CHAPTER 8 PROTECTING AN INTERNATIONAL MINERAL INVESTMENT THREATENED BY POLITICAL UPHEAVAL IN A DEVELOPING COUNTRY
| Jurisdiction | United States |
(Feb 1991)
PROTECTING AN INTERNATIONAL MINERAL INVESTMENT THREATENED BY POLITICAL UPHEAVAL IN A DEVELOPING COUNTRY
Welborn Dultford Brown & Tooley, P.C.
Denver, Colorado
I
A mineral company should not invest in a developing country unless it has made a careful and detailed assessment of political risks involved in investing in that country. Should these risks appear too high relative to the anticipated benefit, the investment should not be made. On the other hand, if the degree of risk is outweighed by the anticipated benefit of the investment, then the investment should be made. A political risk should thus be evaluated just as any other investment risk would be, including normal commercial and market risks and, of course, the risk of poor results after detailed exploration of mineral reserves have been undertaken.
A recent study has concluded, albeit on somewhat limited data, that mineral companies do treat political risks in just this manner.1 The author reports that his limited survey among mining companies revealed that sixty one per cent of the mining companies queried listed the geologic potential of the project area as the main criterion in selecting a country for exploration. Only twenty one per cent listed political stability as the main criterion.2
A World Bank evaluation of mining prospects in Africa noted that few significant mineral discoveries had been made in Africa during the past twenty or thirty years, as contrasted with other developing areas of Asia and Latin America, although Africa had at least equivalent, if not superior, mineral potential.3 The study attributed this fact not to greater political risk in Africa, but rather to the absence of an "enabling environment" — that is, the absence of a legal and regulatory institutional framework more conducive to minerals investment.4
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In any event, the fact that countries such as Chile, Indonesia, Papua New Guinea and the Philippines all shared, during the past decade, in the "boom" of exploration for and development of gold, despite fairly significant political risks associated with each, suggests that mineral companies will in fact go where the minerals are, even when significant political risks exist.5
Mineral investments, if successful, continue for decades. Assessing political risks in a developing country is, however, very much a short term enterprise. Given the volatility of developing countries, significant changes in political leadership and structure—instability and upheaval, if you will—are an expected event in any long term scenario.
At a lawyers conference held in New York in January 1990, one speaker undertook to evaluate investment conditions in Arabic countries that would be of interest to an American multinational company. With regard to Saudi Arabia he had only two concerns. The first was that the "economic crisis" of the 1980s (presumably the decline in oil prices) had led to an increase in late payments on government contracts. The second was that commercial dispute resolution is slow and tedious, although fair.
As for Iraq, he commented favorably on the improvement of Iraq's petroleum export capacity through Turkey and its amendment of the company's law to provide for more liberal foreign investment in commercial activities, including those through wholly owned branches. He expected that United States support for Iraq during the Iran-Iraq war would continue the significant increase in trade between the two countries. His only warning note was that Iraq's use of poison gas against its Kurdish minorities might lead to political problems with the U.S. Congress.6
The dramatic changes affecting those two countries so soon thereafter are atypical, but as events in the Middle East illustrate, they do occur with predictable unpredictability. Changes in eastern Europe and the Soviet Union may yet lead to substantial instability, difficult to predict with any degree of specificity either as to the precise nature or as to the time within which such developments might occur. In Liberia,
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what seemed in January 1990 to be a fairly minor, typical skirmish in the northern part of the country, perhaps one manufactured by the government as a convenient excuse to crack down on some of its political opponents, turned with tremendous suddenness into a full civil war pitting tribal and ethnic groups against one another, ultimately devastating the country and leaving it without an effective government.
It is quite clear that political risks may be unacceptably high even in a developed country (e.g. strained relations between major powers may foreclose the desirability of investments by nationals of one such power in the territory of the other, or domestic instability such as that in Germany during the Weimar Republic may be so severe as to resemble conditions more commonly found in developing countries). But this article shall concentrate on political risk and instability as it affects developing countries. By developing countries I mean those countries that tend to be importers of capital, technology and management skills (although even developed countries to varying degrees are importers of all three). Developing countries also tend to be poorer countries with far lower standards of living (but, contrast the wealthy oil-producing countries of the Middle East), and to have newly evolving or immature political and social institutions and sense of national identity. The combination of these factors, which may exist to a greater or lesser degree in a particular country, increases the chance for substantial future instability. Poverty or lower standards of living while not, in and of themselves, a sufficient cause of instability, do tend to add fuel to the fire of rapidly changing and evolving social and political institutions and ways of life which characterize developing countries.
There are certain well-known ways to protect against this type of instability. They include, among other things, the conclusion by investors of specific agreements with the governments of developing countries that are enforceable, as a matter of international law, before objective tribunals, and that clearly define the rights, privileges and duties of the parties to such agreements. A common feature is the use of "stabilization clauses" in such agreements to prevent the unilateral abrogation of an investor's rights or alteration of the terms under which the investment has been undertaken. The validity of such clauses has been a source of ongoing
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discussion and controversy over the years. The enforceability of such clauses is now, however, well established in most circumstances.7
In some cases, a bilateral investment treaty may be concluded between a developed and a developing country to provide protection for investments by nationals of the developed country in the developing country. The expectation is that these treaties will also prove beneficial to developing countries by encouraging such investments.8
Increasingly, investors in developing countries welcome the involvement of a World Bank arm, such as the International Finance Corporation, as a project lender or minority equity participant. The involvement of such a multilateral agency acts to discourage host country measures that may harm the project. In return, the developing country may derive some comfort from the presence of such an agency which presumably would not be a party to, and would use its professional expertise to prevent, sales and administrative practices which unfairly benefit the investor at the expense of the country. Such practices, including siphoning off profits through exorbitant internal charges for services by affiliates, characterizing most contributed capital as debt rather than equity and questionable sales practices, were a common feature of such projects at one time.
Some investors have sought (or have been required to accept) nationals of the developing country as equity holders. Such local partners may ward off actions, including expropriation, which adversely affects their interests and therefore those of their foreign partners. However, local partners may add little in equity capital or technical competence. If they become merely the means whereby the current elite, or its agents, gain an advantage, then the likelihood that a future instability will affect the project in a negative way may be enhanced. Unstable times are likely to come and to bring in their wake new leaders anxious to expose
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the corruption of their predecessors and perhaps hostile to an enterprise with which those predecessors were associated. The new leaders may also be anxious to grab their share of the pie, and feel entitled to do so.
Insurance may be obtained against most forms of political risk through private insurers, or preferably, in order to cover longer term risk, through government insurers such as the Overseas Private Investment Corporation of the United States.9 The formation of the Multilateral Investment Guarantee Agency of the World Bank has provided greater flexibility for obtaining such insurance without the national ownership and other constraints imposed by national government-owned insurers.10
The precise concern of this article is, however, with what measures an investor may take when it finds itself in the midst of political upheaval in a developing country jeopardizing its investment. Mineral companies, like other major investors in developing countries, prepare for risks of expropriation, or lack of foreign exchange, or unilateral efforts to abrogate investment agreements. But in reality, they are perhaps more likely to encounter problems not so easily provided for in carefully crafted legal documents. These include political and social instability and their companions, civil strife, terrorism and even war. These...
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