PRESERVE, PROTECT AND DEFEND - GLOBAL NATIONALIZATION RISK: PRACTICAL CONSIDERATIONS FOR INVESTORS - BAKER MCKENZIE
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PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Preserve, Protect and Defend Global Nationalization Risk: Practical Considerations for Investors
PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Contents 1 Foreword 3 2 The Political Situation 4 3 The value of Investment Treaty protections 8 4 How to structure your investment 11 Legal structuring and restructuring 12 Tax structuring 14 5 Case Studies 16 Argentina 18 Indonesia 22 South Africa 26 United Kingdom 30 United States of America 34 6 Key Contacts 38
Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 3
Foreword
Ed Poulton Maria del Carmen Tovar
Partner, London Partner, Lima
The extent of governmental involvement in their We have looked at the treaty framework that
national economies goes to the very heart of political underpins investment decisions, assessing the
and economic debates that have raged since time protections afforded by investment treaties and tax
immemorial, and as such can seem to be an issue on treaties - how they are valuable to international
which opinions are clearly and irrevocably set. However, investors and how investments can be structured
the last few years of political upheaval has shown that to take advantage of them.
those sands can, and do, shift. The last few days and
weeks have arguably accelerated this momentum, While debates around nationalization are widespread,
albeit in response to a punctual threat: governments we have applied this analysis to five case study
have torn up what were perceived as immutable rules jurisdictions of particular relevance, each demonstrating
of economic engagement in response to the Covid-19 a particular aspect of the debate: Argentina,
pandemic. The question is whether the genie will be Indonesia, South Africa, the UK and the US.
able to be returned into the bottle.
Baker McKenzie’s uniquely global platform enables
In August 2019, Baker McKenzie’s Dispute Resolution us to assess these risks and the associated practical
team in London produced UK Nationalization: Practical considerations with an equal focus on local remedies
Considerations, an introductory guide to practical and global protections. In this report, we draw upon
steps that investors can take to protect their position the collective knowledge of more than 1100 international
in the event of a nationalization, such as was proposed disputes lawyers around the world, embedded in
by the UK’s opposition Labour Party for wide their local markets, experts in their industries.
swathes of the UK economy.
In a related report (available here), our team has
In response to client demand, we have broadened our partnered with the Investment Treaty Forum at the
analysis to look at the issue through a global lens. British Institute of International Comparative Law
(BIICL) to present the first comprehensive empirical
Working with geopolitical commentator, business study of corporate restructuring and investment
advisor and co-founder of Global Torchlight, David treaty protections, examining all publicly available
Chmiel, we dispel four commonly-held misconceptions decisions of investor-state tribunals dealing with
about the nature of nationalization policy, (each of issues of corporate structuring and restructuring.
which has been disproved by governments’ responses Our findings from that study support and inform
to the current crisis), namely: the recommendations we make here.
• Misconception One: Nationalization risk is limited We trust you will find this report useful and
to countries with weak political and legal systems; interesting. Please use the box below to register
• Misconception Two: Nationalization policies focus for any further updates on this topic. For more
on natural resources companies; specific questions, please contact any of the authors
• Misconception Three: Nationalization is driven listed at the back of this report, or your usual
only by economic concerns; and Baker McKenzie contact.
• Misconception Four: Nationalization is carried
Ed Poulton & Maria del Carmen Tovar
out only by expropriation.
To be kept informed of further events and publications on this issue, please click herePRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
The Political SituationReturn to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 5
The Political Situation
The COVID-19 pandemic is now shattering long-held assumptions about the global
economic and political order. Quite rightly, the principal focus of policy makers is
to protect public health. However, the potential for immense economic damage
David Chmiel is already causing governments to embrace mitigative measures that are far more
Geopolitical Advisor and co-founder
of Global Torchlight radical than many would have thought politically conceivable a few months ago.
These policies will likely include nationalization of governments often favoured privatization. During
assets currently in private hands. Some of these acts that time, Australia, Canada, France, Germany and the
will be welcomed as governments effectively step UK all put government- run companies into private
into the shoes of private owners of distressed assets hands. The privatization of state-owned enterprises in
in an effort to stem economic contagion – much as Central and Eastern Europe and the former Soviet Union
was the case during the global financial crisis a was a cornerstone of post- Cold War economic reforms
decade ago. In other cases, demands may grow for and throughout the developing world, governments
more compulsory action to expropriate assets seen opted for public-private partnerships over state-led
as critical to public health security or to the basic economic expansion initiatives.
functioning of society in order to ensure that resources
are directed toward areas of greatest need. But nationalization never completely disappeared
as a policy option and the political pendulum may be
Even when the immediate medical crisis abates – swinging once again in favour of taking assets into
and may that be as soon as possible – many of state control. This report sets out a number of cases
the world’s largest economies may have altered in which governments in some of the world’s most
fundamentally. It is likely that debates will then important economies have recently nationalized assets
emerge about the need for more foundational policy or where arguments in favour of nationalization have
change, including whether critical assets should sit in re-entered the mainstream of political discourse.
public or private ownership. By that point, whole
sectors of the economy may already have been As private investors grapple with these changes, it is
nationalized and the nature of these debates would important to recognise that there is no single pattern
be very different from those seen recently in some to this debate. Risk takes different forms in different
of the countries examined in this report. places. However, it is important to dispel commonly-
Nationalization would already be a fact of life. held misconceptions about the nature of
nationalization policy if businesses are to hone their
It is, therefore, vitally important for companies to gain a risk management and mitigation processes to deal
greater understanding of the political dynamics that with this re-emerging challenge.
have driven nationalization in the past in order to better
appreciate how those policies may work in the present
and future. The issues set out in this report are more
relevant today than at any time in the recent past.
