Restructuring business to take advantage of investment treaty – a cautionary tale
Global Head of Practice Development – Arbitration
26 July 2016
In Philip Morris Asia Ltd v The Commonwealth of Australia, PCA Case No. 2012-12, Award on Jurisdiction and Admissibility, an investment arbitration tribunal has found that the Philip Morris International group (PMI Group) restructured its Australian business for the sole purpose of gaining investment treaty protection, in order to bring an investment treaty claim against Australia to challenge new tobacco plain packaging (TPP) legislation. The restructuring was carried out at a time when that claim was foreseeable. As a result, the entire claim was dismissed as an abuse of process. While structuring investments so as to secure investment treaty protection can provide important rights of recourse against certain state acts, there are risks in restructuring existing investments for this purpose, especially where (as in this case) a dispute is foreseeable.
The Tobacco Plain Packaging Act 2011 (the TPP Act) was enacted in Australia on 21 November 2011, requiring tobacco companies in Australia to package their cigarettes in logo-free, dark brown packs, with large and graphic health warnings. On the same date, a Hong Kong incorporated subsidiary of the PMI Group, Philip Morris Asia Limited (PM Asia), filed its Notice of Arbitration challenging the TPP Act as contrary to the Hong Kong/Australia bilateral investment treaty (the Treaty).1 PM Asia’s complaint was that its entire business rests on its intellectual property and, in particular, the recognition of its brands. Australia contested the claim both as to its admissibility and the jurisdiction of the tribunal under the Treaty, as well as on the merits.
The Tribunal hearing the claim ordered that the admissibility and jurisdiction issues be considered prior to the merits of the dispute.
A key issue concerning the application of the Treaty (and therefore the jurisdiction of the tribunal) was whether the PMI Group had restructured its Australian business in order to take advantage of the arbitration provisions in the Treaty at a time when the dispute relating to the TPP legislation was foreseeable. This required the Tribunal to examine both the history of the PMI Group’s restructuring and the way in which the TPP Act came about.
The Australian government first began considering TPP legislation in 2008, at which time the PMI Group’s business in Australia was owned by Philip Morris Brands Sàrl, a Swiss company (PM Brands). In October 2009, an Australian subsidiary of the PMI Group wrote to the Australian Health Minister, expressing concerns about interference with its rights and the potential effect of TPP legislation on its business. Internal memoranda show that, even at this point, the PMI Group viewed this in legal terms.
In April 2010, the Australian Government announced its intention to introduce TPP legislation. Earlier the same month, the PMI Group produced a plan to further streamline its corporate structure. Although 2010 saw a change of Prime Minister followed by a general election in Australia, coupled with some uncertainty as to the detail of any TPP legislation, nothing happened to make clear that the introduction of TPP legislation was being abandoned.
In September 2010, the PMI Group approved certain restructuring arrangements, including the transfer of its Australian businesses from PM Brands to PM Asia, the future claimant in the arbitration. As required by Australian law, PMI Group filed a Foreign Investment Application for the transfer, which was later approved and the transfer formally took effect on 23 February 2011, nine months before the TPP Act was enacted.
The restructuring brought investments under the protection of the Treaty
The Tribunal found that PM Asia only acquired a protected investment under the Treaty as at 23 February 2011, when the restructuring was completed. The restructuring had been effected in accordance with Australian law and regulations. The investment was also held to be within the temporal scope of the Treaty’s protection, the crucial time for assessing this being the point at which the measure alleged to constitute a Treaty breach occurred. This was the date on which the TPP Act was enacted, at which time PM Asia owned the PMI Group’s Australian business.
Restructuring solely to bring a treaty claim in respect of a foreseeable dispute is an abuse of process
The Tribunal considered whether PM Asia’s claim amounted to an abuse of process, as alleged by Australia.
The Tribunal began by emphasising that the threshold for finding an abuse of process is a high one and the notion does not necessarily imply bad faith. Nor is the mere fact of restructuring to gain investment treaty protection illegitimate per se. Such restructuring may, however, amount to an abuse in respect of a foreseen dispute. The Tribunal cited jurisprudence that “it is clearly an abuse for an investor to manipulate the nationality of a company subsidiary to gain jurisdiction under an international treaty at a time when the investor is aware that events have occurred that negatively affect its investment and may lead to arbitration.”2
The Tribunal ruled that the test of whether a dispute was “foreseeable” is whether “there is a reasonable prospect that a measure which may give rise to a treaty claim will materialise”. This is a somewhat less stringent test for abuse of process than that adopted in an earlier decision, which required a specific dispute to be foreseen as a “very high probability”.3
Applying this test to the facts of the case, the Tribunal held that the key question was whether the dispute over TPP legislation was reasonably foreseeable prior to the PMI Group restructuring. In the Tribunal’s view, from April 2010 when it was announced that TPP legislation would be introduced, there was no uncertainty as to the Australian Government’s intentions. Despite the various political events over the course of 2010, nothing happened which could reasonably lead PM Asia to conclude that TPP legislation was no longer foreseeable. Accordingly, when the restructuring took place, the dispute was foreseeable.
The Tribunal found that the restructuring could not be justified by any legal or commercial considerations other than the possibility of bringing a treaty claim. The Tribunal held that PM Asia could not prove that there were any tax or other business reasons, which were determinative for the restructuring and it was only possible to conclude that the “main and determinative, if not sole, reason for the restructuring was the intention to bring a claim under the Treaty”.
The Tribunal, therefore, dismissed PM Asia’s claim as an abuse of process.
Ensuring that cross-border investments come under the protective umbrella of an investment treaty typically provides a number of valuable substantive protections. Most of these treaties allow an investor to pursue arbitration proceedings directly against a state that has (allegedly) breached the treaty, providing an important right of recourse, which would otherwise not exist. It is recommended that consideration be given to structuring transactions for investment treaty protection at the time they are entered into (in the same way considerations as to tax and other matters are factored in). This ensures protection for investments from the outset. While restructuring existing investments is not in itself illegitimate, the PM Asia case demonstrates risks associated with such restructuring if it is not done correctly. This is particularly the case if the restructuring is done with the aim of securing treaty protection against a backdrop of events that may form the basis of, or be relevant to, a future claim under the treaty. Specialist advice should be taken before any restructuring of this kind takes place. Failure to do so could result, as it did in PM Asia, in a claim being deemed inadmissible as an abuse of process.
1 Agreement between the Government of Hong Kong and the Government of Australia for the Promotion and Protection of Investments, dated 15 September 1993.
2 Lao Holdings N.V. v. Lao People’s Democratic Republic, ICSID Case No. ARB(AF)/12/6, Decision on Jurisdiction, 21 February 2014, para. 70.
3 Pac Rim Cayman LLC v El Salvador, ICSID Case No. ARB/09/12, Decision on the Respondent’s Jurisdictional Objections, 1 June 2012, para. 2.99.
This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication. For more information please contact Sarah Garvey firstname.lastname@example.org, or tel +44 20 3088 3710.