978-0132718974 Chapter 5 Solution Manual Part 1

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Foreign Investment

I. Text Materials

Foreign Investment Laws and Codes

Foreign investment involves ownership by one person (an individual, a partnership, business

organization, or government entity) of 10 percent or more of the controlling interest in an

enterprise not located in the person’s home country.

The regulations governing foreign investments are commonly set out in investment laws. In

socialist-oriented countries that allow foreign investment in joint venture form only, the

regulations are usually called joint venture laws.

A few states do not have general investment laws but instead put restrictions on investment in

specific sectors of the economy, such as agriculture, technology, media (television and movies),

and tourism. Many other economies have a complex system of laws controlling investment,

providing incentives, governing technology transfers, and limiting foreign exchange such that the

combination of these laws functions as a kind of investment code. Often these laws are

incorporated into bilateral investment treaties (BITs), which usually define foreign investment

and the conditions under which investors from one state can invest in the other state.

National Foreign Investment Policies – The precise form of foreign investment regulations will

vary from state to state, but the underlying purposes of these regulations are much the same

worldwide. These include (1) promoting local productivity and technological development, (2)

encouraging local participation, and (3) minimizing foreign competition in economic areas

already well served by local businesses.

To achieve these purposes, investment laws establish basic policies for screening and regulating

foreign investment applications. These generally fall into three categories. The first is to

encourage investments through incentives and minimal regulations. The second is to use

investment incentives but also to require local participation quotas. The third is to allow foreign

investment subject to local screening and supervision.

Regional Investment Policies – Nations in a geographic region may agree on general standards

for investment in the region. The ASEAN (Association of Southeast Asian Nations) area is one

such region. The United States, Canada, and Mexico not only created an investment alliance or

pact, but entered into a formal trade agreement (the North American Free Trade Agreement) that

provides significant protections for investors of nations that are members of WTO.

Screening Foreign Investment Applications – Most countries require foreign investors to (1)

Foreign Investment

The Screening Agencies

Foreign investors will ordinarily register and file proposals with a single central agency set up

specifically to facilitate foreign investments. The central agency may conduct the screening, or it

may instead coordinate the process.

Proposals Requiring Screening

A few states may subject all foreign investment to some form of screening. Other states limit their

reviews to proposals seeking investment incentives to those that involve a certain percentage of

foreign investment, or to those whose projected investment exceeds a certain amount of capital.

Proposals Requiring Special Screening

Certain kinds of foreign investment proposals require the approval of specialized agencies.

Commonly, investments in natural resource–based industries need the approval of agencies that

formulate special criteria tailored to the specific requirements of the industries involved.

Information That Must Be Disclosed

Foreign investors are required to supply screening agencies with quite detailed information about

their proposals.

Evaluation Criteria

A foreign investment proposal is judged, in general, on its congruence with a country’s national

development objectives. Some investment laws establish standards for screening projects in

general or for granting incentives in particular.

Formal and Informal Application Processes – The investment application submitted by a

foreign investor must demonstrate two things to the regulatory authority: First, that the proposed

investment fits the guidelines of the investment law; second, and most important, that the

investment agrees with the investment philosophy of the host country.

Although compliance with the statutory provisions is reasonably straightforward, conforming to

the regulatory philosophy can prove difficult. It may be difficult because the regulatory authority

is often secretive and may not be sympathetic to foreign investors. Or it may be difficult because

the investor is insensitive to the investment environment in the host country.

Approval of Foreign Investment Applications – If the foreign investor’s proposal did not ask

for the host to grant any incentives, and if the host state does not insist upon any concessions

from the investor, the approval will often be in the form of a letter from the appropriate agency. If

the host state grants an incentive or the investor agrees to some concession, the arrangement will

be set out in a formal investment agreement. The burden for ensuring that the proper approval has

been granted rests with the investor.

Case 5-1: Arab Republic of Egypt v. Southern Pacific Properties, Ltd., et al.

Facts: Southern Pacific Properties (SPP) entered into two contracts that involved the construction

of a tourist center near the pyramids of Giza. The first was between SPP, the Egyptian General

Foreign Investment

Organization for Tourism and Hotels (EGOTH, an Egyptian state owned corporation), and the

Egyptian minister of tourism who had signed as a representative of the Egyptian government. It

provided that SPP would establish a local holding company to operate the center. The second

contract was between SPP and EGOTH. This second contract provided, among other things, for

arbitration in the event of a dispute. The Egyptian minister of tourism endorsed it with the words

“approved, agreed and ratified.”

