Challenges and opportunities: The outlook for US private equity in 2020
Private equity continued to be a popular and active asset class in the United States during 2019.
Africa’s economic growth has historically been linked to the fluctuation of commodity prices. Modern economy indeed increasingly relies on a number of components derived from minerals such as copper, cobalt, bauxite, iron ore, tin, lithium and gold. For instance, smartphones and electric vehicles are powered by rechargeable lithium ion batteries, a component of which is cobalt. According to the African Natural Resources Centre of the African Development Bank, minerals account for an average of 70 percent of total African exports and about 28 percent of gross domestic product, and the potential for growth is immense.1 The Democratic Republic of Congo (DRC) alone contributes over half of the world’s cobalt reserves.2
Against this background, some states and state-owned counterparts of mining investors in Africa have, over the past few years, taken a series of measures perceived by investors as an attempt to force them to renegotiate their long-term agreements.
In particular, several African countries have amended their national legislation to significantly increase taxes and royalties on revenues derived from mining activities with immediate effect. Major changes to customs regimes have also been introduced. African states claim that the changes are aimed at better distributing revenue from mining activities to the local population.
The mining industry requires significant capital expenditures from investors in the sector. Return on investment can only be expected in the long term. This is the reason why domestic mining codes typically include provisions that guarantee a stable tax and customs regime to investors over a protracted period of time, providing foreseeability on these heads of costs.
In light of the above, the legislative changes introduced by several African states to their national mining code have given rise to multiple disputes. International mining companies have3 or may thus initiate arbitration proceedings for breach of the stabilization clause in the mining code or on the basis of bilateral investment treaties.
Other bones of contention between state-owned entities and foreign investors relate to their respective rights under joint venture agreements. Contractual relationships between state-owned entities and mining title holders are typically governed by a joint venture agreement that refers to the domestic mining code as applicable law. The investing mining company contributes the capital investment, know-how and expertise to the joint venture, whereas the state-owned entity, which generally holds a minority shareholding, contributes the mining license. African state parties have shown a growing dissatisfaction with the contribution or revenue balance set forth in joint venture agreements, in particular regarding the underlying value of the mining title and all the more so in greenfield projects. In this regard, indexation clauses and the basis for valuation of the license (mining capacity versus actual extraction) are specific areas of concern. Mine shutdowns by investors in the presence of a slump in commodity prices is another source of litigation.
Faced with investors’ reluctance to renegotiate the joint venture agreements on their terms, some state-owned minority shareholders may attempt to obtain the dissolution of the joint venture company before local courts, on the ground that it is undercapitalized, in breach of OHADA law. This strategy may enable the minority shareholder to exert further pressure on the investor or to eventually regain control over the mining titles that could then be allocated to another investor on more favorable terms.
Another recent trend in mining arbitration in Africa is the increased reliance by states and state-owned entities on environmental issues but also the treatment of such issues by arbitral tribunals. Recent case law tends to show that compliance with domestic legislation aimed at protecting the environment could become a requirement for an investor to claim protection of its investment in international arbitration proceedings. Could this be the sign of the emergence of an international environmental public order?
As government budgets and socio-economic growth in many African countries highly depend on income derived from the mining of metals and minerals, several countries have, over the past few years, amended their mining and tax legislations with a view to increasing this source of revenue as well as improving environmental protection.
On March 9, 2018, the DRC implemented a revised Mining Code through the adoption and enactment of Law No. 18/001, followed by the adoption of new mining regulations on June 9, 2018.
These instruments introduced changes that are unfavorable to investors in the mining sector, including a significant increase of the tax burden, a mandatory free state participation in the equity increased from 5 percent to 10 percent, a new requirement for at least a 10 percent mandatory participation of DRC individuals in the equity of newly constituted mining companies, additional restrictions on exchange control and severe restrictions on the choice of contractors.4
These amendments to the 2002 Mining Code also reduced the scope and duration of the 10-year stability guarantee previously granted to mining title holders under Article 276 of the 2002 Mining Code, upon which investors relied to invest in mines in the DRC, and which guaranteed them a stability of the provisions of the 2002 Code (including the tax, customs and exchange control regimes).
