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1. INTRODUCTION
Foreign
Direct Investment can be defined as involving
the transfer of tangible assets or physical property from one country
(capital-exporting State/Home Country) to another (Capital-importing State/the
Host) for the purpose of their use in that country to generate wealth under the
total or partial control of the owner (investor) of the assets.[2] These physical properties
include equipment, or physical property that is bought or constructed such as
plantations or manufacturing plants by the investor to be utilised in the Host
Country.
It is said that at the point of
entry - the point the investor seeks to establish their investment in the
Host Country - the investor yields more contractual authority and a stronger
bargaining hand than the Host Country.[3] This is so as the Host Country
is usually eager to attract the investment, hence, it would be willing to
concede more favourable terms to appease the investor. This is particularly evident in developing
countries that operate under the classical theory of investment, which views
foreign investment as essential for national development, especially where the
country is in urgent need of such growth.
However, once the investor begins
to establish their investment in the Host country – such as through the
development of physical infrastructure – the balance of power gradually shifts.
At this stage, the Host state’s contractual authority and bargaining power
increases and may eventually surpass that of the investor. This shift occurs
because the Host State retains full control over its legislative and regulatory
machinery, which it can deploy to interfere with or even dominate the
investor’s operations. In doing so, the State may prioritise its own interests,
sometimes in disregard of the prior contractual arrangements with the investor.
Therefore, there are several risks
that a foreign investor is exposed to when establishing their investment, this is notwithstanding several investment law principles and minimum
standards that seek to protect a foreign investor’s investment. Equally, a prudent foreign investor
has at their disposal several legal and strategic devices that may be employed
to mitigate or circumvent such risks. On the above footing, this writing will
discuss several legal devices that an investor may use to curb the risks to
their direct investment. The discussion begins with a brief overview of
the common risks faced by foreign investors.
2. RISKS TO FOREIGN DIRECT INVESTMENT
Risks
to foreign direct investment means the dangers or challenges that a foreign
investor may be exposed to once they establish their investment in the Host
Country.
The
risks discussed below are not an exhaustion of all of them but represent the
common ones.
2.1.
IDEOLOGICAL HOSTILITY
A
Country’s political ideology is actually a huge factor that any prudent
investor must take into consideration when deciding on which country to establish
their investment. Some Countries have political ideologies that are receptive
to foreign investment while others may resent or not welcome foreign
investors. Some Countries view foreign
investment generally as a western tool to promote exploitation of smaller or
economic weaker Countries.[4] Additionally,
regime changes,
particularly those ideologically inspired, pose problems for foreign
investment.
Therefore,
such Countries may be quick to interfere or exert their control of the
investor’s investment. This would be achieved by drastic implementation of
regulations and laws with stiff standards and introducing strict requirements
that suffocate the investors monetary gain, or directly taking over the
investment.
2.2.
NATIONALISM
Nationalistic sentiments pose a
threat to foreign investments. Particularly at times when the host economy is
in decline, prosperous foreign investors who are seen to control the economy
and repatriate profits will be easy targets of xenophobic nationalism.[5] They are ready targets for opportunistic
politicians who may seek advantage in such a situation to bring about a change
of government. It is also easy to deliver the promise of taking over or
divesting ownership of established foreign-owned business ventures. It is a
popular measure, which would appease nationalistic forces.[6]
In SPP v. Egypt,[7]
after the assassination of Egyptian President Sadat, who had introduced foreign
investor friendly policies, the incoming government of Mubarak, which had
promised a revamping of nationalism in Egypt, halted the SPP’s project to build
a tourist complex near the pyramids. This resulted in a dispute that was
characterised by protracted arbitral proceedings.
Therefore, Countries that hold
strong nationalist sentiments are more inclined to nationalise the
economy.
