Facing Latin America’s Uncertain Investment Climate: “Expropriation” and Remedial Risk Management
August 7, 2007
In light of the current investment climate in certain Latin American countries, it is essential for companies investing in the region to consider proactive measures of risk management to protect themselves against potential loss of investment and of remedies vis-à-vis the host country.
The recent decisions by certain Latin American countries to compel foreign investors to re-negotiate their investment contracts on sanction of expulsion has introduced considerable uncertainty to the investment climate in that region of the world. Affected investors face the actual or threatened withdrawal from recognized investment protection mechanisms on which they rely for the enforcement of their rights vis-à-vis the countries in which they invest. Thus, on May 2, 2007, the World Bank received Bolivia’s notice of its intention to withdraw from the Washington Convention establishing the International Centre for Settlement of Investment Disputes (ICSID), the World Bank’s highly effective forum for protecting the rights of foreign investors against actions by their host states. Several other countries in the region have announced that they may follow Bolivia’s example.
Since an ICSID withdrawal notice will not take effect until six months after its filing, affected investors should consider acting now to secure their remedies respecting future disputes. Measures of risk management that foreign investors should consider include:
- Giving notice of the investor’s general acceptance of ICSID consent expressed in the past by individual countries in cases potentially subject to ICSID arbitration
- Negotiating forum selection clauses which stipulate that the contractual choice of forum (i) is non-exclusive, (ii) is not intended to derogate from the investor’s right to invoke arbitration under a bilateral investment treaty with respect to all claims relating to the investment, and (iii) is subject to a fallback forum if ICSID arbitration is unavailable
- Transferring affected investments to affiliates in countries with which the Latin American country concerned has bilateral treaties offering an effective dispute resolution mechanism
- Taking a critical look at their political risk insurance coverage
Identifying the risk
Exposure to governmental interference with foreign investments can manifest itself in multiple ways. Some provisions in Latin American project documentation prohibit foreign participants from negotiating for, or voluntarily agreeing to, any "expropriation action" by the host country or any instrumentality, subdivision or agency thereof, with the exception of routine actions that do not materially interfere with the operation of the project concerned.
This raises the following question: Can the re-negotiation of a royalty or fiscal regime under a contract between a foreign project participant and a state or state-owned entity be said to constitute an "expropriation action" voluntarily agreed to or negotiated by the foreign party, or does such activity fall within the category of "routine actions that do not materially interfere with the operation" of the project? And if the host state or one of its entities engages in an expropriation action causing economic damage to the foreign investor, what remedies are available to the investor?
In light of the current legal climate, it is prudent for companies investing in Latin America to assess whether they have meaningful exposure to governmental interference and, if they do, to take proactive measures of risk management to protect themselves against loss of investment, and possibly of remedies to address such loss.
What is "expropriation"
The answer to the question whether an action by a state or any instrumentality, subdivision or agency thereof constitutes an expropriation, as that term is understood in law, cannot be answered in the abstract, but rather must be analyzed on the basis of particular circumstances and in the context of particular purposes. Much depends on the law governing the question presented: the domestic law of the host state or the law governing the contract may lead to different results than those dictated by the international law of expropriation, as interpreted by international courts and tribunals. The majority of treaties providing protection of foreign investment do not contain a definition of expropriation.
Expropriation may take many forms, direct as well as indirect (or "creeping" expropriation). It is not necessarily restricted to the straightforward case of the outright deprivation of an owner of property of his title thereto and other interests therein. Expropriation may include a state’s imposition of extensive restrictions on a foreigner’s effective control of property or on the exercise of the normal rights of, or the enjoyment of the benefits of, ownership. It may also include the deprivation of, or interference with, intangible property such as contractual rights, including rights to exploit or share in oil and related shareholder rights—the form of a concession agreement often being of decisive significance in this context.
Classic examples of outright expropriation include the nationalization of entities owing debts to foreigners or having outstanding contractual relations with them, the direct annulment of debts or claims, measures denying the foreign owner access to its funds and profits, and the appointment of administrators to manage the foreign property in the enforced absence of the owner.
One of the key criteria or indicia developed by international tribunals is whether a state has interfered with a foreign property right to such an extent that such right was rendered useless in practice—even though the legal title formally remains with the original owner. Also, an expropriation often is assumed whenever events demonstrate that the owner was deprived of fundamental rights of ownership, and it appears that this deprivation is not merely ephemeral, such as when the foreign owner is no longer able to participate in the enterprise’s day-to-day management and control or the situation where the action permanently and irrevocably deprived the foreign company of all use of its investment. In assessing the nature of any action, international tribunals have ruled that the intent of the government is less important than the effects of the measures on the owner, and the form of the measures of control or interference is less important than the reality of their economic impact.
Not all regulatory or legislative activity that renders an investment less profitable, or even unfeasible, is an expropriation. The term "expropriation" must be distinguished from other (lesser) measures affecting property rights and from bona fide regulatory or "police power" activity. A given action must meet a certain threshold level of governmental interference before it constitutes an expropriation. Such interference must be material (i.e., its effect must be sufficiently substantial) and sufficiently lasting, in the sense that it has the effect of depriving the foreign owner, in whole or in significant part, of the use or reasonably-to-be-expected economic benefit of the property. An expropriation arises in an indirect way only if regulatory measures make continued operation of a project uneconomical so that it is abandoned or sold at a distress price.