Since the election of President John Magufuli in 2015, the Parliament of Tanzania has passed several laws that have significantly increased government control over mining operations in the country. These laws aim, among other things, to compel mining companies to renegotiate the joint venture agreements.5
The main provisions impacting foreign investors are contained in the Natural Wealth and Resources Contracts (Review and Renegotiation of Unconscionable Terms) Act 2017, which grants the government authority to renegotiate the terms of investor–state agreements deemed ‘unconscionable’ by Parliament. If the investor refuses to renegotiate such terms within the allocated time frame, the agreement will be deprived of any effect.6
In 2017, Tanzania also adopted two other Acts, respectively the Natural Wealth and Resources (Permanent Sovereignty) Act and the Written Laws (Miscellaneous Amendments) Act, with a view to maintaining at least a 16 percent interest in all mining projects and acquiring up to 50 percent of the equity shares of mining companies.7. Other legislative provisions include a 2 percent increase on export royalties of gold and silver, the requirement that natural resources disputes be heard by local courts under Tanzanian law and the right to cancel contracts with dispute resolution clauses providing for the application of foreign laws or fora.8
Tanzania subsequently introduced additional measures aimed at putting further pressure on reluctant investors, such as bans on mineral exports.9
In this context, many international investors have initiated arbitration proceedings against Tanzania.10
In August 2014, the Mozambican Parliament approved Mining Law No. 20/2014 along with a new Specific Regime of Taxation and Fiscal Benefits for Mining Operations Law. These laws provide for the right of the state to progressively increase its participation in all mining projects, a 32 percent tax on capital gains arising from the direct or indirect transfer of mining rights, and a 10 percent income tax on revenues arising from services provided by non-resident entities to mining companies located in Mozambique.11
In 2015, Zambia adopted the Mines and Minerals Development Act No. 11, which repealed and replaced the 2008 Mines and Minerals Development Act No. 7. This new law increased the royalties payable on underground mining from 6 percent to 8 percent, and the royalties payable on open-pit mining from 6 percent to 20 percent. Moreover, it applies a 30 percent income tax to tolling and processing – beforehand, this was only imposed on production.12
Law No. 2016/017 dated December 14, 2016 effectively implements President Paul Biya’s new mining policies, with a view to contributing durably to the growth and development of the country. The main changes brought about by the new legislation revolve around the contributions of the mining companies to the social and economic development of neighboring communities, the reinforcement of environmental protection through mandatory environmental impact studies, transparency in reporting, and the obligation to set up security, hygiene and health measures for the benefit of mine workers.13
The new Zimbabwean Mining Code notably requires mining companies operating in the country to list the majority of their shares on the Harare Stock Exchange.
Kenya adopted a new Mining Act in 2016, which is the first major revision of its mining legislation since the 1940s. The statute notably includes pre-emption rights of the government in relation to strategic minerals, the entitlement of the government to the attribution for free of a 10 percent stake in large-scale mining projects, and the requirement to offer a minimum of 20 percent of the equity in such projects for trading on a local stock exchange.14
Namibia reviewed the 1992 Minerals (Prospecting and Mining) Act in the course of 2018. The new legislation is yet to be published.
In June 2015, the Burkinabe parliament adopted a new Mining Code aimed at protecting the environment, supporting the local population and decreasing customs and tax exemptions granted to mining companies.15 The new Mining Code also provides for an increased state participation in mining operations and a 20 percent capital gains tax on the transfer of mining titles.
In 2016, Senegal adopted a new Mining Code, which came into force on November 8, 2016 and was the outcome of a four-year long revision process of the former 2003 Mining Code.
The main changes implemented by the new legislation deal with the mandatory contribution of investors to a local development fund at the rate of 0.5 percent of the turnover of the company, the possibility for mining companies and the state to enter into production sharing contracts, the increase of reporting and transparency obligations of investors, and the modification of the method for calculating taxes and royalties. Moreover, exploitation title holders for small mines have the obligation to start mining operations within a period of three months following the acquisition of the authorization.16
The Malian government recently initiated negotiations with the major mining companies established in the country to seek an agreement on how to amend the Mining Code. In case of failure of the negotiations, the government has reserved its right to unilaterally adopt the new Mining Code without any of the changes submitted by the investors.17
In the wake of these recent changes in legislation, it is foreseeable that several mining companies may initiate arbitration proceedings against African states or state-owned entities to protect their investments. Strategies may vary but the main arguments that could be raised revolve around the reliance upon the stabilization provisions contained in the mining or investment codes or within the joint venture agreements by reference to the doctrine of legitimate expectations. They may also refer to the doctrine of acquired rights or the doctrine of indirect expropriation.