Because of protests from environmentalists, the Egyptian government withdrew its approval for

the tourist center. SPP and its holding company then initiated arbitration against both EGOTH and

the Egyptian government. The arbitration tribunal held that it had jurisdiction over both EGOTH

and the government, and it awarded a judgment in favor of SPP. The government brought suit in a

French court of appeal to have the tribunal’s judgment set aside.

Issue: Was the Egyptian government a party to the arbitration agreement?

Holding: No.

Law: Egyptian law requires that the minister of tourism has to approve all agreements relating to

Explanation: By endorsing the second contract, the minister of tourism was giving the

Order: The judgment against the Egyptian government is set aside.

Business Forms – Most states generally prefer that foreigners limit themselves to businesses that

(1) have local participation and (2) fully disclose their activities to the public.

Local participation usually means some form of joint venture, which can be organized either as a

partnership, a limited liability company (LLC), or a publicly traded stock corporation. Host state

laws requiring public disclosure of the activities of large firms or firms with foreign ownership is

a second factor affecting the choice of business form. Not all countries encourage their companies

to disclose their financial and other activities. So-called tax haven countries, which try to attract

foreign multinational investment, commonly impose no disclosure requirements. Some tacitly

encourage the organization of partnerships and LLCs.

Limitations on Foreign Equity – Foreign investment laws frequently forbid or limit the

percentage of equity that foreigners may own in local businesses.

Sectoral Limitations – Foreign investment is commonly restricted by economic sector.

Regulations typically (1) reserve certain sectors of the economy exclusively to the state or its

nationals, (2) permit a limited percentage of foreign capital participation in certain sectors, or (3)

define certain sectors in which full or majority foreign ownership is allowed or encouraged.

Closed Sectors

Most states close certain economic sectors to foreign ownership. Among those most often closed

are: (1) Public utilities, (2) vital or strategic industries, (3) industries that are sufficiently

developed, and (4) medium- or small-scale industries that can be developed by domestic

entrepreneurs.

Restricted Sectors

Foreign Investment

Many states limit the percentage of foreign investment allowed in certain economic sectors.

Commonly, this is done to limit the influence that foreigners have in domestic political, social,

and economic affairs.

Foreign Priority Sectors

Foreigners are often encouraged to invest in sectors where local development resources are

limited, where foreign investment will increase the number of local jobs, and where the foreign

export trade will grow. Developing countries, especially, allow foreign capital participation in

pioneer industries and in industries that are capital intensive, use advanced technology, increase

employment, are export oriented, and have products with a high degree of local value added.

Geographic Limitations – A few countries limit the geographic areas in which foreign investors

may conduct business or own land. Moreover, some countries forbid foreign investment in their

entire territories. The right of a state to restrict foreign investment in particular geographic areas

is respected by other states as an expression of the state’s sovereign authority.

Case 5-2: Brady v. Brown

Facts: Brady and Cardwell (B&C), U.S. citizens, wanted to buy beachfront property in Mexico.

Issue: Does comity prevent U.S. courts from granting relief to B&C?

Holding: No.

Law: Comity is based on respect for the sovereignty of other countries. It requires the forum state

Explanation: Because Brown misled B&C into believing that they were complying with

Order: The trial court’s award is affirmed.

Foreign Investment

Free Zones – These are geographical areas wherein goods may be imported and exported free

from customs tariffs and in which a variety of trade-related activities may be carried on. Free

zones can be categorized by their geographical size and by the kinds of activities that may be

carried on within them.

Free Zones Categorized by Size

The largest free zones are called free trade areas (FTAs) and are made up of two or more states

that have agreed to let some or all of each other’s enterprises carry on their trades across and

within each state’s borders free from customs tariffs and other restrictions. Examples: NAFTA

and The European Community Treaty establish FTAs.

A state may provide for its entire territory to open up some or all of its economic sectors to

international trade. Example: Singapore. Similarly, it may open certain regions. Example: China’s

special economic zones and Latin America’s free perimeters.