2.3. CHANGE OF GOVERNEMNT
Political stability is one of the
factors of a good investment climate.[8] A Country with political
chaos is generally not an ideal investment destination. On the same token, a
change of government in a Country irrespective of how politically stable the
Country poses a risk to an investor’s investment. Usually, new
governments scrutinise most contracts and arrangements made by the previous
government, usually in search to expose corruption and maladministration. As
such, a new government might cancel or revoke an investor’s concession citing
corruption, maladministration or that the contract was made onerously. Suffice
to note that most investors establish their investments based on a good
business relationship they might have with people in government, therefore, a
change of government may affect the investors prospects.
Suffice to note that a change of
government should be a foreseeable likelihood, it would therefore, be unreasonable for an
investor not to contemplate a change of government during the lifeline of their
investment. This is why it may be unwise for an investor to establish their
investment in a Country where the next general is approaching, given the uncertianity it brings.
2.4. EXPROPRIATION
This is probably the most severe
risk that an investor faces. Expropriation is the taking over of the property
or taking control of the investor’s asserts without their consent, frustrating
the economic interests of the investor.[9] Expropriation takes two
forms: direct and indirect expropriation.
Direct expropriation occurs where
the Host Country takes over the title of the investor’s investment. This is a severe and an extreme measure the Host Country would take. Due to the severity
involved, direct expropriation is rare. Indirect expropriation occurs where the
Host Country while allowing the investor to retain title and continue to
operate their investment, acts in a way that substantially affect the economic
returns of the investor. The Host Country may introduce legislation that
increase taxes payable or introduces mandatory contributory schemes or any
other measure that frustrate the investors financial interests that had existed
initially.
3.
CURBING THE RISKS TO FOREIGN DIRECT INVESTMENT
Curbing the risks to foreign direct
investment should be understood as legal devices, means or ways to avoid or
circumnavigate the dangers attached to foreign direct investments as discussed
above. These legal devices are to be employed before or at the point of entry, and
way before a dispute arises. There are
two ways of curbing the risks to foreign direct investment; (i) through
Contractual devices and (ii) by internalisation.
3.1. CONTRACTUAL DEVICES
There are several contractual
devices that a prudent investor would employ to circumnavigate the risks
discussed. To start with, contractual devices mean clauses that a prudent
investor might want to include in the investment contract or concession with the
Host Country. These contractual devices are adumbrated below:
3.1.1.
Stabilisation
Clause
Stabilisation clauses are clauses
that seek to freeze the laws of the Host Country so as to ensure that the laws
that existed or enticed the investor to establish their investment at the point
of entry stay the same.[10] Any investor would not want the laws of the Host Country to frequently change. Change in laws have
the effect of unilaterally altering the terms agreed upon between the Host
Country and the investor. Therefore, by incorporating a stabilisation clause,
the Host Country provides a legitimate expectation to the investor that its
laws will not change at least to the detriment of the investment. A breach of
this would entitle the investor to an appropriate remedy. Ultimately a stabilisation
clause places the Host Country under an obligation to be bound by their
agreements entrenched in the doctrine of pacta sunt Servanda –
‘agreements must be kept’.
Suffice to note that, stabilisation
clauses may be direct or indirect and some flexible while others rigid. Direct
stabilisation clauses speak directly to the freezing of the Host Country
laws. The terms are expressed in clear
terms that the Host Country will not alter its laws. For example, the contract
between Aminoil v Kuwait[11]
contained a stabilisation clause that stated:
The Shaikh [leader of
Kuwait] shall not by general or special legislation or by administrative
measures or by any other act whatever annul this Agreement except as provided
in Article 11. No alteration shall be made in terms of this Agreement by either
the Shaikh or the Company except in the event of the Shaikh and the Company jointly
agreeing that it is desirable in
the interests of both parties to make certain alterations, deletions or
additions to this Agreement.
The above illustrates a classical
example of a direct stabilisation clause. It expressly froze the laws of Kuwait
from alteration to the detriment of the Aminoil the British Company. However,
it should be noted that the efficacy of such clauses is contentious inviting a
debate of whether a Country’s legislative authority can be halted or froze by a
clause in a contract, especially so that Countries have permanent sovereignty
over their natural resources. The apparent conflict between permanent
sovereignty and pacta sunt servanda (which is the basis for
stabilisation clauses) is one that requires an independent writing.
