Mike Laffin: Impact of China-Canada FIPA on Chinese M&A in Canada Oil and Gas Sector

First published on Blake, Cassels & Graydon LLP website

January 2014

By Mike Laffin, Greg Kanargelidis and Paul Blyschak

INTRODUCTION

Much has been written about the significance of the Foreign Investment Promotion and Protection Agreement (China-Canada FIPA) concluded by China and Canada in September of last year. Given the substantial contribution of Chinese investment to the Canadian economy in recent years, as well as the fact that negotiations toward the China-Canada FIPA first began in 1994, this attention has been warranted.

Considering that Chinese investment in Canada has primarily targeted the oil and gas sector – it is estimated that Chinese enterprises invested approximately C$28 billion in the Canadian oilpatch between 2007 and 2013 – it is perhaps surprising that more attention has not been paid to the application of the China-Canada FIPA to Chinese investment in the Canadian oil and gas sector in particular. This legal insight seeks to probe this topic and to survey several of the elements of the China-Canada FIPA of key relevance to Chinese investment in Canada’s oil and gas sector, including by Chinese SOEs in particular.

BILATERAL INTERNATIONAL INVESTMENT TREATIES

The China-Canada FIPA is a bilateral investment treaty. Bilateral investment treaties, also known as BITS or FIPAs in Canadian government parlance, serve two principal and interrelated functions.

First, BITs enumerate a number of protections each state signatory will provide to investors of the other state that invest in the host state's territory. Such protections consist primarily of certain standards of treatment each state signatory commits to afford investors of the other party, including “national” treatment, i.e. treatment no less favourable than that afforded to a state’s own nationals; “most favoured nation” treatment, i.e. treatment no less favourable than that afforded to nationals of another state; and “fair and equitable” treatment, i.e. treatment conforming with a minimum baseline as established by international law. Such protections also consist of certain guarantees, such as a covenant to provide compensation in the event of expropriation or to allow for the unrestricted transfer of capital by foreign investors out of the state’s territory.

Second, BITs provide foreign investors who believe one or more of these assurances have been breached with a direct means of redress against the host state, namely a right to institute arbitration proceedings against the host state before an international tribunal. This allows foreign investors to pursue their claims in an impartial forum and outside the domestic court system of the host state. Common arbitration institutions nominated by BITs include the International Centre for Settlement of Investment Disputes (ICSID) and the International Chamber of Commerce, as well as the UNCITRAL Arbitration Rules. Typical claims levied by disaffected investors include arbitrary or prejudicial treatment, disproportionate and/or unnecessarily severe government responses to an investor’s business activities, or inadequate compensation in the event of direct or indirect expropriation.

Recourse to investment arbitration has become increasingly more common over the last decade and a half. The 58 new investment arbitration cases filed in 2012 represent the highest number of treaty-based disputes filed in a single year. It is also interesting to note that only five countries have had more investment arbitration claims filed against them than Canada, being Argentina, Venezuela, Ecuador, Mexico and the Czech Republic. That said, foreign investors filing investment arbitration claims against Canada have generally experienced a lower success rate than is typical for investment arbitration claims globally.

INVESTMENT TREATIES

BITs and the international oil and gas industry have an important relationship. In particular, given their often long-time horizons, large capital commitments and heavily regulated nature, oil and gas projects represent the classic type of investments BITs are intended to safeguard. This has led to the largest “multilateral” international investment treaty, the Energy Charter Treaty (ECT), which includes the protection of oil and gas investment among its principal objectives and has been ratified by approximately 50 states as well as the European Union. Both China and Canada hold observer status in respect of the ECT.

