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Comments on Draft Law on Stimulation of Foreign Investments in Romania (1997)

This a text version of my Comments on Draft Law on Stimulation of Foreign Investments in Romania, prepared for ABA/CEELI (Spring 1997)

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M E M O R A N D U M

 

March 25, 1997

 

 

TO:                 Mr. John C. Knechtle

Director, Legal Assessments, ABA/CEELI

 

FROM:           N. Stephan Kinsella [current contact info as of 04/2002: www.KinsellaLaw.com]

 

RE:                 Draft Law on Stimulation of Foreign Investment for the Republic of Romania

 


The following are my comments on the referenced Draft Law. Please note that these comments are my personal opinion and do not represent the opinion of my firm, Schnader Harrison Segal & Lewis, or any of its clients. In the following, my focus, in general, is on the issue of whether and to what extent the Draft Law serves to protect private property, in particular private property related to foreign direct investment in Romania.

 

General Reaction

 

The Draft Law is commendable in that it is an attempt by Romania to add further protections to the private property of foreign investors. However, the Draft Law is problematic in that it is somewhat vague, it does not go far enough in protecting the private property of investors, and it leaves too much discretion in the hands of government in deciding whether to accord “special” treatment to investment. The Draft Law also rests on the assumption that some investments ought to be given favorable treatment, which rests on the false assumption that some investments are objectively “worse” than others, and that the government can accurately assess which investments are relatively more desirable than others. The Draft Law will result in some investors being given favorable treatment with respect to other investors, which is problematic and undesirable. To the extent possible, the Draft Law should be revised to clarify and strengthen the security of a foreign investor’s property rights, as explained in more detail below. The protections provided by the law should be broadened and extended to as many investors and types of investment as possible to reduce the discriminatory treatment that the Draft Law would otherwise provide.

 

Preliminary Considerations

 

The protection of private property of foreign investors is essential if Romania is to attract foreign direct investment. This is the essential touchstone by which any proposed policy, law, regulation, or regime is to be judged. The degree to which private property rights are respected is extremely significant in attracting foreign investment. The Draft Law should be amended to clarify and strengthen the security of a foreign investor’s property rights, for example by taking steps to lower political risk and taxation rates.

 

Many changes to the legal and political climate of Romania could be suggested to contribute to these factors. Constitutional, limited government, low taxes, respect for private property, the free market, and civil liberties contribute to both a health economy and to a low political risk.

 

Promulgating a pro-foreign investment law which provides for government guarantees that property rights will be respected can also play an important role in attracting foreign investment. However, as investors are all too aware, even a pro-investment law may be changed at a later time by the legislature due to the government’s legislative sovereignty. A new government may desire to nationalize certain industries, for example. Thus, the ability of Romania to promulgate new laws that might override property rights previously guaranteed to investors tends to reduce the attractiveness of any government guarantees that are made. For a developing economy such as Romania, such guarantees should be made more effective by reducing the chance that the laws will change to investors’ detriment.

 

One way to increase the likelihood that such a guarantee, once granted, will be respected by future governments is to implement a constitutionally limited government, with an independent judiciary having the power of judicial review. Another way is to make the guarantees binding under international law, since states are often reluctant to be seen as clearly violating international law. An investment agreement executed between the host state and investor accordingly may be “internationalized,” so that the state’s obligations contained therein are binding under international law. For example, the agreement may contain both an international arbitration clause, which grants jurisdiction to a neutral third party (such as the International Center for the Settlement of Investment Disputes (ICSID)), and a stabilization clause. A stabilization clause provides that the law in force in the state on a given date is the relevant law for purposes of interpreting the investment agreement, regardless of future legislation. This effectively “freezes” the legal regime in place on a certain date, so that any future changes in law contrary to the state’s guarantees are without effect, at least under international law.

 

General Comments

 

The Draft Law essentially assumes that there is some background protection of the private property of foreign investors, such as that provided by international law, other municipal laws in force, or by treaties entered into by Romania (see, e.g., Art. 3). The Draft Law then attempts to add another measure of protection to foreign investors by providing for various tax and custom duty exemptions or favorable rates, and other incentives, if the investment qualifies for such treatment under the Draft Law or in the determination of the Government. (Art. 4.)

 

One problem with the foreign investment regime established by the Draft Law is that it will result in some types of investment being favored over others. This presumes that some types of investment are objectively superior, more efficient, or otherwise more preferable than others; and that the Government accurately assess proposed investments accordingly. However, government is notoriously incapable of determining which type and amount of investment or other capital allocation is efficient or proper. This is why Russian-style centralized economic planning has failed so disastrously. Economic planning on a more modest scale is also unwise. Government is unable to centrally collect the relevant information that would be required to efficiently allocate capital; and even if all the relevant information could be centrally collected, government is unable to efficiently allocate capital since centralization destroys the private property and market price system that otherwise efficiently allocates capital. Footnote Further, even assuming away these problems, decisions will tend to be made or at least influenced by political factors, such as favoritism, corruption, bribery, and special interest lobbying.

