Companies affected by recent nationalizations in South America and elsewhere may have a number of relief options available. Among these are political risk insurance (PRI), bilateral investment treaties (BITs) and other analogous bilateral and multilateral treaties, and any investment agreement between the company and the host government. Each of these must be analyzed to determine which procedural and substantive bodies of law they implicate and what obstacles or recovery avenues they present.
For some companies, recovering under a PRI policy and assigning their direct claims against the host government to their insurer may be preferable to direct arbitration against the host government. Other companies may have purchased too little or no political risk insurance or may determine that direct arbitration under BITs or analogous agreements would be more advantageous in their particular circumstance.
For some companies with PRI and an applicable BIT, both avenues might be available, and the company will need to assess which options afford the greatest potential for recovery.
Recently nationalized companies in Latin America may recover some losses this way.
Recent nationalizations
Recent nationalizations in countries such as Venezuela, Bolivia, and Ecuador are resulting in harmful losses to several industries doing business in those countries-most particularly international oil and gas companies. Several companies have been forced to renegotiate contracts, giving the host government majority ownership in their operations in those countries. Others have been forced to sell their equity stakes to the host government, arguably at well below fair market value, and some have had their operations seized outright.
These activities appear to be driven by shifting political trends and the host governments’ desires to obtain a greater share of the revenue from their countries’ resources.
Events in Venezuela illustrate how the combination of a resource-rich country and political volatility can rapidly change the climate for foreign investors.
Venezuela has the world’s seventh largest proved conventional oil reserves, and its nonconventional oil deposits-the heavy crude oil found in the Orinoco belts-are equal to the world’s total reserves of conventional oil.
However, for many years Venezuela did not have the investment capital to exploit the potential financial benefits from these resources. Consequently, the country turned to foreign investors and entered into service contracts with numerous foreign oil companies to invest in and operate Venezuela’s oil fields. In the 1990s, almost 60 foreign companies, many from the US, participated in the Venezuelan oil sector at the government’s invitation.
Under these service contracts, the companies would operate the fields and Venezuela’s government-owned oil company Petroleos de Venezuela SA (PDVSA) would pay a fee and purchase the oil at market-linked prices. With the help of this foreign investment, Venezuela soon became the fourth-leading supplier of crude oil and petroleum products to the US.
Foreign investors also entered other Venezuelan industries. In 1991, Venezuela privatized its largest telecommunications company, CANTV. Verizon Communications Inc. ultimately purchased a 28.5% stake in CANTV. In 2000, US power company AES Corp., Arlington, Va., purchased an 82% stake in Grupo La Electricidad de Caracas (EDC), the largest Venezuelan utility.
However, Venezuela’s hospitality towards foreign investors did not endure. In the past few years, as rising oil prices spurred rapid economic growth, Venezuela’s gross domestic product increased by 17.9% in 2004, 9.3% in 2005, and 10.4% in 2006. The Venezuelan government then sought to obtain a greater share of revenue from the industries in which it had previously encouraged foreign investment by forcing the renegotiation of contracts and by nationalizing entire companies.
These efforts have been driven by Venezuelan President Hugo Chavez, who has pledged to implement “21st Century Socialism.” After leading an unsuccessful military coup in 1992, Chavez was elected president in 1998, pledging broad reforms. He rewrote the constitution in 1999, and he was re-elected in 2000 and again in December 2006. Since his most recent election, Chavez has pursued a strategy of nationalization with renewed intensity.
Venezuela’s efforts to increase its share of revenue from foreign investor-run operations have ranged from regulatory measures to forced renegotiation of contracts, to outright nationalization. First, from 2004 to the present, Venezuela increased corporate income tax on foreign oil companies by 30-50%, in some cases retroactively, and it increased to 33% the formerly1% royalties owed by those companies to the government.
Then, in 2005, Venezuela gave foreign oil companies operating conventional oil fields 1 year to convert their service contracts into joint venture agreements under which PDVSA was to be granted a minimum 60% stake. In April 2006, after Total SA and Eni SPA refused to enter into the proposed JV agreements, the Venezuelan government seized the oil fields operated by those two companies. The remaining companies either sold their stakes or acceded to the government’s demands.
More recently, the Venezuelan government declared it would take a minimum 60% stake in the Orinoco basin heavy oil projects by May 1. ExxonMobil Corp. announced Mar.1 that it would hand over to PDVSA operations of Cerro Negro-one of the four Orinoco basin oil fields that it operates as part of a JV with BP.
Earlier this year, Venezuela also began nationalizing companies in other industries, including the energy and telecommunications industries. On Jan. 31, Venezuela’s congress granted Chavez “extraordinary powers” to pass laws by decree for 18 months. Less than 2 weeks later, AES sold its stake in EDC to the Venezuelan government for about $840 million, reportedly $550-650 million less than book value. AES reportedly had purchased EDC in 2000 for $1.7 billion and had since invested another $600 million in the company.
Days later, Verizon sold its stake in CANTV to the Venezuelan government for $572 million, about $100 million less than a sale price already agreed to in a deal that was awaiting Venezuelan regulatory approval.
