Patrick Childress
Attorney
Sidley Austin LLP, Washington, DC
Over the past few decades, oil and gas companies have turned to international investor-state arbitration to resolve high-profile—and high-value—disputes with foreign governments. When Hugo Chavez's government nationalized ConocoPhillips's assets in Venezuela, for example, rather than try its luck in a Caracas court, ConocoPhillips looked to an independent, international arbitration tribunal to resolve its $30-billion dispute. Likewise, when affiliates of Yukos Oil Co. demanded $100 billion from the Russian government, instead of suing Russia in the Russian courts, they sought relief through international investor-state arbitration. All told, oil and gas companies have initiated more than 60 such arbitrations against foreign governments.
However, a new wave of pushback from sovereign states—and uncertain signals from the administration of US President Donald Trump—threaten to erode access to investment treaty arbitration for oil and gas companies. This article discusses these recent developments, provides a basic overview of investor-state arbitration, and explains how oil and gas executives can help ensure that their international investments enjoy adequate protection.
Investor-state arbitration basics
Oil and gas companies can access investor-state arbitration through to use of an international investment agreement (IIA). There are two basic types of IIAs: bilateral investment treaties between two countries and free-trade agreements (FTA) with investment chapters—such as the North American Free Trade Agreement (NAFTA)—that are often between more than two countries. This section explains who can bring a claim under an IIA, introduces the protections IIAs typically afford, and describes—in very basic terms—the international arbitration process.
Who can bring a claim? Generally, a company can initiate investor-state arbitration if:
• It is from one of the countries that signed the relevant IIA.
• It invests in another country that signed the same agreement.
For example, if a US company invests in a Mexican natural gas project, that company likely can sue Mexico under NAFTA because both the US and Mexico are NAFTA signatories.
What protections do IIAs offer? Although the specifics vary from treaty to treaty, most IIAs offer at least three core protections:
• Fair and equitable treatment. IIAs almost universally guarantee "fair and equitable treatment" for foreign investors. The fair and equitable treatment standard is potentially quite broad—it protects investors from a wide array of actions that are arbitrary, discriminatory, or contrary to an investor's expectations. For example, in the Mobil v. Venezuela arbitration, the tribunal held that certain production restrictions and export curtailments violated ExxonMobil's "reasonable and legitimate expectations" and therefore breached the fair and equitable treatment standard. The tribunal awarded ExxonMobil $1.6 billion in that case. In the Perenco v. Ecuador arbitration, the tribunal held that a 99% tax on so-called "extraordinary revenues" in the hydrocarbons sector also violated the fair and equitable treatment standard.
• Protection against expropriation. IIAs typically also limit a government's power to expropriate (i.e., seize or take possession of) foreign investments. An expropriation usually will violate an IIA unless it comports with certain international law requirements. In the Occidental Petroleum v. Ecuador arbitration, the tribunal held that the cancellation of a production-sharing contract was a measure "tantamount to expropriation" that violated the relevant treaty. Expropriation provisions normally are not limited to literal takings. Typically, they cover a range of measures that deprive the investor of the substantial value of its investment. For example, in the Yukos v. Russia arbitration, the tribunal found that Russia did not directly expropriate Yukos. However, the measures Russia took, which included levying onerous taxes and fines, had an effect "equivalent to nationalization or expropriation," and therefore violated the treaty. The tribunal ordered Russia to pay more than $50 billion in compensation.
• Full protection and security. IIAs also normally require host governments to exercise due diligence in providing "full protection and security" to foreign investments. This standard requires a host country to, at a minimum, protect foreign investments from physical threats (e.g., violent demonstrators, guerilla groups, or the country's own military). In the recent Ampal-American Israel Corp. v. Egypt decision, the tribunal ruled that Egypt's failure to protect a natural gas pipeline from third-party attacks in the wake of the Arab Spring uprising breached Egypt's obligation to provide full protection and security.
What does the process look like? Typically, a panel of three independent arbitrators will rule on an investment treaty claim following an exchange of detailed written pleadings and at least one oral hearing. Normally, the investor and the host government will each select one arbitrator and then try to agree on the third, who is deemed the "president" of the tribunal. If the parties cannot agree on a president (incidentally, a common occurrence), the arbitral institution administering the case often makes the appointment. The World Bank's International Centre for Settlement of Investment Disputes is the most frequently designated forum for investor-state arbitration, although treaties may specify other arbitral institutions.
If the arbitral tribunal ultimately awards damages, the prevailing party can enforce that award in any of the more than 150 countries that have signed the New York Convention—a separate treaty regarding the enforcement and recognition of arbitration awards. The broad scope of an arbitration award's enforceability is a critical advantage over US court rulings, which often are not enforceable in foreign jurisdictions.
The value of treaty planning
It is almost always preferable to bring a claim before an independent, international tribunal instead of suing a government in that government's own courts. For this reason, prudent oil and gas executives will ensure that they have recourse to international arbitration for each of their foreign investments. To do this, an executive should confirm—before making the investment—that a proper IIA is in place between the company's home country and the so-called "host" country of the future investment. If no such treaty exists, then the executive should consider adding a subsidiary in a third country that does have an IIA in place with the "host" country to the chain of ownership. The assistance of legal counsel likely will be necessary to ensure that this third country subsidiary meets all of the requirements under the relevant IIA. Some IIAs require, for example, that a company bringing a claim maintain substantial business activities in its home country to qualify for treaty protection.