As the above examples show, an expropriation action usually consists of some unilateral action by a governmental entity that is imposed on a foreign party—it typically does not involve an element of negotiation or other voluntary act on the part of the foreign investor. Indeed, expropriation actions are reserved for governmental actors—a private party cannot itself take such actions.
The bottom line is that an action which is not arbitrary or discriminatory, is based on the application of duly adopted laws or otherwise is taken in accordance with due process of law, and also is in the public or national interest—as opposed to a matter of individual animosity against a particular foreign company—is less likely to be labeled an "expropriation" triggering an obligation to pay just compensation. International law permits states to take such action provided it is accompanied by the prompt payment of adequate compensation.
If the investment has not become unprofitable as a result of the governmental interference or action (i.e., the foreign owner continues to earn profits), the foreign owner maintains control over its investment and continues to direct or manage the day-to-day operations of the investment, the directors and managers of the company continue to be appointed by the company, and the company’s business continues to operate, any governmental action is less likely to be deemed an expropriation. In this context, the right freely to select management, supervisors and subcontractors has been judged an essential element of the right to manage a project. The preceding description demonstrates that the question raised above could very well fall within the category of "actions that do not materially interfere with the operation" of a project. While none of these factors alone is necessarily conclusive, taken together they may tip the expropriation/regulation balance away from a finding of expropriation. Ultimately, the line between bona fide regulation and "expropriation" is a function of all the circumstances of a particular case.
In any event, common sense dictates that a foreign investor who agrees to negotiate a revised royalty or fiscal scheme while facing the alternative of an outright expropriation or nationalization of his investment property will have a valid defense vis-à-vis other interested parties. In this scenario, the re-negotiated fiscal or royalty option would constitute the lesser of two evils. Thus, such action on the part of the foreign investor could be said to be taken in mitigation of real or imminent damages.
Whether or not any action is taken in mitigation of damages caused by the host state, the investor may have a claim for expropriation or some other cause of action. For example, international tribunals increasingly entertain claims alleging a violation of the standard of "fair and equitable treatment" of foreign investment in addition to, or in lieu of, expropriation.
The availability of effective remedies
Foreign investors with existing economic interests, or who contemplate investing in Latin America can take several measures of risk management with a view to protecting their investments through effective remedies.
Out of an abundance of caution, investors with economic interests in Latin American countries such as Bolivia may consider "perfecting" the consent to ICSID jurisdiction that Bolivia undeniably expressed at the time it became a party to the ICSID Convention before Bolivia’s withdrawal from the Convention takes effect upon the expiry of ICSID’s six-month notice period on November 2, 2007—on the theory that Bolivia gave its consent upon joining ICSID and remains an ICSID Contracting State until its denunciation takes effect. The affected investor could do so by submitting a letter to Bolivia accepting its general consent to ICSID jurisdiction. It remains uncertain whether such action will be ruled to survive treaty denunciation by a competent ICSID tribunal faced with an actual notice of denunciation. Such a tribunal would settle this question under the applicable rules of public international law.
Investors facing ICSID withdrawal threats from other Latin American countries may consider giving notice of their general acceptance of the ICSID consent expressed by such countries in the past before notice of denunciation is given by them, i.e., before the country concerned actually files its notice of denunciation with the World Bank. While such early action is preferable over the situation facing foreign investors in Bolivia, its effectiveness still would be subject to scrutiny by a competent ICSID tribunal.
Another possible measure of risk management designed to ensure the availability of an effective remedy (preferably, international arbitration) would involve the immediate transfer of investments in the "unstable" country to an affiliate in a country having a bilateral investment treaty with the former country. The investor could then profit, through its affiliate, from the dispute resolution mechanism provided under that treaty.
Foreign investors facing governmental interference with their rights as investors may invoke whatever remedies are available to them in their investment agreements and under any applicable host state investment laws or bilateral/multilateral investment treaties. While ICSID arbitration is arguably the most effective remedy available to foreign investors in that it produces awards that are as good as a judgment from the highest court of each country belonging to the ICSID mechanism, other dispute resolution mechanisms also may provide effective remedies against governmental interference with foreign investments. For example, investors may claim the benefit of arbitration under the rules or laws developed by the United Nations Commission on International Trade Law or UNCITRAL. Such alternative mechanisms may survive, and effectively "neutralize," the withdrawal by host states from treaty-based investment protection schemes, especially if they are covered by the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, which has been ratified as widely as the ICSID Convention (namely, by some 140 countries). To this end, investors should negotiate forum selection clauses in their contracts with host states which provide that the contractual choice of forum (i) is non-exclusive, (ii) is not intended to derogate from the investor’s right to invoke arbitration under an applicable bilateral investment treaty with respect to all claims relating to the investment, and (iii) is subject to a fallback forum in the event that ICSID arbitration is unavailable.
