Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. CHAPTER 19 Nationalizing, Expropriation, and Privatization

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 2 Theories Relating to Takings of Foreign Property Traditional theory: prohibition of all takings. Modern-Traditional theory: prompt, adequate and effective compensation for all takings. Non-Western theories: State has sovereign right to take, based on the Calvo Doctrine : sovereign placed ahead of foreign investor.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 3 Theories Relating to Takings of Foreign Property Calvo rejected the modern-traditional theorys prerequisites: Public Purpose and Non- Discrimination. But sovereign rights states do take property based on public purpose. –Nationalization: taking an entire industry e.g. steel. –Expropriation: taking a single company.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 4 INA Corp. v. Islamic Republic of Iran INA Corp. v. Islamic Republic of Iran: INA acquired a 20% share of an Iranian insurance co. In 1979 Iran passed a law of Nationalization. INA sought the value of its shares with interests and costs from the Iran-US Claims Tribunal. The Tribunal awarded what INA was seeking. Why? What factors were weighed? What did the Tribunal say about nationalizations of a lawful character?

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 5 Creeping Expropriation Gradual erosion of value. Discriminatory taxes. Price controls. License cancellation.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 6 Guarding Against Political Risk U.S. investors in countries that once held sovereign rights theory, is now at risk from raw political power. Political Risk Insurance. –Government: OPIC, MIGA –Private: insurance syndicates.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 7 Resolving Disputes with Foreign Nations Foreign Sovereign Immunities Act. –Generally the state is immune from suit –Exceptions: waiver, commercial activity and noncommercial torts. –In light of terrorism, Congress amended the FSIA to allow U.S. citizens to bring suit against the sovereign for state sponsored acts of terrorism.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 8 Resolving Disputes with Foreign Nations: FSIA Saudi Arabia v. Nelson : FSIA warrants dismissal of the case brought by a former U.S. employee of a Saudi hospital. Supreme Court ruled that Nelsons could not bring suit in US court over actions in Saudi Arabia.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 9 Resolving Disputes with Foreign Nations: Act of State Doctrine Even if court can hear case under FSIA, investor must still move past Act of State doctrine, a shield to prosecution. Prevents court from passing on the validity of a foreign governments action.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 10 Resolving Disputes: Act of State Doctrine W.S. Kirkpatrick v. Environmental Tectronics Corp. –Case allowed to go forward because it involved the successful bidder and the unsuccessful bidder on a government contract and only tangentially brings in governments action. Act of State would not be an obstacle when there is a treaty applicable to investors. Act of State also has commercial activity exception.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 11 International Adjudication National Thermal Power Corp v. The Singer Co.: foreign investor failed to structure a contract that allowed binding arbitration under local law. International Center for the Settlement of Investment Disputes (ICSID). Arbitration. What is the role of a BIT treaty? Insurance.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 12 Preparation for Privatization Creation of an Independent Government Corporation. Preparation of a Legal System for Privatization. –Clearing of any expropriation claims. –Development of property rights and contract law. –China, Russia, East Germany examples.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 13 Methods of Distribution Assets are transferred to new entity, run as private entity during transition. Private and public equity placements. Voucher systems. Debt-for-Equity swaps.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 14 Models of Privatization Sale of a Noncontrolling Interest (Partial Sale). –Advantage: simple –Disadvantage: depends upon perspective. –Lack of control, conflicting interests (full employment v. efficiency), may not invest in what cant be controlled.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 15 Partial Sale Government Underwriters New Company New Operator General Public Local Government Assets Shares (100%) $ Shares

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 16 Trade Sale Stock or Asset trade sale. – Advantages : speedy, useful in small enterprises. – Disadvantages : backlash, require capital infusion, conditions subsequent. Government New Operating & Investment Group New Company Assets $ Shares $

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 17 The Sale to Employees Similar to leveraged buyouts (LBOs). Advantages : gives government employees a stake in the outcome, may bring in labor unions. Disadvantages : if management was poor- now they are owners, layoffs difficult.

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 18 The Sale to Employees Government New Company Management or Employees Waivers Shares $ Government Management or Employees Assets $ Employment Contract

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 19 Concessions: BOTs and BOOs Two major types of concessions: BOT and BOO. –BOT: Build-Operate-Transfer. –BOO: Build-Operate-Own. Government uses private sector to build infrastructure. Joint venture: mix of trade sale and non- controlling interest model. What about anticompetitive considerations?

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 20 BOT Transaction New Company Equipment Manufacturer Contractor Services Government Private Users Operator Banks Developer Payment for Services Concession Equity Investment Shares Construction Contract Construction Fees Payment for Equipment Equipment Shares Developers Fees Equity Investment Shares Loans Repayment Services Payment for Services Operating Fees Operating Agreement Equity Investment Shares

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 21 Models in Combination: Joint Venture Privatization New Operating & Investment Group New Company Assets $ Government Shares (50%) Shareholder Agreement

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 22 Mixed Example Assets $ Government Shares (40%) Shares (20%) Payment for Shares New Operating & Investment Group New Company Employees Underwriters General Public Shares (30%) Payment for Shares Shares (30%) Waivers of Prior Obligations Shares (10%) New Labor Contract Capital Contribution Shares (50%)

Copyright © 2009 South-Western Legal Studies in Business, a part of South-Western Cengage Learning. 23Conclusion Major issue for business in 21st century Transition of nonmarket economies to market economies Business must assess political risk and use contracts to protect interests Consider arbitration clause