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Ltr Knechtle ABA CEELI Draft Law comments Nizhny Novgorod oblast for Russia
M E M O R A N D U M
October 21, 1996
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: Nizhny Novgorad Oblast for Russia: Draft Law on Foreign Investment Activities
I have reviewed the referenced Draft Law, as well as the Explanatory Note to same. The
following are my comments on the 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.
General Reaction
The Draft Law is a largely commendable attempt to welcome foreign investment into the
oblast, despite apparently being somewhat hampered by boundaries imposed by controlling laws of
the Russian Federation. Within these boundaries, the Draft Law should be amended to clarify and
strengthen the security of a foreign investor’s property rights, as explained in more detail below. To
the extent the oblast has influence over laws of the Russian Federation or their applicability to the
oblast, the oblast should seek to have the laws of the Russian Federation similarly amended.
Preliminary Considerations and General Comments
The Explanatory Note explains that the Legislative Assembly’s main objective in
considering the enactment of a law modeled after the Draft Law is to render the oblast as attractive
as possible to foreign investors, within the bounds of Russian Federation laws. The Explanatory
Note properly recognizes that various factors tend to attract foreign investment, including: a stable
political and economic situation (low political risk); convertibility and stable rates of national
currency; low taxation; and reliable government guarantees of private property rights. Another
factor, not explicitly mentioned, but which also attracts foreign investment, is a healthy economy.
Low political risk, low taxation, and a healthy economy are extremely significant factors in
attracting foreign investment. The Draft Law generally favors these factors, but more could be done
to bring these things about. The Draft Law should be amended to clarify and strengthen the security
of a foreign investor’s property rights in view of these factors.
Many changes to the legal and political climate of the oblast and Russia itself 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 Russia or the oblast 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. Especially for a developing economy
such as Russia and its component units, in which there has been a history of hostility to private
property rights, 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.
It is my understanding that the oblast is not a state under international law, but is instead a
political subdivision of the Russian Federation. Therefore, the cooperation of the Russian
Federation would appear to be necessary in order to properly provide for any internationalizations
of agreements. Likewise, any constitutional changes in favor of limited government and a free-market economy, would presumably require appropriate authorization from the Russian Federation.
Therefore, although movement in these directions is in my view desirable, below I will discuss
primarily unilateral changes that may be made to the Draft Law that do not necessarily require
cooperation with the Russian Federation.
Detailed Comments
The following comments, where possible, are made with reference to the relevant section of
the Draft Law.
A presumption of legality should be included, to the effect that any type of investment not
specifically prohibited by the Draft Law is legal. Art. 26 appears to contain a similar presumption,
but, if so, this should be clarified.
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 provide that “property”
and “property rights” include immovables and movables, corporeals and incorporeals, intellectual
property rights, and contract rights.
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 the oblast, 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 the oblast.
Art. 1. A Statement of Principles should clearly indicate that the oblast 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 the oblast 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.
Art. 2: Definitions. “Investment Agreement” ought to be clearly defined as a listed, defined
term. Its status under international law should be clarified, with a view towards making it clear that
any obligations or guarantees undertaken by the oblast in the Draft Law are to be considered binding
under international law (to the extent permissible under both Russian Federation law and
international law).
Art 3. I was unclear as to whether “Participants” in foreign investment, who may be Russian
citizens, could also be oblast citizens or not.
Art. 5. This article prohibits foreign investment that “violates legislation of the RF [Russian
Federation] and the oblast.” This seems to be an awfully broad exception. It should be narrowed
as much as feasible. For example, the oblast legislation that prohibits certain types of investment
could be listed, and the Draft Law could provide that no further prohibitions will be enacted. The
law could at least make it clear that any existing foreign investments are exempt from changes in the
law that render that type of investment unlawful. (Art. 14, discussed below, contemplates only a
three-year stabilization.)
Art. 6. The oblast is stated to have an obligation to ensure proper fulfillment of terms on
which foreign investments were attracted. This obligation should be asserted more directly and
forcefully, and its nature clarified—e.g., is it an obligation under international law? Russian
Federation law? Oblast law only? Also, there seem to be no consequences to the oblast if it does
not fulfill this obligation (e.g. is it subject to lawsuit by a foreign investor?).