Misconception One: Nationalization risk is
limited to countries with weak political and
legal systems
Given historic patterns, there is sometimes a presumption
Nationalization is not a new risk that risk of nationalization exists only in countries
for multinational companies. where free market economic systems are not firmly
established or where political and legal institutions are
There is a long, global history of governments insufficiently robust to prevent arbitrary expropriation.
expropriating assets or otherwise bringing them under One of the most striking features of the current debate
domestic or state-owned control. In fact, such acts over state versus private ownership is that it is prominent
have sometimes been catalysts for more substantive in some of the countries that were at the forefront of
geopolitical disruption. In the 1980s and 1990s, however, the privatisation movement in recent decades.6 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
The Political Situation
Recently, some governments have simply let relevant operating licenses
expire without giving foreign investors the opportunity to renew them or they
have altered criteria to favour domestic or state bidders...
To give a few examples, the Polish government has The global financial crisis of 2008-9 saw banks,
embarked on a policy of “repolonisation” which insurance companies and other troubled businesses
encourages domestic companies to acquire greater come into state ownership in order to restore public
stakes in financial institutions, media companies and confidence in national financial systems. More
other strategic sectors. The renationalization of recently, some political leaders have sought greater
railroads and utilities was a key plank of the last two control of media assets or, at the very least, to limit
general election manifestos of the opposition Labour the extent of foreign ownership in that sector.
Party in the UK. Even in the United States, prominent The motives for doing so are often linked to desires
politicians have called for de facto nationalization or to control political narratives, limit criticisms of
“municipalisation” of private health insurers and government or promote broader nationalist agendas.
electricity companies.
Ownership of public utilities is another area for heated
More recently, US Attorney General William Barr debate as politicians argue that continued private
suggested that the US – alone or with its allies – ownership of these businesses results in price inflation
could acquire controlling stakes in Ericsson, Nokia and for consumers and an absence of long-term investment
other companies competing with China’s Huawei in in infrastructure renewal. In other countries, such as
the provision of 5G infrastructure. To be fair, South Africa, even some types of privately-owned
nationalization is also a growing risk in some emerging land are now potentially subject to expropriation.
economies. Indonesia’s policy of bringing key natural Those investors operating in sectors with historic
resources under domestic control has heightened propensities for nationalization are often attuned to
investor concern in that sector. Governments in mitigating associated risks from the inception of any
Argentina, Bolivia, Ecuador and Venezuela have all investment. As the breadth of the risk grows,
embarked on nationalization exercises in the past however, larger swathes of national economies are
decade – to varying degrees of success. potentially susceptible to these kinds of policies,
warranting much broader attention to the
This debate does not respect geographical boundaries. circumstances in which political leaders in any country
Multinational investors can no longer simply presume may choose to target a particular sector.
that because they do not do business in parts of the
world where expropriation has been used in the past,
Misconception Three: Nationalization is driven
that they need not pay heed to underlying political
only by economic concerns
dynamics elsewhere to assess whether governments
are developing more favourable attitudes to In many cases, a government’s motives for
renationalization. nationalization are economic in nature. Such actions
may allow for retention of greater shares of
associated revenue in national treasuries – often only
once foreign investors have borne the sunk costs of
Misconception Two: Nationalization policies
building a particular investment or making it
focus on natural resources companies
competitive. This is thought to be a key motive behind
Some of the most recent high-profile examples of the Mexican government’s decision to halt private
nationalization have involved natural resources investment in the country’s oil and gas sector.
companies, particularly in the mining and oil and gas Renationalized industries are also sometimes viewed
sectors. However, governments are also demonstrating as champions of broader economic growth with state
a growing propensity to target other sectors of ownership of assets ensuring that resources are
national economies as well. allocated to domestic priorities.Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 7
The Political Situation
However, it is wrong to presume that nationalization nationalization over extended periods of time or by
risk is minimised where a country’s economy is strong. using less overt methods. Recently, some
National security can also be a powerful motivator. governments have simply let relevant operating
In the wake of the 9/11 terrorist attacks, the Canadian licenses expire without giving foreign investors the
and US governments both nationalized airport opportunity to renew them or they have altered
security screening through the creation of national criteria to favour domestic or state bidders in any
government agencies to carry out those functions. reprocurement exercise. In other cases, changes to
Governments have also justified expropriation of underlying legal or regulatory environments may, over
natural resources on similar grounds. The assertion of time, render a particular asset or sector less attractive
national security creates additional complications for to foreign investors and cause them to divest their
investors seeking ex post facto compensation, since interests – often at an undervalue to their true worth.
some avenues of legal recourse allow exemptions in
circumstances where national security is involved. This “quasi-nationalization” or “stealth nationalization”
has taken many forms. For example, in the resources
Nationalization must also be viewed in the context of sector, some governments have enacted mandated
heightened populism and nationalism. There has been beneficiation laws requiring that any natural resources
a backlash against foreign investment in countries where be processed or refined in-country, rather than
such activity is perceived to be favoured over domestic exported in their raw state. Other countries have
interests and where politicians think they can generate instituted bans on “fly-in / fly-out” workers in order
popular appeal by challenging foreign investors. Equally, to encourage greater hiring within local communities.
