Diamonds in the Rough: Managing Legal Risk in Emerging Economies

risk-in-emerging-markets

Days ago, foreign oil companies scrambled to evacuate their employees from Libya in the wake of the ongoing rebellion against the Gaddafi regime.  The heart of the rebellion is in Marsa El Brega, an oil refinery town on the northeastern coast of Libya.  It is here that Gaddafi’s forces are focusing their eastern counter-offensive.  As political and social upheaval continue to spread throughout the Arab world, multinationals and individual investors alike will be keeping steady watch over their assets and holdings in this troubled region.  Thus far, revolutions in Libya and elsewhere in the region have profoundly impacted trade and commerce locally and, in turn, financial markets around the world.

Critically, turmoil in this region has also impacted the typical investor’s view of emerging markets.  Dramatic events such as those unfolding in Libya, Egypt, and Tunisia, drive uninformed investors to assume biased views toward untapped, yet potentially lucrative, emerging markets.  While it is true that investors must fully take into account the potential pitfalls of doing business in these emerging markets, those that adequately protect themselves against these risks will stand to benefit the most from the opportunities that these markets present.  Investors can implement measures to mitigate, if not eliminate, the many risks typically encountered in these developing markets, including rampant corruption, political instability, fraud, and money laundering.

This article will briefly outline the risks associated with investing in the world’s vast emerging markets, and highlight both general and specific actions that investors can take to protect themselves against these risks.  In particular, this article will also discuss the use of arbitration and mediation as alternative forms of dispute resolution.  Finally, this article will review the use of forum selection clauses as a shield against local protectionism, as well as U.S. courts’ enforcement of forum selection clauses through foreign anti-suit injunctions.

Political Risks

Political risks are a grave concern for investors entering emerging markets.  The inherent weakness and instability of many such governments may deter foreign investors who are risk-averse.  For those investors who are accustomed to operating in more “developed” business cultures, the political dynamic in regions such as the Middle East and Latin America can be complicated, if not overwhelming.  Certain risk factors are beyond the investor’s control, such as currency instability, ineffective government institutions, and patchy regulatory regimes.  The events unfolding in Libya, for example, demonstrate how such factors can cause foreign investors to question whether the risks of entering an emerging market truly outweigh the rewards.

As seen in Libya and certain regions of Latin America, investors must also seriously consider the risk that their assets may be expropriated by the government without just compensation.  Investors must take preventative measures when investing in countries where government expropriation is or has been commonplace.  Many U.S. investors have been forced to sue in U.S. courts seeking just compensation for property “nationalized” by governments throughout Latin America and the Middle East.

Money Laundering Concerns

Foreign investors must also be aware of the heightened risks of money laundering in emerging markets.  Few governments are well-equipped to comply with the strict anti-money laundering requirements of the U.S. Treasury Department’s Office of Foreign Assets Control and other highly developed regulatory regimes.  Still pervasive in many emerging markets, including Latin America and the Middle East, terrorism and drug financing pose high risks for investors transferring capital across borders.  Due to the copious amounts of money exchanged during the course of high-volume investment projects, funds invested in such regions can trigger red flags.

Unlike political risks, money laundering threats can be mitigated by taking adequate precautions, such as conducting due diligence, making careful inquiries about fund transferees, and maintaining proper documentation throughout the transaction.  If an investor or foreign corporation is flagged for links to terrorism or for concerns about money laundering in his or her home country, or if the local authorities have commenced a parallel investigation, the investor must promptly seek experienced counsel who can assemble a team to represent the client’s best interests throughout the course of the investigation.

Legal Risks

Given the diversity of legal systems in today’s “emerging markets,” foreign investors must understand the pertinent laws and regulations that will affect their investments.  These investors must formulate an exit strategy which conforms to local laws.  Since many Latin American and Middle Eastern nations have overly bureaucratic, unstable, and disorganized judicial systems, it is critical to work with a reputable, experienced partner who is familiar with domestic laws, customs, trade practices, business norms, and regulations.