The doctrine of legitimate expectations was developed by international law academics with a view to protecting investors against unexpected and detrimental changes in policy. Mining companies could rely on this doctrine where changes in policy have the effect of damaging a significant investment, for instance when the investor relied on a representation by a public authority that a specific policy would be stable18 Stabilization provisions could be relied upon in the framework of international mining arbitrations as having created legitimate expectations on the part of investors that a mining or fiscal regime initially applicable to a mining project would remain stable for the duration of the project. Such provisions generally provide that, in case of a change in legislation, the rights of mining title holders would not be impacted by the new legislation for a protracted period.19 In this context, investors may argue that all their financial projections or investment forecasts were based, when carrying out their investment decision, on a set of fixed rules, in particular with regard to the tax and customs regimes, which cannot reasonably be significantly amended by the state at a later stage, on a discretionary basis.
Most legal systems in Africa provide for stabilization provisions either in their mining codes (for instance, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Ivory Coast, Guinea, Gabon, Mali and Niger) or investment codes (for instance, Benin and the Comoros). However, certain legal systems apparently do not provide for such provisions (for instance, Equatorial Guinea, Guinea-Bissau, Senegal and Togo), but they may, however, be included in the joint venture agreements.
Certain domestic laws provide for a general concept of ‘acquired rights’ according to which the state has undertaken, directly or indirectly, to comply with its own legislation, and protect and respect the ‘acquired rights’ of the holders of mining titles. If such individual rights are significantly impacted by a change in legislation, the state may be required, under this doctrine, to indemnify and compensate the affected parties.
The doctrine of indirect expropriation can be relied upon when a state takes measures that, although not depriving the owner from the title to his or her assets, have, in practice, the same effect as direct expropriation. The state measures often take the form of a law or regulation that interferes with the investment by, for instance, significantly decreasing the income-producing potential of an asset, thereby affecting its overall value. When determining whether the measure constitutes indirect expropriation or legitimate regulation, the arbitral tribunal may take into consideration the effect of the measure on the investment, the purpose of the measure and the proportionality of the purpose in light of the public interest to the effect. The arbitral tribunal may also take into consideration the legitimate expectations of the investor.20
Foreign investments in the mining sector in Africa often follow a pattern whereby mines are operated through a joint venture between a foreign investor and a state or state-owned entity. The latter brings or lends mining titles to the joint venture and the foreign investor provides funding, resources and the expertise necessary for both the exploration and exploitation phases. The parties’ respective obligations are usually set forth in a joint venture agreement.
This widespread corporate structure can lead to a number of disputes between the joint venture partners, which frequently arise out of the shifting balance between each party’s contribution to the joint venture and revenues, particularly when projects transition from exploration to production.
An example of disputes commonly encountered is the determination of the underlying value of the mining titles contributed by the state or state-owned party and the associated compensation. This issue is all the more salient with regard to greenfield projects as the value of mineral resources available in the perimeter covered by the mining title is to a large extent unknown to the parties at the time the joint venture agreement is negotiated. The information available to the parties and that would assist them in agreeing on an adequate level of compensation is therefore limited. As a result, state parties may claim that they are entitled to an adjustment of their compensation in the course of the life of the mine should the underlying value of the mining titles evolve, either through an adjustment mechanism contractually agreed by the joint venture partners or by way of a contract review that is more often than not unilaterally imposed by the state party.
To ensure that the underlying value of their mining titles is factored into their remuneration, African minority shareholders also tend to include clauses providing that a portion of their revenues will be indexed by reference to mineral resources or ore reserves identified during the life of the mine within the perimeter of the mining titles. These clauses, often insufficiently detailed, are a typical source of disputes before arbitral tribunals. Indeed, resources determination, even when it is conducted in accordance with internationally recognized standards such as the JORC Code,21 the NI43-10122 or the PERC,23 Such decisions, which can go as far as shutting down mines pending resumption of price growth,24 may be incompatible with the state parties’ expectations and in some cases may even breach foreign investors’ contractual undertakings. Indeed, investors’ contribution to the joint venture typically involves obligations to conduct exploration, issue a feasibility study, develop community projects, build infrastructures or reach certain levels of production. State parties have no interest in seeing the mining permits that they contributed to the joint venture being kept on hold.
