11 October 2016

Outbound Investment — Managing risks and exiting with grace

1 Introduction

China’s outward foreign direct investment (FDI) has increased substantially over the past decade.  At US$111.5 billion in total in 2015, outbound FDI exceeded inbound FDI for the second year running.  Aided by the creation of new / simplified regulatory channels, China’s outbound FDI is expected to grow more than 10% per year for the next five years .  China’s 13th Five Year Plan has also encouraged acquisitions and investments by Chinese investors in a wider range of sectors (e.g. fintech, high-end manufacturing and real estate).

A significant increase in infrastructure investment is also expected following the implementation of China’s “Silk Road Economic Belt” and “21st Century Maritime Silk Road” policy (known as One Belt, One Road or OBOR).  In just the first quarter of 2016, Chinese investors have already made US$3.59 billion of direct investment into OBOR countries (mainly Singapore, India and Indonesia), a 40.2% increase versus the same period in 2015 (according to MOFCOM).  With Chinese investors looking to play an increasingly important role in global markets, this article will look at some of the key steps investors can take to mitigate their risks, as well as the legal protections available to safeguard their investments. 

2 Key risks for Outbound Investment

2.1 Overview 

Investors must understand that as well as providing opportunities, large-scale investment projects face numerous risks and challenges.  Understanding how to control, navigate and mitigate these risks is key for ensuring project success and profitability.  Some of the key risks associated with outbound FDI include:

  • Country operational risk – this includes risks associated with national security, political stability, government effectiveness, local labour market, financial risks, tax policy and standards of local infrastructure. 
  • Political risk – when investing in politically unstable countries, investors may face a number of political risks, including significant changes in government policies affecting controls on prices, outputs, activities and currency remittances or changes of regime.  Political risks may also result from events outside of government control such as war, revolution, terrorism, labour strikes, extortion and civil unrest.
  • Credit risk – one of the major risks of outbound FDI is the potential of the host country defaulting on foreign lending and / or investment projects.  This risk is particularly high in a number of OBOR countries, which lack sound creditworthiness.  Investors should also be aware that during periods of financial crisis, governments may be excused from providing the substantive protections granted under bilateral investment treaties (BITs), as discussed below. 

2.2 Outsourcing experts to conduct risk analysis

Investors should therefore consider outsourcing risk analysis to outside experts who will be able to help identify and factor in potential risks into the cost of outbound investment projects.  A number of external advisors offer a range of professional services, including:

  • Economic and political risk consulting and analysis – providing tailored, client-specific reports that assess the political, economic and security risks associated with a particular transaction / investment. 
  • Anti-corruption risk assessment and due diligence – identifying risks related to interactions with government customers and regulators, ensuring compliance with anti-corruption laws and providing adequate training to directors and officers with regard to anti-corruption compliance. 
  • Operational risk management – creating strategies, policies and solutions to protect assets and reduce the likelihood of losses from operational risks and providing crisis response services to help reduce the impact of critical events that might affect the investor’s business in the host country.

3 Corruption risks 

3.1 Criminal offences under PRC law

Chinese investors should also be aware of potential risk of criminal liability under PRC law in relation to their overseas activities due to the introduction of China’s own foreign anti-corruption laws in 2011.  The laws are similar in nature to the UK Bribery Act (2010) and US Foreign Corrupt Practices Act (1977).  Article 164 of the PRC Criminal Law makes it a criminal offence for Chinese companies and individuals to bribe “foreign government officials” and “officials of public international organisations” to obtain an improper commercial benefit.  

The law sets a minimum monetary threshold for bribes of RMB 30,000 (approx.. US$4,500) and violations will result in the detainment and imprisonment of the individuals involved for up to 10 years, plus a fine.  The level of fine imposed depends on the severity of the conduct but to date, the largest fine imposed under China’s anti-corruption laws was RMB 3 billion.   Importantly, senior individuals of companies which commit an offence, or individuals who are directly responsible, are subject to the penalties outlined above and the company itself will also be subject to a fine.  However, it is important to note that Article 164 provides for leniency if the offence is voluntarily reported before an investigation has been initiated.  