A well-designed dispute resolution procedure is an essential part of one’s overall investment strategy, as it often gives an investor the best opportunity to protect his or her interests in a neutral forum.  Thus, investors venturing into emerging markets must carefully consider, evaluate, negotiate, and implement such mechanisms prior to entrance.  Arbitration is usually preferred over litigation due to the potential savings in time and cost, as well as the relative flexibility associated with adjudication by an arbitral tribunal and the mutual designation of arbitrators.  A well-drafted arbitration clause should designate, at a minimum, a proper arbitration tribunal and the applicable laws, procedures, and chosen language for the arbitration.  Of course, it is always beneficial for U.S. investors to ensure that the nation in which they seek to invest is a party to the 1958 New York Convention, which provides for domestic recognition and enforcement of cross-border arbitration awards.

Fraud, Bribery, and Corruption

Where there is money, there is sure to be fraud and corruption.  Uninformed investors entering emerging markets have a high chance of falling prey to Ponzi schemes and other fraudulent tactics.  Thousands of investors continue to lose their hard-earned money as a direct result of such activities.  Accordingly, investors must at a minimum be cognizant of the common badges of fraud, as well as the risks posed by fraud, in order to best formulate specific strategies for avoidance.

Moreover, U.S. investors who conduct business or engage in financial transactions abroad, and especially in emerging markets, must also be mindful of the Foreign Corrupt Practices Act (“FCPA”).  The FCPA prohibits the bribery of foreign officials to obtain business or secure an unfair business advantage.  Its anti-bribery provisions apply to all U.S. persons and certain foreign issuers of securities, as well as foreign organizations and persons who cause, directly or through agents, an act in furtherance of such a corrupt payment to take place within U.S. territory.  Implementing rigorous internal compliance programs and conducting proper due diligence, inquiry, investigation, and training of personnel will help minimize the risk of civil and/or criminal liability under the FCPA.

Starting in April 2011, investors will also need to familiarize themselves with the new U.K. Anti-Bribery Act.  The Anti-Bribery Act is in many respects more stringent than the FCPA.  Significantly, the Anti-Bribery Act has no mens rea requirement, and holds individuals and corporations strictly liable for their conduct.  The Act also prohibits the bribery of private (as opposed to just government) entities and individuals.  Under the Anti-Bribery Act, corporations and individuals can be sanctioned for both offering and receiving a bribe, although foreign officials who receive bribes cannot be sanctioned.  Unlike the FCPA, the Anti-Bribery Act does not provide an exception for “grease payments” or reasonable business expenses.  As a result, investors in emerging economies should be aware that seemingly innocuous acts, such as paying for someone’s plane ticket, may be permitted under the FCPA but forbidden under the more stringent U.K. Anti-Bribery Act.

Forum Selection Clauses and Anti-Suit Injunctions

While the allure of profit from doing business in emerging economies continue to attract U.S. and other foreign investors, business relationships in these parts of the world can quickly and unexpectedly sour.  Unstable political regimes, fluctuating economic factors, and constant shifts in bureaucratic governance, to name just a few elements, can transform a once friendly business relationship into a costly legal dispute.

Consider the following scenario.  A U.S. supplier enters into a distribution agreement with a Tunisian company to sell heavy industrial machinery for petroleum extraction in that country.  The parties are both sophisticated business entities and have enjoyed a decades-long relationship.  In this agreement, the parties include a forum selection clause, which provides – in no uncertain terms – that any disputes between them “will be brought exclusively in a state or federal court situated within the State of New York.”  Shortly after the parties signed the agreement, a dispute arises.  The Tunisian distributor, perhaps due to ongoing political and economic turmoil, fails to remit timely payment for several shipments of goods it had received from the U.S. supplier.  The distributor quickly falls into significant arrears.  Unable to collect payment or reach a mutually tenable agreement, the U.S. supplier is forced to terminate its agreement with the Tunisian distributor.

