently negotiating investment treaties with narrower, more well-defined, protections than those contained in many existing treaties.  Some treaties contain carve-outs for certain type of government regulation, including taxation.  Others contain broader protections, such as guarantees that the host state will honor any "undertakings" or "obligations" that it makes to you.  In this regard, comparing investment treaties can be like comparing insurance policies.

What steps can be taken to take advantage of an investment treaty?

Almost every emerging market in which you are investing, save Brazil, has an international investment agreement currently in force.  There are over 2500 such agreements–some of which are bilateral, and others that are multilateral (such as NAFTA and the Energy Charter Treaty).

International arbitration tribunals have recently found that foreign investors are permitted to structure (or restructure) their investments to take advantage of the protections offered by an investment treaty.  For instance, in ConocoPhillips Petrozuata B.V. et al v. Venezuela,[1] the tribunal found that the claimants legitimately restructured their investment through Dutch subsidiaries, even though the sole business purpose of the restructuring was to obtain the protection of the Netherlands-Venezuela bilateral investment treaty.  The tribunal went on to find Venezuela liable for unlawfully expropriating ConocoPhillips’s investment, and is now in the process of assessing the appropriate quantum of damages owing to ConocoPhillips.[2]  There are three important caveats to the finding in the ConocoPhillips case, which investors should be aware of:

• It may be too late to seek the protection of an investment treaty after a dispute has arisen.  In this regard, ConocoPhillips restructured its investment prior to the threat of expropriation, and ConocoPhillips continued to make significant investments in Venezuela after the restructuring.  Those facts were important to the decision reached by the Tribunal that ConocoPhillips’ restructuring did not amount to "treaty abuse."

• The Dutch-Venezuela investment treaty did not require, as some investment treaties do, that the investor have "significant economic activities" in the investor’s home state, i.e., the Netherlands.

• The Dutch-Venezuela investment treaty did not contain a "denial of benefits" clause, which may allow a host state the right to deny the protections offered in the investment treaty to a company that has no substantial business activities in the territory of the treaty Party under whose laws it is constituted.

Two important lessons emerge from the ConocoPhillips case:

• You should think about investment treaty structuring as early as possible in the life of your investment.

• You should be sure that you are structuring your investment to take advantage of the most favorable investment treaty available to you.  Otherwise, you may not be getting the protections you bargained for.

I would like to know more about investment treaty structuring, who may I contact?

Should you have any questions related to investment treaty structuring, or a potential claim under an investment treaty, please feel free to contact the Gibson Dunn lawyer with whom you normally work, or one of the investment treaty lawyers listed below.  We would be pleased to assist you.

Cy Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
Rahim Moloo – New York (+1 212-351-2413, [email protected])