Planning for Disputes in Cross-Border Private Equity Deals: Managing Risk (and Getting Some Benefits) with International Arbitration

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Planning for future disputes is essential to managing the risk of any transaction—but it is ever more so for private equity managers, who are increasingly investing in foreign assets and in industries exposed to sovereign risk (e.g., oil & gas, natural resources, telecommunications, infrastructure). Appropriate dispute planning can avoid the pitfalls of local courts, the risk of parallel litigations in multiple jurisdictions and avert pyrrhic victories by ensuring the enforceability of any future judgment or award. At the same time, important trade benefits and investment protections offered to foreign investors by many states under bilateral investment treaties (BITs), multilateral treaties (e.g., the Energy Charter Treaty) and other trade agreements should not be ignored by private equity managers—who can unlock coverage under these treaties and sovereign risk protections with appropriate deal structuring. This article surveys the advantages of using international arbitration for disputes arising out of cross-border private equity deals. 

The Importance of Planning for Disputes

Disputes planning should provide answers to three critical preliminary questions that arise in every cross-border controversy: where, by whom and by which legal rules will this dispute be decided?  

The answers to these questions can be decisive to the outcome on the merits of a dispute, the availability of monetary damages and other relief (such as specific performance and injunctive measures), the ultimate enforceability of the judgment or award, the speed and flexibility of the proceedings, and the neutrality and fairness of the process. Indeed, the more predictable the outcome of future disputes the greater contractual certainty will be during the term of the contract. In these respects, businesspeople rightly cite the centralization of disputes, neutrality, procedural flexibility, confidentiality and the near world-wide enforceability of arbitral awards as major advantages of international commercial arbitration for resolving disputes arising out of cross-border contracts. These features have seen arbitration become the predominant means of resolving cross-border disputes, particularly those arising out of transactions in the emerging markets.

At the same time, important trade benefits and investment protections are offered to foreign investors by many states under BITs and bilateral and multilateral trade agreements. As discussed in more detail below, appropriate deal structuring can ensure foreign investors secure these benefits—the most important being the ability to directly seek recourse by international arbitration against host states for expropriation and other wrongful interferences with foreign investments. 

Advantages of International Arbitration: Neutral, Centralized, Final, Flexible, Confidential

Contractual rights are the lifeblood of international commerce, and are especially critical to private equity managers and investors who are increasingly investing internationally and in emerging markets, often alongside local partners and/or in politically important industries. 

International arbitration seeks to aid in the legal predictability and stability of international contracts by providing for the impartial, centralized and final resolution of disputes arising out of international contracts:  

  • Neutrality. To avoid perceived (or, worse, actual) impartiality of domestic courts and “home court advantage”, international arbitration provides for a neutral forum, neutral arbitrators, neutral governing law and neutral procedures. The demand for neutrality means arbitration is often the only possible agreement for cross-border contracts.
  • Centralized forum. By agreeing to exclusively arbitrate disputes arising out of their contractual relationship, those disputes are centralised in one forum. This minimizes the risk of litigating the same dispute in multiple different courts and jurisdictions.
  • Final and binding adjudication. Arbitral awards are final and binding on the parties and they are only permitted to be appealed or challenged on very limited grounds.

At the same time, the hallmark of international arbitration is the procedural autonomy parties and arbitral tribunals enjoy to agree on procedures most suitable for the circumstances of their particular dispute. While domestic court procedures are often prescriptive and onerous and courts slow to deal with disputes, parties to arbitration enjoy very wide autonomy to agree on appropriate procedures and arbitrators have flexibility to adopt them. If parties seek efficiency and speed, then they can readily agree to procedures and appoint an appropriate tribunal to achieve those objectives. International arbitration is also a private process, and in most cases will be confidential provided parties specifically contract for confidentiality in their contract.

