Thursday, February 4, 2016

#TBT: Tactics When Caught in an Expropriation


This post is part of an occasional series highlighting a project finance article or news item from the past. It is often interesting and thought provoking to look back on these items with the perspective of months, years or decades of further experience. 

With this installment, we turn to an article that was published in the February 2013 Project Finance Newswire and written by Kenneth W. Hansen, a partner of Chadbourne's Project Finance group.





Tactics When Caught in an Expropriation



What to do?
The new president of a country decrees all foreign-owned assets in your line of business to be the people’s property. Rumors reach you that military officers are being dispatched to various corporate headquarters and operational sites to ensure the smooth transition of management and the speedy expatriation of foreign managers.

Or, perhaps the decree declares that foreign business owners must sell a controlling interest in their businesses to domestic owners within 100 days.

Or it might decree that existing concession agreements with foreign project sponsors are terminated effective in six months, subject to prior renegotiation of their respective terms.

Such headlines have greeted foreign investors in a number of Latin American countries in recent months. What would you do? What would you wish you had already done?

Crisis Management

The first concern is physical security of managers, staff and their families. An expropriation may be implemented in orderly fashion through local legal process. However, such actions have also occurred, amidst popular rebellion or military crackdowns against foreign interests.

Debating national economic policy with the master sergeant who arrives to assume control of the executive office is probably not the right move.

However, imagining the scene does suggest the importance of corporate disaster recovery arrangements. Such arrangements are typically designed with earthquake, fire, flood or terrorist attack in mind. Host government intervention could also create a circumstance in which the ability to communicate with employees from off-site and to access corporate records, notwithstanding loss of physical control of headquarters, would be invaluable.

An effective means of communications could be critical to coordinate management and staff, whether for purposes of evacuation or orderly turnover of the facilities or the shutdown of operations. It might also assist, should the opportunity arise, in taking steps that could improve one’s bargaining position in subsequent negotiations with the government. In one Asian power project that ultimately became the subject of expropriation claims against the host government, certain computer disks needed to operate the facility departed the project site with the foreign managers. These became a source of some bargaining strength in subsequent settlement negotiations.

In extreme cases, there may be little to be done immediately except evacuation. At the other end of the spectrum, there may be time and opportunity to attempt to persuade the government to rescind its actions. This article assumes that the government is committed to the expropriatory actions it has declared and that the inventor’s challenge is to cope with them.

Legal Claims

Once personnel and, to the extent feasible, property have been secured, attention turns to the legal front and preparing for what will likely become an international legal action against the offending government.

The first step is to inventory possible bases for legal claims. Rights might be found in contracts, local law and applicable treaties or conventions to which the host country is a party. Assemble and carefully review the documents and, if applicable, the local laws pursuant to which the project was undertaken. Possibilities include any concession agreement, license or project contract with a governmental authority. What do those documents say about expropriation, termination, liability or compensation? Are there local laws providing any protections to foreign investors or generally to holders of private property? Is the host country party to any bilateral investment treaties or other international conventions that could protect investments in your project? This inquiry should obviously be undertaken with the assistance of local counsel, whose role is discussed further below.

Might the developing political circumstances constitute the basis for a claim under any political risk or other insurance policies? Might the project company’s, or the project sponsor’s, obligations to third parties be affected by political force majeure clauses?

Pressing legal claims will probably entail one or more of the following: an arbitration under project-specific documents, an international arbitration pursuant to a bilateral investment treaty, or asking one’s home country to espouse a claim diplomatically (which will require prior exhaustion of legal remedies in the host country). In each case, you will face a problem of proof. Even if what the host government did is perfectly clear, it may be of critical legal relevance to show why the government acted as it did. Was its motivation national security? Politics? Theft?

A core question will be whether the government’s actions were justifiable under international law. Did those actions constitute a “taking without prompt, adequate and effective compensation” — thus an illegal expropriation — or were they an exercise of police power in a time of economic crisis or possibly regulatory actions within the proper scope of governmental discretion? Wrongful intent is not required for a government to be held responsible for an expropriation of property or rights, but a government may be excused from any obligation to compensate for losses cased by bona fide regulatory measures. (Both regulatory discretion and police powers have been offered by Argentina as defenses for its “pesification” of foreign currency-denominated contracts in 2001.)