some governments are questioning the equity of bilateral A host of governments have also repealed investment
investment treaties, arguing that they favour multinational incentives or changed tax and royalty laws in ways
companies over nation states. Others argue that that are less favourable to foreign investors.
meaningful efforts to tackle systemic problems such
as climate change can only be achieved when associated Even where assets are directly taken into government
industries are brought back under state control. ownership, there can be considerable variances in the
compensation paid for them. The Canadian
These motivating factors are almost never mutually government acquired the Trans Mountain pipeline
exclusive and governments will often pursue between Alberta and British Columbia in 2018 for a
nationalization policies due to a combination of negotiated market value. In contrast, when the UK
economic and political factors. This means that Labour Party proposed to renationalize electricity,
investors must develop much greater awareness gas and water suppliers, it said that Parliament would
of the complex interplay of issues in domestic and undertake the valuation exercise, with deductions
regional politics in order to understand how particular made for variables such as pension fund deficits and
investments are perceived within a country and the the state of repair of assets. The net effect could have
degree to which they are at risk of politicisation. meant that minimal compensation was paid in practice.
These changes in methodology present investors
Misconception Four: Nationalization is carried
which a much more complex environment to assess as
out only by expropriation
part of any risk management strategy. The net effects
Expropriation is probably seen as the most common of legal or regulatory changes may not be readily
tool with which to take assets back into state control. apparent and traditional avenues of legal recourse
For investors, the growing challenge lies in the fact may not be available where measures such as outright
that many governments are now opting to effect expropriation without compensation are not used.PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
The value of Investment
Treaty protectionsReturn to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 9
The value of Investment Treaty protections
Ed Poulton Katia Ekaterina Finkel Richard Molesworth Dogan Gultutan
Partner, London Senior Associate, London Senior Associate, London Associate, London
Investment Treaties State). This type of provision prevents shell, or
letterbox, companies from obtaining the benefit
An investment treaty is an of investment protection.
agreement made between two Investment: only an investment as defined by the
or more states, containing relevant treaty will be protected. The definition
reciprocal undertakings for the usually constitutes a general and wide opening
phrase, such as “every kind of asset”, followed by
promotion and protection of a non-exhaustive list, including:
investments made by nationals • movable and immovable assets and rights
and companies of one state in in property;
the territory of the other state(s). • company shares, stocks, bonds and other
interests in companies;
• claims to money;
Many investment treaties are bilalteral investment
treaties (or BITs) between two states. There are also • copyright, trademarks and IP rights; and
multilateral investment treaties (such as the Energy • business concessions and licences.
Charter Treaty and the ASEAN Comprehensive
Investment Agreement) and investment chapters in
Many investment treaties contain more favourable
free trade agreements (such as NAFTA and the TPP).
terms, such as specific acknowledgment that a change
in the form of the investment will not affect its
As they are individually negotiated treaties, their terms
vary and the precise wording of particular provisions characterisation as an investment for the purposes of
will affect their interpretation in any dispute. Nevertheless, the BIT. Similarly, some investment treaties have more
they typically include common definitions, substantive restrictive provisions, for example requiring investments
protections and dispute resolution mechanisms along to be pre-approved by the host state to qualify for
the lines of those described below. protection, limiting protected investments only to
certain sectors or requiring investments to have
Common definitions certain characteristics such as the commitment of
capital or the assumption of risk.
Investor: only an “investor” as defined by the relevant
treaty can benefit from the investment protection. While the term “investment” is typically defined widely,
Most investment treaties define investors as (i) natural this is an area of significant scrutiny in arbitral
persons (i.e. individuals) who are nationals of the
proceedings and has accordingly developed its own
relevant state and (ii) legal persons (e.g. companies)
jurisprudence in the field of Investor-State arbitration.
incorporated or established there. Some investment
treaties require legal persons to have an actual
economic presence or seat of establishment in the Common substantive protections
jurisdiction. For example, the ASEAN Comprehensive
Investment Agreement (ACIA) requires corporate National treatment; most favoured nation (MFN)
investors to have substantial business operations in treatment: investment treaties typically provide that
the State in which they are incorporated (the Home foreign investors are entitled to be treated no less10 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
The value of Investment Treaty protections
While the term “investment” is typically defined widely, this is an
area of significant scrutiny in arbitral proceedings
favourably than local investors (national treatment) and
other foreign investors (MFN treatment), subject only
Dispute resolution and enforcement
to certain limited and specifically described exceptions.
The most valuable aspect of investment treaties is
Fair and equitable treatment (FET); full protection that they usually provide foreign investors with a
and security: investment treaties include additional private right of action: the right to bring an
broad guarantees of treatment for foreign investors in international arbitration claim directly against the
accordance with international law. The host state will host state. While in many cases (and as we explore in
typically promise “fair and equitable treatment” and the case studies below) investors will have the option
“full protection and security” for investments, and of pursuing domestic claims, the ability to pursue a
promise not to engage in “arbitrary” or “discriminatory” public international law claim before an international
decision-making. FET clauses generally require the tribunal provides additional comfort and leverage.
host state to maintain predictable and stable investment
environments consistent with legitimate expectations. Dispute resolution mechanism: The applicable
This involves providing an independent, impartial and arbitral institutions will be determined by the relevant
effective legal process (to deal both with administrative investment treaty in each case, however many
treaties provide for arbitration:
and substantive claims) where investors can pursue
the effective protection of their rights (and in some • under the International Centre for Settlement
circumstances, it may be necessary for the investor to of Investment Disputes (ICSID) Rules;
pursue these before any treaty claim can properly be
• ad hoc, under the United Nations Commission on
brought). Full protection and security clauses require
International Trade Law (UNCITRAL) Arbitration Rules;
the host state not only to abstain from physically
damaging foreign investment, but also to implement • occasionally, under the arbitration rules of the
positive measures to protect foreign investment (for Arbitration Institute of the Stockholm Chamber
example against harm caused by private actors). of Commerce (SCC) or the International
Chamber of Commerce (ICC).
