March 01, 2022

Significant Developments in Chile’s Natural Resource Sector

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SIGNIFICANT DEVELOPMENTS IN CHILE’S NATURAL RESOURCE SECTOR

Over the last year, several Latin American countries, including Chile, Peru, and Mexico, have discussed various measures that, if adopted, could materially affect the mining, energy and natural resource sectors. 

In Peru, the Castillo administration has pushed for measures to raise mining taxes, though Peru’s Congress has rejected the administration’s proposals as of December 2021. In Mexico, President López Obrador has proposed constitutional amendments which would adversely impact the electricity and mining sectors, including measures to cease granting concessions for lithium and other minerals.[1]

In Chile, the Senate’s mining and energy committee approved a draft bill proposing: (i) a sales tax of up to three percent on gross revenue from copper, lithium and other extractable materials (thus requiring taxes irrespective of losses) and (ii) a profitability tax on the operating margin of copper mining companies. The Chilean legislature aims to make this bill law by March 11, 2022, creating potential challenges for the industry in the near future.

In a similar vein, Chile’s Constitutional Convention—a group of 155 delegates tasked with rewriting Chile’s constitution—has proposed measures affecting the mining and lumber sectors, including: (i) the nationalization of mining companies; (ii) annulment of mining and foresting concessions on indigenous lands; and (iii) requiring water use permits for mining, farms and utilities. While the success of these measures is uncertain, if implemented they will fundamentally alter the landscape for existing and future investments in Chile. To be enacted, the measures must pass another committee vote, a two-thirds vote of the plenary session of the Constitutional Convention, and then a public referendum on the draft constitution, which could occur by mid-2022 if the mandate of the Constitutional Convention is not extended. Investors should accordingly stay apprised of developments on the Constitutional Convention process over the next several months. 

This note examines each of Chile’s recent proposals and highlights their relevance to affected companies. This note further highlights potential legal considerations for protecting and enforcing investors’ rights to mining investments in Chile. Shearman & Sterling remains available to provide advice to investors considering how best to protect their investments, including proactive risk mitigation measures, in response to the proposed measures in Chile.

Measures Pending before Chile’s Legislature – The Royalty Bill

On September 12, 2018, Chile’s Chamber of Deputies proposed a bill to impose new royalty measures on the mining of copper and lithium. The original bill imposed a royalty of three percent of the value of the extracted materials. On May 6, 2021, after several years of deliberations and revision, the Chamber of Deputies approved a revised version of the bill, which proposed to apply a three percent royalty on sales of copper, lithium and all materials eligible for concessions under Chilean law. It also established an additional progressive royalty based on the annual price of copper. The bill then moved to the Senate, where it was submitted for discussion in the mining and energy committee. This bill was notable in that the royalty would be tied to a reference price calculated from industry guides instead of the actual price at which a company sold the affected ore. Thus, the proposed royalty failed to account for discounts or other arrangements affecting actual sales prices in any given transaction. Further, as it was based on a reference sales price, it was not connected to profits earned by mining companies.

These early legislative proposals were met with significant resistance from both Chile’s executive branch and the mining industry. At least one executive official stated that the proposed legislation would put Chile “completely out of kilter” with other mining nations.[2] Representatives from Sonami, Chile’s National Mining Society, protested that the proposed “tax levels are akin to expropriation and this is going to inhibit investment immediately.”[3] Lundin, which has substantial copper mining operations in Chile, announced that it was “going to wait and see before we put too much money into it and I’m sure everybody else is doing the same.”[4]

On January 27, 2022, the Senate’s mining and energy committee approved an amended draft of a bill to regulate royalties for copper, lithium and other extractable minerals. For copper, the amended bill imposes a tax on both sales and profitability. The sales tax is one percent of annual sales of copper products for companies producing under 200,000 metric tons of copper per year, and one to three percent of annual sales of copper products (depending on copper prices) for those producing over 200,000 metric tons per year. Companies producing under 50,000 tons per year are exempt. The second component is a tax based on the operating margin of the copper mining companies. This tax would be an amendment to and increase of the current specific tax on mining activity. Although this proposed tax is partially tied to profits, it still imposes a royalty on mining companies based on sales, which would apply regardless of whether the sales were profitable.