Enforcement “Premium” of Arbitral Awards — Arbitrating to avoid Pyrrhic Victories  

Perhaps the most important advantage of international arbitration, however, is the near world-wide enforceability of international arbitral awards pursuant to the recognition and enforcement regime created by the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”). The New York Convention obliges Convention States (now over 140) to ensure foreign arbitral awards are recognized and capable of enforcement in their jurisdiction in the same way as domestic awards, thereby precluding discrimination against foreign arbitral awards and providing for straight-forward enforcement where necessary. With court judgments enjoying no similar international enforcement framework, this is commonly referred to as the arbitration “enforcement premium” and is one of the primary reasons why parties to international contracts arbitrate disputes arising out of those agreements. It is against this background that voluntary compliance with arbitral awards has been said to be in the range of 90%. 

Drafting the Right Arbitration Clause 

Arbitration is a creature of contract. Parties must contract to arbitrate future disputes to the exclusion of domestic courts or other forums. Whether arbitration is the best choice of forum will need to be determined in the circumstances of each transaction—neutrality is a fine goal, but private equity managers should always seek to negotiate the forum where they have the best prospect of achieving—and enforcing—success. If arbitration is the most appropriate dispute resolution mechanism, then the best combination of governing law, arbitral institution (e.g., ICC, AAA-ICDR, LCIA, SIAC), seat and other necessary provisions will need to be considered and, usually, negotiated.

Protecting Foreign Investments against Sovereign Risk: International Investment Agreements

In addition to minimizing contracting and enforcement risks, private equity managers making foreign investors are increasingly structuring investments to take advantage of the investment benefits and protections of BITs and other international investment agreements, such as the Energy Charter Treaty and the increasing body of bilateral and multilateral free trade agreements. These international treaties contain reciprocal promises to encourage foreign direct investment from nationals of the other state and important substantive protections for investments so made.   

There are three important features of such trade pacts that are of particular importance for private equity managers.

  • Qualifying “investments”. Under international law the definition of what qualifies as an “investment” is typically very wide, and under most BITs refers to “every kind of asset” followed by an illustrative but usually non-exhaustive list of assets which often includes movable and immovable property, interests in companies (e.g., shares, stocks and other forms of equity participation in an enterprise), claims to money and claims under a contract having a financial value (including loans, bonds, debentures, and other debt instruments), and intellectual property rights.  
  • Substantive trade benefits and investment protections. While these vary from BIT to BIT, the substantive protections offered by host states to investors from the other contracting state most commonly include a promise not to expropriate (directly or indirectly) the investor’s investment without prompt payment of adequate compensation, to afford the investor “fair and equitable” treatment, to treat the investor no less favorably than the host state’s nationals (non-discrimination) and to treat the investor no less favorably than the host state offers to treat investors from other states (as a most-favored nation).
  • Direct recourse by arbitration against the host contracting state. While historically foreign investors have had to rely on government-government diplomacy in the event a host state interferes with an investment, a critical innovation of BITs has been to provide foreign investors with the ability to directly seek recourse against the host state by international investment arbitration. The past decade has seen a marked increase in the number of investment arbitration claims by foreign investors against host states, and investor-state arbitration is now seen an important way for investors to enforce their rights and seek compensation where appropriate. Investor-state arbitrations are commonly brought by investors at the World Bank’s autonomous international institution the International Centre for Settlement of Investment Disputes (ICSID), established under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the “Washington Convention”)—to which over 150 states are party.

Given these valuable benefits and protections, it is important for private equity managers to assess whether their investment will enjoy investment protection under an applicable BIT or trade agreement. If there is no applicable BIT or trade pact it may be possible for private equity investors to structure their investment to obtain BIT coverage (and investors commonly do so). Each case will necessarily be fact- and BIT-specific, and specialist advice will be necessary to ensure, so far as possible, that investments benefit from BIT protection under international law.

Footnotes

1 Queen Mary University ‘International Arbitration: Corporate Attitudes and Practices’ (2008)

International Centre for Settlement of Investment Disputes (ICSID) website.

 

Topics:  Arbitration, Arbitration Agreements, Cross-Border, Cross-Border Transactions

Published In: Alternative Dispute Resolution (ADR) Updates, General Business Updates, Finance & Banking Updates, International Trade Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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