Investment Treaty Planning – is Your Investment Structured Well?
Olexander Martinenko, Îlga Shenk
Why is it necessary?
When structuring investments in Ukraine, investors usually keep in mind a variety of considerations — tax, commercial, corporate, financial, etc. Yet, there is one more factor that may seemingly play an insignificant role at the outset of entering the Ukrainian market, and may yet become a life rope when the investor runs into troubles with the local authorities.
Target investment jurisdictions (especially emerging markets, including Ukraine) are not always easy to survive in when it comes to dealing with regulatory authorities. Despite certain improvements in recent years, Ukraine can hardly boast an impressive track record of productive and law-abiding approach on the part of tax, law-enforcement and regulatory authorities towards business. It is not uncommon for the Ukrainian authorities and regulators to initiate dubious investigations into the day-to-day activities of businesses. That practice causes disruption of operations and creates negative reputation exposure for commercial entities. As a result, embattled foreign investors/business owners sometimes prefer to withdraw their businesses from Ukraine than to keep fighting the administrative Goliath.
Foreign investors typically turn to default tactics in countering such troubles. They turn to Ukrainian courts to obtain redress from the harassment tactics of the state authorities. Regretfully, the proceedings in Ukrainian courts do not always deliver the necessary results. Even if the investor wins its case on merits, that victory may become hollow as it does not necessarily mean that the public authorities will ease their grip on the investor’s business.
Yet, there is a useful legal contrivance that remains available to many foreign investors. Call it the Judgement Day’s weapon or means of last resort, but a lot of them are able to bring host states to order by using purely legal mechanisms.
Ukraine is a party to a wide network of bilateral and multilateral treaties requiring that Ukraine follow high standards in protecting the rights of foreign investors. Those standards include (i) protection from unlawful expropriation of their investments in Ukraine (whether the explicit taking of property or equivalent measures), (ii) the prohibition of discrimination in favour of Ukrainian or other foreign investors, (iii) the requirement to accord investors fair and equitable treatment, as well as (iv) to ensure full protection and security of their investments in Ukraine.
How does it work?
The important feature of the above international treaties is that they allow the foreign investor directly to sue its host state for violation of obligations in a treaty. It can do so by instituting an international arbitration against its host state.
A number of international treaties prescribe the so-called “cooling-off” procedure for all investor-state claims. That means that the foreign investor is obliged to follow that route as a precondition for actually launching the investment arbitration proceedings based on its investment claim. Depending on the treaty, such cooling-off period may last from three to six months and only then, unless the matter is resolved, can the investor proceed with full-fledged arbitral proceedings against its host state.
Put simply, Ukraine has a range of obligations under a variety of international treaties with regard to dealing with foreign investments. Its breach of such obligations may well result (and has, on a number of occasions, resulted) in Ukraine’s liability towards affected investors.
For the sake of fairness, one has to admit that the investment arbitration procedure is not a quick and inexpensive shortcut to success. Yet, it is a very good tool of the last resort available to the foreign investor if the host state fails to heed the investor’s pleas for justice. An arbitral award can always be enforced against Ukraine around the world – in a variety of jurisdictions (including Ukraine, of course) where the state’s assets amenable to compulsory execution can be found.
If the arbitration tribunal was constituted under the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID) and the ICSID Rules, the award would be subject to compulsory enforcement in 154 member states of the ICSID Convention (including Ukraine). Specifically, where an ICSID award ordering compensation to the foreign investor is rendered against Ukraine, Ukraine has to comply (and pay) under such an award immediately (i.e., no further legal actions in Ukrainian courts are required).
If, however, the arbitral award is rendered not by an ICSID arbitration tribunal (e.g., by a tribunal constituted under UNCITRAL, LCIA, ICC or SCC Rules), such award will be enforceable in Ukraine or in 161 member states of the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. However, in this case the award will need first to be enforced via a local court with very few grounds for refusal of enforcement (e.g., violations of the due process in arbitration, or if the award goes beyond the jurisdiction of the arbitral tribunal).
On those rare occasions where the winning foreign investor can locate the state assets in a jurisdiction that is not a party to any international multilateral arbitration treaties (like ICSID or the 1958 New York Convention), even then the foreign investor is likely to enforce the respective arbitral award against Ukraine by following local procedural rules.
What is there to start with?
To gain the benefit of the above investment protection mechanism, the foreign investor needs to think over the way its investment in Ukraine is structured. It is certainly better for the investor to think of it well in advance of actually making its investment.