Protection against unlawful expropriation and
compensation: investment treaties do not prohibit There is general consensus that recourse to ICSID
expropriation, but establish clear limits on expropriation arbitration can be useful. While ICSID is an
(and measures having equivalent effect1). Such provisions autonomous international organisation, it operates
typically only permit expropriation where it is carried out: under the auspices of the World Bank.
• in the public interest;
The existence of ICSID proceedings is made public
• following due process of law; (and awards are generally published) meaning that
• in a non-discriminatory manner; and the threat of commencing proceedings under the
• in return for just compensation (at market or fair value) ICSID may be sufficient to persuade a state that it
should take an investor’s claim seriously. Additionally,
Free transfer of funds: investment treaties commonly any award issued by an ICSID tribunal must be
give foreign investors the right to transfer funds into recognised and enforced as if it were a judgment of
the highest domestic court in any ICSID member state.
and out of the host state without delay, using a market
rate of exchange. This covers all transfers related to an
investment, including interest, proceeds from liquidation,
repatriated profits and infusions of additional financial
resources after the initial investment has been made.
1. Expropriation is not limited to physical takings; it can include a wide range of measures that deprive the investor of the economic value of its investment.Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors
How to structure your investment12 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
How to structure your investment
Ed Poulton James Smith Ekaterina Finkel Oliver Pendred
Partner, London Partner, London Senior Associate, London Senior Tax Advisor, London
Legal structuring and Treaty shopping is an attempt to structure the way
in which an investment is held (which can involve
restructuring entering into transactions and/or establishing entities
in certain unconnected states) solely, or in large part,
Investment law on abuse of process for the purpose of enjoying the benefits of favourable
and “treaty shopping” treaty rules. Given that in investment law there is no
doctrine of legal precedent and that arbitral tribunals
are not bound by the decisions of previous tribunals,
A key issue for investors is the there is a lack of consistent approach to so-called
‘treaty shopping’.
ability to structure the way they
hold investments to benefit from It is therefore difficult to say with absolute certainty
in which circumstances tribunals will permit
investment treaties, or more restructuring an investment through a seemingly
favourable treaties. Alternatively, unconnected state to gain greater treaty protection.
Much depends on the facts of each case and the
investors sometimes want to views of the members of the tribunal appointed.
restructure their investment to
While arbitral tribunals have often expressed some
gain the benefit of a treaty, or unease in connection with investors’ treaty shopping,2
they have generally taken a literal view of the
more favourable treaty. This is definitions which both states agreed in the
often referred to as “treaty investment treaty in favour of investors. Arbitral
tribunals will not “add other requirements [to the
shopping” and, particularly in agreed definition of investor] which the parties could
the case of restructuring once themselves have added but which they omitted to
add”.3 Where an investment treaty requires only that
the investment is already held, the claimant investor be constituted under the laws of
is a controversial issue in the relevant contracting state, this will be sufficient.
international investment law. The situation is more difficult for investors in the
case of restructuring, particularly if this takes place
after the issues giving rise to the claim have arisen.
Phoenix Action v. Czech Republic4 is an extreme
illustration of this. The case concerned the Czech
Republic-Israel BIT of 1997 and the claimant investor’s
claim under that treaty for compensation for breach
in connection with its investments in two
Czech companies.
2. See for example in Saluka Investments B.V. v. The Czech Republic, UNCITRAL, Award 17 March 2006 (accessible here) where the Tribunal stated that it had “some
sympathy for the argument that a company which has no real connection with a State party to a BIT, and which is in reality a mere shell company controlled by another company
which is not constituted under the laws of that State, should not be entitled to invoke the provisions of that treaty. Such a possibility lends itself to abuses of the arbitral
procedure, and to practices of “treaty shopping” which can share many of the disadvantages of the widely criticised practice of “forum shopping.”” [para. 240]. 3. Ibid, para. 241
4. Phoenix Action, Ltd. v. The Czech Republic, ICSID Case No. ARB/06/5, Award 15 April 2009 (accessible here).Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 13
How to structure your investment
2020 Empirical Study: Corporate Restructuring and Investment Treaty Protections
Our team has partnered with the Investment Treaty Forum at the British Institute of International
Comparative Law (BIICL) to present the first comprehensive empirical study of corporate restructuring
and investment treaty protections, examining all publicly available decisions of investor-state tribunals
dealing with issues of corporate structuring and restructuring. Access the report here.
