1. 1 Political Risk: Nationalization, Expropriation, and Other Taking of Investments Chapter 19 © 2005 Thomson/West Legal Studies In Business

2. 2 Pendulum Swings Nationalization: government takes over private assets Privatization: government sells off assets to private investors

3. 3 Governmental Takings Public Purpose Non-Discrimination Nationalization: taking an entire industry e.g. steel Expropriation: taking a single company

4. 4 Theories Traditional theory: prohibition of all takings Modern traditional theory: “ prompt, adequate and effective” compensation for all takings Non- Western theories: Sovereign rights- right to take

5. 5 Theories Calvo doctrine: sovereign placed ahead of foreign investor 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.

6. 6 INA Corp. V. Islamic Republic of Iran The Tribunal awarded what INA was seeking. Why? What factors were weighed? What did the Tribunal say about nationalizations of a “lawful” character?

7. 7 Creeping Expropriation Gradual erosion of value Discriminatory taxes Price controls License cancellation

8. 8 Political Risk Insurance Private sources Government: OPIC MIGA

9. 9 When Does This Occur? Political pendulum swings Different beliefs about the role of government and economic development The rise and fall of communism A resurgence of communist ideology in the chaos of Russia? Comparison between China (PRC) and Russia

10. 10 Resolving Disputes with Foreign Nations Foreign Sovereign Immunities Act Generally the state is immune from suit Exceptions:waiver, commercial activity and noncommercial torts Congress amended to allow U.S. citizens to bring suit against the sovereign for state sponsored acts of terrorism

11. 11 Disputes with Foreign Nations Saudi Arabia v. Nelson: FSIA warrants dismissal of the case brought by a former U.S. employee of a Saudi hospital Acree v. Iraq: POW’s from the first Gulf War sued Iraq for their torture and treatment during the war. The court found jurisdiction under FSIA and entered a multimillion dollar judgment. Now the plaintiffs have to collect !

12. 12 Act of State Shield Prevents court from passing on the validity of a foreign government’s action Kirkpatrick v. Environmental Tectronics Case allowed to go forward because involves the successful bidder and the unsuccessful bidder on a government contract and only tangentially brings in government’s action

13. 13 Act of State (cont.) Act of State would not be an obstacle when there is a treaty applicable to investors Act of State also has commercial activity exception

14. 14 International Settlement of Disputes ICSID Arbitration Role of treaty Insurance National Thermal Power Corp v. Singer

15. 15 Nationalization and Privatization Pendulum swings Government sale/transfer of assets to private sector History Recent history: Prime Minister Thatcher in Great Britain but see South Africa

16. 16 Other Examples Africa South America France

17. 17 Preparation for Privatization Prepare legal system China, Russia, Germany examples Property and contract law Clear expropriation claims Former East Germany example

18. 18 Comparison of Russia & China Russia: revolution 1917, 1989 reform, Glasnost (openness) and perestroika (restructuring) at the same time China: 1949 revolution, 1979 began economic reforms but no commitment to political freedom, gradual transition

19. 19 Russia & China Different goals Different approaches Consequences: Where would you prefer to live? To invest?

20. 20 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

21. 21 Models Sale of a non controlling interest Advantage: simple Disadvantage: depends upon perspective Lack of control, conflicting interests (full employment v. efficiency), may not invest in what can’t be controlled

22. 22 Partial Sale Government Underwriters New Company New Operator General Public Local Government Assets Shares (100%) $ Shares

23. 23 Trade Sale Stock trade sale Asset trade sale Advantages: speedy, useful in small enterprises Disadvantages: backlash, require capital infusion, conditions subsequent

24. 24 Trade Sale Government New Operating & Investment Group New Company Assets $ Shares $

25. 25 Sale to Employees Similar to leveraged buyouts (LBO) Advantages: gives employees a stake in the outcome, may bring in labor unions Disadvantages: if management was poor- now they are owners, layoffs difficult

26. 26 Sale to Management or Employees Government New Company Management or Employees Waivers Shares $ Government Management or Employees Assets $ Employment Contract

27. 27 Concession Financing: BOT and BOO Government uses private sector to build infrastructure Channel Tunnel example Joint venture: mix of trade sale and non- controlling interest model

28. 28 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 Developer’s Fees Equity Investment Shares Loans Repayment Services Payment for Services Operating Fees Operating Agreement Equity Investment Shares

29. 29 Joint Venture New Operating & Investment Group New Company Assets $ Government Shares (50%) Shareholder Agreement

30. 30 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%)

31. 31 Taxation Negotiate with government on taxation issues May include arbitration agreement

32. 32 Conclusion 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