Oil and gas disputes also represent perhaps the most common type of investment dispute brought under BITs, with ICSID advising that 25% of disputes brought before it are attributable to the oil, gas and mining sector; by far the largest contribution to its caseload by any economic sector (the next largest is the power sector, constituting 12% of ICSID’s caseload). The largest award issued to date by an investment arbitration tribunal involved an oil and gas dispute, being the US$1.77-billion award issued in 2012 in Occidental Petroleum Corp. v. Ecuador, a case arising out of the unilateral termination by Ecuador of an oil and gas participation contract issued to Occidental. Other prominent investment disputes involving oil and gas companies include a series of claims filed by shareholders of Yukos following its alleged indirect expropriation by Russia by means of arbitrary taxation measures brought against the company in 2007, as well as Repsol’s claims against Argentina in connection with the alleged direct expropriation of 51% of the stock in two of Repsol’s Argentinian subsidiaries in 2012.

Canada has to date only had two investment arbitration claims levied against it directly involving the oil and gas sector.

In September 2013, Lone Pine Resources LLC, a Delaware incorporated entity, filed an investment arbitration claim against Canada under the North American Free Trade Agreement (NAFTA) alleging breaches of its right to “fair and equitable treatment” and to payment of compensation in the event of expropriation. Lone Pine seeks C$250 million and costs following the May 2011 revocation by the Quebec provincial government, in connection with concerns regarding the safety of shale gas exploration and production, of Lone Pine’s permits to mine for oil and gas in Quebec and beneath the St. Lawrence River.

In May 2012, an initial award was issued further to a NAFTA investment arbitration claim filed in 2007 by Mobil Investments Canada Inc., an indirect subsidiary of ExxonMobil Corporation, and Murphy Oil Corporation against Canada in connection with the Hibernia and Terra Nova projects located offshore Newfoundland. Mobil and Murphy Oil claimed that certain research and development payment obligations imposed on the offshore projects in 2004 violated NAFTA’s prohibition of “performance requirements” regarding inbound foreign investment and, while a majority of the tribunal found in their favour, a ruling on the quantum of damages was postponed pending further evidence on actual damages suffered.

CHINA-CANADA FIPA

An exhaustive provision-by-provision analysis of the application of the China-Canada FIPA to the oil and gas sector is beyond the scope of this legal insight. Nevertheless, the following observations regarding the treaty’s application to investment in Canada’s oil and gas sector by Chinese SOEs are noteworthy:

Establishment Rights. The national treatment rights provided by Article 6 of the China-Canada FIPA are "post-establishment," meaning that the right of a foreign investor to be treated no less favourably than a domestic investor does not apply in the context of acquisitions, and is only exercisable once a foreign investment has been admitted and established according to applicable law in the host state. Foreign investors are only able to access "pre-establishment" protections that are no less favourable than those afforded to other foreign nationals pursuant to the Article 5 most-favoured nation provision. It is also worth noting that Article 6 limits protections regarding the "expansion" of investments to "sectors not subject to a prior approval process under ... applicable laws."

These provisions effectively preserve Canada’s ability to subject prospective investments into its territory, including investments by Chinese SOEs such as CNOOC Limited, Sinopec and CNPC and their affiliates, to the “net benefit” test under the Investment Canada Act. In fact, the treaty in its annexes goes so far as to specifically state that “a decision by Canada following a review under the Investment Canada Act … with respect to whether or not to: (a) initially approve an investment that is subject to review; or (b) permit an investment that is subject to national security review” shall not be subject to the investment arbitration claims procedure established by the treaty.

Territory of Application. While the “territory” of China under the China-Canada FIPA includes “land territory, internal waters, territorial sea … and any maritime areas beyond the territorial sea over which, in accordance with international law and its domestic law, China exercises sovereign rights or jurisdiction,” a different formulation is used to describe the territory of Canada. In particular, in defining the “territory” of Canada, the China-Canada FIPA, in addition to referencing the “internal waters and territorial sea over which Canada exercises sovereignty,” goes on to specifically reference both the “exclusive economic zone of Canada” and the “continental shelf of Canada,” each as determined by Canada’s domestic law pursuant to the United Nations Convention on the Law of the Sea (UNCLOS).

