CHAPTER 12 MANAGING MULTI-COUNTRY INTERNATIONAL RISK: WHAT TO LOOK FOR BEFORE INVESTING
| Jurisdiction | United States |
(May 2008)
MANAGING MULTI-COUNTRY INTERNATIONAL RISK: WHAT TO LOOK FOR BEFORE INVESTING
Shearman & Sterling LLP
London, United Kingdom
Henry Weisburg
Shearman & Sterling LLP
New York, New York
Christopher Ryan
Shearman & Sterling LLP
Washington, D.C.
I. Introduction
Pursuing foreign investments, particularly in emerging markets, can be extremely challenging. Investors must not only confront financial and operational issues, but a long list of legal issues will also arise, as to which the foreign investor will often be subject to the caprice of the foreign host state. Every company considering a foreign investment will be aware of numerous disaster stories that have bedeviled others: expropriations, confiscatory taxes, regulatory reversals, corruption, loss of currency convertibility, abrogation of contracts, unreliable courts, and many others. These issues can be particularly acute for natural resource companies, given the deep-seated association of natural resources to the "national patrimony" of states, and the huge amount of money often involved in natural resource investments.
The issues and risks confronted by companies investing in the natural resources sectors of foreign countries is demonstrated by the high incidence of disputes submitted to international arbitration. Indeed, 40% of the cases currently pending before the International Centre for Settlement of Investment Disputes ("ICSID") involve mining operations1 or water, natural gas, oil, or other hydrocarbon operations.2
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Identifying and managing the risks that confront foreign investors is an extremely broad subject, embracing numerous different issues. It is not possible to adequately address all of those subjects in any single article. Nevertheless, in this article we attempt to summarize significant legal risks that should inform cross-border investment decisions. To this end, Part II of the article discusses the extent to which a country's legal stability and adherence to the rule of law can affect foreign investment. Part III focuses on political stability and examines issues such as the form of government, historical treatment of investments, and transparency levels. Part IV then looks at regulatory and financial risks associated with a country, focusing largely on how the regulatory environment can shape an investor's reasonable expectations at the time of investment. Finally, Part V offers suggestions as to how investors can minimize, or at least plan for, legal risk prior to making a major foreign investment.
II. Legal Stability and Adherence to the Rule of Law
Legal stability and adherence to the rule of law are critical factors in a country's ability to attract and support foreign investment. As two leading international law scholars have commented, "[a] host state must do far more than open its door to foreign investment" to benefit from the international system; it must "establish and maintain an appropriate legal, regulatory, and administrative framework, the legal environment that modern investment theory has come to recognize as a conditio sine qua non of the success of private investment."3
How does a potential investor assess whether a country's legal system is stable and whether the government adheres to the rule of law? Unfortunately, there is no bright-line test that will determine a country's relative legal stability and respect for the rule of law. There are, however, domestic and international indicators that historically have allowed these factors to be measured.
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A. Domestic Indicators of Legal Stability and Respect for the Rule of Law
Investors are attracted to countries whose legal systems are predictable and efficient, and can provide a stable environment in which to operate their businesses. An unpredictable legal system -- i.e., one in which there are unexpected and unpredictable changes in the law or inconsistencies in how laws are interpreted and enforced -- deprives investors of certainty and undermines their reasonable expectations as to how their investments will be governed and regulated.4 Indeed, a World Bank report found that a "government's credibility, the predictability of its rules and policies and the consistency with which they are applied, can be as important for attracting private investment as the content of the rules."5 An inefficient and unpredictable legal system increases transaction costs and discourages investment and capital expenditures. In extreme situations, a defective legal system can impair or destroy the value of an investment.
A predictable and consistent legal system will extend to both the country's substantive law (including its contract, property, mining, labor, environmental, trade, and tax laws) and to its procedural law (including laws relating to litigation, regulatory and criminal enforcement, land use and construction permitting, and administrative ruling making). Ideally, a prospective foreign investor will have the time and resources to conduct a comprehensive analysis of the substantive and procedural aspects of the law of the host state, in order to fully appreciate the risks and determine whether any mitigants can be adopted. However, it is often difficult to objectively measure a country's legal stability and respect for the rule of law. Although there are no checklists that can predict with absolute certainty a potential host state's legal stability, there are some basic questions that all potential investors should ask when weighing the risks of various countries. For example:
• how transparent is the country's legislative process?
• is the legislature free from corruption?
• how transparent is the country's regulatory process?
• are regulatory agencies free from corruption?
• are regulatory agencies independent from the executive branch?
• are the courts independent from the executive branch?
• is the judicial system free from corruption?
• do cases proceed at a reasonable pace?
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• are there legal, economic, or practical barriers to accessing the country's courts?
• does the country have experienced and reliable counsel?
• does the country's legal system respect contract and property rights?
• does the country's courts and regulatory agencies provide adequate due process (e.g., notice, right to be heard, right to counsel, etc.)?
This list is necessarily highly abbreviated, and, unfortunately, there is almost no limit on the legal issues that may be potentially relevant to a large, capital- and labor-intensive project. Non-governmental organizations, such as Transparency International, provide reports on the corruption level in a number of countries.6 Likewise, the U.S. Department of State, U.S. Department of Commerce, the Central Intelligence Agency and the major accounting firms all provide information on the legal, economic, and business environments in various countries. Each of these sources can help investors measure the risk associated with a potential host country and should be consulted as part of the pre-investment diligence process. Of course, sophisticated counsel in the host state can be highly informative.
B. International Indicators of Legal Stability and Respect for the Rule of Law
A long and consistent history of domestic adherence to the rule of law and of respect for the rights of foreign investors provides substantial comfort to new investors. However, many countries do not have that history, and offer spotty domestic legal protections. In some countries, which may be highly attractive for their natural resources, basic property and due process rights may not be respected, and the judicial and regulatory infrastructure corrupt, politicized or otherwise unreliable.
Countries seeking to attract foreign investment will often seek to supplement their domestic mechanisms by committing to adhere to a variety of international norms, enforceable through international proceedings designed to reassure foreign investors that their expectations in making investments will be satisfied. Countries may do this even where their domestic legal structures are strong; alternatively, some developing countries have attempted to overcome deficiencies in their domestic systems by taking on stringent international obligations to protect property rights.7 Typically, governments assume these obligations in one of three ways.
First, the government may expressly include property rights protections and undertake to adhere to international standards in the investment agreement signed with foreign investors.
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Although possible, this option is not common in practice. Governments typically are sensitive about the scope of obligations that they undertake and, as such, are loath to contractually bind themselves to internationally-derived standards that they have not already adopted either in their domestic laws or through a bilateral investment treaty. Few investors have the political or economic clout to force governments to provide unique protections that are not generally available to the larger body of foreign investors. Moreover, statistics show that approximately 50 percent of the concession agreements signed since the mid-1980s have been renegotiated or cancelled, frequently leading to litigation or arbitration.8 As a practical matter, therefore, governments are cognizant when they enter investment agreements that they may be brought to litigation or arbitration and, therefore, are typically reluctant to increase their obligations and, in turn, their potential liability.
Second, governments may incorporate international standards into domestic legislation that allows for foreign investment. For example, a foreign investment law may offer foreign investors a variety on investment protections, such as tax stability, as well as the right to challenge governmental action other then in...
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