Almost immediately, the Tunisian distributor sues its former U.S. supplier in a Tunisian court.  In this action, the distributor claims millions of dollars in damages under a protectionist law designed to shield domestic distributors from liability to foreign suppliers.  The U.S. supplier cannot afford to ignore the foreign lawsuit, since an adverse judgment may carry with it significant consequences, including a large damages award, injury to the supplier’s reputation, and substantial loss of market share at home and abroad.  Yet, the foreign lawsuit is in clear violation of the parties’ forum selection clause, which designated New York as the exclusive forum for all lawsuits arising from the distributorship agreement.  How can the U.S. supplier navigate this potential minefield?

In this case, the U.S. supplier wisely included a forum selection clause in its contract with the Tunisian distributor.  By predetermining the forum where any contractual dispute must be resolved, both parties gained a measure of predictability and comfort.  Indeed, U.S. courts consistently uphold the enforceability of such forum selection clauses.* However, what if a foreign litigant simply repudiates a contract’s forum selection clause and brings suit in a hostile forum?  In fact, disgruntled parties frequently ignore forum selection clauses and run to the shelter of their domestic courts to seek cover under protectionist laws.  Fortunately, an anti-suit injunction provides a powerful tool for U.S. businesses faced with a foreign party choosing to ignore a forum selection clause.  In a nutshell, courts use anti-suit injunctions to stop a party from commencing or continuing a lawsuit in a foreign forum.  They do not target the foreign forum itself, but rather the party seeking to litigate in that forum.

But what if the parties’ agreement did not include a forum selection clause?  Can an anti-suit injunction still issue?  The Circuit Courts of Appeal are split as to the proper standard to be applied in deciding whether to issue an anti-suit injunction without the benefit of a forum selection clause.  Regardless of the approach taken, the parties must, as a threshold matter, establish that (1) the same parties are involved in both the U.S. and foreign proceedings, and (2) the U.S. action will be dispositive of the foreign action to be enjoined.** Once these threshold requirements have been satisfied, federal courts generally follow one of two approaches in determining whether issuance of an anti-suit injunction is appropriate: the permissive (or liberal) approach, and the restrictive (or conservative) approach.

The Permissive Approach. The Fifth, Seventh, and Ninth Circuits of the U.S. Court of Appeal have adopted the permissive approach to granting an anti-suit injunction.  Under this approach, a court will issue the injunction if it determines that the foreign litigation: (1) would frustrate a policy of the enjoining court, (2) would be vexatious or oppressive, (3) would threaten the issuing court’s in rem or quasi in rem jurisdiction, or (4) would prejudice any other equitable considerations.^

The Restrictive Approach. The majority of federal Courts of Appeal, including the First, Second, Third, Sixth, Eighth, and D.C. Circuits, have adopted the “restrictive approach.”  These courts believe that respect for comity requires that anti-suit injunctions be used sparingly and only in the rarest of cases.  As a result, they generally allow the litigation to proceed on a parallel basis in two fora until a judgment in one court can be pleaded as res judicata in the other court, and will issue an anti-suit injunction only when the foreign action threatens the jurisdiction of the U.S. court, or when interests of the U.S. significantly outweigh considerations of international comity.^^

A Special Case For Forum Selection Clauses. There appears to be one area in which the courts – regardless of their preference for the permissive or restrictive approach – appear to uniformly agree. Virtually every court that has considered a request for an anti-suit injunction to enforce a forum selection clause has granted it.*^^ Arbitration clauses, which are a type of forum selection clause, have enjoyed similar protection.  U.S. courts have routinely protected parties’ contractual forum agreements in the arbitration context and have enjoined foreign proceedings that violated the parties’ agreed-to arbitration clauses.

The only recent decision that did not uphold an anti-suit injunction enforcing a forum-selection clause was issued by the Eleventh Circuit in Canon Latin America Inc. v. Lantech (C.R.) S.A.**^^ The Court in Canon Latin America never reached the question of whether to apply the permissive or restrictive approach – an issue of first impression in that circuit that remains unanswered.  Instead, the court vacated Canon Latin America’s anti-suit injunction on the ground that the claims alleged in the foreign proceedings were not the same at those pending in the Florida federal court.**^^*

Conclusion

Emerging markets are diamonds in the rough.  Investors in these markets must adopt a comprehensive global vision in order to adequately address these complex challenges.  Moreover, potential investors should not be deterred from entering these untapped markets as a result of these inherent risks.  Throughout the difficult process of capitalizing on one’s investments in these markets, it is imperative for investors to retain legal counsel that not only understands the applicable laws, but has a keen awareness of the cultures and customs that have fostered these laws.  Then, and only then, can diamonds emerge from the rough.


