FOREIGN INVESTMENT
Latin America's Uneven Playing Field
December 2011 | Andrés Otero, Miami
Exciting opportunities in Latin America have prompted many foreign firms to invest
at a face pace, often leaving them exposed to potentially costly disputes and legal actions. While the newfound attraction is undeniable, investors need to be aware
of the potential pitfalls.
At a time when the global economy is wracked by uncertainty and volatility, Latin America – led by Brazil – continues to present significant opportunities for investment and growth. The arbitrariness of its legal systems, however, and the lack of independence of the judiciary in several countries continue to be of concern to many investors and corporations operating in the region1. Whether it be a government expropriation of assets of an energy company, a rigged public bidding process, an environmental dispute with an indigenous community, or the alleged corruption of a high-level government official, Latin America continues to raise doubts about transparency, legality, and fairness.
For many decades, investors stood on the sidelines in Latin America because of corruption, political turmoil, lack of competitiveness, poverty and inequality, kidnapping and insecurity, terrorism, and a general lack of trust. This is no longer the case. Many foreign companies, attracted by high commodity prices and expanding local markets, are looking to the region for the first time and liking what they see. International rating agencies have granted investment- grade ratings to several countries in the region, leading to a change of perception and a larger appetite for Latin American risk. Local investment funds, as well as Latin America-based multinational companies, often referred to as multilatinas, have also increased their bets by investing and expanding in neighboring markets.
In addition to producing many of the world’s highly valued food and mineral commodities, Latin American countries are updating and expanding their aging infrastructure, and governments in the region are awarding multi-million dollar contracts and long-term concessions. These opportunities have prompted many international companies to invest at a fast pace, often leaving them exposed to potentially costly disputes and legal actions. While Latin America is undeniably a more attractive business opportunity than it has been in a long time, investors need to be aware of the potential pitfalls.
What many fail to understand fully is that the rule of law in some Latin American countries is a far cry from the international standards of justice that they may be used to in developed markets. In Latin America, they will often be operating on uneven – and potentially hazardous – playing fields. Any litigation may take years to resolve, will be costly, and could potentially impact the company’s global reputation and financial stability.
The main issue is the highly politicized justice system in these countries. Many high courts are composed of political appointees. Magistrates start wearing their robes owing political favors. This leads to intervention by other branches of government in judicial affairs and judgments that can favor politically connected local interests. Some judges can find themselves being pressured by interested parties or negotiating their next political assignment based on the outcome of certain cases. Transparency is often non-existent. In others, court rulings may be made in closed chambers. Under such circumstances, those with fewer connections and less knowledge of how the system operates will be at a distinct disadvantage.
Although this is especially the case in ALBA countries – Venezuela, Ecuador, Bolivia, Nicaragua -- and in most Central American nations, not all countries should be tarred with the same brush. Chile, Colombia, and Brazil, for example, have made strides in strengthening the independence of their judicial systems and higher courts, allowing very limited intervention from their governments. However, given the caudillo mentality of most rulers in Latin America, there remains a constant threat to the order of justice and democracy.
While none of the above will be new to seasoned investors who have been doing business in Latin America for many years, some recent developments have added even more elements of risk for unsuspecting companies.
One example is class action lawsuits against multinational companies, funded by private equity firms. Some lawyers and investors are seeking to replicate the success obtained by the classic “strike suit” law firms in the United States that made billions in product liability litigation. They have targeted large multinational corporations with operations in the less developed world, bringing lawsuits on behalf of local citizens claiming personal environmental injuries, allegedly inflicted by the defendants. In some cases the causes of action have been based on the alleged conduct of predecessor companies acquired by the defendants decades earlier.
Class action fervor in the United States has been quieted to some extent by criminal convictions of lawyers and professional plaintiffs who turned fraudulent schemes into lawsuits against large corporations. However, the concept of piggybacking a contingency award on the backs of alleged mass tort victims has found a new life. In the last few years private equity firms have been created whose main investment specialty has been the funding of such actions. In many cases the founders of these firms have been former litigators themselves.
The firms operate by buying investment stakes in lawsuits. Like the class action law firms, they put up millions of dollars for legal expenses, experts and the other costs of litigation. The contracts they write vary, but essentially the longer the lawsuit goes on, and the more money they put up, the higher their return will be on an eventual judgment.
There is certainly a public benefit to contingency lawsuits. They enable injured people without means to obtain legal redress and compensation for their losses. But lost in the outwardly benign purposes of contingent fees, are those cases where indigenous and community groups who may barely understand the cause of action brought on their behalf, and ultimately may come away with a small fractional share of an award.
Multinational companies face similar challenges with government projects involving public bidding contracts. All too often in several Latin American countries, the player with the closest connections to the project wins. Frequently, the contract award is not based entirely on the lowest bid, the quality of services offered or price. The selection is often made behind closed doors without little if any transparency. This has led to unfinished infrastructure projects, litigation disputes and investigations of corruption. If a frustrated foreign bidder sues a government, the odds of succeeding or even getting a fair hearing in court are uncertain at best. After years of civil litigation a foreign plaintiff may end up seeking recourse in an international arbitration tribunal claiming that it was denied equal justice under bilateral treaty.
There are exceptions to this generalized description. To root out corruption, for example, Brazil and Chile have enacted legislation similar to the United States Foreign Corrupt Practices Act and Britain’s Bribery Act. Other countries, such as Colombia and Peru, are making strong efforts to fight corruption in the public sector and to provide a sound environment for investors. Having said this, the battle against corruption is just beginning and fair play is far from becoming the standard way of doing business in the region. The results of this year’s Global Fraud Survey make this point loud and clear: 70% of companies in Latin America acknowledge that they are vulnerable to corruption and bribery.
Despite the new allure of Latin America as a land of opportunity, in many countries little has been done to address the lack of an impartial system of civil justice. International investors must assess the risks associated with economic opportunities of a country before jumping in. They must also conduct thorough reputational due diligence investigations of their partners and third party agents with whom they plan to do business. Businesses and investors today are excited about Latin America, and there are compelling reasons that support this enthusiasm. Still, they should be aware that structural changes in these attractive markets are long overdue, and that political stability and impartial justice in the region are works in progress.
The Author: Andrés Otero ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ) is a managing director and head of Kroll’s Miami office. He oversees Kroll’s offices in Argentina, Colombia, Mexico and Grenada and manages client relationships in the Andean region, Southern Cone, Central America and the Caribbean.
This article originally appeared in Kroll's 5th annual Global Fraud Report released in October 2011. Click here to download a copy .