Disputes may also arise out of the revenue stream paid by the joint venture to contractors and subcontractors, in particular for mining operations, transport and sales. One trend in joint venture agreements is including provisions aimed at regulating the use of contractors and subcontractors and allowing for both the investor and the state party to propose their services. State parties, when they have operating services, which is rarely the case, are usually less equipped than private contractors to provide the services required in the mining industry. State parties may therefore be unable either to propose the services required by the joint venture or to compete with the services that their joint venture partners or third parties can offer. These situations are a common source of dispute as state parties may be frustrated by not being able to contract with the joint venture, and may seek to obtain compensation for missed opportunities. From the investor’s perspective, however, it appears legitimate to not compensate a state party for work it did not perform.
The above is only a selection of issues that may increasingly be debated in the framework of arbitration proceedings as a result of African state parties or foreign investors being dissatisfied with the contribution or revenue balance in their joint venture agreements. These agreements, because they usually govern long-term projects, are indeed subject to many vicissitudes including metal price fluctuation and changes of government, which make it challenging, if not impossible, to maintain a good relationship for their whole duration, and are therefore an unlimited source of disputes for mining arbitration.
There has recently been an important trend towards the development of disputes relating to the dissolution of joint ventures on the initiative of the minority partner emanating from the state in which the joint venture operates.
Mining is known to be extremely capital-intensive. The financial needs are very heavy during the kick-off phase of the project and the first returns on investment can only be expected after several years. This is especially true for greenfield projects, in which the exploration period is complemented by the infrastructure construction period and the project launch phase.
In light of the above, the company investing in the project will necessarily accumulate losses for several years before making its first sales and profits.
As stated above, joint ventures usually involve an investor bearing all the financial costs of the project alone whereas the state party generally benefits from an anti-dilution clause allowing it to maintain the same equity regardless of the changes that may affect the share capital of the joint venture. Such configuration is an incentive for the investor to favor debt financing (usually through shareholder loans) over capital increases since such increases would be solely financed by the investor while proportionally benefiting its partner. Indeed, shareholder loans have priority over capital, and are therefore reimbursed before the capital. Consequently, since the joint venture will pay out dividends only in the very distant future, it is understandable that the investor prefers debt financing, especially if it is adequately remunerated.
Thus, the investor shall have its loans reimbursed and its interests paid before the distribution of dividends, and sometimes even before the joint venture is able to distribute dividends.
However, accumulated losses and debt financing have the effect of automatically reducing the joint venture capital and – at least for OHADA member states – of triggering a legal recapitalization obligation. It is on this recapitalization obligation that some minority partners in joint ventures have recently relied to request the dissolution of the joint venture.
Such dissolution, if it were to be imposed, would have the effect of allowing the minority partner to regain control over its mining licenses and operate them directly, or enter into a new joint venture with another investor under more favorable terms while the initial investor would lose all of its investment in the project.
Investors, therefore, bear a substantial risk from a substantive law standpoint. Procedural issues arising out of the commencement of legal proceedings before local courts despite the existence of an arbitration agreement may also arise.
The Uniform Act on Commercial Companies and Economic Interest Group (UACCEIG) includes several provisions applicable to commercial companies. In substance, the UACCEIG provides that if a company’s equity capital falls below half of the share capital as a result of recorded losses, the governing bodies of the company shall call a shareholders’ general meeting to decide on the dissolution of the joint venture.
If the dissolution is not pronounced, the joint venture is required to restore its equity capital within two years of the end of the financial year in which the losses were recorded.25
If the reconstitution of the equity capital does not occur within such period, any interested person may request the relevant court to rule on the dissolution of the joint venture.
The equity capital reconstitution can be achieved through a capital increase in cash or through the conversion of receivables into capital.
Thus, the investor which – in most of the joint ventures – contributes alone to capital increases without being able to dilute its minority partner will be compelled to convert all or part of its shareholder loans to meet the recapitalization obligation.
However, such capital increase can only be decided by a qualified majority. That is to say, the agreement of the minority shareholder is generally needed for the capital increase to be voted.
A minority state-owned shareholder refusing to vote in favor of the capital increase can therefore jeopardize the process and expose the company to a risk of dissolution.
The investor is not deprived of legal means to overcome the opposition of the state-owned partner that refuses to vote – without any apparent good reason – the capital increase as required by the UACCEIG.
The investor may require the appointment of a special purpose trustee with the mission of voting in favor of the capital increase instead of the reluctant shareholder. The investor may also argue that such refusal constitutes an undue use of minority powers and must therefore be sanctioned.