Similar nationalization movements are taking place in Bolivia and Ecuador. In May 2006, the recently elected president of Bolivia, Evo Morales, announced plans to nationalize the country’s oil and gas industry by “negotiate[ing] new contracts that will give ownership to the state.” All foreign oil companies were told to either negotiate new contracts giving greater control to the state by Nov.1, 2006, or be forced to leave the country. Morales also recently announced plans to nationalize companies in other industries and to implement new tax measures aimed at foreign investors.
In Ecuador, the law regulating the oil and gas industry recently was amended to require a minimum 50% state share in all oil revenues.
Means of recovery
Companies can mitigate losses from these types of actions by purchasing PRI and establishing or working with business entities in countries that have investment treaties with the host countries before investing in infrastructure.
Political risk insurance
PRI provides one potential avenue of recovery for companies whose foreign investment has been expropriated by a host government. PRI policies provide coverage for losses resulting from unpredictable actions of the host government, including government confiscation or nationalization of the insured’s investment. Other insured risks include contract frustration, currency inconvertibility, political violence, and wrongful calling of guarantees or nonhonoring of guarantees.
PRI originated as a means of inducing direct private investment in developing foreign economies. Thus, the first political risk policies were issued by the US after World War II to encourage private investment in Western Europe. In 1969 Congress established the Oversees Private Investment Corp. (OPIC), a wholly owned government corporation, to provide direct financing and PRI for projects in developing countries.
OPIC remains a dominant provider of PRI. Other political risk insurers include the Multilateral Investment Guaranty Agency (MIGA), which is part of the World Bank Group; Lloyd’s of London; Zurich Financial Services Group; Sovereign Risk Insurance Ltd.; American International Group Inc. (AIG); and Chubb Corp. PRI policies typically have large limits and long policy periods or “tenors” of 5-20 years.
OPIC and MIGA offer maximum limits of $250 million and $200 million respectively, while the limits offered by private insurers range from AIG’s $85 million to Sovereign’s $125 million. Additionally, political risk insurers often form consortiums to increase the total limits available to the policyholder.
If the insurer disputes coverage, PRI policies generally contain arbitration clauses. The publicly available OPIC policy form requires arbitration in Washington, DC, under the commercial arbitration rules of the American Arbitration Association.
Other PRI policies contain similar provisions, although the location of the arbitration and the applicable rules vary. Because the OPIC policy form is publicly available, and because of OPIC’s dominant role among political risk insurers, its expropriation coverage is used here to illustrate the issues likely to arise for companies affected by the recent wave of nationalization.
OPIC policies provide coverage for “total expropriation” if an act or series of acts by the host government violate international law or materially breach local law and directly deprive the insured of fundamental rights in the insured investment. The standard OPIC policy form does not further define when an expropriation constitutes a violation of international law. Thus, OPIC looks to general principles of international law. As a general matter, an expropriation violates international law when it is discriminatory or without just compensation or not for a public purpose.
Just compensation
While many recent disputes under international law have turned on whether a host government’s regulatory measures and other acts so deprived the investor of the benefits of its investment that they were “tantamount to expropriation”-also referred to as “creeping expropriation”-that is not the issue in Venezuela.
To be sure, Venezuela’s dramatic increases in taxes and royalties directed at US and other foreign oil companies operating in Venezuela may be characterized as examples of creeping expropriation. But there is no question that the Venezuelan government’s recent overt policy of nationalizing private companies and operations owned by foreign investors, if found to be in violation of international law, would constitute outright expropriation. Thus, the real issue will be whether those companies have received “just compensation.”
Not surprisingly, in public statements, Venezuela has taken the position that the terms it has offered to foreign investors such as AES, Verizon, and numerous oil companies have been fair. However, such statements have often been followed, virtually in the next breath, with contradictory statements suggesting that the companies have little choice but to accept whatever terms the Venezuelan government offers. For example, in discussing the nationalization of operations in the Orinoco belt, President Chavez stated: “We want to negotiate...but I have given instructions that on May 1 when the sun gets up, we will have all those oil fields under our control.... The company that wants to stay as our partner, we left the possibility open to them. The one that does not want to stay as minority partner, return the oil field and goodbye...good luck, thank you very much.”
Indeed, recent history demonstrates that the terms offered by Venezuela have been nonnegotiable. As discussed above, when Total and Eni refused to convert their service contracts to joint venture agreements that would give PDVSA majority control, Venezuela seized control of the oil fields that they had been operating. At the time, Energy Minister Rafael Ramirez stated: “Those two companies resisted adjusting to our laws.... Companies that don’t adjust to our laws, we don’t want them to continue in the country.” Thus, the choice for companies negotiating with the Venezuelan government appears to be either to take what is offered or risk getting nothing.
Other facts, as mentioned, suggest that companies such as AES and Verizon did not receive just compensation.