In this case: was reasonably foreseeable at the time of the
restructuring that a dispute with the respondent
• the investment had been made at a time when
would arise.8 The Tribunal was not convinced that
there was an already existing (for over a year)
any other reasons for the restructuring cited by the
civil litigation and problems with tax and
claimant (including tax or business specific reasons)
customs authorities;
were determinative for the restructuring,9 and that
• the Israeli entity was created by a Mr Vladimir gaining access to a new treaty claim was the
Beno, who had fled the Czech Republic while determinative reason for the restructuring on
under criminal investigation and had obtained the facts.10
Israeli nationality, to purchase shares in the two
Czech companies he had owned as a Czech citizen
while living in the Czech Republic. His aim was
therefore to bring pre-existing disputes to the
attention of the ICSID Tribunal, and the investment
Tips for successful (re)structuring
was a medium through which to do that; and
• consistent with the above, no economic activity in Based on our analysis of the cases, the following
the market place was either performed or even factors are key to an effective (re)structuring:
intended by the claimant investor.
Ensure any structure complies with the
The tribunal agreed with the Czech Republic’s express wording of the applicable investment
argument that it did not have jurisdiction as “Phoenix treaty (or investment contract), and that this
is nothing more than an ex post facto creation of a treaty is in force at all material times.
sham Israeli entity created by a Czech fugitive from
justice, Vladimír Beňo, to create diversity of nationality”
A (re)structuring has more chance of being
and that the case was “one of the most egregious cases
recognised as legitimate if the investor can
of ‘treaty-shopping’ that the investment arbitration
point to some economic justification or merit
community has seen in recent history”.5
for holding the investment in this particular
way (for example, tax or internal
It ruled that the claimant’s investment did not
reorganisation) - we always recommend
qualify as a protected investment under the BIT
working alongside tax advisers in working out
or the ICSID Convention6 and the arbitration was
the most efficient structure from both a tax
declared as an abuse of the system of international
and investment protection perspective.
ICSID investment arbitration.
In Philip Morris Asia v Australia,7 the claimant The earlier any (re)structuring is done in the
conducted a corporate restructuring in anticipation of life-cycle of an investment, and in particular if
a dispute (linked to introduction of plain packaging this takes place before the alleged breach
laws) to gain access to a treaty claim under the occurs (or is anticipated), the less likely it is to
Australia – Hong-Kong BIT which would not otherwise be viewed as an abuse of process.
have been available. The Tribunal held that the
restructuring constituted an abuse of process as it
5. Ibid, para. 34. 6. Ibid, para. 145. 7. Philip Morris Asia v Australia, PCA Case No. 2012-12, Award on Jurisdiction and Admissibility 17 December 2015 (accessible here).
8. Ibid, para. 569. 9. Ibid, para. 582. 10. Ibid, para. 584.14 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
How to structure your investment
Tax structuring (dealing with matters such as double taxation), and
sometimes will require mandatory binding arbitration
between the two states to resolve particular disputes.
Decisions on investment protection and, in particular,
Therefore it will be important to consider the taxation
access to favourable investment treaties, cannot be
considerations alongside investment protection
taken in isolation. Other factors have to be taken into
considerations when evaluating possible investment
account, most notably taxation. The amount of tax
structures, as both can have a material effect on the
incurred during the lifecycle of an investment, and the
economics and risk profile of the investment.
implications of the structure on the effective rate of
tax on the investment, means that tax will often be
a primary factor in structuring decisions. International norms in tax treaties
There are more than 3,000 bilateral tax treaties that
Tax treaty protections are currently in force. Whilst they are generally based
on international norms, including model treaties
The effective rate of tax on the investment, both developed by the Organisation of Economic Cooperation
in the jurisdiction of the investment and in the and Development (“OECD”) and the United Nations
jurisdiction in which the investor is resident for tax (“UN”), they often have different terms and rates
purposes will be significantly affected by any tax attached to them, which may have depended on the
treaty between those jurisdictions. Broadly, tax relative negotiating positions and preferences of the
treaties serve to allocate taxing rights between the parties at the time the treaties were agreed. Often
two contracting states for different types of income there will be structures that are commonly used for
and gains that might arise. For instance, the foreign direct investment into particular jurisdictions
investment jurisdiction may impose a withholding that might take advantage of a particularly favourable
tax on dividends paid by a company resident in that tax treaty. However simply establishing an investment
jurisdiction of say 15% and that rate of withholding vehicle in a particular jurisdiction is not sufficient to
tax may be reduced to, say, 5% or 0% by a tax treaty be able to access the benefit of that jurisdiction’s tax
between that jurisdiction and an investor jurisdiction. treaties for a number of reasons.
Similarly, the investment jurisdiction may impose a tax
on capital gains arising on the disposal of shares in a Firstly, tax treaties apply to persons that are resident
company resident in that jurisdiction but a tax treaty for tax purposes in the jurisdiction and if, for instance,
with the investor jurisdiction may stipulate that such a company is managed and controlled in another
gains are only taxable in the investor jurisdiction, jurisdiction, it may not be considered resident there.
potentially at a lower rate.
Secondly, the income received by the entity in
Tax treaties should also protect taxpayers to some the treaty jurisdiction must be beneficially owned
degree from being taxed on the same income in both by the recipient (ie, it is not simply passed through
jurisdictions when that is the result of applying the to another person) otherwise certain reliefs may not
domestic law in the states involved. In this respect, be available, such as reduced rates of withholding
tax treaties will override tax rules in domestic law and tax on dividends.
can offer taxpayers some relief from double taxation.