 

Another problem with the Draft Law is that at least some of the incentives provided are provided only at the discretion of the Government. The incentives provided in Arts. 6 and 7 appear to be available as long as the more or less objective conditions of Art. 5 are met. However, the additional incentives contemplated under Art. 8 are available only if the Government so approves; and the amount and types of incentives to be provided appear to be wholly within the discretion of the Government or the Romanian Development Agency (RDA). Further, it is not clear that an investor denied the incentives under Arts. 6 and 7 have any legal recourse to challenge this decision, so the incentives of these Arts. appear to be discretionary as well, for all practical purposes. (Additionally, the incentives under Arts. 6 and 7 require the RDA’s approval. Art. 5.)

 

One problem with such discretion is that it is bound to be misused for corrupt or petty purposes—e.g. influenced by bribery, special interest group lobbying, and other forms of political favoritism—from time to time. This will lead to an inefficient selection of favored investments. Further, such discretion will make Romania a less attractive home state for investment from the outset, since the discretion increases the uncertainty as to whether the investor will be able to obtain the maximum incentives available. Such favoritism can also cause an investor to fear being put to a competitive disadvantage with other investors receiving more favorable treatment. Finally, giving discretion to the Government will likely lead, in the long run, to fewer favored investments than would be favored under an overall more liberal investment policy.

 

The law could be improved by reducing this discretion, and by providing for a legal right of an investor to challenge a decision relating to the approval of these incentives in a Romanian court, or, better yet, in an international arbitration forum.

 

As mentioned above, favoritism or discrimination in investment treatment can be problematic. Ideally, there should be no discrimination between foreign investors, on the basis of nationality or any other criterion. Rather, all foreign investors (and, for that matter, municipal or local investors) ought to enjoy equal, i.e. MFN treatment. Otherwise, foreign investors could be justifiably concerned that competition between them is not fair.

 

A superior alternative, then, to the present regime contemplated by the Draft Law would be to accord the maximum feasible protection of private property rights to all foreign investors and types of investment. This would reduce the overhead expenses associated with government oversight, reduce corruption, and spur overall investment to a greater extent than would be obtained from piecemeal and discretionary favorable treatment.

 

Another general consideration concerns bribery and corruption. Bribery and corruption of public officials is well-known in many developing countries. However, American investors are prohibited by the Foreign Corrupt Practices Act (FCPA), 15 U.S.C. § 78m(b) et seq., from engaging in such activities. If bribery and political corruption are widespread in Romania, American investors will be at a competitive disadvantage with respect to investors from other regions such as Western Europe. Thus, given the existence of the FCPA, the existence of widespread bribery and corruption will tend to reduce American investment in Romania.

 

It is preferable, for the reasons given above regarding internationalization of obligations, that the Draft Law be given as much force as possible by internationalizing it, for example by making its terms part of a multilateral treaty or bilateral investment treaties (BITs), or by incorporating its provisions into internationalized, stabilized investor-state contracts. Romania also ought to attempt to strengthen the protections of private property and foreign investment provided in BITs and other treaties. Romania also ought to support the negotiation of the OECD’s multilateral agreement on investment (MAI), and seek to accede thereto as soon as possible. Footnote

 

The Draft Law should include a Statement of Principles that clearly indicates that Romania recognizes the importance and sanctity of private property, and that purpose of the Draft Law is to protect the private property rights of foreign investors. Such a statement may be useful in persuading investors that Romania is serious in its commitment to protecting and respecting investors’ property rights. This statement would also increase the chance that the Draft Law, in cases of ambiguity, would be interpreted in favor of investors’ property rights.

 

“Foreign investment” is insufficiently defined in the Draft Law. Further, it is often unclear whether contractual rights are considered to be property rights on an equal footing with other types of property rights. The Draft Law should clearly define foreign investment, and should provide that foreign investment includes “property” and “property rights” or foreign investors, including immovables and movables, corporeals and incorporeals, intellectual property rights, and contract rights. As a general matter, it is preferable to adopt general terminology or concepts utilized in or compatible with established Western legal systems, primarily Anglo-American common-law concepts and terms.

 

Detailed Comments

 

The following comments are made with reference to the relevant section of the Draft Law. These comments assess various provisions of the Draft Law without further criticizing the Draft Law’s assumption that favorable investment conditions will be accorded only to some investors or types of investment, and only at the Government’s discretion. Thus, the suggestions below are aimed at strengthening the investment protections currently provided by the Draft Law, even though it would be preferable if these investment protections would not be handed out selectively by the Government.

 

Art. 2. The term “foreign capital companies” is not well-defined. Also, the fact that the treatment to be given to such companies is to be “in accordance with the laws in force” serves to reduce the certainty of any guarantee of treatment by making it conditional on laws in force.

