Stephanie Nieuwoudt, 2 April 2009
The global economic crisis makes it even more imperative that investors ascertain the economic and legal conditions in foreign countries.
"When one has dealings overseas, you encounter special problems," Tony George and Carol Searle, partners in the international law firm Ince & Co., told delegates at the Third Annual Africa Trade and Investment Conference in Cape Town, South Africa, last week.
"You become involved in another country's customs and practice and rules and regulations. These may change during the life of your contractual relationship with your counterparty, particularly in countries which are economically under pressure."
Aside from operational risks - which may be increased by the distance goods have to travel - the local labour force may have different working practices. There may be a risk of late or non-payment. Investors have to consider political risks - war, state protectionism, terrorism, and so forth.
George and Searle cautioned that investors should familiarise themselves with the regulatory background of a country before committing to a deal. Important questions to ask are: what is the host country's legal system's attitude to sovereign immunity? What are the local regulations?
Other questions are: what is the extent of the authority of the government or parastatal you are dealing with? And what happens if the counterparty goes bust?
These questions, as well as measures to meet any challenges, have become increasingly important in the current situation where the global economy is seeing a downturn unprecedented in almost 80 years.
In order to protect an investment, a local partner may help a company wishing to invest in a foreign country to navigate its way in a foreign regulatory environment. The partner could be an agent or a local lawyer.
"To resolve any stand-off, frequently the parties to international contracts find a middle-ground by agreeing that their relationship shall be governed by the application of a well-developed body of law from a neutral jurisdiction which they both respect. For example, English law or the law of the State of New York," George told delegates.
Bilateral investment treaties (BITs) between developed and developing countries have an in-built protection mechanism. It provides for investors to have direct recourse to arbitration against the host state or other means of dispute settlement.
Often the parties entering into BITs designate the World Bank's International Centre for Settlement of Investment Disputes (ICSID) as the body for dispute resolution. So far 155 states have signed a convention giving authority to ICSID, of which 143 have ratified the convention.
There is currently 33 concluded and 11 pending ICSID cases involving sub-Saharan African states.
However, even if large monetary sums are awarded during an arbitration process there is no guarantee that these would be paid out because the different partners and countries do not always comply with the rules and regulations as set out by agreements or conventions.
"With actions against commercial entities, there are often international conventions in place which will allow the enforcement of foreign judgments or awards against them in their home territory," George explained.
"If, however, it is their government's action or inactions that have caused the contractual breach for which they are held responsible, this may be more theoretical than real."
Aside from legal protection, investors in foreign countries should make sure that their investments are insured against different risks. Regarding political and trade credit risk insurance, George and Searle pointed out advantages and disadvantages of private and government insurers.
Government agencies and private insurers generally cover the same risks. But the private market can offer bespoke coverage. Government insurance is usually cheaper than that offered by the private sector, but there is more flexibility in private insurance policies.
Types of cover offered include "confiscation, expropriation and nationalisation" (CEN) - confiscation is the state's seizure of property without compensation; expropriation includes the host government seizing property of a foreign investment by passing new laws to annul title or ownership in a property; nationalisation is generally a form of expropriation by a government to advance reform programmes.
Another form of insurance is "contract frustration". This is cover to ensure the performance or payment obligations of public buyers or to protect against the impact of government action on private buyers.
"War and terrorism or political violence" cover insures against damage to property or income lost because of damage to property caused by war or terrorism. "Currency or inconvertibility" insurance compensates investors if they cannot convert local currency into hard currency and transfer it outside the host country.
In an effort to answer a question about whether or not political and trade credit risk insurance worked, Searle and George said complaints are usually not about claims payment records, but about bureaucracy and inflexibility.
In the private sector, figures show that the insurance giant AIG paid out 1.2 billion dollars between 1978 and 2006. Lloyds, a leading insurer, paid out over 315 million dollars over 25 years.
However, there have been a number of complaints against private insurers which were largely centred on CEN claims, which are more complicated that other claims.
George and Searle reminded everybody that the political risk insurance market has been around for 35 years. It has weathered storms from the Middle East petrodollar boom, the Iranian revolution, the collapse of the USSR to currently facing the challenges of the global financial meltdown.
It is unlikely that this market will fail to deliver in future.