Canada: The Impact Of China-Canada FIPA On Chinese M&A In Canada Oil & Gas Sector

Establishment Rights. The national treatment rights provided by Article 6 of the China-Canada FIPA are "post-establishment," meaning that the right of a foreign investor to be treated no less favourably than a domestic investor does not apply in the context of acquisitions, and is only exercisable once a foreign investment has been admitted and established according to applicable law in the host state. Foreign investors are only able to access "pre-establishment" protections that are no less favourable than those afforded to other foreign nationals pursuant to the Article 5 most-favoured nation provision. It is also worth noting that Article 6 limits protections regarding the "expansion" of investments to "sectors not subject to a prior approval process under ... applicable laws."

These provisions effectively preserve Canada's ability to subject prospective investments into its territory, including investments by Chinese SOEs such as CNOOC Limited, Sinopec and CNPC and their affiliates, to the "net benefit" test under the Investment Canada Act. In fact, the treaty in its annexes goes so far as to specifically state that "a decision by Canada following a review under the Investment Canada Act ... with respect to whether or not to: (a) initially approve an investment that is subject to review; or (b) permit an investment that is subject to national security review" shall not be subject to the investment arbitration claims procedure established by the treaty.

Territory of Application. While the "territory" of China under the China-Canada FIPA includes "land territory, internal waters, territorial sea ... and any maritime areas beyond the territorial sea over which, in accordance with international law and its domestic law, China exercises sovereign rights or jurisdiction," a different formulation is used to describe the territory of Canada. In particular, in defining the "territory" of Canada, the China-Canada FIPA, in addition to referencing the "internal waters and territorial sea over which Canada exercises sovereignty," goes on to specifically reference both the "exclusive economic zone of Canada" and the "continental shelf of Canada," each as determined by Canada's domestic law pursuant to the United Nations Convention on the Law of the Sea (UNCLOS).

UNCLOS, which Canada signed in 2003, is an international convention pursuant to which its signatories have agreed, amongst other things, to attempt to resolve disputes regarding the territorial extent of their "exclusive economic zones" and their "continental shelves." This includes disputes regarding sovereignty over arctic waters and subsoil, wherein as much as 25% of the world's remaining oil and gas reserves have been estimated to rest and a number of territorial submissions have already been filed with UNCLOS's Commission on the Limits of the Continental Shelf.

Towards this end, UNCLOS also provides that each state has the sovereign right to explore and exploit the natural resources of its exclusive economic zone and continental shelf, including mineral resources within the seabed and subsoil, as well as "the exclusive right to authorize and regulate drilling on the continental shelf for all purposes." These specific references in the China-Canada FIPA to Canada's exclusive economic zone and continental shelf and the associated provisions of UNCLOS therefore appear intended to make certain that the FIPA protects Chinese investments into Canada's exclusive economic zone and continental shelf, including any oil and gas interests therein.

No Umbrella Clause. Unlike China's most recent model BIT and like Canada's 2004 model FIPA, the China-Canada FIPA does not include an umbrella clause. Umbrella clauses, sometimes referred to as "observation of obligations" clauses, constitute a covenant by the state parties to a BIT to observe all contractual obligations entered into with investors from the other state. They have been traced back to the nationalization of the Anglo-Iranian Oil Company by Iran in 1952 and have often served as the basis for investment arbitration claims filed by oil and gas companies under BITs.

That said, the omission of an umbrella clause from the China-Canada FIPA does not necessarily constitute a significant loss or disadvantage for Chinese SOEs investing in Canada's oil and gas sector. Umbrella clauses are of greatest value to oil and gas investors where they are likely to enter into business relationships with foreign state ministries or agencies, as is often the case in production sharing contracts (PSCs) issued in Africa, Latin America, Asia and elsewhere. Given that in Canada the role of the state is reserved to administering the oil and industry from a regulatory position, umbrella clauses are generally less relevant to oil and gas investors in Canada.  

Rights in the Context of Expropriation. The China-Canada FIPA prohibition of direct and indirect expropriation includes language not included in Canada's model 2004 FIPA. This new language states that "[e]xcept in rare circumstances ... a non-discriminatory measure or series of measures ... that is designed and applied to protect the legitimate public objectives for the well-being of citizens, such as health safety and the environment, does not constitute indirect expropriation."

