Guest Post: A BIT of Project Finance Arbitrage in Mongolia

By Kinnari Bhatt

As Jennifer Lander observed last week, RIO is getting out the big guns.

My new book – Concessionaires, Financiers and Communities: Implementing Indigenous Peoples’ Rights to Land in Transnational Development Projects, shows how investors like RIO use highly technical contractual terms to choose from different legal structures, systems, standardised debt and project documentation, insurances and layers of expensive security arrangements to create development project legal structures that protect investor rights over all others. The use of these structures is especially pertinent for developing countries and the international project financing of the Oyu Tolgoi mine is no exception. This is because they help to shield investors from the number of variables that can impact on financial return: taxation, political, legal changes, environmental and social risk, for instance. Investors will argue that any government seeking to increase regulation and change investment laws and policies will stymie FDI (Bhatt, 2013) and amount to ‘resource nationalism’.

In this context, the easy enforcement of contractual promises becomes a major concern.  In developing economies arbitration is deemed better than going to court because of its perceived efficiency, privacy and binding nature but also because of the anticipated ability of arbitrators (rather than judges) to understand the web of interrelated commercial and financial contracts. When disputes arise, arbitrators will, it is presumed, be better equipped to preserve the transactional unity of and ongoing relationships within a complex, mutliparty, contractual transaction that can last decades.

Of course, views over the necessity of these structures will differ. My aim is not to debate the morality of these mechanisms but to show their wider context and importance to the political economy of the project.

Living in an uncertain world

The risk landscape for investors has rarely been as challenging : the US- China trade war, Brexit, increasing recognition of dodgy deals that harm the environment, society and rights to development, international pressure around tax avoidance and now, a pandemic.

The Oyu Tolgoi mine provides, frankly, textbook illustrations of this landscape. The company and its project financiers came under fire for its resettlement practices, it has already reported a slowdown in copper concentrate shipments to China as a result of the coronavirus (no doubt it will soon be serving force majeure notices on its numerous contractual counterparts, as China has already done), and it has been persistently questioned around its taxation practices. These include its use of Dutch, Luxembourgish and BVI tax havens and clauses that stabilise the taxation regime at a specific moment in time -in this case, 2009: the date the Investment Agreement (IA) was signed.

RIO’s counter argument has consistently been that its arrangements are reasonable, balanced and legal.  Yet, taxation disputes have a habit of rumbling on. To resolve its dispute with the Mongolian Tax Authority that it owes around USD 155 million to the public purse, RIO has served Mongolia with a notice of arbitration under a bilateral investment treaty (BIT) – treaties between two countries that set up ‘rules of the road’ for foreign investment in each other’s countries.

What might the arbitration look like?

Answering this is, of course, a matter of speculation, but I make a few observations.

International Arbitration and Project Finance Contracts

RIO will benefit from the protection offered by the Mongolia Canada BIT which provides RIO with investment rights and protections protected under public international law. The treaty permits dispute settlement using international arbitration mechanisms, in this case UNCITRAL arbitration rules, and provides other protections such as freedom from indirect expropriation without compensation.

Peeling the onion

International economic law scholars tend to focus on treaty mechanisms, which whilst important, do not illustrate the full legal context and watertight quality of the negotiated deal. In the natural resources field, BIT protections are routinely supplemented through the types of contractual arrangements discussed in my book, like the specific protections within the IA. These arrangements are crucial as they move from the generic treaty provisions into project specific duties and obligations that give greater comfort to an investor. Having worked in practice, I have never come across an emerging market extractive project financing that relies solely on BITs. To do so would leave to much unsaid.

On the disputed tax liability RIO could argue the government’s tax claim amounts to an indirect expropriation. Rio’s lawyers can build their case on similar tax based claims but also the specific language of the IA entered into with the government.  It could present its underlying financial instruments to show how the interdependency of the IA with the debt instruments (there will be numerous cross references to other contracts) and RIO’s reliance on the functioning of these structures as contractually stabilised in the IA. An argument could run that any unforeseen tax payments would result in RIO’s inability to pay interest on its debt instruments, construction contractor invoices and ultimately sell copper, jeopardising its investment. Producing realms of confidential contracts that illustrate the highly structured technical legal foundations upon which its investment and property rights have been modelled, would be no issue given the private nature of arbitration.

Hotel Room Justice

Under UNCITRAL rules Mongolia will be able to choose one member of the arbitral tribunal. The problem here is that often, lesser developed countries do not have experienced arbitrators and will have to appoint foreign arbitrators from a relatively small group of people. Often, those arbitrators are male (the diversity gap has been reported), enable a revolving door system and are schooled in Western legal thinking that proritises sanctity of contract promises over all other values. Consequently, developing countries perspectives are not brought to bear on the decision making process.

The arbitration scene has been derided as ‘hotel room justice’, where arbitration hearings take place in private conference rooms of luxury hotels and result in awards requiring poor economies to pay hundreds of millions, sometimes billions, of dollars in compensation to multinational companies like RIO. Historically, Mongolia has not fared well in these rooms.

Whilst positive steps are being made to correct this imbalance: the drafting of arbitration rules for business and human rights disputes (albeit voluntary) and fledging technical assistance programmes, these initiatives do not do enough to plug the massive gaps in finance and technical knowledge needed by lesser developed countries to advise on contracts and fight these awards.

Nonetheless. advocacy and knowledge sharing about how these complex and confidential legal structures work can illuminate these issues and potentially result in systemic change towards a fairer international economic system.

About Kinnari Bhatt

Dr Kinnari Bhatt is a post-doctoral researcher at Erasmus University Rotterdam where she researches on the legal and political economy aspects of private and public-private financing for natural resource use, infrastructure and climate/conservation projects. Her book Concessionaires, Financiers and Communities: Implementing Indigenous Peoples’ Rights to Land in Transnational Development Projects (2020) was recently published with Cambridge University Press. Kinnari worked as a project finance lawyer with leading global law firms White and Case and Milbank, Tweed Hadley and McCloy in London and Asia and acted as a legal adviser to the Ministry of Mineral Resources in Sierra Leone. She advises NGOs on issues of equitable natural resource management and has taught courses on legal aspects of international finance and project finance at the University of East Anglia and University College London.

About Julian Dierkes

Julian Dierkes is a sociologist by training (PhD Princeton Univ) and a Mongolist by choice and passion since around 2005. He teaches in the Master of Public Policy and Global Affairs at the University of British Columbia in Vancouver, Canada. He toots
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