3.2 Ensuring anti-corruption compliance

The most effective way of ensuring compliance with these laws and avoiding criminal liability is to establish a robust anti-corruption program. An effective anti-corruption program should have three key pillars covering prevention, detection and response, as follows:

Outbound Investment –¬ Managing risks and exiting with grace

3.3 Anti-corruption due diligence 

It is important for investors to remember that investigations and prosecutions can happen even if there is no actual knowledge that bribes are being paid.  Investors should therefore ensure that adequate anti-corruption due diligence processes are in place, when making acquisitions or investments.  Key risk areas can be explored by seeking information in the following areas prior to an acquisition or investment into:

  • a company’s control environment: policies, procedures, employee training, audit environment and whistleblower issues;
  • any ongoing or past investigations (government or internal), adverse audit findings (external or internal), or employee discipline for breaches of anti-corruption law or policies;
  • the nature and scope of a company’s government sales and any history of significant government contracts or tenders;
  • any employee or family relationships with government officials or state owned enterprises;
  • the company’s important regulatory relationships, such as key licenses, permits, and other approvals (e.g. focus on employees who interact with these regulators); and
  • the company’s relationships with distributors, sales agents, consultants, and other third parties and intermediaries, particularly those who interact with government customers or regulators.

4 Overbearing cost of foreign investment regimes

4.1 Regulatory issues

When making acquisitions or investments, foreign investors often face unpredictable regulations, excessive regulatory red tape, investment restrictions and frequent delays in obtaining permits and approvals.  Navigating these unpredictable government decision-making processes can result in delay and costs overruns.  Even in historically investor friendly jurisdictions, foreign investors may face challenges and political opposition when the privatisation of public assets is involved.  The proposed acquisition of Ausgrid is one example.


On 19 August 2016, the Australian Government announced that it had blocked the proposed acquisition of a 50.4% stake in Ausgrid (a state owned electricity producer) by investors from mainland China and Hong Kong.  In rejecting the bid, the Australian Government stated that the acquisition would be contrary to the national interest, including unspecified security concerns about the transaction structure and Ausgrid’s business.  However, since 2001, there have only been a handful of rejections by the Australian Government (less than 1% of non-real estate applications received).

4.2 Foreign investment rules

Foreign investment rules don’t just cover restricted industries and provide caps on ownership.  For example, some countries (e.g. the Philippines) prevent foreign nationals from directly holding executive roles in locally incorporated companies.  This can lead to a significant increase in costs, with investors having to duplicate roles by hiring local executives in key positions, in addition to “real” executives who shadow and provide guidance to their local counterparts.  

Additionally, although some jurisdictions may allow initial majority foreign ownership, local laws may require the foreign investor to sell their interest to a local partner over time, which can lead to a fire sale of assets and decreased pricing.  For instance, Indonesian law requires foreign investors to sell up to 51% of the interest in local mining operations by the 15th year of production, depending on the nature of the activities.

5 Bilateral Investment Treaties (BITs) – Can they protect against sovereign risks?

5.1 What are BITs and what do they do?

BITs are international law instruments agreed between two countries allowing for reciprocal protection of “investments” made by private foreign “investors” from each country in the territory of the other country.  BITs are important because:

  • they provide a broad range of substantive protections against actions taken by the host country (discussed below);
  • the foreign investor is also allowed to enforce its rights under the BIT against the host country through confidential and independent investment arbitration (e.g under ICSID, UNCITRAL or private arbitral institutions such as the International Court of Arbitration); and
  • the awards are generally enforceable in domestic courts (e.g. ICSID awards may be enforced through the domestic courts of contracting states as a final award and non ICSID awards are typically enforced under the New York Convention). 

Outbound Investment –¬ Managing risks and exiting with grace

5.2 China’s BITs with key countries

Currently, China has 129 BITs in force and this year hopes to finally conclude a BIT with the United States, having gone through 28 rounds of negotiations since 2008 to date.

