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A typical project finance transaction involves one or more sponsors (the equity investors) and a syndicate of banks providing loans as well as hedging instruments. The borrower is usually a project company established ad hoc for a specific project such as, in the energy sector, a pipeline or wind farm.
Policy measures by the host State, for instance the tariff at which electricity can be sold, play a key role in ensuring the financial viability of the project. Project finance actors should carefully consider their options in the event of regulatory changes, including potential investment treaty protection, from the outset of the project.
Project finance as an investment in the host State?
Investment treaty protection under an international investment agreement (IIA) between the home State of the investor and the host State of the project usually requires (i) a qualifying investment (ii) in the territory of the host State. The definitions of ‘investment’ found in various IIAs can differ, but there are commonalities among the various definitions. These requirements have proven to be fertile ground for debate in respect of certain types of financial investments.
ICSID arbitration tribunals have decided in several cases that loans and/or hedging instruments can constitute an investment in the host State. For example, at the heart of the dispute in Deutsche Bank v Sri Lanka was a derivative contract entered into between Deutsche Bank (DB) and state-owned company Ceylon Petroleum Corporation (CPC), intended to protect CPC against rising oil prices. Following a court-ordered suspension of payments by CPC, DB commenced ICSID proceedings, relying on the Germany-Sri Lanka BIT. The arbitral tribunal held that such hedging transaction constituted an investment and that the investment benefited, and was therefore located in, Sri Lanka.
The existence of an investment in the host State appears to have been found also in the recent ICSID case of Portigon AG v Kingdom of Spain. While the award on jurisdiction is still unpublished, it has been made known that the tribunal held project finance (i.e. both the loans and the hedging instruments) to constitute an investment (see Arbitration International, 36(4), December 2020 601-609, 602). This case is of particular interest to banks participating in energy project finance transactions, as it arises under the Energy Charter Treaty (ECT), which requires a financial investment to be “associated with an investment”. Apparently, the Portigon tribunal held that such association requirement is already satisfied when a bank provides loans and hedging instruments in the context of a project finance transaction.
It should be noted, however, that these awards included dissenting opinions and have attracted criticism in academic articles. The circumstances of the case and the precise wording of the relevant IIA will be fundamental in determining whether the financing of an infrastructure project constitutes an investment in the territory of the host State.
Practical considerations for project finance lenders
If seeking to maximise IIA protections, project finance lenders will first have to ensure that investment protection is available under an IIA between the home State of the investor and the host State of the project.
Project finance lenders should also pay attention to the location of their financial investment. This can be difficult to determine, for example where monies are provided to a holding company and then transferred to project companies in different jurisdictions by way of inter-company loans. In such a scenario, a proper contractual description of the purpose of the loan can support the finding of an investment in the territory of the host State where the project company is located. Similarly, instead of entering into global transactions hedging the risks of more projects together, the conclusion of hedging transactions linked to a particular project could support the finding of an association with an investment.
With respect to intra-EU scenarios, where the home and host States are both EU-Member States, there is a further layer of complexity. In its 2018 judgment in Achmea v Slovakia, the CJEU found that intra-EU bilateral investment treaty arbitration is incompatible with EU law. Most recently, in its judgment dated 2 September 2021 in Komstroy v Moldova, the CJEU held that its Achmea ruling applies likewise to the ECT as a multilateral investment treaty (for details, see our earlier post on the Komstroy judgment). From the perspective of IIA protection, an intra-EU scenario is thus not ideal and, if such IIA protection is the goal, it may need to be considered whether it is possible to structure the transaction differently.
To help maximise enforceability of the arbitral award, project finance lenders with a choice of where to bring proceedings pursuant to the applicable IIAs would normally prefer ICSID or arbitration in a seat party to the New York Convention. Against the backdrop of the ongoing discussions around investment treaty arbitration in the EU, it may be helpful, especially in an intra-EU situation, to consider arbitration with seat outside the EU and whether there are non-EU assets available for enforcement.
Finally, when participating in a project finance transaction, banks may wish to assess, ex ante, the investment protection considerations laid out above. As noted, the particular combination of home and host States determines the potentially applicable IIAs, so to the extent that there are options for the structuring of the transaction involving different such combinations, an upfront assessment may help maximise the chances of successfully invoking IIA protections. Such upfront assessment might also enable more realistic appreciation of the expected loss given default due to negative policy measures.
Georg Haas would like to thank Ulrich Zanconato (Legal Counsel, ING Bank NV) who co-authored this article in a personal capacity.