CHAPTER 19 Nationalizing, Expropriation, and Privatization

1. CHAPTER 19 Nationalizing, Expropriation, and Privatization

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.

3. Theories Relating to Takings of Foreign Property • Calvo rejected the modern-traditional theory’s 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.

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?

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

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.

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. 

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.

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 government’s action.

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 government’s 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.

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.

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.

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.

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 can’t be controlled. 

15. Partial Sale Assets NewCompany Government Shares(100%) NewOperator $ Shares Shares Shares GeneralPublic Underwriters Shares LocalGovernment

16. Trade Sale NewOperating & InvestmentGroup Shares $ Assets NewCompany Government $ • Stock or Asset “trade” sale. • Advantages: speedy, useful in small enterprises. • Disadvantages: backlash, require capital infusion, conditions subsequent.

17. The Sale to Employees • Similar to leveraged buyouts (LBO’s). • 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. 

18. The Sale to Employees ManagementorEmployees Assets Government $ NewCompany Shares Government $ EmploymentContract Waivers ManagementorEmployees

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?

20. BOT Transaction Developer Contractor Banks ConstructionFees • Developer’s Fees • Equity Investment • Loans ConstructionContract Shares • Shares • Repayment • Equity Investment Concession Shares EquipmentManufacturer NewCompany Equity Investment Services Government Payment for Equipment Paymentfor Services Equipment Services Equity Investment • Paymentfor Services Operating Fees Shares Operating Agreement Operator Private Users

21. Models in Combination: Joint Venture Privatization NewOperating & InvestmentGroup $ Assets NewCompany Government Shares(50%) Shares(50%) ShareholderAgreement

22. Mixed Example Assets NewCompany Government Shares(40%) Shares(30%) Shares(10%) CapitalContribution Shares(50%) $ New LaborContract Waivers of Prior Obligations NewOperating & InvestmentGroup Underwriters Employees Shares(20%) Shares(30%) Paymentfor Shares Paymentfor Shares GeneralPublic

23. 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