Important Arbitration Decision for Lenders

Project Finance Lender Can Claim Directly Against State Under Investment Treaty

A recent decision of an arbitral tribunal constituted under the auspices of the International Centre for Settlement of Investment Disputes (ICSID) has opened the door for potential direct claims by project finance lenders against states in circumstances in which the projects they finance are adversely affected by state measures. In a decision rendered on August 20, 2020, the tribunal in Portigon AG v. Kingdom of Spain (ICSID Case No. ARB/17/15) held that project finance provided by Portigon, a German financial services company, qualified as an investment protected under the Energy Charter Treaty (ECT) and the ICSID Convention. The tribunal thereby allowed Portigon to bring claims for losses allegedly caused by changes introduced to Spain’s renewable energy incentive regime.

The decision provides welcome news for development finance institutions, commercial banks, investment funds and other providers of project finance active in project finance transactions across all industry sectors.

Protection Under International Investment Treaties

More than 3,000 treaties protecting foreign investments impose rights and obligations on states and investors in relation to foreign investments. These treaties seek to promote cross-border investment flows by requiring states to extend certain standards of treatment to foreign investors and their investments. While the specific scope of protection differs from treaty to treaty, investment treaties generally impose the following obligations on states:

• to pay fair, prompt and adequate compensation in the case of expropriation of foreign investments;
• to abstain from adopting arbitrary or unreasonable measures in relation to foreign investments;
• to accord foreign investors due process and not deny justice;
• to honor commitments entered into as regards to investments or investors; and
• not to discriminate against foreign investments. The prohibition of discrimination extends to compensation relating to losses suffered as a result of a series of circumstances such as armed conflict, civil revolt, natural disaster or national emergency.

Crucially, investment treaties generally provide that a foreign investor may arbitrate disputes related to investments before international arbitral tribunals. This provides an important alternative to litigation in the host State courts of the investment. Even if a foreign investor decides not to pursue an arbitration claim, this procedural protection can provide powerful leverage in negotiations with a host State should a dispute arise.

Tribunal Holds Project Finance Is a Protected Investment and That There Is a Dispute Between Portigon and Spain

Although the decision has not yet been published, the arbitral tribunal in Portigon reportedly held by majority that millions of euros in long-term loans and interest rate hedging instruments provided by Portigon to a project company for the development, construction and operation of over 30 renewable energy projects in Spain qualified as an investment under the Energy Charter Treaty and Article 25 of the ICSID Convention. It further held that there was a direct relationship between the project financing provided by Portigon and the dispute at issue, i.e. whether Spain’s 2013–2014 changes to its regulatory framework breached the ECT. Portigon could therefore proceed with its claim that Spain’s measures adversely affected the renewable energy projects it financed, impairing their creditworthiness, and thus the value of the project finance loans.

This is the first reported decision of an investor state tribunal holding that project finance provided to a project company, without any direct legal relationship with the host State, is a protected investment under an investment treaty. While a number of claims have been brought against Spain and other States by direct and indirect owners of renewable power projects, the decision opens the door to potential claims by project financiers of such projects—and more generally, by project finance lenders in long-term infrastructure and energy projects—in circumstances where State measures adversely affect a project they financed to such an extent that such measures adversely affect the project loans.

Key Considerations for Investment Treaty Protection

Project finance lenders should carefully consider whether recourse to investment treaty protection is available for projects they finance and should evaluate the structure of proposed or existing project financing transactions to ensure the availability of optimal treaty protection. As a general matter, this entails an assessment of whether one or more investment treaties exist between the host State of the investment and the home state of the lender, whether the lender is eligible to make a claim under the treaties, and whether the treaties contain adequate protections for the lender. Where existing project financing does not benefit from adequate treaty protection, it may be possible to restructure a financing arrangement in advance of any dispute to secure more favorable treaty protection.

In addition, lenders should carefully assess treaty protection implications when making changes to existing financing arrangements, for example by syndicating or transferring project finance loans. This decision also suggests that financing for projects, regardless of the form it takes, may well benefit from investment treaty protection.

Shearman & Sterling’s International Arbitration team provides advice and advocacy to companies, ahead of and throughout investment treaty disputes, and is widely regarded as one of the very best in the market. We would be pleased to answer any questions or to provide any further analysis of the above.