Finally, tax treaties may offer legal mechanisms for And thirdly, there are specific and increasingly
resolving disputes with respect to particular mutual well-developed provisions in treaties that are targeted
agreement procedures between the contracting states at treaty shopping and other forms of treaty abuse.Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 15
How to structure your investment
...94 jurisdictions have signed up to implement tax Treaty related
measures to prevent base erosion and profit shifting...
‘Limitation of benefits’ and the including having adequate premises and employees
for whatever activity that entity may be engaged in,
‘principle purpose test’ even if that entity is simply an investment holding or
financing company. Tax authorities may contend that
Tax avoidance involving treaty abuse was a specific a lack of economic substance means that the entity is
focus on the G20 and OECD Base Erosion and Profit only established there to benefit from the tax treaty,
Shifting (“BEPS”) project that began in 2013 and has such that the principal purpose test is failed. The
transformed the international tax landscape over the requirement to have substance in treaty jurisdictions,
last few years. As part of the BEPS project, measures and the commercial feasibility of having such substance,
were agreed to prevent the granting of treaty will therefore be another important factor to consider
benefits in “inappropriate circumstances”. In particular, alongside the merits of particular tax and bilateral
this involved having a minimum standard of investment treaties.
introducing a “limitation of benefits” rule or “principal
purpose test” to tax treaties. Amending tax treaties
normally involves a lengthy bilateral negotiation,
Interaction between investment
which may have delayed the implementation of this treaties and tax treaties
minimum standard. However, 94 jurisdictions have so
far signed up to the Multilateral Convention to It is also worth pointing out that the interaction
Implement Tax Treaty Related Measures to Prevent between tax and investment treaties is more complex.
Base Erosion and Profit Shifting (“MLI”), which will Governments can often use their fiscal regimes to
result in changes to the thousands of bilateral treaties achieve nationalist objectives by capturing a greater
between the signatories coming into effect much share of the economic returns of an investment in
more rapidly. their jurisdiction. Given that tax treaties override
domestic law they can offer some protection to
A “limitation of benefits” clause, which are standard investors. However, tax may also be included in the
for US tax treaties, includes certain additional tests to scope of an investment treaty and substantial tax
establish whether an entity qualifies as a “resident” for disputes have been dealt with under the procedures
the purposes of the relevant treaty such that the under such treaties. There are various articles that are
person can avail itself of its benefits. The alternative commonly used in investment treaties that may serve
to the limitation of benefits clause is to include a to protect investors from arbitrary changes to the tax
general anti-abuse rule by way of a “principal purpose code and expropriatory levels of taxation, including
test”. Under this test, which is common in European those that require that investments be accorded fair
treaties, if one of the principal purposes of transactions and equitable treatment and provisions requiring
or arrangements is to obtain treaty benefits, those compensation for losses suffered in certain
benefits would be denied unless it were established circumstances.
that granting them would be in accordance with the
object and purpose of the provisions the treaty.
The principal purpose test is a contributor to the ever
increasing importance of having sufficient “economic
substance” in treaty jurisdictions. Economic substance
in this context means not only the management and
direction of the entity in the jurisdiction, but also
potentially certain core income-generating activities,PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
Case StudiesReturn to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors
Argentina
Indonesia
South Africa
United Kingdom
United States of America18 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
Case study: Argentina
Political Situation
by David Chmiel
Argentina is no stranger to mate – now the Vice President – was former
President Cristina Fernández de Kirchner. On that
nationalization or expropriation. news, shares on the country’s stock exchange dropped
At various times in its history, by 48% and the Argentine Peso lost 26% of its value
against the US Dollar, amidst concerns that the new
oil companies, railways, airlines, government would revert to old ways and undertake
further nationalization in sectors such as energy.
utilities and postal services, There is widespread belief that President Fernández
among others, have been is unlikely to take action against foreign investors in
Vaca Muerta, at least in the near-term. The project
brought back into state is important to Argentina’s overall economic
ownership – sometimes development and generation of foreign currency
reserves. Moreover, foreign energy companies possess
on multiple occasions. the technological know-how necessary to extract
oil and gas from shale reserves.
The most recent high-profile act of nationalization in
Nevertheless, investors are paying close attention to
the country occurred in 2012, when the government
an emerging potential dispute between the government
of President Cristina Fernández de Kirchner
and its foreign creditors. On taking office in December
renationalized 51% of the shares of YPF, the country’s
2019, the new government suspended repayments for
largest energy company which was privatised in 1993.
two years on US$ 150 billion in outstanding sovereign
That spawned a raft of multijurisdictional litigation
debt as a precursor to negotiating a broader
between the Argentine government and affected
restructuring of those obligations. The International
shareholders which continues to the present.
Monetary Fund subsequently stated that it considers
Argentina’s debt position to be unsustainable.