See, e.g., M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 13-14 (1972) (determining that the “elimination of all such uncertainties by agreeing in advance on a forum acceptable to both parties is an indispensable element in international trade, commerce, and contracting.”); see also Scherk v. Alberto-Culver Co., 417 U.S. 506, 507 (1974) (stating that a forum selection clause “obviates the danger that a dispute under the agreement might be submitted to a forum hostile to the interests of one of the parties or unfamiliar with the problem area involved.”).

** See E. & J. Gallo Winery v. Andina Licores S.A., 446 F.3d 984, 991 (9th Cir. 2006).

See generally Kaepa, Inc. v. Achilles Corp., 76 F.3d 624 (5th Cir. 1996); Allendale Mut. Ins. Co. v. Bull Data Sys., Inc., 10 F.3d 425, 431-33 (7th Cir. 1993); Seattle Totems Hockey Club, Inc. v. Nat’l Hockey League, 652 F.2d 852, 856 (9th Cir. 1981).

^^ See generally Goss Int’l Corp. v. Man Roland Druckmaschinen Aktiengesellschaft, 491 F.3d 355, 361 (8th Cir. 2007); Quaak v. Klynveld Peat Marwik Goerdeler Bedrijfsrevisoren, 361 F.3d 11, 18 (1st Cir. 2004); Gau Shan Co., Ltd. v. Bankers Trust Co., 956 F.2d 1349, 1354 (6th Cir. 1992); China Trade and Dev. Corp. v. M.V. Choong Yong, 837 F.2d 33, 36 (2d Cir. 1987); Compagnie Des Bauxites De Guinea v. Insurance Co. of N. Am., 651 F.2d 877, 887 (3d Cir. 1981); Laker Airways Ltd. v. Sabena, Belgian World Airlines, 731 F.2d 909, 926-27 (D.C. Cir. 1984).

*^^ See, e.g., E. & J. Gallo Winery, 446 F.3d at 984; Int’l Equity Inv. Inc. v. Opportunity Equity Partners Ltd., 441 F. Supp. 2d 552 (S.D.N.Y. 2006); Farrell Lines Inc. v. Columbus CelloPoly Corp., 32 F. Supp. 2d 118, 130 (S.D.N.Y. 1997).

**^^ 508 F.3d 597 (11th Cir. 2007).

**^^* Id. at 602.

About the Author

Michael Diaz Jr., Carlos F. Gonzalez, Sumeet H. Chugani and Xingjian Zhao

Michael Diaz, Jr. About the Authors
Michael Diaz, Jr. is the founder and managing partner of Diaz, Reus & Targ, LLP, where he focuses his practice on helping corporate and individual victims of international financial fraud recoup assets from Ponzi schemes, pyramid schemes, money laundering and RICO litigation. He can be reached at mdiaz@diazreus.com.

Carlos F. Gonzalez Carlos F. Gonzalez is a partner in Diaz, Reus & Targ, LLP’s Miami office, where he concentrates his practice in appellate litigation and trial support with an emphasis on international, civil, and commercial disputes and white collar criminal defense. He can be reached at cgonzalez@diazreus.com.

Sumeet Chugani Sumeet H. Chugani is an associate attorney in Diaz, Reus & Targ, LLP’s Miami office. Mr. Chugani focuses his practice on international litigation, financial services, regulatory compliance, and cross-border transactions. He can be reached at schugani@diazreus.com.

Xingjian Jeff ZhaoXingjian Zhao is an associate attorney in Diaz, Reus & Targ, LLP’s Miami office. Mr. Zhao focuses his practice on complex commercial litigation, regulatory compliance, cross-border transactions, and various substantive areas of P.R.C. law. He can be reached at xzhao@diazreus.com.