A common criticism of BITs by certain Canadian public policy groups has been that they decrease the ability of Canadian authorities to effectively regulate matters related to health, safety and the environment by possibly making such regulatory efforts subject to attack by foreign investors, and it is therefore likely that this additional language was added to the China-Canada FIPA to further allay concerns of this ilk. The result for Chinese SOEs investing in Canada's oil and gas sector is a potentially more limited protection against indirect expropriation than might otherwise be the case, and which requires that "a measure or series of measures is so severe in light of its purpose that it cannot be reasonably viewed as having been adopted and applied in good faith" in order for a contravention of the treaty to occur.

Although not of relevance to the oil and gas sector in particular, it is also interesting to note that the China-Canada FIPA prohibition against direct and indirect expropriation contains a more favourable valuation mechanism than that included in Canada's model 2004 FIPA. This provides that the amount of compensation will either be calculated on the date of expropriation or using the value of the expropriated investment before the impending expropriation became public knowledge, whichever occurs earlier. Given that public knowledge of an impending expropriation is likely to significantly decrease an investment's value, this addition constitutes an important new benefit.

Lastly, given that Canada does not constitutionally protect property rights in a manner similar to the United States, the availability to Chinese SOEs of the expropriation provisions in the China-Canada FIPA constitutes an advantage not shared by Canadian investors in the Canadian oil and gas industry. Stated differently, depending on the circumstances and the nature of the alleged offending government regulation, it is possible that a Chinese SOE would have a direct or indirect expropriation claim against Canadian authorities of a nature that a Canadian joint venture partner of the SOE subject to the same regulation would not enjoy.

Dispute Resolution. The China-Canada FIPA includes robust investor-state dispute resolution provisions that feature detailed rules on standing of the investor, procedural requirements and judgment enforcement. As discussed, dispute settlement mechanisms of this sort allow aggrieved foreign investors to seek remedies against the host country outside of national court systems pursuant to the rules and procedures of one of the various nominated international arbitration regimes (i.e. ICSID).

China has historically negotiated BITs characterized by significant limitations with regard to non-discrimination and dispute resolution. The China-Canada FIPA reflects China's recent tack toward allowing more robust protections in its international investment treaties, as also evidenced in its recent BITs with Germany and the Netherlands. Also, although China ratified the ICSID Convention in 1993, Canada had not done so until Nov. 1, 2013. Therefore, while arbitration before the ICSID will now be available to Chinese SOEs under the China-Canada FIPA, a couple of important points regarding arbitration before the ICSID should be kept in mind.

The first is that it remains an open point regarding the circumstances state-owned and/or state-controlled entities, as opposed to privately owned corporations, have standing to bring claims before the ICSID. This uncertainty is rooted in the fact that the ICSID was established in part to depoliticize investment disputes by removing participation of the home state of the investor, a separation which dissolves where the investor is owned or controlled by its home state.

Another characteristic of ICSID arbitration for Chinese SOEs to be cognisant of is its significant transparency provisions, as well as its allowance for the participation of non-disputing parties (i.e. NGOs and public interest groups) in certain circumstances. Such openness of the proceedings may come as a surprise to someone more accustomed to arbitrating disputes before institutions providing greater confidentiality, such as the China International Economic and Trade Arbitration Commission (CIETAC) or the Beijing International Arbitration Centre.

Of course, the ICSID arbitration rules addressing transparency issues must be read in conjunction with the China-Canada FIPA's provisions on these points. In any dispute filed by a Chinese SOE, Canada as the defending state will have the discretion to determine whether the proceedings will be open to the public as well as what arbitration filings will be made publically available. Given certain sensitivities in Canada to foreign SOE investment in the oil and gas sector, it can be anticipated that the Canadian government will be hard-pressed to ensure anything less than full openness of the proceedings to the public. Should the investment dispute involve environmental regulation or measures, it would also be reasonable to expect that one or more non-disputing parties would seek to participate in the proceedings, i.e. the submission of amicus curiae briefs by environmental groups.