For lithium, the bill includes a three percent sales tax with an exclusion for certain contracts. 

The bill now moves to the Senate’s finance committee. If approved, it will move to the plenary session of the Senate. If passed by the Senate, it will return to the lower Chamber of Deputies. The legislature’s stated objective is for the bill to become law by March 11, 2022. 

While touted as an improvement over more aggressive proposals approved by the Chamber of Deputies, the Senate bill has also received a negative reception from the mining sector. The president of the Chilean Mining Counsel (Consejo Minero), a trade association for large mining companies operating in Chile, has called the sales tax “problematic” as it requires the payment of taxes even when companies experience losses. Similarly, the Mining Counsel considers the profitability tax to be “a disincentive to future investment in Chile” because the tax does not account for depreciation or start-up expenses, representing a departure from the current specific tax on mining activity.[5]

Measures Pending before Chile’s Constitutional Convention

In 2019, after months of protests over social and environmental issues, Chile’s congress authorized a referendum, in which the electorate would decide whether to hold a convention to write a new constitution. In October 2020, 78 percent of the public voted “yes” and approved the initiative to form a constitutional convention to draft a new constitution. The results of the election were surprising and signaled a shift left in the political system. The center-left and left-leaning parties hold more than a two-thirds majority in the Convention, with the right holding less than one-third of the seats.

The Convention began its work on July 4, 2021. It was given nine months (with the potential for a three-month extension) to present the new draft constitution. Once presented, the new constitution must be approved by a national referendum, which must take place within 60 days of the presentation of the draft constitution. If the new constitution is rejected, the 1980 Constitution will remain in place. In short, Chile may have a new constitution by June 2022 (September 2022, if the extension is invoked).

While there are several proposed additions to the new constitution that, if enacted, could affect natural resource companies, three recent proposals stand out as potentially significantly problematic: 

  • Nationalization of Mining Companies: On January 13, 2022, an initiative for the Nationalization and New Social and Environmental Management of Copper Mining, Lithium and other Strategic Assets was introduced in the Constitutional Convention to nationalize mining companies along with their assets, including those companies involved in the extraction of copper, lithium, gold, silver, liquid or gas hydrocarbons, uranium, magnesium, molybdenum, cobalt, boron, rare earth and other minerals. On February 1, 2022, the environmental committee of the Constitutional Convention approved the proposal for discussion. The basis for this initiative is that there has been a sharp decline in the contribution of copper to the national treasury. In particular, in 1989, when 90 percent of copper production was owned by the government, Chile produced 1.6 million tons of copper and copper contributed about 25 percent to the national budget. In 2020, Chile produced 5.73 million tons, but copper only contributed to 5.9 percent of the national budget. The proposal asserts that there has been a sharp decline in copper contributions because more than 70 percent of copper production is owned by foreign mining companies, which have generally avoided paying taxes. Under the proposal, Chile’s President would have one year after enactment of the new constitution to implement this provision. Nationalized companies would have the right to an indemnity in the amount of their book value as of December 31, 2021 with Chile’s Comptroller General having the power to determine the amount to be paid to the companies and their subsidiaries. This proposal has received strong criticism from the existing center-right government (which is being replaced by left-led coalition that will take office in March 11, 2022), as well as some members of the Constitutional Convention. 
  • Annulment of Mining and Forestry Concessions on Indigenous Land: On December 28, 2021, an initiative regarding the Rights of Pre-Existing Peoples and Nations to Land, Territory, Resources and Natural Assets was introduced in the Constitutional Convention. The initiative arises out of the historical ill treatment of indigenous peoples by the State and broadly addresses the State’s debt to provide restitution to indigenous peoples. This plan proposes, in part, to annul mining and forestry concessions granted without prior consent of indigenous groups. Concessions could be reinstated within two years if the indigenous community agrees after a period of consultation. The goal of the proposal is to review the authorizations of concessions which have clearly violated the interests of the indigenous people. The environmental committee voted in favor of beginning discussions on the initiative on January 25, 2022. Another related proposal which has not yet gone to a vote suggests setting time limits on mining and forestry concessions.
  • Water Use Permits for Mining, Farms, and Utilities: On February 3, 2022, the environmental committee also voted in favor of opening discussions on an initiative that would require mines, farms and utilities to seek permits for water use. Water use concerns have become a social justice issue in Chile, arising from the last decade of droughts and lax oversight of water use. The goal of the proposal is to create a new model for water usage that prioritizes human consumption, the sustainability of water reserves and indigenous rights. The proposal would annul the water use rights granted to the private sector and require mines, farms and utilities to apply for temporary use permits. Other non-industrial holders of water rights would receive compensation within two years. 

