Rebuilding Ukraine: investor protection amid legal challenges and corruption
Varun Zaiwalla & Zuhair Farouki shed light on legal hurdles and corruption risks that may arise in Ukraine's post-war reconstruction
The war in Ukraine has brought attention to various issues concerning international law, the law of armed conflict and humanitarian issues. When the time comes to rebuild Ukraine’s damaged infrastructure, there will be a whole new set of legal challenges to consider.
The reconstruction efforts will require substantial international investment, with both international financial institutions and private investors being called upon to fund and undertake these crucial infrastructure projects. Before committing their resources, these investors will carefully assess the risk environment and seek a legally stable framework that is free from corruption.
This article considers some of the challenges international investors may face, taking as an example the ongoing case of a British investor who, for several years, has been seeking to recover damages in the local courts from the City of Kyiv over a public-private partnership infrastructure project.
The problem defined
The Russian invasion obviously represents a pressing and existential threat to the country. However, the enormity of future reconstruction needs should not be underestimated. The World Bank estimates that $135bn will be required to repair the physical damage and $411bn in replacement costs. While much of the funding for this is expected to originate from the private sector, factors such as corruption and unpredictable judiciary could deter risk-sensitive investors.
The German Marshall Fund recently suggested that Western nations should support Ukraine's post-war recovery, but with conditions. Aid would be contingent on tangible progress in combatting judicial corruption, reinstating asset declaration obligations for public officials, and ensuring transparent tracking of recovery funds.
This presents a formidable challenge as Transparency International ranks Ukraine as one of Europe's most corrupt countries, second only to Russia. Moreover, its 2016 report found that 38 per cent of Ukrainian households admitted to paying bribes for essential public services.
Even the legal system is not exempt from these worries. For instance, in May, the Chairman of Ukraine's Supreme Court was arrested on allegations of accepting a multi-million-dollar bribe to influence a case, highlighting how systemic corruption concerns can reach into the administration of justice.
Challenges
Reconstruction also dovetails with the UK government’s policy imperatives of ‘Global Britain’, namely supporting international development and championing the rule of law and democracy. Given the unprecedented and unrivalled level of political, military, and financial support offered by the UK in this time of crisis, it is natural that UK firms and investors should seek to participate in those reconstruction efforts.
However, a perception that corrupt public officials are able to ignore the law and subvert the judicial process may deter foreign investors of all types. British investors may derive a small measure of comfort from a bilateral investment treaty (BIT) concluded between the UK and Ukraine in 1993. The purpose of the BIT is to offer UK investors who invest in Ukraine a broad panoply of international law protections, including an obligation on the last state to afford qualifying investments “fair and equitable treatment”, most favoured nation treatment and protection from expropriation. A claim for the breach of the BIT may be enforced by the investor against Ukraine through international investment arbitration.
It is questionable whether the existence of the BIT has provided the necessary confidence for investors. The amount of outward UK FDI to Ukraine is, according to UK government figures, very slight. In 2021, it was just £4.1bn, a mere 0.2 per cent of the total UK outward FDI stock of £1.8 trillion. As such, there is little evidence of the efficacy of investment treaty protection.
However, evidence indicates that recourse to domestic legal remedies in Ukraine cannot, without reform, offer any kind of realistic protection for foreign investors. This is illustrated by the recent experience of Tamaz Somkhishvili, a British private investor experienced in investing in the UK, European Union, Georgia and Ukraine. Somkhishvili’s example should stand as an instructive warning to UK investors that investment in post-war Ukraine may still carry high levels of commercial risk.
In 2007, Somkhishvili won a public tender to develop a major project for the Kyiv City State Administration (KCSCA) known as “Gates of Kyiv.” The project involved the reconstruction of Kharkiv Square and the construction of a hotel and office complex, intended to be complemented before Ukraine co-hosted the 2012 UEFA European Football Championships. Somkhishvili invested over $14m in the project, while committing to other tasks such as engaging subcontractors for design work.
The KCSA, however, failed to transfer the land timeously or duly fulfil their obligations under the investment agreement. The project was continuously delayed and ultimately cancelled by the city authorities in 2013, resulting in Somkhishvili losing his investment.
Ultimately, Somkhishvili commenced proceedings in the Kyiv courts and initially obtained a partial judgment in his favour for $24.4m. The KCSA appealed and had this judgment overturned, but the Supreme Court decided to remit the issue of damages back to the Court of Appeal. The court process has taken years and may take a few years more. At the time of writing, the case is still in the Court of Appeal.
Despite being a British investor with the intention of aiding Ukraine’s development, Somkhishvili is still waiting for the return of his investment and compensation for his losses. His ongoing battle for justice in the Ukrainian courts has been made difficult by the conflict and what are believed to be attempts by corrupt forces within Ukraine to subvert the administration of justice.
Additionally, Somkhishvili has become the target of an orchestrated and unprecedented smear campaign within Ukraine. Believed to be coordinated by those who profited from the failure of the "Gates of Kyiv" project, this smear campaign is executed by professional "character assassins" employing unscrupulous tactics, clearly aimed at influencing the court proceedings in Ukraine.
Somkhishvili even directly appealed to President Volodymyr Zelensky through an open letter, which he hand-delivered to his office and published online.
Moreover, when an overseas party brings a legal action against a foreign state, resistance is anticipated. In Somkhishvili's case, state authorities attempted to strengthen their position by canceling his residence permit in Ukraine. This action creates significant obstacles for him to achieve justice by enforcing any judgment he might obtain.
Given such a history, overseas investors in Ukraine who find themselves in disputes will be very reluctant to approach the Ukrainian courts. The English High Court may find itself overwhelmed by claims where the claimant argues that the Ukrainian court is forum non conveniens as a result of this perceived injustice.
What is the solution?
There have been notable efforts in Ukraine to combat corruption, with law enforcement activities leading to the dismissal or resignation of 15 government officials in January 2023.
However, more significant reforms are needed is needed to sufficiently assure foreign investors and businesses that their investments will not be dishonestly plundered and expropriated without compensation. The EU’s seven accession conditions Ukraine must achieve to progress with EU membership further emphasised the need to address corruption.
Investment treaty protection needs to be balanced against concerns that have been raised about institutional corruption, including the court system. The inability to obtain expedient justice over cases of flagrant violations of an investor’s rights, as Somkhishvili has experienced, raises questions about the effectiveness and enforcement of international arbitration awards.
Clearly, there is still much work to be done to accelerate the pace of change and reform. As a key ally in Ukraine’s current times of need, the influence of the UK and other Western allies is at its zenith. This is an ideal opportunity to oversee real and effective change to ensure that reconstruction efforts begin when necessary and without delay and to deliver maximum benefit to the people of Ukraine.
Varun Zaiwalla is a barrister and Zuhair Farouki is a solicitor at Zaiwalla & Co
