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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
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.
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.
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.
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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