 

Art. 5. The capital requirements ought to be lowered as much as feasible to extend the favorable coverage provided by the Draft Law to as many investments as possible.

 

Art. 6. The term “contribution in cash effectively disbursed” is confusing and unclear.

 

Art. 7. The three-year exemption from payment of import customs and value-added taxes ought to be extended as much as possible, for example to six, ten, twenty years, or longer. Another useful change would be to allow the exemption period to be indefinitely repeated for an investor. This automatic renewal of protections could be usefully applied to other favorable treatments provided by the Draft Law.

 

A problematic aspect of Art. 7 is the provision that the exemptions provided therein are conditioned upon the investor’s securing of financing of imports using sources from abroad that do not encumber Romania’s “balance of payments.” This ought to be completely deleted from the Draft Law, since it rests on the economically fallacious (but widespread) mercantilist idea that there can be a “favorable” or “unfavorable” balance of trade. Unlike a budget deficit, which is undesirable, it is irrelevant whether there is a trade “surplus” or “deficit,” since this results from the sum total of a large number of individual credit transactions, each of which presumably benefits both parties thereto. Footnote Developing economies ought to be careful not to adopt fallacious economic doctrines unwisely adopted in the West in this century. While the West’s free-market systems are worth emulating, various Western policies are not, such as our anti-trust laws, fiat-money and Federal-reserve-controlled banking system and other Keynesian-based institutions and policies, protectionism, and the like.

 

Art. 8 contains several possible “additional incentives” that are unacceptably vague, such as “high technology,” “free writ of possession over land,” and the like.

 

Art. 9 states that the RDA provides investment counseling to foreign investors. It is not clear why this ought to be monopolized or even engaged in by a government agency. Private enterprise would better fill this need.

 

Art. 13. The prohibition against nationalization or expropriation of investments should be clarified and broadened, to clarify that these concepts include both indirect and creeping expropriation.

 

Arts. 13 and 14. The provision for compensation in the event of a (lawful) expropriation should be clarified to provide that the full, market value of nationalized property will be paid to the expropriated investor, and the concept of “equitable” principles enunciated in Art. 14 ought to be examined to ensure that there is no implication that less than full compensation can be awarded. Additionally, the following standard should be adopted to make clear to investors Romania’s commitment to the sanctity of the investors’ property rights: the standard of compensation should be the greater of the full market value of the investment, or the commercial value to the investor (which may be greater than the market value due to synergy, etc.) Further, the Draft Law should clarify that any taking is “illegal” if not done for a public purpose, or if done in a discriminatory manner. This will help to dissuage Romania from engaging in such an expropriation for fear of being seen as commiting an unlawful taking, which should help to ensure investors that Romania is sincere and serious about respecting the property rights of investors.

 

Art. 15 provides for a disputed amount of compensation to be established “through the courts of law, in accordance with the legal provisions.” It is unclear to what “the legal provisions” prefers. It is also unclear whether “the courts of law” contemplates only Romanian courts or whether international arbitration is available. Courts should be empowered to nullify the effects of an illegal taking or nationalization. Further, international arbitration should be authorized, and commitments in the Draft Law internationalized if possible, as discussed above.

 

Art. 17. “Non-mediated foreign investment” is unclear in meaning, and consequently the meaning and purpose of this article is unclear as well.

 

Art. 19. The certificate of investor ought to be internationalized, e.g., by stabilization and international arbitration clauses, or protected through BITs or other treaties if possible.

 

Recommended Commentary

 

Paul E. Comeaux & N. Stephan Kinsella, Protecting Foreign Investment Under International Law: Legal Aspects of Political Risk (Dobbs Ferry, New York: Oceana, 1997)

 

Paul E. Comeaux & N. Stephan Kinsella, “Reducing Political Risk in Developing Countries: Bilateral Investment Treaties, Stabilization Clauses, and MIGA & OPIC Investment Insurance,” 15 New York Law School Journal of International & Comparative Law 1 (1994) (copy attached)

 

N. Stephan Kinsella, “Lithuania’s Proposed Foreign Investment Laws: A Free Market Critique,” Russian Oil & Gas Guide, Apr. 1994, at 60 (copy attached)

 

Bernard H. Siegan, Drafting a Constitution for a Nation or Republic Emerging into Freedom (2d. ed. 1994)

 

Robert W. McGee, “Some Tax Advice for Latvia and Other Similarly Situated Emerging Economies,” 13 International Tax and Business Lawyer 223 (1996)

 

Daniel T. Ostas & Burt A. Leete, “Economic Analysis of Law as a Guide to Post-Communist Legal Reforms: The Case of Hungarian Contract Law,” 32 American Business Law Journal 355 (1995)

 

“Symposium: Development of the Democratic Institutions and the Rule of Law In the Former Soviet Union,” including the article by Judith Thornton, “Economic Reform and Economic Reality,” 28 John Marshall Law Review 847 (Summer 1995)

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