Analysis of the appropriateness of the government’s actions under local circumstances, including local law, will require, if available, the assistance of local counsel. Such counsel might offer both strategic and tactical advice about negotiating with the host government if that opportunity arises. Local counsel can also supply useful legal and factual data for the brief against the government in whatever forum that brief might be filed. Local counsel may be able to make a case that the government’s actions were illegal even under local law. If the expropriation was engineered carefully to include legislative approval, the contribution of local counsel may be limited to elaborating arguments as to why local circumstances did not justify the government’s actions under international law. Whether through legal analysis, fact finding or facilitating negotiations, local counsel can be useful, perhaps critical, participants in the process of pressing an international law claim.

The problem is that local counsel may not, as a practical matter, be able or willing, to help. Among the criteria likely to have been carefully weighed when local counsel was selected was a close and influential relationship with the host government. When the crisis comes, that counsel may not be prepared to antagonize those relationships by acting on your behalf. Even if he or she might otherwise be inclined to help, the counsel is likely to lack an important option available to you, namely, the opportunity to leave the country and go home. The local counsel is home and will need to navigate the crisis, professionally and personally, as best he or she can. Zealous representation of your interests may not fit well with a local survival strategy. If the counsel were to leave the country, his or her usefulness would be diminished.

So, what is to be done? Possibly not much. One is unlikely to choose local counsel up front for the person’s lack of intimacy with local government authorities. There may be value, however, in recognizing the issue and, as circumstances in-country for foreign investors deteriorate, in cultivating a relationship with alternative counsel who, ideally through off-shore offices, may be able to provide effective support of a subsequent expropriation claim.
Some mitigation of the adverse impact of a lack of effective local counsel may be found in the fact that the validity of one’s expropriation claim will depend on international, not local, law. There are mechanisms beside local counsel for finding the facts and proving your claim. Appropriate international counsel will certainly be part of the process.

Litigation: A Long Road

Here, however, you face some harsh realities of international legal claims. First, to date, the world offers no international court where aggrieved investors can sue a host government that violates their rights under international law. Your sole option may be to ask your home state to “espouse” your claim diplomatically, which under international law it has the right, but no obligation, to do. Further, under customary international law, a state’s right to espouse the claim of its national arises only after that national has exhausted local remedies, so you would be required first to seek redress through the offending host country’s own courts. Even if your home country eventually agrees to take up the cause, espousal is no guarantee of results. It is not a lawsuit with a reasonably high probability of reaching a decision, whether favorable or adverse. Rather, it offers at best a long-term hope of negotiation, but with no end necessarily in sight.

The more direct approach requires finding a forum where you, the aggrieved investor, can assert your claims directly against the offending government. The most obvious route, if applicable to your case, will be through the dispute resolution mechanisms built into your concession agreement or project documents. The government may well have consented to offshore arbitration. If so, the next steps for holding the government to account will be as clear as the relevant provisions in those documents.

Such a consent to arbitration of disputes might also, or alternatively, be found in a “bilateral investment treaty” (or “investment protection agreement”) binding the host government with respect to investors from your home country (or possibly those from a jurisdiction through which your investment was structured). Today, roughly 10,000 such agreements are in force, so the chances are significant, though not assured, that you may be able to take advantage of the government’s promise in such a treaty to settle disputes with foreign investors in an independent, offshore forum (often the International Centre for the Settlement of Investment Disputes, or “ICSID,” of the World Bank Group in Washington).

Absent arbitration rights based in project documents or a bilateral investment treaty, your right to effective litigation against an offending host government is likely to lie somewhere between illusory and non-existent.

The fourth and probably final, but perhaps best, option for recourse, or at least recovery, could be to your political risk insurer — if any. If your investment was insured against expropriation, your course of action will be clear. The first step, of course, will be to re-read the policy. Are you out of compliance with any covenants or conditions that could excuse the insurer from paying a claim? Can any such circumstance be quickly remedied? Are there obligations or conditions under the policy with respect to operating under the present crisis — for example, to act non-provocatively or, alternatively, to act as if uninsured? Almost certainly there will be an obligation to keep the insurer fully informed of the circumstances of the potential claim as they develop. Failure to comply with such obligations could result in rejection of the claim regardless of its merits.

