News & Insights

Energy Law Exchange

October 1, 2013

Bilateral Investment and Related Treaties Would Likely Have a Key Role in Mitigating Investment Risks If Mexico Undertakes Energy Reforms

As described in detail in another article in this Newsletter entitled "Mexican Congress to Consider Constitutional Oil and Gas Reforms: Bold Stride Forward or Half-Step?," the reform of Mexico's energy industry and its national oil company Pemex is an avowed priority of the nation's President Enrique Pea Nieto of the Institutional Revolutionary Party (PRI). President Pea Nieto's reform proposal would eliminate Pemex's longstanding and constitutionally-mandated monopoly in the oil and gas business. The Pea Nieto's main opposition party the business-oriented Partido de Accin Nacional (PAN) is pushing for an even more complete overhaul of Mexico's energy sector. PAN's alternative reform proposal suggests a large-scale privatization of the Mexican oil and gas business that would allow private companies to, among other things, enter into concession contracts in the upstream sectora highly controversial matter between both parties.

The potential opening of the exploration and production market in Mexico has caught the attention of international oil companies, which generally welcome the opportunity to tap onto Mexico's shale and deep-water oil and gas reserves in the Gulf of Mexico. But given the Mexican population's national sentiment surrounding their oil and gas resourcesMexico still celebrates as a national holiday the 1938 nationalization of the oil industrypotential foreign investors face risks over Mexico's long-term commitment to this energy reformassuming it gets passed.

While foreign investors cannot control the Mexican government's potential appetite for amending, or even disavowing, this expected new legislation, they can protect against certain future adverse changes in the legal and regulatory framework by availing themselves, at the time of investment, of Mexico's well-established and vast net of international treaties on direct foreign investment. The uncertainty surrounding the new energy legislation makes it all the more important for foreign investors to take advantage of these treaties.

Mexico is a party to no fewer than twenty-eight bilateral investment treaties (BITs) with other nations around the globe, including the vast majority of Western Europe, several Eastern European states, and other South American and Asian countries. Mexico is also a party to the North America Free Trade Agreement (NAFTA), a multilateral treaty with the United States and Canada, whose chapter 11 on foreign investment offers protections comparable to those in BITs.

These bilateral treaties set forth enforceable legal obligations on the part of the signatory states vis--vis the investing companies of the other signatory state. They typically include a prohibition against expropriation without compensation, an obligation to afford fair and equitable treatment, and full protection and security to investments, and a prohibition against discrimination. A distinct feature of BITs is that they usually offer the investor a direct recourse against the state party. If a dispute arises regarding a State's compliance with its obligations in a given treaty, most BITs allow the foreign investor to initiate international arbitration directly against the State in various arbitral fora (notably, however, Mexico is not a party to the ICSID Convention). The arbitration panel constituted per the treaty has the ability to award damages against the State (absent an express limitation in the particular BITa rare occurrence), and its award is enforceable under the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, a multilateral treaty to which 149 states are party. Barely used 20 years ago, today investors make use of international arbitration under BITs with relative frequency as a mechanismsometimes the only mechanismto enforce their rights against states.

BITs protect investments of many kindsas long as they belong to a national or company of one of the Contracting Parties. The definition of investment typically includes not only physical assets but also legal and contractual rights, licenses and permits, titles to money, intellectual property, etc. Shares or stock in a companywhether directly or indirectly owned or controlledusually also constitute a protected investment. In other words, BITs cover indirectly-held shares of a several-tier subsidiary (normally the investment vehicle).

This expansive definition of a protected investment has not been without controversy. Some authors raised concerns of "BIT shopping" i.e., creating a "shell company" in an intermediary state that entered a BIT with an investment-recipient state, with the main purpose of affording BIT protection to that investment. But, for the most part, arbitration panels constituted under BITs have considered that structuring an international investment through a subsidiary in a third country to maximize protection against adverse state action is a legitimate conduct by a prospective investorjust as legitimate as international tax planningand does not deprive the investment of its due protection under the relevant treaty.

Not all BITs, however, afford the same level of protection. Seemingly-minor wording differences between two BITs can make the difference between recovering the fair market value of the investment, or not recovering any damages at all. When evaluating an investment opportunity of the significance that Mexico's oil and gas sector is likely to requireboth in terms of duration and amounta careful planning of the investment's structure (via BIT or NAFTA protection) may turn out to be critical years later in a worst-case scenario that hopefully would never materialize. Companies considering an investment in Mexico now or later are thus well advised to analyze their options carefully and to obtain specialized advice as to the best way to structure their investment.

For additional details on Mexico's new energy proposals, click here.