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Ukraine is losing competition over investors. Why its treatment of them is to blame?

Taras Dumych, Managing Partner, Wolf Theiss Kyiv

Ukraine is not the only country competing over foreign as well as domestic investments and investors. However, this competition proves to be tough for the country.

In fact, just in terms of pure figures, Ukraine seems to be losing investors.

The outflow of foreign capital has exceeded new foreign direct investments in Ukraine in the first half of 2021.

For the first nine months of 2021, the country only saw FDI inflows of $744 million, the lowest since 2014, excluding the crisis year of 2020. According to the National Bank of Ukraine, this year’s foreign investments remained low and have not played a significant part in stimulating the economy.

Making matters worse are the growing number of investment claims that foreign investors are initiating against Ukraine, making it one of the leaders among the respondent states targeted by international investment arbitration. There were 26 publicly known claims against it as of 2020.

What’s striking is that all these alarming signs are emerging at a time when the Ukrainian government tirelessly pleads with foreign businesses to invest in Ukraine, promising to protect them.

But protection is not something investors can expect. Many foreign investors who sought to resolve their issues peacefully or in Ukrainian courts eventually turned to international arbitration, stating that the state was not only not defending their rights, it was treating them unfairly and unscrupulously.

The roots of such treatment lie in systemic problems such as the blatant negligence of state bodies to their duties, which leads to investors being deprived of certain benefits and guarantees as their legal rights are violated. Such an attitude towards investors seems to be affecting all the "generations" of political regimes for at least the past fifteen years.

A striking example of how Ukrainian state bodies violate the rights of foreign investors is the case of British investor Tamaz Somkhishvili, who since 2018 has not been able to recover his losses of $ 98.5 million, incurred as a result of the termination of the investment agreement by the Kyiv city authorities.

The investor won the tender to rebuild the Kharkiv Square in Kyiv in 2007, transferred $13.5 million to the account of the Kyiv city authorities and invested heavily in obtaining all the permits, design and development of the area to find out later that the investment project and agreement was terminated in 2013. And that termination was not at all for any possible breaches on the side of the investor.

At first, Kyiv authorities had not questioned the investor's right to be compensated for losses, referring the investor to the Ukrainian courts, for the latter to determine the amount of the compensation. However, after the court decided that the amount of direct damages to be compensated to the investor is USD 24 million, the authorities have completely changed their mind, and started unanimously stating they are not responsible for investment obligations to the investor and that the investor has no right to compensation for any losses at all. This is despite Ukrainian law expressly obliges authorities to compensate investors for the losses the authorities caused.

On top of that, the Kyiv Prosecutor's Office, which had decided to step in into the case, stated that the investor's made a deal with the authorities at his own risk. This effectively means that if state authorities in any investment project breach their commitments, it’s only the investor’s problem but not the authorities.

The investor, desperate to defend his legal rights within the Ukrainian legal system and faced with an unfounded and unfair position of the state and city authorities, in November 2021 sent a notice of a dispute to the government of Ukraine under the UK-Ukraine Bilateral Investment Treaty.

Following the same principle, the Ukrainian government is failing to fulfill its obligations under the memorandum between the government and green energy producers on the payments for produced electricity. Green energy developers have been the largest recent class of investors in the Ukrainian economy.

Multibillion-dollar debts on the "green" tariff and its reduction in 2020 by the government made many investors think about terminating projects in Ukraine and caused others to turn to Ukrainian courts and international arbitration.

This is why Modus Energy, owned by Lithuanian investors, filed a lawsuit against Ukraine in the spring of 2021 for failing to fulfill its obligations to pay for electricity and changing the rules, thereby cutting its revenues.

The crisis situation was further fueled by the Ukrainian government on November 13 blocking the payment of debts in the amount of UAH 19.3 billion to "green" investors from targeted "green" Eurobonds under state guarantees. Instead, the Ukrainian government wanted to transfer all funds to state-owned company Energoatom, which has higher tariffs.

As of now, all companies received payments, except for one major Ukrainian renewable energy producer, which told Western creditors about the discriminatory actions of the Ukrainian government.

Putting aside the frankly irresponsible and unfair behavior of the state bodies in the above cases, the mere facts of disputes between investors and governments are not necessarily something negative and inherent only to Ukraine. Investment claims are filed even against exemplary democracies where the rule of law is respected.

But what’s important is the true willingness of the state to resolve these disputes in a civilized way and to take responsibility for the violated interests of investors before it comes to arbitration. In the end, the resolution of disputes is in the interests of the state itself, since their delay only disappoints existing investors, repels potential ones and can lead to even greater financial and reputational losses of the state before the international business community.

Therefore, here is a short-list of practices that Ukraine’s state bodies should stop doing if they really want to attract foreign and Ukrainian investments:

1. Pacta sunt servanda . Oddly enough, the fundamental principle of “agreements must be kept” is often not followed by government authorities or state-owned enterprises. In practice, there are even approaches like "we agree that we have obligations, but if you want us to fulfill them, go to court."

2. Evasion of responsibility . There are cases when the obligation is assumed by one government agency, and its implementation depends on another. And then both government agencies begin to shift responsibility between themselves.

3. Investment projects with the state are an investor's risk . This may sound crazy, but as described in the above case of Mr. Tamaz Somkhishvili, , there are cases where the state party declares that entering an investment project with it is an activity that the investor takes at its own risk.

4. Disrespect for the fact that the investor may attract debt or capital from third parties for the implementation of the project , and thus be liable to its own investors or creditors. When the state violates its obligations, it not only damages the investor's direct relationship with the state, but also the investor's relationship with its creditors and investors.

5. Refusal to protect violated rights of foreign investors . Investors often suffer from unscrupulous counterparties or partners in Ukraine. When this happens, and when investors turn to the courts or law enforcement agencies for protection, the latter take the approach of "it is your fault". And this is a violation by the state of its obligations to protect the legitimate rights and interests of investors in Ukraine, and these obligations are not only part of the national legislation, but also Ukraine's commitments under the international treaties.

6. Actual refusal to resolve disputes in a civilized and legal manner. Disputes do occur, and the very fact of a dispute is not necessarily negative. It is unquestionable that the state has its own interests and must protect them. However, it is also unquestionable that if the state violates the legitimate interests and rights of the investor, it is in the interests of the state to settle the dispute or or conduct the dispute in a fair way.

7. Hypocrisy in the behavior of the state bodies . Unfortunately, there are situations when, in negotiations with investors, government officials make promises and take on obligations that they do not intend to fulfill. This echoes the very first principle of pacta sunt servanda mentioned above, and is just another form of relationships where this principle matters. In any case, nothing harms the reputation of the state more than making promises that are not kept, or not fulfilling obligations, not even promises.

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