'Political risk' in foreign investment is the risk that an investment will be adversely effected by a host country's political or regulatory decisions. These political or regulatory decisions might result in unfavorable tax legislation, revocation of a business license or, nationalization or 'expropriation' of an investment by, for example, the direct or indirect taking of control over the investment by the government. For instance, earlier this year the Argentinean Government announced that it would assume ownership and control of YPF, Argentina's biggest energy company. At the time, YPF was privately and partly foreign owned and controlled. 

Foreign investors can take steps to minimize exposure to political risk. These steps include structuring the foreign investment so that it falls within the protections provided by an investment treaty to which the host country is a party. Alternatively, if you are a foreign investor and are already affected by adverse government action, you should consider whether investment treaty protection is available.

Investment treaties

Investment treaties are agreements between countries as to the protection each country will provide to investments made by investors of the other countries. Many of these treaties give investors the right to commence international arbitration proceedings against a host country that fails to provide the promised protections. An arbitral award resulting from such proceedings can be enforced in accordance with commitments made under the 'New York Convention' to do so. Currently, 146 countries are signatories to this Convention and provide legal means for enforcing international arbitral awards in their country.

There is an estimated 2,500 investment treaties worldwide. China has concluded over 130 investment treaties. The actual protection provided by each treaty depends upon the wording of each treaty. This wording should be examined carefully before an investment decision is made to ensure that adequate protections are provided and that the investment, as structured, will be protected by the treaty.

Nature of protection

Whilst each treaty is different, investment treaties tend to provide the following protections to foreign investors:

  1. prompt and adequate compensation for the expropriation or nationalization of investments;
  2. fair and equitable treatment, in accordance with the investor's reasonable expectations as to the treatment it would receive by the host country. This can protect investors against 'arbitrary' treatment and significant alterations to the legal and business environment in which it invested;
  3. protection and security for investments;
  4. treatment no less favorable than that provided to domestic investors (so that, for example, the host state is prohibited from passing a tax law which only applies to foreign investors);
  5. treatment as favorable as that offered to other foreign investors (referred to as "Most Favored Nation Status");
  6. undertakings to comply with contractual agreements made in respect of investments; and
  7. guaranteed repatriation of income from investments.  

Significance

These protections can operate independently of the host country's law and judicial system. For example, it may be constitutionally valid in the host country to enact a retrospective tax applying only to foreign investors. Also, many countries consider the expropriation or nationalization of property to be within their sovereign right and do not provide compensation for doing so.

In such circumstances, the host country's domestic law is unlikely to provide a means for challenging such government actions. However, if the investor is protected by an investment treaty which gives the investor the right to commence arbitration, the treaty can provide a means of addressing the government action. For example, in November 2011, White Industries Australia Limited, represented by King & Wood Mallesons, won approximately AU$10 million in an arbitration against the Republic of India under the Australia-India Investment Treaty.  The tribunal held that India was liable as a result of the Indian courts taking more than 9 years to deal with the enforcement of an arbitral award in White Industries' favour, against Coal India. The tribunal held that this delay breached India's obligations under the treaty by failing to provide White Industries with ‘effective means' of enforcing its arbitral award. [1]

In many cases, the success of an investor commenced arbitration will require the tribunal to determine whether the government action is permissible or impermissible regulation. This will depend upon the terms of the investment treaty and the rules of international law, Not all government action (or inaction) which harms an investment will be compensable.

If an investor is successful in the arbitration it is most likely to receive an award for monetary compensation. Where an investor has lost its entire investment, the amount awarded may be significant. The successful claimant can seek to enforce the arbitral award in the host country or one of the other 146 countries party to the New York Convention.