UNCLOS, which Canada signed in 2003, is an international convention pursuant to which its signatories have agreed, amongst other things, to attempt to resolve disputes regarding the territorial extent of their “exclusive economic zones” and their “continental shelves.” This includes disputes regarding sovereignty over arctic waters and subsoil, wherein as much as 25% of the world’s remaining oil and gas reserves have been estimated to rest and a number of territorial submissions have already been filed with UNCLOS’s Commission on the Limits of the Continental Shelf.

Towards this end, UNCLOS also provides that each state has the sovereign right to explore and exploit the natural resources of its exclusive economic zone and continental shelf, including mineral resources within the seabed and subsoil, as well as “the exclusive right to authorize and regulate drilling on the continental shelf for all purposes.” These specific references in the China-Canada FIPA to Canada’s exclusive economic zone and continental shelf and the associated provisions of UNCLOS therefore appear intended to make certain that the FIPA protects Chinese investments into Canada’s exclusive economic zone and continental shelf, including any oil and gas interests therein.

No Umbrella Clause. Unlike China’s most recent model BIT and like Canada’s 2004 model FIPA, the China-Canada FIPA does not include an umbrella clause. Umbrella clauses, sometimes referred to as “observation of obligations” clauses, constitute a covenant by the state parties to a BIT to observe all contractual obligations entered into with investors from the other state. They have been traced back to the nationalization of the Anglo-Iranian Oil Company by Iran in 1952 and have often served as the basis for investment arbitration claims filed by oil and gas companies under BITs.

That said, the omission of an umbrella clause from the China-Canada FIPA does not necessarily constitute a significant loss or disadvantage for Chinese SOEs investing in Canada’s oil and gas sector. Umbrella clauses are of greatest value to oil and gas investors where they are likely to enter into business relationships with foreign state ministries or agencies, as is often the case in production sharing contracts (PSCs) issued in Africa, Latin America, Asia and elsewhere. Given that in Canada the role of the state is reserved to administering the oil and industry from a regulatory position, umbrella clauses are generally less relevant to oil and gas investors in Canada.

Rights in the Context of Expropriation. The China-Canada FIPA prohibition of direct and indirect expropriation includes language not included in Canada’s model 2004 FIPA. This new language states that “[e]xcept in rare circumstances … a non-discriminatory measure or series of measures … that is designed and applied to protect the legitimate public objectives for the well-being of citizens, such as health safety and the environment, does not constitute indirect expropriation.”

A common criticism of BITs by certain Canadian public policy groups has been that they decrease the ability of Canadian authorities to effectively regulate matters related to health, safety and the environment by possibly making such regulatory efforts subject to attack by foreign investors, and it is therefore likely that this additional language was added to the China-Canada FIPA to further allay concerns of this ilk. The result for Chinese SOEs investing in Canada’s oil and gas sector is a potentially more limited protection against indirect expropriation than might otherwise be the case, and which requires that “a measure or series of measures is so severe in light of its purpose that it cannot be reasonably viewed as having been adopted and applied in good faith” in order for a contravention of the treaty to occur.

Although not of relevance to the oil and gas sector in particular, it is also interesting to note that the China-Canada FIPA prohibition against direct and indirect expropriation contains a more favourable valuation mechanism than that included in Canada’s model 2004 FIPA. This provides that the amount of compensation will either be calculated on the date of expropriation or using the value of the expropriated investment before the impending expropriation became public knowledge, whichever occurs earlier. Given that public knowledge of an impending expropriation is likely to significantly decrease an investment’s value, this addition constitutes an important new benefit.

Lastly, given that Canada does not constitutionally protect property rights in a manner similar to the United States, the availability to Chinese SOEs of the expropriation provisions in the China-Canada FIPA constitutes an advantage not shared by Canadian investors in the Canadian oil and gas industry. Stated differently, depending on the circumstances and the nature of the alleged offending government regulation, it is possible that a Chinese SOE would have a direct or indirect expropriation claim against Canadian authorities of a nature that a Canadian joint venture partner of the SOE subject to the same regulation would not enjoy.