Firstly, it will need to check whether the pre-planned home jurisdiction of its outbound investments has a valid investment treaty with Ukraine. Secondly, and if yes, then it will need to check whether that investment treaty fits the specific features of the investor’s pre-planned investment into Ukraine. Although generally similar, investment treaties may significantly vary in their understanding of who qualifies as a foreign investor and precisely what an investment can be. Obviously, those matters will be of paramount importance in the event of a dispute arising between a foreign investor and Ukraine.
Generally, by selecting the foreign holding jurisdiction with the most beneficial (i.e., for a particular business venture) investment treaty, the investor can obtain wider protection guarantees. It follows that it will certainly increase its chances of prevailing in any investment arbitration against its host state. And even more to follow — if the foreign investor has a strong case against the respondent state, the state will be more inclined to negotiate an amicable settlement with the investor rather than face the prospects of a full-scale investment arbitration prone to affect its financial position as well as its reputational image.
The proper investment structuring exercise is an important pre-condition to venturing into Ukraine, as protection via an investment treaty is accorded only to those foreign investors (whether individuals or companies) that meet the definition of “investor” and whose assets in Ukraine qualify as “investments” under the respective investment treaties.
As it stems from various investment treaties involving Ukraine, they typically understand the term “investor” as either an individual or a company whose origin is in a jurisdiction other than Ukraine. As a general rule, for individuals the criterion is him/her being a national of a foreign state while for companies — their incorporation (constitution) in that foreign jurisdiction. Certain investment treaties allow a company that is not incorporated in a signatory state to benefit from the protection that is granted by the respective investment treaty if the company is de facto controlled by a national or a company from the signatory state (e.g., Ukraine-The Netherlands treaty).
One should remain well-advised to exercise extra vigilance if one carries out the investment jurisdiction shopping exercise for a foreign investor who has multiple nationalities or where he/she holds permanent residence, as opposed to citizenship, in a certain foreign state.
“Investments”, in turn, are usually understood broadly, and include real estate assets, movables, shares in companies, other securities, intellectual property, concessions, mining permits, etc.
Interestingly, simple claims for money (including investments in sovereign debt) face opposition from certain arbitrators, who refuse according them the status of “investments” that can allow the foreign investor to gain protection under investment treaties. That position developed despite the fact that many investment treaties explicitly recognise them as an “investment” that is to be offered protection under the respective treaties.
For example, an arbitration tribunal refused to recognise almost EUR 504 million invested by the Slovak Bank Poštová banka in Greek sovereign bonds as an investment protected by the 1991 Slovakia–Greece Agreement for the Promotion and Reciprocal Protection of Investments due to peculiarities of that treaty’s definition of “investments”. As a result, the arbitration tribunal refused jurisdiction over Poštová banka’s claims against Greece.
As stems from the above, it is essential to ensure that the criteria of “investor” and “investment” are met before structuring the investment to Ukraine. That is, the applicable investment treaty needs to be chosen by the investor already at that stage (i.e., a long time before any controversies with the Ukrainian state authorities actually arise or become likely to arise). Restructuring investments later on in order to benefit from a particular investment treaty can be viewed as an abusive tactic and render the investor’s claims inadmissible or beyond the jurisdiction of the arbitration tribunal.
Finally, there is one more aspect of paramount importance for foreign investors seeking treaty protection for their investments in the host state (including Ukraine). Namely, the issue of “expropriation” of foreign investments by the host state. The general understanding behind international investment treaty mechanisms is that the unlawful expropriation of foreign investments is a bad thing to happen. It is generally unlawful if (i) the state’s actions do not follow the due process and public interests, (ii) the host state fails (a) adequately and (b) promptly to compensate the foreign investor for the loss of its investments in the host state, and (iii) the state’s actions are discriminatory.
Many foreign investors have already found themselves in dire straits for having overlooked what they might have originally perceived as an unimportant minuscule matter. For that very reason, a very careful exercise in investment treaty selection becomes even more important for the proper shaping of the upcoming investment plans.
Takeaways
To cut a long story short, foreign investors entering Ukraine should always ensure that they take every measure for gaining protection from one of the investment treaties that Ukraine is a party to, and have structured their investments into Ukraine accordingly.
In the same vein, having investments in Ukraine protected by the guarantees provided in an investment treaty is a solid safeguard against possible unreasonable measures or abuses by the public authorities of the host state. If any controversies around those matters emerge, the proper investment treaty protection accorded to the foreign investor can serve as a life jacket for it either in the negotiations or, if necessary, in the investment arbitration against Ukraine.
Olexander Martinenko
is a senior partner at CMS Cameron McKenna Nabarro Olswang (Ukraine)
Olga Shenk
is a counsel at CMS Cameron McKenna Nabarro Olswang (Ukraine)