Full attention should turn, of course, to the requirements for proving a claim -– proof both of the nature of the government actions and of the amount of the investor’s related loss. Local counsel has already been identified as likely to play a potentially key role in the process. So, too, may accountants — both local and offshore. Proof of loss will be aided immensely by the project’s books being in order.

Being Prepared

So, what would you wish, upon the onset of such a crisis, that you had done in advance? That follows fairly directly from the steps that you would want to be able to take in the event the crisis comes.

As already noted, you would want to be able to maintain communication with critical staff and to access and preserve corporate records. This becomes yet another good reason for having an effective disaster recovery plan.

You will want to hold the government to account for the losses that it has caused. Thus, going into an investment, you need to think carefully about what legal recourse you would have in the event that things should subsequently turn sour. A real premium should be attributed to an applicable bilateral investment treaty. Even if your home country lacks such an agreement with the prospective host country, perhaps the host government has concluded agreements with other countries through which your investment might be structured. All of the equity investors in Enron’s infamous Dabhol power project structured their investments in the project company through Mauritius for tax reasons. When the project was shut down and eventually abandoned in 2001, those investors became the beneficiaries less of tax advantages than of the India-Mauritius bilateral investment treaty, which gave them the right to initiate offshore arbitrations against the government of India for the expropriation of their respective investments, a right that two of the three equity investors exercised. At the time settlement was reached, offshore lenders were exploring their options to bring similar claims through an assortment of jurisdictions. The pressure on the Indian government attributable to these arbitrations contributed greatly to achieving a settlement of all foreign debt and equity claims.

The value of finding an arbitral forum is somewhat countered by the harsh reality that winning an arbitration is no guaranty that an award will be paid. The risk of an uncollectible award is not, of course, unique to investor-state arbitration. Any civil defendant may be judgment proof. While governments will normally have the ability to pay, they may not be willing to do so, and the process of enforcing an award is both speculative and expensive. Enforcement through the host country’s own courts is unlikely to be fruitful, so the process necessarily entails a search for host government assets located outside the host country. Though a challenging exercise, it is certainly not pointless, and a number of international lawyers earn their livings seeking and, once found, attaching offshore assets of governments. Bank accounts, real estate (if not covered by a diplomatic protection treaty) and state-owned aircraft (that land unaware in a foreign jurisdiction) are all popular targets. There can, however, be no assurance going into an arbitration that any such asset will ultimately be found to satisfy an award.

One way to avoid the risk of a winning but fruitless arbitration is political risk insurance. Both public agency political risk insurers — such as OPIC and MIGA — and commercial political risk insurers are typically willing to insure a host government’s payment of an arbitral award that results from an arbitration brought against it under project documents.

With such coverage, the investor has the burden of initiating arbitration against the host government and of achieving an award in its favor. Then, reasonable steps must be taken to enforce and collect that award. If, after a waiting period (typically six months), the respondent government has not paid the award, then, in exchange for an assignment of the award, the insurer will pay the insured investor the insured amount of the award. Thus, such insurance provides the investor with a reasonable assurance that an award will be paid, a result that cannot be assumed or even expected when initiating arbitration against a host government.

Details in this arena are important. For instance, the typical insurance policy requires the arbitral award to be assigned to the insurer free and clear of any lien or other encumbrance. If the claim arises from a project that was project-financed, the project lenders’ collateral package may well include a lien over any such award. A carve-out from, or a release of, that lien will need to be negotiated, or the equity investor may not be able, so long as the project debt remains outstanding, to satisfy the requirements for a claim under the political risk insurance policy.

