Investor nationality planning in international investment arbitration

By Wang Jihong and Liu Ying, Zhong Lun Law Firm

International investment arbitration is undertaken to resolve disputes between a foreign investor and the investment destination country under a bilateral investment promotion and protection treaty (BIT) or the investment chapter of a free-trade treaty by the foreign investor. A major difference between international commercial arbitration and international investment arbitration is that the former deals with disputes arising under a commercial contractual obligation set out by arbitration agreements/clauses, while the latter deals with disputes arising out of BITs between the countries involved.

In a cross-border greenfield investment or acquisition project, it is normal to set up multilayer dealing structures, which provide possibilities for the investor to design and select a favourable BIT in advance. When selecting a BIT, the following factors need to be considered.

王霁虹, Wang Jihong, Partner, Zhonglun Law Firm
Wang Jihong
Zhong Lun Law Firm

The scope of matters for which arbitration may be instituted

The scope under BITs executed between different countries may be broad or narrow and the provisions of the BITs executed by a country at different times may also differ significantly. Taking the BITs between China and Mongolia and Mongolia and Malaysia as examples, the scope of arbitrable matters of the former is narrower, whereas that of the latter is broader.

Article 8 of the China-Mongolia investment agreement provides that if a dispute involving the amount of requisition compensation is not resolved within six months from the commencement of amicable consultations between the parties and it is not referred to a competent court of the host country, either party has the right to refer it to an ad hoc arbitral tribunal. A “dispute involving the amount of requisition compensation” may be interpreted as:

(1) a dispute that involves the amount of requisition compensation only, leaving out disputes involving any other issues (the narrow interpretation); or

(2) a dispute involving the amount of requisition compensation but also involving other issues (e.g. whether requisitioning has occurred, and whether such requisitioning was lawful) (the broad interpretation).

In a mining rights dispute decided in 2017 between three Chinese companies, including China Heilongjiang International Economic and Technical Co-operative Corp and the Mongolian government, the tribunal adopted the narrow interpretation, holding that the China-Mongolia BIT only allows the referral of “disputes involving the amount of requisition compensation” for arbitration and does not cover any other disputes. Accordingly, a dispute as to whether the host country carried out a requisition illegally can only be heard by a domestic court of that country.

Under article 7 of the Malaysia-Mongolia investment treaty, International Centre for Settlement of Investment Disputes (ICSID) international arbitration may be instituted for any investment dispute involving the obligations of the contracting parties under the agreement or the impairment of any rights under such agreement. The institution of international arbitration under the Malaysia-Mongolia BIT will not raise a significant obstacle as to whether the dispute is a “dispute involving the amount of requisition compensation” or whether the investor has “referred the dispute to a competent court of the contracting state in which the investment was made”. Under the Malaysia-Mongolia BIT, disputes over whether requisitioning has occurred, and whether such requisitioning was lawful, clearly fall within the scope of arbitrability.

刘瑛, Liu Ying, Partner, Zhong Lun Law Firm
Liu Ying
Zhong Lun Law Firm

Scope of the investors

Since the scope of matters for which an arbitration may be instituted under BITs executed between certain countries is relatively broad, does this mean that a special purpose vehicle (SPV) established by an investor in such a country automatically gives the investor the right to institute investment arbitration in the host country in its capacity as an investor in that country?

Not necessarily. This depends on the provisions of the BIT and the method by which the nationality of the company is determined. The criteria for a company to acquire a country’s nationality varies from country to country and include such methods as the incorporation doctrine, domicile doctrine and actual control, etc. A significant number of countries use the place of registration or domicile as the criterion to determine the nationality of a company, which makes it possible for an investor to select a BIT with a broader scope of protection.

In the Netherlands, for example, the definition of investor in many BITs executed by the Netherlands is “a legal person incorporated under the laws of the Netherlands”, which is one of the reasons why many SPVs in cross-border investment projects are incorporated in the Netherlands. In arbitration practice, there are a significant number of cases in which investors have instituted investment arbitration through a Dutch holding company – Mobil Oil v Venezuela is one typical example.

Although international investment arbitration practice does not bar investors from seeking the most favourable protection through the design of a dealing structure, the ability to do so depends on the provisions of the specific BIT and whether it constitutes treaty abuse. If there is a “denial of benefits” or “substantive business activity” clause in certain BITs that expressly preclude the application of the BIT to shell companies or companies that do not engage in substantive business activities, then protection will not be available under such a BIT. This is the situation in the China-Canada and China-Asean investment agreements.

To date, China has executed BITs with 125 countries and regions (17 of which have not yet entered into effect), which provide remedies for enterprises to obtain protection for their overseas investments but, in practice, the percentage of Chinese enterprises that take advantage of international investment arbitration to assert their rights still remains at a very low level.

The authors recommend that investors take securing the protection of the most favourable BIT as one of the factors they consider at the deal structuring stage, as past cases illustrate that it is basically impossible to secure such protection if a mezzanine SPV is set up once an investment dispute has arisen, or at the last moment, when its occurrence can be foreseen. On the other hand, once a dispute has arisen, one’s own rights and interests should be vigorously asserted, after a prudent assessment by a professional firm, in order to obtain compensation for investment losses.

Wang Jihong and Liu Ying are partners at Zhong Lun Law Firm

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