It is November 15, 1998. Management is considering a significant investment in oil-rich Venezuela. The Democratic Action Party and Copei (the Republicans and Democrats of Venezuela) have dominated every election in the past 40 years. For the first time, they have united to back a Yale-educated businessman, Henrique Salas Romer.

Sounds promising, right? But, the upstart candidate, former Venezuelan army Col. Hugo Chavez, is leading the polls, even though he spent four years in jail for attempting a coup in 1992. The board wants advice on the political risk of making a substantial Venezuelan investment, not knowing what the election will bring.

It was an isolated event then, but the unforeseen ramifications have turned out to be widespread. What lessons can be learned, now that your board is asking you about Perú, Mexico, Bolivia and Ecuador?

While a senior lawyer at a major U.S. oil company that had a lot of international exposure, a board subcommittee (chaired by an outside director who had been a U.S. ambassador) had to pass judgment on every country where the company was chasing oil and gas plays. Many of our employees had years of hands-on experience in several of the target countries. A full-time political-science professional was on staff, whose job description was political-risk analysis.

The objectivity inherent in talking to outside experts was also valued. They were free from the pressures of corporate culture and politics.

In most companies, assessing political risks of a foreign investment falls to the board, because in many cases, the investment is a "bet the company" risk.

Risks can be substantial: from a black eye for investing in a country using child or convict labor, to failure to make projected returns because of "creeping expropriation," to employees being kidnapped, to the adverse publicity from an NGO (non-governmental organization) that takes issue with some governmental policy but uses your company as a tool in the fight.

Political problems can grab the public spotlight and woe to the executives who did not warn the board about this possibility.

There is another aspect to consider. U.S. securities laws require that ongoing market-risk analysis and advisories be given when soliciting investors and to shareholders with regard to current investments. Even after the investment is made, the process does not cease. However, this is not the cautionary language seen in annual reports, but rather the risk input to be analyzed by the board before it commits to spending money on the investment opportunity.

In most companies, the various departments and divisions propose their list of projects to be considered for next year's budget early in the current year. These are culled by the executive team in the third quarter for submission to the board in the fourth quarter. Ideally, the political-risk analysis has been completed by the time the executive team makes its recommendation, certainly before the projects are submitted to the board for approval.

Political-risk analysis at the investment stage is not solely an exercise in compliance with the Foreign Corrupt Practices Act. It's not an investment banker's off-the-record opinion. It's not a State Department advisory, or a formal legal analysis of a country's laws. It is likely to be a bit of each, and a lot more.

In a recent article, "Hands Across the Water," by former GE senior vice president and general counsel Ben Heineman, published in Corporate Counsel's October 2006 issue, Heineman says, "The person with overall responsibility for integrating public policy and politics into business strategy, short of the business leaders, should be the general counsel."

While unsure as to where this leaves the general counsel on country-risk analysis and advice, normally either the chief executive or the chief financial officer will be involved in selecting advisors and monitoring the process.



Proper risk analysis

Where should a board start? Department of State analyses are fine as far as they go, but those recommendations are more a function of federal policy on which countries the U.S. is supporting in the foreign-policy context, as opposed to an objective analysis that includes looking at business risk. It is very difficult for the U.S. to express full support for a foreign government when the State Department's analysis says an investment there would be crazy.

A proper analysis will be more wide-ranging. This should include former and current members of the U.S. government and the target country's government, banks, commercial companies, and local and international lawyers and accounting firms. The main selection criteria should be hands-on experience in the target country.

Proper political-risk analysis also must be commercial in character and, in the first instance, must address the future risks involved in making an investment. What passes as market analysis only focuses on precedent and statistical data, and is more in the nature of marketing information and not true country-risk analysis.

You cannot put together the right country-risk information from the Internet. These approaches miss the mark and do not provide enough useful data on which a company's leaders and board can base their decisions.

Certainly each company's due-diligence needs will depend on the project (but not necessarily on the size of the investment), the company's goals and appetite for risk, the context of its industry or product, and the target country. The minimum information the board should obtain before moving ahead are the best data, experience and insights available on the following factors.

• Political stability. This is done at all relevant levels from local to national. It is highly subjective and calls for a credible, experienced advisor's analysis.

• Sophistication and reliability of local laws and taxes. Look for cues about stabilization, creeping expropriation and other matters. Sometimes, just the existence of a comprehensive body of law is in question. These questions are often best left to local counsel. Certainly, reliability issues cannot be ascertained merely by reading the law.

• Dispute-resolution options. Often the availability of binding arbitration outside the host country may serve as the only deterrent to governmental miscreance. However, do not discount in-country arbitration as it may be preferable to the courts.

• Ease and ability of repatriating profits. The ability to make a fair profit is key to any business model, but getting the money out safely is often the issue.

• Environmental, NGO and indigenous-people issues. These risks are always newsworthy, and often outside of the company's control. When a promised road or facility is not built by the central government, the local population often turns on those closest at hand, e.g. the oil company working in the immediate area.

• Security issues, such as the risk of kidnapping. If doing business in Colombia in the 1980s and 1990s, it was done under this threat on a daily basis. Little known is that it is against Colombian law to pay a ransom.

• Corruption exposure. This involves more than complying with the Foreign Corrupt Practices Act, as many Third World countries' laws may be quite strict on conflict-of-interest violators. On the other hand, even though these local laws may not be enforced, they can be used by a host government, when needed, to exert pressure on an oil company.

• Ability to affect an exit strategy. This is extremely important. When in doubt, structure the deal with one foot in the host country and one foot across the border. With large capital investments and immovable assets, this is the greatest challenge facing a corporate counsel. The legal team must be creative.

• If project-financed, the risk allocations being proposed by the lender. Today, project-finance lenders no longer automatically assume country risks. Rather, a company must negotiate to allocate risk among it and the lenders.

• Currency restrictions and the ability to maintain capital and security offshore. Many countries restrict use of currencies other than their own and disallow offshore accounts.

• Availability and enforceability of host-government undertakings. When able to get them, they have to be ironclad. Also, is a "comfort letter" really enough?

• Likely consequences of overreaching. This is now being claimed by Venezuela. Heineman says, "In global markets (as in domestic ones), the business rationale must include genuine benefits to the host country or region. This cannot be PR flimflam. In this age of corporate distrust and instant communications, disingenuous posturing will be quickly exposed as such. Special deals that only line a company's pockets are inherently troublesome."

• National partnering. Often the benefits of having a well-known, in-country partner to run interference for the investment far outweigh any downside.

These issues should be addressed by people with hands-on experience and insights. It is preferable to access international and local lawyers who are currently involved, or recently were, with projects in the host country; foreign-service and company personnel who were stationed there or responsible for the area; retired government civil servants and elected officials; or others who may have dealt with the sovereign in question.

It is most important to talk to people who have current contacts on the ground in the target nation, who can feed the analysis with real-time, relevant information.



Stephen Molina is of counsel with Patton Boggs LLP's Dallas office, specializing in domestic and international energy transactions. Previously he was general attorney for Arco Oil and Gas, chief counsel for Arco Latin America and general counsel at Vastar Resources Inc., Benton Oil & Gas Co. and the Oman Oil Co. He is chairman of the international committee for the Interstate Oil & Gas Compact Commission's international-affiliate program.

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