While arbitral award coverage is typically available for awards arising from project documents, no such coverage is offered “off-the-shelf” by any public or private sector insurers for arbitral awards achieved pursuant to bilateral investment treaties. This void in traditional coverages appears to be a function of the relatively recent arrival, in significant numbers, of bilateral investment treaties as well to the failure of investors to think to ask for it. There is no clear impediment, other than novelty, to such coverage being offered. I have asked several political risk insurers, including both public and private sector shops, whether they would be willing to offer such coverage. Each indicated that it would seriously consider offering such coverage if an investor were to ask for it.

Conclusion

What is the risk that, through one mechanism or another, your foreign investment will be expropriated? Political predictions are notoriously unreliable, making planning difficult and hedges important. The risk of expropriation is doubtlessly higher in some sectors, such as extractive industries, banking and public infrastructure, than in others. In some countries — Bolivia, Ecuador and Venezuela, for instance — such risks appear obviously higher now than one would have expected a few years ago. Indeed, a long record of pro-Western, pro-business policies is no guarantee against a radical change of course. Consider the ultimate fate of Iran under the Shah. On the other hand, a notorious track record of expropriating foreign enterprises is no proof that a country cannot offer a safe platform for foreign investment. Consider Chile.

Until recently, it had become nearly axiomatic among political risk professionals that “conventional expropriation,” in which the host government explicitly nationalizes foreign-owned investments, though a common feature of the international investment landscape in the 1960’s and 1970’s, was passé. The international legal obligations, and therefore liabilities, of host governments were too well established for host governments to be expected to behave in a fashion that would invite adverse legal, financial and reputational consequences. That is particularly the case when the same objective — abandonment of local operations by foreign investors — might be achieved through a cocktail of regulatory actions that are, or at least can be argued to be, legally defensible: for example, taxes, licensing requirements, environmental regulations and national security policies.

Political risk coverage has evolved since the 1970’s to cover “creeping expropriation” as well as outright nationalization, but proving the merits of a claim against a government that claims to have acted for reasons of economic emergency or other defensible public policy, or not to have acted in any targeted fashion at all, is likely to be more challenging than where the government has admitted, indeed declared explicitly, the circumstances that, under a project document, a bilateral investment treaty or a political risk insurance contract, must be proved by the investor to win the case.

Consequently, one advantage of the recent expropriatory actions of the governments of Bolivia, Ecuador and Venezuela is that any claims that manage to find a forum where they can be asserted, whether in arbitrations or insurance claims, should be easier to prove than the claims that arose, for instance, out of Argentina’s “pesification” in 2001 or the government contract cancellations that occurred in Indonesia and Pakistan amidst the 1997 Asian economic crisis.

Any such contemporary claims pressed in arbitrations will face the inevitable challenge of converting an award against a host government into cash. Any affected investors who armed themselves with political risk insurance will prove to be the lucky — or wise — ones.

Recent developments in Bolivia, Ecuador and Venezuela and actions threatened by the unsuccessful presidential contender in Peru are all against the tide of the global tendency over the past 20 years of ever-increasing private sector involvement in the development, financing and operation of public infrastructure. Are current cases of host governments showing foreign investors the door merely anachronistic curiosities, or is there a spreading revisionism as to the proper roles of the public and private sectors and of foreign versus domestic interests, particularly where public infrastructure is involved?

The issue arises at home as well as abroad. Consider the recent Dubai Ports fiasco. The acquisition by Dubai Ports World of the UK’s Peninsular and Oriental Steam Navigation Company (P&O) would have resulted in Dubai Ports having management responsibilities at major U.S. port facilities in New York, New Jersey, Philadelphia, Baltimore, New Orleans and Miami. After months of attack in the US Congress, and under threat of retaliatory legislation, Dubai Ports resold its interest in P&O to a US firm (to AIG). Much of the political rebellion was doubtlessly attributable to the politics of the home region of Dubai Ports, but the principle argued was that critical national infrastructure cannot be trusted to foreign private management.

Whether backlash against foreign private investment proves to be widespread or localized, foreign investors would do well to think carefully about, and to plan appropriately for, the possibility that the welcome mat may be withdrawn. In that circumstance, your fate is likely to depend on international law rights to arbitration and political risk insurance. Those arrangements need to be assured when first going into an investment. By the time of the xenophobic election, coup d’état or expropriatory decree, the options for mitigating losses may be limited.