Asia / Australasia

Western Europe

Central and Eastern Europe

Middle East / Africa

North / South America

Russia, Mongolia and Central Asia











New Zealand




Sri Lanka


















United Kingdom


Albania Armenia Azerbaijan




Czech Republic























Qatar Tunisia


Saudi Arabia

South Africa

United Arab Emirates

Yemen Arab Republic





Costa Rica












5.3 Qualifying for investment protections 

In order to rely on the protections offered by a particular BIT, the foreign company will need to qualify as an “investor” and the investment must fall within the definition of a protected “investment” under the BIT.

Who is an “investor”?

BITs apply different criteria for determining whether a company is considered an investor of a contracting country to a particular BIT.  For instance, many BITs determine the nationality of a company by reference to:

  • its place of incorporation;
  • the concept of the seat of the company’s management; or 
  • the foreign individual or company that directly or indirectly controls the company.

Importantly, it should be noted that some BITs exclude government controlled entities from the definition of investor (e.g. state owned enterprises, sovereign wealth funds etc.), whilst some countries have separate policies which specifically apply to investments by government controlled entities in addition to the standard BITs. 

What is a qualifying “investment”?

Most BITs define qualifying investments widely, for example as “every kind of asset” or “every kind of investment”, including tangible / intangible property, shares in a company and contractual rights.  A tribunal will also consider the duration of the investment, level on the investor’s commitment / expenditure, level of risk assumed by the investor and contribution to the economy of the host country in assessing whether a qualifying investment exists.  Some BITs will also include a negative list of investments which will be excluded from protection under the BIT (e.g. investments in certain protected sectors). 

5.4 Structuring the investment to maximise treaty protections

Prudent investors should consider investment structuring at the outset to maximise protections because the scope and comprehensiveness of BITs can vary significantly between older and newer BITs and by region.  For example, many of the early China BITs were only limited to claims for expropriation and compensation (e.g. China-Ghana BIT), although this has changed in recent years, and since 2002 China has been actively renegotiating / amending its older BITs.

Subject to the restrictions described below, it is normally permissible to structure an investment to allow a company to take advantage of a BIT concluded by the relevant host country even where the company’s ultimate home country does not have a BIT with that host country.  This can be achieved through the use of a suitable investment vehicle which satisfies all of the prerequisites required to benefit from the particular BIT the investor is seeking protection under.  

In this regard, the Netherlands is one of the key jurisdictions which offers both favourable tax treatment and an extensive network of investor friendly BITs.  For example, the Netherlands has entered into over 25 BITs with African countries, which provide protection to cross-border investments made through a Netherlands Holdco within the African country to the relevant BIT.

Outbound Investment –¬ Managing risks and exiting with grace


However, some treaties prevent this kind of forum shopping by containing “denial of benefits” clauses, which allows the host states to exclude claims by companies that are owned or controlled by third party nationals or do not have substantial business activities in the company’s place of incorporation.  Similarly, arbitral tribunals may refuse a claim on jurisdictional grounds where an investment is restructured when a dispute had already arisen or was sufficiently foreseeable by the investor (e.g. Philip Morris). 

Philip Morris v Australia 

Philip Morris brought a claim in November 2011, under the Hong Kong-Australia BIT in relation to the Tobacco Plain Packaging Act 2011.  Shortly before bringing their claim Philip Morris transferred its Australian Business to Hong Kong ownership at a time when it knew the Australian Government was likely to implement the legislation.  The arbitral tribunal rejected Philip Morris claim on jurisdictional grounds, citing that the corporate restructuring was an “abuse of process”, with the sole purpose of attempting to seek protection under the Hong Kong-Australia BIT.

Outbound Investment –¬ Managing risks and exiting with grace

5.5 How can BITs protect my investments?

BITs provide a broad range of substantive protections against actions taken by host countries, which include:

  • Fair and equitable treatment: all investors/ investments will be treated fairly and equitably.  Generally, this requires countries to maintain predictable investment environments consistent with investor’s reasonable expectations.  For instance, fair and equitable treatment provisions could be relied upon by a foreign investor if a host country revoked the investor’s business license or undermined the investor’s expectation that its investment would be supported by the state.
  • No discrimination: not to adopt measures which discriminate against particular investors or investments (e.g. industry, nationality etc.).  
  • No expropriation without compensation: to protect investors against government seizure of property, through nationalisation, or through the introduction of regulations, which detrimentally affect the commercial value of an investment.  Unless such action is taken in accordance with the law and with appropriate compensation.    
  • Full protection and security: establishes a state’s responsibility in circumstances where it fails to exercise due diligence and take reasonable measures to protect the affected investor from acts of others. This may be breached if, for instance, the host country did not take adequate steps to protect protestors or the country’s armed forces from causing physical damage to investments.