All of these proposals still require final approval by the environmental committee and then a vote of the plenary session of the Constitutional Convention to become part of the draft constitution.

Potential Disputes Arising out of the Constitutional Proposals and Royalty Bill

If the Royalty Bill is approved by the Chilean Congress and/or the measures pending before the Constitutional Convention are approved as discussed above, existing natural resource projects would be subject to significant uncertainty. The consequences of enacting these proposals could include deprivation of investors’ ownership rights, breach of investors’ contractual rights and impairment of the economic value of investments, all of which would likely give rise to many commercial and investor disputes.

The commercial disputes that may arise will depend on the specific terms of an investor’s commercial contracts, and would likely include claims for breach of contract, force majeure, material adverse change, and changes to local laws and regulations. Investors should analyze their contracts to identify potential claims and liabilities that could arise if the proposed constitutional initiatives or royalty bill are enacted. Investors should also take special care to review any applicable contractual notice requirements to ensure that their claims are preserved.

The enactment of these amendments could also breach Chile’s obligations under the over 50 bilateral and multilateral investment treaties (hereafter, “Investment Treaty” or “Investment Treaties”) to which Chile is a party. These include Investment Treaties with Spain, France, the Netherlands, Germany, Japan, the United States and the United Kingdom. Investors may be able to bring a claim against Chile under one or more of these Investment Treaties.

Investment Treaties protect “investors” from one treaty country that make “investments” in another treaty country from certain adverse government actions. Such investments include physical assets owned in Chile, equity shares held in a company, debt instruments, property interests, certain contractual rights, and other tangible and intangible interests arising out of capital investments made in Chile. Subject to the nationality of the investor and the terms of the specific treaty, investments in the Chilean natural resource sector likely to be affected by the proposed regulations should be covered.

Investment Treaties serve two principal purposes. 

First, they define the types of protections accorded to foreign investors and investments. Protections invoked in Latin American mining disputes:

  • Expropriation: Expropriation occurs when a government seizes private property for a public use. Such property includes physical assets (e.g., a copper or lithium mine), as well as contractual rights, such as mining concessions. An expropriation can occur directly, where a government formally seizes title and possession of an investor’s property, or indirectly, where the investor retains title and possession of its property, but the value of that property is materially diminished through a government’s action (including the passage of laws and regulations). While a government may lawfully expropriate private property, it must compensate the owner for the value of the expropriated asset. Investment treaties permit investors to bring claims against a government where their property is expropriated and either no compensation or inadequate compensation is provided. 

    If they become law, the constitutional provisions annulling mining and forestry concessions, or nationalizing mining companies and their assets will likely constitute direct expropriation by the government. Whether an investor will have a claim will depend on how the provisions are applied and the compensation (if any) received for the expropriation. The enactment of the royalty bill could constitute an indirect expropriation. This determination will depend on the extent to which it impairs the value of the investment and investors’ ownership rights.