Fewer details are known about how much compensation, if any, Venezuela has offered the oil companies in which operations it has taken or will take a majority stake. However, it is unlikely that the amounts offered by Venezuela will compensate the companies for the substantial investments they have made.
Value of the loss
Assuming that a policyholder can show that the expropriation was a violation of international law, the next issue becomes, “What is the value of the loss?” i.e., how much is recoverable under the PRI policy? Unlike “just compensation,” the value of the loss is determined by reference to the policy language. Under its form policy language, OPIC agrees to pay the “book value” of the insured investment, subject to certain adjustments and limitations. Book value is determined as of the date “the expropriatory effect commences” and is based on financial statements maintained by the policyholder in accordance with generally accepted accounting principles.
Thus, that the policyholder already has received some compensation from the host government, such as has been the case in Venezuela, does not mean that it cannot also recover under its PRI policy. Rather, the amount recoverable is likely the difference between the book value of the investment and the amount of compensation received.
Arbitration
PRI provides a means for companies to recover from their insurers for losses of their investments in foreign countries resulting from the actions of the host government. However, for any number of reasons, some companies affected by the recent wave of nationalism in South America may not have purchased PRI. In that case, companies may be able to recover directly from the host government through international arbitration.
Treaties
BITs are agreements between governments in which each government agrees to provide certain protections to investments in their countries by nationals of the other country. The provisions of BITs vary, but they typically include an arbitration clause identifying an arbitral body to which disputes may be submitted. Often the parties identify the International Centre for Settlement of Investment Disputes (ICSID).
BITs typically contain a provision prohibiting either country from expropriating the investments of nationals of the other country without due process or just compensation in violation of international law. Thus, like many PRI policies, BITs specify that international law will provide the applicable legal standards.
Unlike PRI policies-at least the OPIC form-however, many BITs contain their own definition of just compensation. In a recent arbitration between the Airport Development Co. and the Republic of Hungary, the BIT stated that “the amount of compensation must correspond to the market value of the expropriated investments at the moment of the expropriation” and that “the amount of this compensation may be estimated according to the laws and regulations of the country where the expropriation is made.” This language would be particularly unfavorable to a company such as AES or Verizon that was paid “market value” for its assets “at the moment of the expropriation,” as the market value had been driven down significantly as a result of acts of the host government leading up to the expropriation.
In contrast, the BIT between Canada and Venezuela defines “adequate and effective compensation” as “the genuine value of the investment or returns expropriated immediately before the expropriation or at the time the proposed expropriation became public knowledge, whichever is earlier.” This language takes into consideration the fact that, as has been the case in Venezuela, the market value of the affected company’s investment is likely to decline as soon as the threat of expropriation becomes publicly known.
Notably, there is no BIT between the US and Venezuela. That does not mean, however, that US companies whose investments in Venezuela have been expropriated have no forum in which to arbitrate. Often a company’s foreign investments are made through a subsidiary or affiliate that is a national of a different country than the parent. Venezuela, along with 154 other countries, is a party to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States, which is the instrument from which ICSID derives its jurisdiction, and Venezuela has entered into BITs with about 20 countries. Thus, US companies who have suffered a loss may be able to arbitrate their dispute directly with Venezuela if the expropriated investment was owned or controlled, directly or indirectly, by an entity that is a national of a country that is a party to a BIT with Venezuela.
Investment agreements
Additionally, companies should be aware that there are other forms of relief that are analogous to BITs. These include free trade agreements, such as the North America Free Trade Agreement, the Energy Charter Treaty, and others. Also, where the foreign investment involves an agreement with the host government (such as the operating agreements entered into in the 1990s by oil companies operating in Venezuela), the investment agreement itself typically will have an arbitration provision.
The authors
Neil Popovic is an attorney in the law offices of Heller Ehrman in the company’s international arbitration practice, where he represents clients in international negotiations and dispute resolution and in white collar criminal defense. He also is a lecturer at Boalt Hall School of Law at the University of California, Berkeley, where he has taught international environmental law since 1996. Popovic has published numerous articles in law reviews and other publications. He is a member of the International section of the State Bar of California; American Society of International Law; Northwest Subcommittee of the International Chamber of Commerce’s US International Arbitration Committee; and the Bar Association of San Francisco. Popovic earned his JD at Boalt Hall School of Law in 1987, an MA in international relations in 1992 at Tufts University’s Fletcher School of Law and Diplomacy, and a BA in political science at the University of California, Berkeley, in 1983.
Alex Lathrop is a member of Heller Ehrman’s Insurance Recovery Group, where he has assisted large policyholders in the energy, petrochemical, and mining and smelting industries in the recovery of substantial losses from their insurers. Lathrop has participated in omnibus settlements of environmental claims and has taken part in all phases of complex coverage litigation. He also has practiced general commercial litigation, advised companies regarding the Foreign Corrupt Practices Act, and developed corporate compliance and ethics programs. Lathrop received his JD at the University of Virginia School of Law in 1999 and a BA at the University of California at Berkeley in 1991. From 1991 through 1996, Lathrop served on active duty as an infantry officer in the US Marine Corps.
