Over recent years, a number of governments have

sought to adjust the fiscal and regulatory bases of

the contractual rights given to foreign investors
under particular agreements.
Some of the measures include unilaterally changing
domestic laws, or increasing the taxes and royalties on
exploration and production in order to increase the state's
returns from the investors' activities. Most recently, Hugo
Chavez, the President of Venezuela, announced a series of
measures dramatically increasing the tax burden on
exploration and production companies, as well as
requirements significantly adjusting the management
rights of foreign investors in their own exploration and
production investments. But at what point do legitimate
policies become confiscatory action or expropriation?
Moreover, how can foreign investors best protect
themselves from this risk?
Stabilising a contract
More commonly than not, modern economic development
agreements (EDAs) such as concession agreements,
production sharing agreements or host government
agreements will include a "stabilisation" provision. In most
cases, the provision will seek to freeze the law of the
relevant state as it exists at the point in time at which the
concession agreement is entered into, as that law applies to
the concession itself.
As well as including a "stabilisation" provision in the EDA,
an investor can also structure its EDA such that
international law is the governing law of key rights and
obligations under the agreement, as well as providing that
if a dispute arises under the EDA, that dispute will be
subject to binding international arbitration. This process is
called "internationalisation". Internationalising an EDA does
not necessarily mean that it is solely governed by
international law. Rather, it may be governed by local law
except to the extent that its law is inconsistent with
international law. There is nothing that prevents an EDA
from being governed by more than one legal system in this
way.
Expropriation
Under international law, if an expropriation is
discriminatory, arbitrary or retaliatory it will be unlawful. A
state may also be held to have expropriated property where
the actions of the state are considered tantamount to
expropriation or confiscation (as discussed below).
International law also provides that contractual rights can
be the subject of expropriation and that property owners
have a right to control the property they own.
Consequently, international law can provide protection to
an investor where a government unilaterally modifies a
contract in its favour and in doing so, divests the investor of
its contractual rights under the EDA or its management
rights over its assets without actually physically seizing or
taking the investor's property. In other words, the
circumstances constituting expropriation under
international law may be broader than those under the
domestic law of the relevant state.
Using international law in EDAs
Increasingly, international law can play a role in structuring
and protecting foreign investments and lessening an
investor's exposure to political risk, confiscatory taxation
and expropriation.
International law clearly provides that where a foreign
investor's property is expropriated, the state is required to
pay adequate compensation. The requirement to pay
compensation can also be structured into the EDA so that it
also acts, in part, as a disincentive against the state
expropriating the investor's property in the first place. Also,
if the state does expropriate the foreign investor's property,
the foreign investor will receive some compensation in lieu
of the property of which it has been deprived calculated on
a basis agreed in the EDA rather than on the basis
prescribed under the domestic law of the relevant state.
Under international law, a measure may be tantamount to
expropriation if it effectively deprives an investor of, or
renders useless, the investor's property, assets or
contractual rights under an EDA even though the investor
January 2006
Energy Update
Confiscatory action or expropriation?
Protection for foreign investors against confiscatory taxation and expropriation under
international law
by Chris Flynn
Brussels Dubai Frankfurt London Madrid Milan Munich New Delhi New York Paris Singapore Tokyo
may not have been required to divest itself of that property.
It is therefore important for an investor to package its
contractual rights carefully so as to ensure it can receive the
full benefit of the protection available to it under
international law. One way of doing this would be for the
parties expressly to agree that the contractual rights under
the agreement constitute "proprietary" rights.
For example, international tribunals are sensitive to an
investor's need to recoup its investments with a reasonable
return as well as to make a reasonable operating profit.
Consequently, a tribunal may find that changes in taxation
or fiscal regimes which are so onerous so as effectively to
deprive the investor of the commercial value of its
investment amount to expropriation, and, under an
"internationalised" EDA, trigger an obligation on the
relevant state to pay compensation. However, changing
taxation laws will be, prima facie, within the sovereign
domain of the state, so long as such changes are not
discriminatory, arbitrary, confiscatory and are made for a
bona fide public purpose. Such changes will not be illegal
under international law.
It is important to include the international equivalent of a
"no-waiver" provision in the EDA. If a state were to
significantly change the fiscal regime relating to a specific
EDA and, while seeking to negotiate with the state in
respect of those changes, the foreign investor complied
with them, there may be an argument that the EDA has
been modified accordingly due to the acquiescing conduct
of the investor. To prevent this occurring, the investor will
need to ensure that the EDA expressly reserves its rights in
such circumstances.
In addition to the above, the state should waive its right to
rely upon the doctrine of sovereign immunity in the event
of a dispute arising between the parties under the EDA. By
doing so, in addition to each of the other elements of an
internationalised EDA, the state clearly indicates its
intention to treat the investor in a manner consistent with
the investor having "international personality".
Conclusion: internationalising a stabilised EDA
In order to attract the added protection of international law
from political risk, expropriation and confiscatory taxation,
a foreign investor should ensure the EDA provides for the
following:
an appropriate stabilisation clause which also expressly
provides for the stabilisation of the fiscal regime
applicable to the EDA so as to preserve the basis for the
investor's financial model for the relevant project;
a choice of law clause which, at the least, provides for
the law of the state to be read in the context of
principles of international law;
a provision for binding international arbitration in
respect of any dispute arising out of or in connection
with the EDA;
a provision providing for the waiver of sovereign
immunity by the relevant state;
agreement that expropriation, or measures amounting
to expropriation, are illegal and a repudiation of the EDA;
a provision detailing the basis for calculating adequate
compensation (including accounting procedures) in the
event that the investor's property is expropriated;
express agreement that the underlying agreement
constitutes a package of proprietary rights of the
investor; and
an express reservation of rights in the event the parties
need to renegotiate any provision of this agreement
(like an internationalised "no waiver" provision).
By following the above steps, a foreign investor will both
minimise its exposure to any potential expropriation of its
property and, at the same time, maximise the likelihood of
it receiving adequate compensation in the event that its
property is expropriated. Further, these steps will help to
ensure that the investor would be compensated if the state
takes any measures which fall short of physically seizing the
investor's property yet still effectively deprive the investor of
the benefit of that property. In essence, while we cannot be
sure that the investors affected by Mr Chavez's reforms have
the benefit of these protections, we can be sure that if they
don't have them, they now wish they did.
This update is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.
For more information please contact us at Broadwalk House 5 Appold Street London EC2A 2HA Tel +44 (0)20 7638 1111 Fax +44 (0)20 7638 1112
www.ashurst.com 2006 Ashurst Ref: DTP/4211 Jan 06
Contacts
Chris Flynn
Associate, public international law
Tel: +44 (0)20 7859 1490
Email: chris.flynn@ashurst.com
Ronnie King
Partner, head of international arbitration
Tel: +44 (0)20 7859 1565
Email: ronnie.king@ashurst.com
Geoffrey Picton-Turbervill
Partner, head of global energy
Tel: +44 (0)20 7859 1209
Email: geoffrey.picton-turbervill@ashurst.com