Foreign investors should consider treaty protections when structuring their investments abroad

Investment Treaties and Treaty Protections for Foreign Investors

Introduction

Investors seeking to invest abroad – including investment funds – should safeguard and strengthen their investments by considering treaty protections. Investment Treaties can provide foreign investors access to substantive protections under international law. Many investment treaties provide neutral forums to resolve potential disputes through investor-state dispute settlement (“ISDS”). These arbitral tribunals have the power to issue monetary damages awards to compensate foreign investors that are harmed by their host governments in a manner that breaches the treaty. When structuring investments abroad, investors should understand the requirements for treaty protections and structure their investments accordingly.

Nationality Planning and Treaty Protections

Several tribunals, including recent tribunals in Elliott Associates v. South Korea and Gramercy v. Peru, have held that nationality planning, including for investment funds, is not an abuse of process or a bar to jurisdiction.¹ Nationality planning consists of channeling investments through a country other than the investor’s home state for tax, corporate, or other purposes. Reasonable nationality planning can include protecting investments through states that have investment treaties in place with the host state. Investors can structure their investments at the outset or can restructure their investments at a later time and secure treaty protections. Most importantly, investors should keep in mind: the timing of the purported investment, the timing of the claim or dispute, the substance of the transaction, the true nature of the operation, and the degree of foreseeability of the governmental dispute at the time of restructuring.²

Impact of USMCA on North American Investors

This is an issue of critical importance for investors, including in particular investors in the North American Region. On July 1, 2023, the opportunity to bring claims under the North American Free Trade Agreement (“NAFTA”) through the legacy claims clause of the United States-Mexico-Canada Agreement (“USMCA”) expired. The USMCA has much weaker protections for foreign investors in North America than its predecessor agreement, the NAFTA. The USMCA contains a limited bilateral ISDS clause between the U.S. and Mexico.³ Canada is outside the scope of USMCA’s ISDS mechanism.⁴ The USMCA provides comprehensive ISDS protections for covered government contracts and lesser protection for other types of contracts and investments.⁵ Thus, U.S., Canadian, and Mexican investors in the North American region should carefully reassess their investments, and consider restructuring them now if they want to ensure investment treaty protections.

Principles of Investment Treaties and Qualification for Protection

While treaty protection requirements may vary depending on the treaty at issue, there are some principles every prudent investor should consider: who intends to qualify for protection, and the limits of corporate restructuring for this purpose.

• Fair and equitable treatment by the host state’s government, such as protection of investors’ legitimate expectations of a predictable and stable economic environment, ensuring due process, and preventing arbitrary and discriminatory conduct;
• Protection from direct and indirect expropriation, nationalization, and similar conduct;
• Non-discrimination when compared to host country investors and third country investors and their investments; and
• In some treaties, the host state’s adherence to commitments and undertakings concerning investments and investors, often in the form of contracts with foreign investors.

Many Investment Treaties provide protections to a broad category of foreign investors, including individuals who are nationals of a home state and companies with the nationality of the home state. Investment Treaties usually determine a company’s nationality by its place of incorporation, and also sometimes through its principal place of business activities, place of corporate seat, and/or place of control. It is important to assess each Investment Treaty to ensure the scope of protections.

Successful Restructuring and Compensation under Investment Treaties

Funds’ structures can be a dispositive factor when tribunals consider jurisdiction because treaty protection typically depends on the nationality of the investor, the investor’s control, and the nature of the investment in the host state. Multiple funds have successfully invested abroad, including through restructuring investments, and received compensation under Investment Treaties.

In Gramercy Funds Management LLC and Gramercy Peru Holdings LLC v. Republic of Peru, two U.S. investors brought claims against Peru regarding their Peruvian agrarian bonds.⁶ Peru objected to jurisdiction under the U.S.-Peru Free Trade Agreement (FTA) for several reasons including alleging abuse of process.⁷ In its 2022 award, the tribunal held that the claimants did not engage in abuse of process, because restructuring an investment to protect from possible future disputes amounted to legitimate investment planning, and was thus not abusive.⁸

Hedge fund Elliott Associates successfully arbitrated a case against South Korea under the Korea-USA Free Trade Agreement (“KORUS FTA”).⁹ Elliott Associates filed for arbitration in 2018, alleging that South Korea breached the KORUS FTA’s investment chapter by facilitating a controversial merger between Samsung C&T and Cheil Industries in 2015.¹⁰ South Korea argued that the claim should be dismissed, because Elliott Associates allegedly structured its investment to gain treaty protections at a time when the dispute was foreseeable.¹¹ The tribunal rejected South Korea’s argument, because Elliott Associates was unaware of South Korea’s intended interference in the merger at a time when Elliott Associates acquired additional shares to prepare for a potential proxy fight as a minority shareholder.¹² In its 2023 award, the tribunal held that South Korea was liable for breaching the treaty and ordered South Korea to pay $54 million in compensation to Elliott Associates plus costs and interest, totaling $108.5 million.¹³ Elliott Investment Management described this victory as “the first [successful] Investor-State Dispute case in Asia in which an investment firm engaged in shareholder activism.”¹⁴ This case shows how timely restructuring to achieve treaty protection is an essential part of securing foreign investments.

In The Carlyle Group L.P. and others v. Kingdom of Morocco, the Carlyle Group and six affiliates (all U.S. entities) sued Morocco under the U.S.-Morocco Free Trade Agreement’s investment chapter regarding investments they made in a Moroccan oil company.¹⁵ Morocco challenged the jurisdiction of the tribunal for various reasons including arguing that the claimants lacked standing because they made their investments through Cayman special purpose vehicles

SDGs, Targets, and Indicators Analysis

1. Which SDGs are addressed or connected to the issues highlighted in the article?

• SDG 16: Peace, Justice, and Strong Institutions
• SDG 17: Partnerships for the Goals

The article discusses the importance of investment treaties in providing foreign investors with substantive protections under international law. These protections contribute to SDG 16 by promoting peace, justice, and strong institutions through the resolution of potential disputes. Additionally, the article emphasizes the need for partnerships and cooperation between countries to safeguard and strengthen investments, aligning with SDG 17.

2. What specific targets under those SDGs can be identified based on the article’s content?

• Target 16.3: Promote the rule of law at the national and international levels and ensure equal access to justice for all.
• Target 17.16: Enhance the Global Partnership for Sustainable Development, complemented by multi-stakeholder partnerships that mobilize and share knowledge, expertise, technology, and financial resources.

The article highlights the role of investment treaties in promoting the rule of law at the international level and ensuring equal access to justice for foreign investors. This aligns with Target 16.3. Additionally, the article emphasizes the importance of partnerships between countries to protect investments and maximize treaty protections, supporting Target 17.16.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

• Number of investment treaties signed between countries
• Number of investor-state dispute settlement (ISDS) cases resolved through arbitration
• Amount of monetary damages awarded to foreign investors in ISDS cases

The article mentions the existence of investment treaties between countries, which can be measured by the number of treaties signed. The resolution of ISDS cases through arbitration serves as an indicator of progress towards ensuring equal access to justice for foreign investors. Additionally, the amount of monetary damages awarded to foreign investors in ISDS cases can indicate the effectiveness of investment treaty protections.

Table: SDGs, Targets, and Indicators

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Source: lexology.com

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