The renationalization of YPF dented investor
The possibility of write-downs and even defaults –
confidence, but seemingly only temporarily. In the
as occurred in Argentina in both 1982 and 2001 –
intervening years, foreign energy companies have
cannot be ignored completely.
made significant investments in the Vaca Muerta
shale oil and gas reservoir, with the total amount of Any sovereign debt crisis has the potential to create
capital committed rising from US$ 3 billion in 2013 significant broader political and economic challenges
to US$ 7.5 billion by 2019. This was aided, to no small for the country’s government. This, in turn, might
degree, by the election in 2015 of President Mauricio lead to the pursuit of policy options currently seen as
Macri on a liberal economic platform which foreign unlikely or unfeasible, such as taking critical assets
investors perceived as offering security and stability back into state control. The risk in this case, is not one
after years of uncertainty. of a government embarking on nationalization in its
own right, but rather seeing it as a feasible option as
However, the country’s political environment has a consequence of other policy decisions. All of this
changed once again. In October 2019, Macri was demonstrates the need for continual reassessment of
defeated in his bid for re-election by the populist, nationalization risk to account for changing broader
Peronist candidate, Alberto Fernández, whose running circumstances.Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 19
Protection of foreign investments in Argentina
Claudia Benavides Luis Dates Maria del Carmen Tovar Santiago Maqueda Jorge Valencia Natalia Mori
Partner, Bogota Partner, Buenos Aires Partner, Lima Senior Associate, Senior Associate, Associate, Lima
Buenos Aires Bogota
Overview Constitutional protection of
Should a foreign investor have property rights
its assets expropriated (whether Under Argentine law, shares in a private company
directly, or through creeping are constitutionally protected property rights, and
can only be expropriated through the enactment of
expropriation or regulatory an expropriation law by the National Congress with
encroachment), a qualifying previous proper compensation and a formal
declaration of the public use or utility involved
investor would have claims (National Constitution, art. 17).
for unlawful expropriation and
breach of the FET standard Expropriations Law No. 21,499
under any applicable investment
Expropriations Law No. 21,499 further regulates this
treaties. A map of those treaties formal expropriation proceeding. In general terms,
to which Argentina is a party after the National Congress enacts the law, the
National Executive and the expropriated party must
is set out below. The main agree on the value and, absent such agreement, an
advantage of being able to official authority must appraise the property’s value,
which must be previously paid or deposited by the
pursue such an investment treaty National Executive prior to taking possession
claim would be to avoid having over the property.
to sue the Argentinian authorities However, this procedure can present some setbacks
in their own courts. In addition, in certain cases, most notably due to the fact that
Expropriations Law No. 21,499 prohibits the payment
investors may have access to of compensation in respect of loss of profits—a key
claims in the domestic courts. compensation concept in the expropriation of
profit-making companies.
Official appraisals may therefore widely vary
depending on the methodology used to ascertain
the present value of the expropriated shares
(e.g., in the expropriation of Spanish-owned airline
Aerolíneas Argentinas, appraising authorities reached
the conclusion that the value was negative due to its
current capital-debt structure, and therefore no
compensation had to be paid).20 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
The International Monetary Fund [has] stated that it considers
Argentina’s debt position to be unsustainable.
Nonetheless, the legal system allows for a judicial
procedure to be initiated to discuss the appraisal
Administrative proceedings
methodology and assumptions.
Another manner in which nationalization can take
place is through the unilateral revocation of licenses,
Additionally, there are indirect or “creeping” ways
permits or contracts granted to the investor
nationalization may take place, such as the enactment
authorizing a specific activity or service (this is
of legislative or administrative regulations that
especially the case for public utility companies, mostly
substantially limit the exercise of the owner’s rights.
natural gas and electricity distributors or transporters,
For these cases, Argentine law grants several remedies
as well as telecommunication operators).
that may apply depending on the case.
In these cases, such decisions must be challenged in a
For instance, the owner may seek to consider such a
previous administrative procedure, and only once the
case as an “abnormal” expropriation and thus go to
latter is completed can the expropriated licensee,
court to seek to obtain a full expropriation, with
permittee or contractor submit its challenge in court.
payment of the compensation, under the “abnormal”
expropriation proceeding regulated by Expropriations
As a final note, in all these cases the National
Law No. 21,499 and which is similar to the one
Government must be sued before Federal Courts,
described above.
which in turn tend to defer in favour of the National
Government’s policies and decisions, unless explicit
Alternatively, the owner may seek annulment of
and gross violations to applicable laws took place.
such regulations and full compensation of all losses
suffered (including loss of profits) under State Liability
Law No. 26,944. In such a case, it would have to
demonstrate that such regulations are unconstitutional.
In addition, before reaching a court it would have to
submit a prior administrative claim according to
Administrative Procedures Law No. 19,549.
Finally, if the regulations are not nullified, still the
owner may seek compensation under State Liability
Law No. 26,944, but without being able to obtain loss
of profits and also having to meet a higher evidentiary
standard (i.e., having to demonstrate that the
regulations imposed a “special sacrifice” over the
owner, different than that to the rest of society
or similar market players).Return to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 21
Argentina: Investment Treaties
In force Czechia
Denmark
Lithuania
Malaysia
Senegal
Spain
Signed
(Not in force)
Algeria Egypt Mexico Sweden
Armenia El Salvador Morocco Switzerland Dominican Republic
Australia Finland Netherlands Thailand Greece
Austria France Nicaragua Tunisia Japan
BLEU (Belgium & Luxembourg) Germany Panama Turkey New Zealand
Bulgaria Guatemala Peru Ukraine Qatar
Canada Hungary Philippines United Kingdom United Arab Emirates
China Israel Poland United States of America
Costa Rica Italy Portugal Venezuela
Croatia Jamaica Romania Vietnam
Cuba Korea, Republic of Russian Federation22 PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors Return to Contents Page
Case study: Indonesia
Political Situation
by David Chmiel
In keeping with current global companies. The government also announced plans for
state-owned energy companies to take control of
trends, Indonesia is not immune dozens of oil and gas fields such as the Mahakam
from the recent incursion of Block in East Kalimantan when existing production
sharing contracts expire over the course of the next
nationalism into economic decade, rather than submit them to rebidding by
foreign oil and gas companies.
policymaking.