Art. 7. Equal treatment of investors is mandated (paragraphs 2-3), but this appears to be
contradicted by the last paragraph, which allows special privileges to be set up for some investors.
It would be preferable to delete paragraph 4, to prevent discrimination and also to reduce the chance
that the oblast government will engage in inefficient determinations of which types of investment
are “most important.” (Art. 16 also contemplates such special privileges.)
Art. 8. This article contemplates legal measures taken by the oblast against “unfair
competition,” which presumably includes Western-style anti-trust type laws. While a legal
monopoly, such as the government’s monopoly over the printing of money or the building of roads,
are true monopolies, the concept of a non-legal monopoly has always been problematic, and legal
systems would be well-served to abolish this concept.
Typically, “monopoly power” or “economic
power” is attributed to successful companies that grow and prosper due to innovation, efficiencies,
and satisfaction of customer demands. To punish firms for being “monopolistic” is to punish
success and prospering. The oblast should not persecute successful companies, but should instead
encourage success to attract foreign investment.
Also in art. 8, certain numbered obligations are “taken” by the oblast. These obligations
should be made subject to international law, if possible. Also, (1), concerning creating a
“favorable” image in the region for foreign investment, is vague; (3) is unclear in meaning; (6),
concerning compensation, should be amended to read “to fully and promptly compensate for losses
. . . .” Regarding (1), although this suggestion is not directly relevant to the Draft Law itself, the
oblast should consider setting up a Web Site on the World-Wide Web to promote itself.
Art. 9 concerns funds for the oblast’s “state guarantees security.” I found this unclear, and
it seems to be insufficiently integrated with and related to the rest of the Draft Law. Are these funds
for paying for damages resulting from expropriations of property and the like? Also, if so, provision
should be made to place such funds with a neutral third-party escrow agent located outside the
Russian Federation’s jurisdiction.
Art. 10. The financial measures such as provision of loans, surety, etc., should not be
handled by the oblast, but should be allowed to be serviced by firms on the market. Government
involvement in such activities is unnecessary and can distort the market. The availability of private
insurance is a better indicator of the true riskiness of investing in the oblast.
Art. 11. “Expropriation” should be added to the list of types of nationalization, for clarity
and completeness. The exception for nationalization, “except for the decision of the authorized
Federal bodies in conformity with the RF legislation,” is very broad, and greatly reduces the value
of a guarantee against expropriation, as virtually any expropriation can be seen as being in
“conformity with” law.
Art. 12. The guarantee against nationalization should be clarified and broadened.
Specifically, “expropriation” should also be listed alongside nationalization; and it should be made
clear that the full value of nationalized property will be paid to the expropriated investor.
Additionally, the following standard should be adopted to make clear to investors the oblast’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.) Also, the relevant interest rate
should be a market rate of interest, not the interest rate of the Russian Federation (see also Art. 30
on this). 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, and courts should be empowered to nullify the
effects of an illegal taking or nationalization.
Art. 13. The taxes required to be paid before profits may be transferred should be “any non-disputed” taxes.
Art. 14. This article appears to attempt to “stabilize” the legal regime so that laws cannot be
enacted to the detriment of an investment. However, the stabilization lasts only three years, far too
short a time for investors who often calculate the feasibility of an investment on the scale of
decades.
Art. 21 contemplates suits in court, but the Draft Law should be clarified to clearly provide
for judicial review, that is, the power of a court to overturn actions of the legislature or executive
that are considered illegal under the Draft Law or other laws of the oblast or Russian Federation.
Also, the type of court is not specified: is it Russian, a court of the oblast, a court of a neutral third-party forum?
Art. 39. It is unclear whether property that may be acquired includes immovables such as
land; even though real property is mentioned, land seems to be excluded by implication of not being
listed along with less-important types of property. If so, this should be made clear (Art. 43 also
implies that land can be owned by foreign investors).
Recommended Commentary
Paul E. Comeaux & N. Stephan Kinsella, Protecting Foreign Investment Under International Law:
Legal Aspects of Political Risk (Dobbs Ferry, New York: Oceana, forthcoming 1996)
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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