In 2015, China invested $14.8 billion in 49 One Belt One Road (OBOR) countries. The figure is predicted to hit $200 billion in the next three years. Spanning 65 countries, China’s OBOR policy offers a world of opportunity for Chinese investors, but comes with numerous risks. The Silk Road economic belt and maritime Silk Road include politically risky countries such as Afghanistan, Syria and Myanmar where investors may have to deal with terrorist attacks, expropriation and unstable regimes. A number of legal risks can also cause trouble for investors so they should be vigilant when drafting agreements. If disputes do arise, arbitration and investment treaties may offer solutions for investor protection.
Investors should do their due diligence and take note of contract mechanisms when negotiating and settling agreements with local businesses and governments, especially in politically unstable countries.
“As a preventative measure, Chinese investors need to do their due diligence,” says Libin Zhang, partner at Broad & Bright. “The seller of the target in the host country may not be willing to disclose critical information. For example the owner of a local target company may be set up as a trust and it is not clear who is behind the trust. The beneficiary of such a trust may be a protégé of someone in the government in the host country. If there is any political turmoil there and the project is cancelled, the management of the Chinese investor, particularly if it is a listed company, has the fiduciary duty to be responsible for public investors if they did not identify and disclose such problems.”
A number of contract mechanisms need to be thought through carefully and negotiated wisely to help investors minimise legal risks. “In liquefied natural gas (LNG) share purchase agreements, for example, in Indonesia and Qatar along the maritime Silk Road, force majeure clauses are usually narrowed down for energy security and the entity has the obligation to supply the gas in spite of certain risks, such as facilities failure or availability of LNG ships” says Zhang. “Under the frustration theory in contract law, a party could get off the hook but the common law tends to limit the use of frustration or commercially impracticality rules, such as the blockage of a canal or route by war or terrorism. Generally speaking, the force majeure clause should be carefully negotiated to avoid any abuse by a party to get off the hook for its delivery obligation under the contract.”
Investments along the belt and road have been mainly in natural resources, including oil and gas, and minerals in addition to infrastructure, for which approvals may span multiple countries, so a requirement for intergovernmental agreements should be a condition before closing on an agreement. A number of other contract mechanisms are also commonly used.
“Features such as stabilisation, renegotiation and hardship clauses are being included in modern contracts for international trading or investment transactions,” says Zhang. “It is important to note that common-law jurisdictions favour the sanctity of contracts and protect enforcement, and do not easily apply such principle of a change of circumstances. On the other hand, negotiation of force majeure clause and exit mechanisms are also important for Chinese investors in order to control the political risks involved in those host countries.”
When worse comes to worst, litigation may be necessary. “The local legal systems are not developed in many of the countries and they can be unfair and inefficient,” says Li Qing, partner at JunHe.
Including arbitration clauses is wise for investors to protect themselves from the possibility of having to resolve disputes in local courts.
One point to remember when drafting arbitration clauses is that your dispute resolution neutral jurisdiction is should be a New York Convention member state so an arbitral award can be enforceable in more than 150 countries that have signed the convention.
“In commercial arbitration in Asia, the most popular fora for arbitration are the Hong Kong International Arbitration Centre (HKIAC), Singapore International Arbitration Centre (SIAC) and the Arbitration Institute of the Stockholm Chamber of Commerce (SCC) because they are neutral,” says Li. “It is important to choose a neutral place to arbitrate and unless there is special reason, don’t limit who can arbitrate on the tribunal. The governing law should be one of a neutral country.”
“Singapore has been a popular forum for arbitration, especially with India companies, since both use common law systems,” says Li. “The China International Economic and Trade Arbitration Commission (CIETAC) is preferred by Chinese companies because it is quick. Cases are usually resolved in nine months compared to 20 to 24 months for other arbitration centres, but whether the foreign partner accepts CIETAC depends on how much bargaining power the Chinese investor has.”
Investor protection through investment treaties
Chinese investors can take advantage of multilateral and bilateral treaties in the settlement of disputes and for host legal protection. Out of the 65 OBOR countries, 38 have signed bilateral investment treaties (BITs) while 55 are party to the International Centre for Settlement of Investment Disputes (ICSID). Investors can rely on enforcement mechanisms under this convention. Common forms of protection include compensation for expropriation, fair and equitable treatment, and most favoured nation treatment.
In Ping An Company v Fortis Group, the first claim under ICSID from Chinese investors, where there was a grey area because of two versions of bilateral investment treaties, investors from mainland China failed due to a lack of jurisdiction since the dispute arose before entry into a new treaty.
To protect Chinese investors into other countries, investment treaties need to be updated. “Many of China’s existing BITs are of the old generation treaties and are out of date,” says Zhang. “They were made when foreign investment was going into China and China was trying to protect itself as a host country.”
Energy Charter Treaty
The recent Yukos case offers an example of the uncertainty that still surrounds treaties. In the case, former shareholders of Yukos made claims against Russia and were given a $50 billion compensation award, but The Hague district court overturned the decision and set aside the award. This case is directly relevant to investment arbitration seated in The Netherlands but could impact other courts and pre-October 2009 energy investments in Russia not covered by the Energy Charter Treaty (ECT).
“The case raises the alert of the Chinese government as to the danger involved if China joins the ECT,” says Zhang. “First of all, the case is tainted with the possible abuse of an international treaty which is offering treaty arbitration for investors who hardly fall under the category of “investors from another state". On this issue, the denial of benefits clause under the ECT will not help. China has many fake foreign investors who are really Chinese investors with round-trip investments back to China. Secondly, Chinese laws and policies in the energy sector, especially the renewable energy sector, are in transition and undergoing changes. Considering the explosion of renewable energy arbitration cases under the ECT, China's joining the ECT will subject China to lots of claims in this area for foreign investment in China.”
Investors should be prudent when structuring contracts and be aware of the protection of their rights under investment treaties that cover OBOR countries. How investment treaty protection is enforced in arbitration and the way new investment treaties are drafted will be an area to keep an eye on. With the influx of investments focusing on minerals, infrastructure and energy into OBOR countries, investors should pay particular attention to how disputes are resolved in these sectors.