An indirect stabilisation clause is
one that speaks in general terms. It
however, seeks to freeze the Host Country’s laws by implication. An example of
this is found in Texaco v Libya[12]
wherein a clause that had the effect of a stabilisation clause read:
The Government of Libya
will take all steps necessary to ensure that the company enjoys all the rights
conferred by the concession. The contractual rights expressly created by this
concession shall not be altered except by the mutual consent of the parties.
Notably, there is no explicit
mention of alteration of laws, however, the fact that the agreement disallows
the Government to alter the terms of the contract unilaterally by implication
prevents the government by effecting an alteration by its laws.
Rigid stabilisation clauses are
ones that do not provide room for renegotiation. They speak in direct terms
that the Host Country shall not introduce any laws that alter the terms of the
investment agreement. An example is that contained in Aminoil v Kuwait. Obviously,
suggesting a rigid stabilisation clause would be taken with affront by the Host
Country. Such clauses are undesirable as they are considered as directly flying
in the face of a Host Country’s permanent sovereignty. A flexible stabilisation clause allows for
renegotiation. As seen in the Texaco v Libya case wherein the clause
allowed for an alteration of the concession by mutual consent.
It would be unreasonable for an
investor to expect a rigid stabilisation clause. As was held in Micula v
Romania[13]
an investor can not reasonably expect that the laws of the Host Country
will remain the same during the life of their investment. Therefore, a prudent
investor in choosing to incorporate a stabilisation clause, may want to opt for
a clause that allows for renegotiation. Such clauses also maintain a healthy
relationship between the investor and Host Country.
3.1.2.
Arbitration
Clause
A prudent investor must contemplate
the occasion of a dispute with the Host Country in some point during their
relationship. Therefore, the existence of an arbitration clause successfully
ousts the jurisdiction of the Host Country’s courts of law. An arbitration
clause by its nature is binding and parties can not resolve their dispute by
litigation unless the arbitration clause is defective.
Having an arbitration clause
governing the relationship is beneficial to the investor as it successfully
ousts the jurisdiction of the Host Country’s courts of law thereby submitting
their dispute to an independent party. The courts of law of the Host Country
may have a bias towards the Host Country, or the Host Country may exert
political pressure on the courts to decide in their favour. Additionally, the
courts may also face pressure from the public, as most member of the public
would not want to see an alien seemingly rip benefits from their own country.
Therefore, an arbitration clause binds the state to an avenue of dispute
resolution that is neutral.
It is the authors observation that
an arbitration clause may arise in three ways, namely; (i) arbitration by
contract (ii) arbitration by legislation (iii) arbitration by a Bilateral
Investment Treaty (BiT)
Arbitration by contract simply
means that the arbitration clause has been incorporated in the investment
contract and arbitration proceedings stem from the contract. Arbitration by
legislation means a country voluntary submits itself to arbitration by the
existence of a certain piece of legislation that provides so. In this instance,
even in the absence of an arbitration clause in the contract, the dispute will
still be referred to arbitration pursuant to a specific piece of legislation.
In Zambia, the Investment Disputes Convention Act (1970)[14] is a piece of legislation
to give effect to the Convention on the Settlement of Investment Disputes
between States and Nationals of other States (ICSID). Section 8 of the Act
states that the Act binds the Republic, and as such, Zambia has bound herself to
voluntary submit its investment disputes to the ICSID Tribunal to be resolved
by way of Arbitration.[15]
Arbitration by a BiT is an
arbitration clause that has been incorporated in an existing Bilateral
Investment Treaty between two States. In such an instance, the states commit
all investment disputes involving its nationals to arbitration. They tribunal
is often expressly mentioned.
3.1.3.