Dispute Resolution. The China-Canada FIPA includes robust investor-state dispute resolution provisions that feature detailed rules on standing of the investor, procedural requirements and judgment enforcement. As discussed, dispute settlement mechanisms of this sort allow aggrieved foreign investors to seek remedies against the host country outside of national court systems pursuant to the rules and procedures of one of the various nominated international arbitration regimes (i.e. ICSID).

China has historically negotiated BITs characterized by significant limitations with regard to non-discrimination and dispute resolution. The China-Canada FIPA reflects China's recent tack toward allowing more robust protections in its international investment treaties, as also evidenced in its recent BITs with Germany and the Netherlands. Also, although China ratified the ICSID Convention in 1993, Canada had not done so until Nov. 1, 2013. Therefore, while arbitration before the ICSID will now be available to Chinese SOEs under the China-Canada FIPA, a couple of important points regarding arbitration before the ICSID should be kept in mind.

The first is that it remains an open point regarding the circumstances state-owned and/or state-controlled entities, as opposed to privately owned corporations, have standing to bring claims before the ICSID. This uncertainty is rooted in the fact that the ICSID was established in part to depoliticize investment disputes by removing participation of the home state of the investor, a separation which dissolves where the investor is owned or controlled by its home state.

Another characteristic of ICSID arbitration for Chinese SOEs to be cognisant of is its significant transparency provisions, as well as its allowance for the participation of non-disputing parties (i.e. NGOs and public interest groups) in certain circumstances. Such openness of the proceedings may come as a surprise to someone more accustomed to arbitrating disputes before institutions providing greater confidentiality, such as the China International Economic and Trade Arbitration Commission (CIETAC) or the Beijing International Arbitration Centre.

Of course, the ICSID arbitration rules addressing transparency issues must be read in conjunction with the China-Canada FIPA’s provisions on these points. In any dispute filed by a Chinese SOE, Canada as the defending state will have the discretion to determine whether the proceedings will be open to the public as well as what arbitration filings will be made publicly available. Given certain sensitivities in Canada to foreign SOE investment in the oil and gas sector, it can be anticipated that the Canadian government will be hard-pressed to ensure anything less than full openness of the proceedings to the public. Should the investment dispute involve environmental regulation or measures, it would also be reasonable to expect that one or more non-disputing parties would seek to participate in the proceedings, i.e. the submission of amicus curiae briefs by environmental groups.

CONCLUSION

While it has been said that the China-Canada FIPA represents a greater benefit to Canadian investors looking to invest in China than vice versa, the fact remains that the treaty will establish valuable protective measures that Chinese SOEs investing in Canada’s oil and gas sector would otherwise have been without. It is also important to recognize that the granting of such protection to inbound Chinese investment constitutes another strong signal by Canada that further Chinese investment in the country is both welcome and desired.

While it remains to be seen whether such protection will ever prove necessary, the signing of the China-Canada FIPA is a significant development. Although China began its BIT program later than many of its trading partners, it has now concluded more investment treaties than any other country, with the exception of Germany. Chinese investors and the Chinese arbitration community are also becoming increasingly familiar with investment arbitration proceedings, with the first ever award rendered in favour of a Chinese claimant issued in 2011 and Chinese arbitrators now having been appointed to a number of different investment arbitration tribunals, including the ICSID. It is therefore anticipated that, encouraged by these developments, Chinese investors will likely continue to bring investment disputes against host states in the future as circumstances may reasonably warrant.

For further information, please contact:

  • Mike Laffin 403-260-9692
  • Greg Kanargelidis 416-863-4306
  • Paul Blyschak 403-260-9704

or any other member of the Blakes Mergers & Acquisitions group.

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