And if a company has already invested overseas without establishing any treaty protection, all is not lost. A company may be able to restructure an existing, unprotected foreign investment through a third country subsidiary to gain IIA protection. Time is of the essence, however, as ExxonMobil learned in its investment arbitration against Venezuela.
In 1996 and 1997, Mobil1 invested in two heavy crude oil projects in Venezuela's Orinoco belt through US-based subsidiaries. No IIA was in place to protect these investments—the US and Venezuela have never signed a bilateral investment treaty and they are not parties to any common FTA.
In 2004, the Venezuelan government began passing a series of restrictive measures in the oil and gas sector. That year, the royalty rates applicable to ExxonMobil's two projects jumped from 1% to more than 16%. Later, in 2006, ExxonMobil restructured its Venezuelan assets through Dutch subsidiaries, thereby obtaining the protection of the Netherlands-Venezuela bilateral investment treaty. After this restructuring, Venezuela continued to harm ExxonMobil's investments, passing further taxes, export restrictions, and ultimately expropriating the projects outright.
In the investor-state arbitration that ensued, ExxonMobil sought damages for all of Venezuela's hostile actions—including those from before the 2006 restructuring. However, the arbitral tribunal held that it could only consider claims under the Netherlands-Venezuela bilateral investment treaty that arose after the restructuring. Thus, ExxonMobil received no compensation for its losses tied to the 2004 royalty rate increase. This valuable claim vanished simply because ExxonMobil did not have proper investment treaty protection in place.
The lesson of Mobil v. Venezuela is clear: Do not wait until a dispute arises to secure investment treaty protection. Instead, the wisest course is to ensure that an IIA is in place to protect each of a company's foreign investments as early as possible.
The uncertain road ahead
Over the last few years, protecting overseas investments through treaties has become a bit more complicated, as some states—so far, a small minority—have pulled back from their investor protection commitments. Most recently in May, Ecuador made headlines when its legislature voted to terminate 12 of its bilateral investment treaties—with China, Chile, Venezuela, the Netherlands, Switzerland, Canada, Argentina, the US, Spain, Peru, Bolivia, and Italy. Ecuador is not alone. Venezuela, Indonesia, South Africa, Russia, and Italy also have withdrawn from treaties that protect foreign investors (see table, p. 23).
Although these withdrawals should raise some concern, most IIAs contain "sunset" provisions that can protect existing investments for many years even after the termination of a treaty.
Other countries have stopped short of renouncing investment treaties outright, but instead are changing the terms of their IIAs to make them less favorable to international investors.
One high-profile example is the European Union's effort to change the dispute-resolution process for foreign companies. Under the current system, panels of three independent arbitrators—one of which the investor appoints—typically decide investment disputes. The EU is stepping away from this model, hoping to replace it with an "international investment court" that would employ a standing roster of full-time, government-appointed judges. Some observers worry that an investment court of this sort—headed by judges of the governments' choosing—would favor states over foreign investors.
So far, the investment court approach has only appeared in a handful of treaties, but the EU seems resolute in its stance against traditional investor-state dispute settlements (ISDS). In a recent statement related to its ongoing trade negotiations with Japan, the European Commission stated that it has "fundamentally reformed the existing system for settling investment-related disputes."
The EC said, "A new system—called the investment court system, with judges appointed by the two parties to the FTA and public oversight—is the EU's agreed approach that it is pursuing from now on in its trade agreements. This is also the case with Japan. Anything less ambitious, including coming back to the old [ISDS] is not acceptable. For the EU ISDS is dead."
The EU's sharp policy shift and the treaty renunciations by Ecuador and others could be isolated incidents, or they could portend a broader wave of anti-investment arbitration sentiment.
Only time will tell
Adding to this uncertainty is the Trump administration's relative silence on US policy toward investor-state arbitration. On the one hand, the president withdrew from the Trans-Pacific Partnership and has pressed for the renegotiation of NAFTA—which he recently deemed "the worst trade deal ever made by any country." These antiglobalization themes suggest that the new administration might be hostile to investor-state arbitration. On the other hand, the administration's recently released "Summary of Objectives for the NAFTA Renegotiation" indicates that the administration might not want to abandon ISDS outright—just tweak the system here and there. To date, the current White House has left few clues and the US stance remains unclear.
All of this uncertainty makes proper treaty planning a bit more complex, but by no means impossible. In most cases, oil and gas companies investing abroad still have options for protecting their overseas interests. A prudent oil and gas executive should work with legal counsel to do the following:
• Identify which IIAs protect each of the company's foreign investments.
• Ensure that those treaties contain a full range of investor protections, including access to international arbitration.
• Keep up-to-date on current events that may impact the availability of investment treaty protection.
• If necessary, restructure foreign investments to ensure that they are properly protected by IIAs.
Following these steps will help oil and gas executives invest overseas with confidence so that when the next Hugo Chavez emerges, their foreign investments will be protected.
Reference
1. The investments at issue occurred before the 1998 merger of Exxon Corp. and Mobil Corp.
The author
Patrick Childress ([email protected]) is an associate in the international arbitration group at Sidley Austin LLP in Washington, DC. He'd like to thank Mattie Wheeler, who assisted in this article's preparation.