Choice
of Law Clause
This contractual device allows the
parties to decide which law will govern the dispute. This presents an
opportunity for the investor to choose a law other than the Host Country’s for
obvious reasons – so as to limit or oust the Host Country’s legislative
power. The effect of choosing the laws
other than the Host Country’s is that any subsequent changes of laws in the
Host Country will have no effect to the investment.
A choice of law clause allows the
parties to choose another Country’s laws, or choosing some supranational system
of laws. Obviously, choosing another Country’s laws would be treated with
affront by the Host Country which would not want to be bound by another
Country’s laws.[16]
On the investor’s part, choosing the Home Country’s laws (capital-exporting
Country) would be favourable though difficult to negotiate for. In practice,
the most durable option is choosing some form of supranational system of laws.
This system of laws could be either a Bilateral treaty, or general principles
of international law. This option is
preferable as it is a way of internationalising the investment contract. A device discussed in the next section.
3.2. INTERNATIONALISATION OF THE INVESTMENT CONTRACT
A point to underscore is that the
devices of curbing the risks to foreign direct investment are all aimed at as
far possible reducing the bargaining strength of the Host Country.[17] Indubitably, the Host
Country retains strong bargaining power if the investment contract is
excessively nationalised i.e. dominated
by national law and its system.
Therefore, internationalisation of the investment contract is a device
of removing as far as possible, the investment contract from national sphere or
jurisdiction of the Host Country.[18]
It is intended to allow a
supranational system of law to preside over the contract. A supranational
system presumptuously provides more protection of the investor than the Host
Country’s laws. Therefore, subjecting the contract to some form of international
framework frustrates the application of the Host Country’s laws. This form of
supranational system of law can take the form of a Bilateral Investment Treaty,
or more commonly, general principles of international investment law. General
principles of investment law provide for minimum standards of protecting
foreign investment and principle such as non-discrimination, fair and adequate
compensation, pacta sunt servanda. It is thus safer for an investor to
internationalise the investment contract than allowing it to be subjugated by
national laws of the Host Country.
An investment contract can be
internationalised by allowing a supranational system of law to govern the
contract and/or allowing an internation body to preside over any disputes
arising.
4.
CONCLUSION
Foreign Direct Investment, is key to
the growth of Host economies and offers significant advantages to the investor
by providing access to new markets, diversifying business operations, enhancing
profitability, and creating opportunities for strategic global expansion.
However, Foreign Direct Investment
inherently exposes investors to significant political, legal, and economic
risks, including ideological hostility, nationalism, governmental change, and
expropriation. These risks, however, can be effectively mitigated through
strategic legal mechanisms employed at the point of entry. Contractual devices
such as stabilisation clauses, arbitration provisions, and choice of law
clauses, alongside the internationalisation of investment contracts, serve to
protect investors by constraining the Host Country’s unilateral powers.
[1] Teddy Musonda.
[2] M.
Sornarajah, The International Law on Foreign Investment. 3rd Edition (Cambridge
University Press: 2012)
[3] Ibid
[4] A
recent instance is the fall of Suharto in Indonesia. The incoming government
sought to rescind existing contracts, alleging that they were improperly made.
The situation resulted in many disputes, some going to arbitration, for example
Himpurna v. Indonesia (2000) 25 YCA 13.
[5] M.
Sornarajah (n 2 above)
[6] Ibid
[7] ICSID
Case No. ARB/84/3
[8] S.P,
Subedi, International Investment Law: Reconciling Policy and Principle.
2nd ed. (Bloomsbury Publishing, 2024)
[9] Ibid
[10] M.
Sornarajah (n 2 above)
[11] I.L.M.
21 (1982), 976.
[12] 17
I.L. 1 (1978)
[13] ICSID Case No. ARB/05/20.
[14] Chap 42. Laws of Zambia
[15] Article 25of the ICSID Convention
which is incorporated in the schedule of the the Investment Disputes
Convention Act
[16] M.
Sornarajah (n 2 above)
[17] S.P,
Subedi (n 8 above)
[18] Ibid
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