    For example, in Crystallex v. Venezuela, an arbitral tribunal found that Venezuela expropriated an investor’s rights in a mine operation contract by refusing to issue an environmental permit to initiate extraction and by announcing an intent to nationalize the mine through political proclamations.
  • Discriminatory Treatment: Investment treaties prohibit treaty parties from discriminating against investors or investments from other treaty partners. Specifically, a host government must treat a qualifying investment from a treaty party as well or better than it treats similar investments made by either local investors (National Treatment) or other foreign investors (Most Favored Nation Treatment). For example, Chile would have difficulty enacting measures that prefer domestic mining companies over foreign mining companies operating in the same sectors. Likewise, it would be problematic if Chile enacted a measure that preferred mining companies from one foreign country over mining companies from other foreign countries. Overall, the anti-discrimination provisions in investment treaties are intended to ensure that similarly situated parties are treated equally, regardless of nationality. Depending on how the proposed measures are enacted and enforced, there is the potential for discriminatory treatment. For example, in Quiborax v. Bolivia, an arbitral tribunal found that Bolivia discriminated against a Chilean investor on the basis of nationality by revoking and annulling the investor’s mining concessions in response to public pressures, nationalist sentiment, and riots against Chilean natural resources investment.

    A discrimination claim may similarly arise where the proposal to nationalize mining companies gives the Comptroller General power to determine the amount of indemnification due to nationalized companies and the terms of such compensation. The improper exercise of this discretion could create a situation in which foreign investors are treated materially worse than domestic investors.
  • Unfair and Inequitable Treatment: Foreign investors are protected against unfair and inequitable treatment and are entitled to the full protection and security of the law. These provisions require a host state to ensure a certain level of transparency and stability within the law and may hold a state responsible where its actions undermine a foreign investor’s reasonable expectations regarding the investment climate in which it is operating. If enacted, the constitutional provisions and royalty bill will materially affect foreign investors’ expectations regarding the operating environment for natural resource companies.

    For example, in Infinito Gold v. Costa Rica, an arbitral tribunal found that Costa Rica violated the right to fair and equitable treatment by enforcing a legislative ban on new mining concessions against an investor whose pending application for an exploitation concession pre-dated the ban.

    Ultimately, the full scope of how such expectations may be affected will not be known unless and until the initiatives are enacted. It is clear, however, that the nationalization of mining companies, the annulment of mining and forestry concessions, imposition of new royalties and taxes, or permitting requirement for water usage will fundamentally undermine the existing regulatory regime and investment environment.

Second, investment treaties provide private investors a direct right of action against a host government for violations of international law. Most investment treaties give investors the right to bring claims either in the local courts of the host country or before an international arbitral institution.

Each investment treaty will contain its own dispute resolution provision with the options and requirements for bringing claims against a host state. Investors wishing to bring investment treaty claims against the Chilean government would need to do so in compliance with the procedures set out in the various treaties. For example, certain of the Investment Treaties to which Chile is a party require investors to wait three months after a dispute has arisen to initiate arbitration. Additionally, many of Chile’s treaties require an investor to submit their claims to arbitration or local courts but prohibit submission to both. Investors, therefore, will need to ensure they have complied with the necessary preconditions to initiating arbitration so as not to put their claims in jeopardy.

Chile has been a party to several investment arbitrations (though notably not as a respondent in the mining context) and has prevailed in three of five completed disputes. Most recently, in December 2021, the Chilean state-owned copper producer, Codelco, filed an arbitration against Ecuador for an alleged breach of a 2019 agreement to jointly develop the Llurimagua copper project. Investors considering investment treaty claims against Chile are recommended to obtain legal counsel with expertise in investment treaty disputes, as well as the mining, energy and natural resources sectors.

Pre-Dispute Considerations

Investors faced with changing regulatory environments or emerging disputes should take steps to protect both their legal and commercial interests. While there are a variety of steps companies can take, the focus should be on preserving critical data, assisting in the prosecution of their claims, and minimize corporate disruption. 

Ultimately, the steps that a particular investor should take are highly fact-dependent, so consultation with experienced international arbitration practitioners is recommended. 

Shearman & Sterling has extensive experience representing foreign and domestic companies and states in commercial and investment disputes related to Latin America in various sectors, including mining, energy and natural resources, and remains at the disposal of investors considering potential commercial or investment treaty claims.

Authors and Contributors

Christopher M. Ryan

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国际仲裁

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Garreth Wong

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Anna Stockamore

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Cynthia Urda Kassis

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