The free city or free port is a free zone in which a port city is opened to international trade. The

free trade zone or foreign trade zone [FTZ] is the modern variant of the free city. Rather than

granting free trade status to an entire city, states instead designate smaller areas, usually within or

near port cities, as free trade zones. In addition to FTZs, some states also create special-purpose

subzones associated with, but physically apart from, those zones to accommodate limited-purpose

trading activities.

Case 5-3: Nissan Motor MFG. Corp., U.S.A. v. United States

Facts: A U.S. foreign trade zone (FTZ) subzone was set up at Nissan Motor’s plant in Smyrna,

Issue: Is the import of production equipment into a foreign trade zone subzone dutiable?

Holding: Yes.

Law: U.S. law provides that goods may be brought into an FTZ subzone without the payment of

Explanation: The U.S. law does not say that imported equipment may be “installed,” “used,”

“operated” or “consumed” in the zone, which are the kinds of operations Nissan performs in the

Order: Nissan must pay duty on the production equipment.

Free Zones Categorized by Activities

The range of activities that can take place within a free zone includes storage, distribution,

manufacturing, and retailing; however, not all zones permit all of these activities.

Foreign Investment

Export processing zones (EPZs) are free zones in which manufacturing facilities process raw

materials, or assemble parts imported from abroad and then export the finished product. For

customs purposes, the materials and parts are treated as if they never entered the host country at

all. Thus, no tariffs or other duties are paid either when they are imported or when they are

exported. Example: Mexico’s maquiladora program.

Free retail zones (or duty-free zones) are found in international airports and harbors and near

some border crossings. They cater to tourists and other travelers who are leaving a country by

offering them goods free of local sales and excise taxes.

Bonded warehouses are found at the ports of entry of most countries. Privately owned and

operated by transportation firms, they provide a place where shippers can store goods from the

time of their arrival from overseas to the time they clear customs and are taken away by

importers.

Foreign Investment Guarantees – Host countries provide a variety of guarantees to foreign

investors to make investment in their territories more attractive. Guarantees are granted either (1)

automatically when an investment application is approved or certified by the appropriate host

state agency or (2) on an ad hoc basis.

The most important guarantees relate to:

Compensation in the event of nationalization of a foreign-owned enterprise and repatriation

of the payments made

Repatriation of the proceeds upon the sale of the enterprise

Repatriation of profits and dividends

Repatriation of other forms of current income (such as royalties, licensing fees, and fees for

managerial and other services)

Repatriation of the principal and interest from loans

Nondiscriminatory treatment

Stabilization of taxes and other regulations

Convertibility of local currency

Particular guarantees are found in the constitutions, legislation, policy statements, and legal and

administrative practices of countries.

Constitutional provisions most commonly deal with the compensation due foreign investors in the

event of nationalization or expropriation. These describe how property is to be taken and,

sometimes, how it is to be paid for.

Foreign investment laws also deal with guarantees that are not always found in constitutions,

especially repatriation guarantees, assurances of nondiscrimination, and stability clauses.

The most common repatriation guarantees relate to the right of foreign investors to remit profits

and investment capital to their home country in the event of the partial or complete termination of

their enterprise. Less common are guarantees relating to the repatriation of other kinds of current

income (such as royalties, licensing fees, and fees for managerial and other services) and to the

remittance of the principal and interest from loans.

Foreign Investment

Nondiscrimination guarantees are found in many investment laws, as well as in the constitutions

of several countries. The constitutional provisions generally are guarantees that foreign investors

will be treated in the same manner as national investors. The statutory provisions often specify

that equality of treatment relates to ownership rights, taxation, and, sometimes, social matters.

Stabilization clauses are a special kind of investment guarantee provided by a few countries. Such

a clause promises foreign investors that the host government will not change its tax, foreign

exchange, or other legal régime for a certain period of time, or that changes subsequent to the

establishment of an enterprise will not affect that enterprise. A stabilization clause, like any

contractual provision, can be changed by the mutual agreement of the parties. Changes in the

surrounding circumstances and changes in the way the parties perform may also modify such a

clause. A stabilization clause cannot prevent a state from nationalizing or expropriating a foreign

investment. The violation of a stabilization clause may change the character of a nationalization

decree, from lawful to a breach of contract.