These efforts came at the same time as plans were
In April 2019, incumbent President Joko Widodo won
announced to utilise more of the country’s natural
election to a second five-year term of office following
resources for domestic development needs and to
a campaign in which both he and his opponent
encourage domestic refining capabilities with bans
promised to continue efforts to bring the natural
on the export of raw, unrefined resources.
resources sector under greater domestic control,
including through nationalization where necessary.
It is, however, premature, to take this as a sign of
impending autarky in Indonesian economic policy.
This willingness to prioritise domestic interests over
Widodo has repeatedly said that foreign investment is
those of foreign investors is not new in Indonesian
critical to Indonesia’s sustained development. Shifting
politics. Early in the country’s history as an
geopolitical currents support this trend. The President
independent nation, a number of Dutch and British
has expressed scepticism about the costs to Indonesian
investments were nationalized. More recently,
sovereignty of accepting Belt and Road Investment
Widodo’s immediate predecessor, President Susilo
from China. Moreover, Indonesia is potentially well-
Bambang Yudhoyono, introduced limits on foreign
positioned to serve as an alternate manufacturing
investment in sectors as diverse as oil services, retail,
location for US multinationals seeking to shift
agribusiness and power generation. He also production from China amidst ongoing trade wars.
announced plans to terminate many of the bilateral In that regard, in early 2020, the government tabled
investment treaties to which Indonesia was a party, legislation in Parliament aimed at encouraging foreign
arguing that they favoured the interests of investment, including comprehensive tax reform.
multinational companies over those of developing
countries like Indonesia. In fact, a large number of Ministers have also suggested that additional sectors
treaties have been terminated and some are being will open to outside investment, albeit likely subject
renegotiated. to the continued emphasis on nationalization of
ownership of natural resources and associated
When Widodo was first elected in 2014, some processing. Balancing the need for foreign investment
speculated that he might take a more liberal view on against domestic political pressure for Indonesians to
foreign investment than Yudhoyono. However, his reap the maximum benefits of their country’s
actions in his first term of office did not necessarily economic growth will require careful and sustained
bear that out. In that period, a number of foreign efforts by policymakers.
mining companies made high-profile exits from
Indonesia following sustained political pressure to sell
majority interests in their local operations to domesticReturn to Contents Page PRESERVE, PROTECT & DEFEND Global Nationalization Risk: Practical Considerations for Investors 23
Protection of foreign investments in Indonesia
Jo Delaney Andi Kadir Richard Allen Hadyu Ikrami
Partner, Sydney Partner, Jakarta Of Counsel, Associate, Jakarta
Singapore
Overview In addition, investors may have access to claims in the
domestic courts. In Indonesia, various forms of judicial
Should a foreign investor have protection are available to foreign investors. These
protections are aimed not only at attracting and
its assets expropriated (whether facilitating foreign investments, but also at providing
directly, or through creeping investors with recourse in case of violation of their
rights. The country’s prevailing statute on investment
expropriation or regulatory is Act No. 25 of 2007 on Investment (“Investment Act”).
encroachment), the investor may
have access to claims under any This legislation is supplemented by various
presidential, ministerial, and local governments’
applicable investment treaties. regulations, as well as regulations of the Investment
Coordinating Board (“BKPM”), the country’s single-
While judicial protection for foreign investors exists in
window agency for investment matters. Article 32 of
Indonesia, it has varying degrees of consistency and
the Investment Act provides broad options to investors
predictability. This has made international arbitration
to settle their disputes with the government, namely
an obvious choice for many foreign investors. A map
good offices, arbitration, and/or court proceedings.
of those treaties to which Indonesia is a party is set
out below. Indonesia has terminated approximately
In practice, while most disputes involving foreign
30 BITs in recent years. However, it is party to the
investors are submitted to international arbitration,
ASEAN Comprehensive Investment Agreement and ASEAN
foreign investors may also submit claims to the State
free trade agreements that include investment chapters.
Administrative Courts (“PTUN”) and General Courts.
This means that many foreign investors retain the
Further, judicial protection for foreign investors is also
ability to invoke investment treaty protections (for
available in non-contentious cases; the Supreme Court
example unlawful expropriation or FET, as set out in
and Constitutional Court have the power to conduct
‘The value of Investment Treaty protections’ above) in
judicial reviews to ensure constitutional and
the face of government interference in their investment.
regulatory consistency.
Notably, some of the investment protections are
more restrictive, particularly those negotiated recently. State Administrative Courts
For example, investment protections are denied to
investors who do not have a substantial business PTUN hear claims of violations of good governance
operation. FET is limited to the minimum standard of principles by public officials submitted by individuals
treatment recognised in public international law. In some or private corporations, including ad hoc governmental
treaties, claims must be brought within three years. decisions. As such, many of the cases heard by PTUN
involving investors relate to their licenses.
At the same time, the exceptions to investment
protections have been broadened. For example, the For example, in late November 2019, the Indonesian
ASEAN Hong Kong China SAR Investment Agreement subsidiary of a multinational mining company filed a
extends exceptions to measures relating to the lawsuit with PTUN against the Ministry of Energy and
conservation of natural resources. Mineral Resources (“MEMR”).You can also read