However, host countries may be able to raise a number of defences, including:

  • Necessity: this defence has been invoked in situations of war or financial crisis, where the government has argued the circumstances meant that the action taken was “necessary”.  This defence can only be relied upon in extreme circumstances.
  • Public Policy: BITs often contain provisions which provide exemptions from providing the protections, outlined above, if the government is acting for a public purpose. For example, in Philip Morris the government argued that it enacted the Tobacco Plain Packaging legislation on public health grounds.  

6 Exit mechanisms

6.1 What if it all goes wrong?

Local laws often require foreign investors to enter joint ventures with local partners, either due to statutory caps on foreign ownership or for more practical reasons such as lack of a local business network or unfamiliarity with local business practices.  Significant time and effort is often spent finding the right partner and agreeing how the joint venture will operate on a day-to-day basis, but parties often neglect to consider critical issues such as drafting appropriate deadlock clauses and exit mechanisms, or whether technology and service arrangements should survive exit.

6.2 Deadlock clauses and exit mechanisms

An effective deadlock clause with appropriate exit rights is critical, for example, in circumstances in which there is an unresolved deadlock with the local partner on a major matter (e.g. failure to agree a new business plan).  First, an effective deadlock clause should include for a period of good faith negotiations, which provide a mechanism for referral to senior officers of each party and subsequently escalation through the ownership chain, if necessary.  Alternatively, if the matter is technical, the parties could refer the issue to an independent expert (e.g. a law or accountancy firm etc.).

If the parties are still unable to resolve the deadlock there should be an effective mechanism for the parties to exit the joint venture.  These include:

  • Put / call rights: where one or both of the parties has the right to require the other party to buy or sell their respective interests in the joint venture at a specified price.  This could be after X number of years or much earlier if there is an unresolved deadlock. 
  • Russian roulette: either one of the joint venture parties (A) may serve a notice on the other party (B), offering to transfer A’s interest to B at a price specified by A. B has the option to buy the shares at that price or sell its own shares to A at the same price.
  • Termination for default: upon an event of default, there should be flexibility for the non-defaulting party to exercise a call.  

However, given caps on foreign investment any form of call option may be illusory for a foreign investor because they would need to find a new local partner to replace the outgoing one.  

6.3 Technology and service arrangements 

When drafting exit mechanisms parties should also consider what will happen upon exit to their respective intellectual property rights, as well as other transitional issues which are necessary to allow the joint venture to continue following one parties exit. In particular, investors should: 

  • consider whether, and on what terms the joint venture would be permitted to continue using the trademark or other intellectual property of the exiting joint venture party;
  • address what happens to the intellectual property developed by the parties during the course of the joint venture (e.g. whether the parties are free to use and exploit etc.);
  • consider the effect of termination on any intellectual property license agreements between the joint venture and the exiting party, and whether such agreements should become royalty bearing (if not already); and 
  • whether the remaining party wants to secure ongoing or transitional services from the exiting party.  

7 Conclusion

Effecting planning and management of outbound FDI projects is key to allowing investors to managing risks effectively and maximising the protections available.  In particular investors should:  

  • engage external advisors at an early stage to help evaluate and navigate the risks associated with outbound investments, which can be factored into the overall investment costs. 
  • look to structure investments to maximise the comprehensive protections available under certain BITs in tax favourable jurisdictions; and
  • include an effective deadlock clause with appropriate exit rights in any joint venture agreements to provide for a smooth exit in the event that things go wrong, as well as including provisions dealing with whether technology and service arrangements should survive exit. 

Editor’s note: this article was simultaneously published on Chinalawinsight.com

A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
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