Dissolution requests have recently been introduced upon the initiative of state-owned companies (i.e., the minority partners in joint venture companies) in an African country. Typically, the state-owned partner argued that the joint venture equity had been inferior to half of the share capital for more than two years.
These disputes eventually settled, and it will therefore not be possible to know what the courts’ ruling on the requests for dissolution would have been.
Nevertheless, one can still legitimately question whether, in the presence of an arbitration clause in both the joint venture agreement and the by-laws of the joint venture, local courts would have had jurisdiction over the dissolution request.
In these instances, the state-owned companies referred the dispute to local courts on the basis of the (real or perceived) home country advantage. However, that does not mean that the investor could not have triggered the arbitration clauses set out in the various agreements signed with its partner or in the joint venture by-laws.
Although the arbitrability of a dissolution application has been debated, nothing, in our view, should prevent an arbitral tribunal from ruling on this issue even if the claim is based on a statutory provision rather than on a joint venture agreement or the company’s by-laws.
In recent years, African states have increasingly raised environmental issues as a defense to investors’ claims in the framework of mining arbitration proceedings.
In October 2018, an ICSID tribunal declined jurisdiction over a claim filed by subsidiaries of a Canadian mining company against Kenya on the basis of violations by the Kenyan authorities of environmental local laws in the attribution of the mining license.26
The claim, brought under the UK–Kenya bilateral investment treaty in 2015, related to investments in a niobium mining project in a region that enjoyed a protected status under Kenyan law as a forest reserve, nature reserve and national monument.
Claimants relied on an exploration license granted and renewed by the government of former President Kibaki, as well as a mining license obtained a few years later, just days before a general election.
The license was subsequently suspended by the new government.
Amid claims of corruption, which the panel dismissed for lack of proof, the ICSID panel declined jurisdiction on the basis that the competent Kenyan authority could not have validly issued a mining license under Kenyan law, in the absence of an environmental impact study.
Applicable Kenyan legislation provided that:
"No licensing authority under any law in force in Kenya shall issue a license for any project for which an environmental impact assessment is required under the [relevant statute] unless the applicant produces to the licensing authority a license of environmental impact assessment issued by the Authority under these Regulations."27
The ICSID panel observed that:
"Instead, apparently losing patience with Kenya's "bureaucratic process," the Claimants sought political intervention from the administration of President Mwai Kibaki and engaged the services of an intermediary . . . The Claimants’ intent, according to the Government, was to circumvent the legal obstacles and procure a mining license illegally."28
The tribunal ruled that the ICSID Convention and UK–Kenya BIT both imply that investments should be lawful in order to be protected:
"The Tribunal does not agree simply to interpret the Mining Act so as to facilitate the issue of mining licenses. There may be cases where (as here) issuance of a mining license conflicts with the broader purposes of the Mining Act and the broader Kenyan legislative framework. . . . The Tribunal concludes that for an investment such as a license, which is the creature of laws of the Host State, to qualify for protection, it must be made in accordance with the laws of the Host State. . . . The claimed rights flow from a document which has no legal existence or effect, and cannot therefore give rise to compensable rights. . . . The Tribunal concludes that for an investment to be protected on the international level, it has to be in substantial compliance with the significant legal requirements of the host state."29
In the case at hand, the tribunal ruled that ‘production of a piece of paper with the signature of a rogue official, signed in defiance of the applicable statute law does not constitute a “qualified investment” for purposes of jurisdiction.'30It concluded that in light of the violation of Kenyan environmental laws, the license was void ab initio and that it was without jurisdiction.
An ICSID panel in a case initiated last year may have to address similar arguments. In June 2018, US claimants Bay View group and the Spalena Company initiated ICSID proceedings against the Republic of Rwanda under the USA–Rwanda BIT over a canceled mining concession.31The Rwanda Minister of Mines declared in the press that the license was canceled after the group ‘failed to meet the contractual obligation to invest the agreed amount to increase production’ and breached regulations ‘by polluting the environment.32 Claimants filed their first submission on March 1, 2019.33
An extract from the first edition of GAR’s The Guide to Mining Arbitrations, first published in July 2019. The whole publication is available at https://globalarbitrationreview.com/edition/1001343/the-guide-to-mining-arbitrations-first-edition
Private equity continued to be a popular and active asset class in the United States during 2019.
In 2020, M&A activity should continue apace, driven by a range of factors including the development of legislation, the impact of new technologies, and access to new markets.