Varun Zaiwalla and Zuhair Farouki discuss international investor protection and the legal challenges in Ukraine's post-war reconstruction in Solicitors Journal

Varun and Zuhair's article was published in Solicitors Journal, 3 August 2023, and can be found here. 

Ukraine: International investor protection and the legal challenges for reconstruction

The conflict in Ukraine has focused attention on challenges to the international legal order, the law of armed conflict, and humanitarian issues. Looking to the future, and when it comes time to rebuild Ukraine’s damaged infrastructure, there looms legal issues of a different kind, but no less important.

The reconstruction efforts will require massive international investment, both from international financial institutions and private investors, to finance and undertake reconstruction and other infrastructure works. Before doing so, investors will evaluate the risk environment and seek a legally stable framework free from corruption, a problem that has plagued Ukraine in the past.

This article briefly 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 the future reconstruction efforts that will be required should not be underestimated. The World Bank estimates that $135 billion will be required to repair the physical damage and $411 billion in replacement costs^[1]. While much of this funding will need to come from the private sector, corruption, judicial unpredictability, and political indifference or impotence to combat these issues, will be a strong disincentive to risk-sensitive investors.

The German Marshall Fund recently observed that Western powers should only support Ukraine’s multi-billion-dollar post-war recovery subject to a unified strategy to make aid conditional on clear progress on combating judicial corruption, reinstating the obligation on Ukrainian public officials to declare assets, and ensuring that all recovery funds can be properly traced^[2]. This is a formidable challenge. Transparency International ranks Ukraine as one of the most corrupt countries in Europe, second only to Russia^[3], and its 2016 report found that at least 38% of Ukrainian households responded that they paid bribes to access basic public services such as education or healthcare^[4]. These statistics certainly do not inspire investor confidence.

The legal system is not immune from similar concerns. In May, special anti-corruption prosecutors arrested the Chairman of Ukraine’s Supreme Court on allegations that he accepted a multi-million-dollar bribe to influence a case. The allegations are denied, but the arrest of such a high-profile judge only demonstrates how far concerns of systemic corruption may extend, including into the administration of justice.

Challenges facing Western investors

The UK and its allies have been staunch supporters of Ukraine in this conflict. Reconstruction also dovetails with the 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 only natural that UK firms and investors should seek to participate in those reconstruction efforts. However, foreign investors of all kinds will be deterred from investing in Ukraine if there is a perception that corrupt public officials are able to ignore the law and subvert the judicial process.

British investors may derive a small measure of comfort from a bilateral investment treaty concluded between the UK and Ukraine in 1993 (the “BIT”). 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 £4.1 billion, a mere 0.2% of the total UK outward FDI stock of £1.8 trillion^[5]. As such, there is likely to be little experience of protecting UK investors, and little evidence of the efficacy of investment treaty protection.

However, there is evidence to show 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 who has experience in investing in countries such as the UK, European Union countries, his native 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 (“KCSA”), known as “Gates of Kyiv”, a substantial public-private partnership development and infrastructure project which included the reconstruction of Kharkiv Square and the construction of a hotel and office complex. The project was intended to be completed before Ukraine co-hosted the 2012 UEFA European Football Championships. Somkhishvili invested into this project, including by transferring more than $14 million to the KCSA and engaging subcontractors for design work etc.

The KCSA, however, failed to transfer the land timeously or duly fulfil any of their obligations under the investment agreement. The project was continuously delayed and ultimately cancelled by the city authorities in 2013, resulting in Somkhishvili losing all his investment.

Ultimately, Somkhishvili commenced proceedings in the Kyiv courts and initially obtained a partial judgment in his favour for $24.4 million. 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 who sought to help develop Ukraine, 16 years after he first won the tender, 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.

Within Ukraine, Somkhishvili has become the subject of an unprecedented malicious smear campaign that gives every appearance of being well coordinated by those believed to have profited from the demise of the “Gates of Kyiv” project. Executed by professional "character assassins" who are known for their unscrupulous tactics, the smear campaign is clearly timed to influence the court proceedings in Ukraine.

So firm is his conviction in this regard, that Somkhishvili took the extraordinary step of appealing directly to President Volodymyr Zelensky by means of an open letter hand-delivered to the office and published on the internet.^[6]

Furthermore, any overseas party who invokes the courts of a foreign state against that state itself can expect to face resistance. However, in Somkhishvili’s case the state authorities have attempted to strengthen their position by canceling his residence permit in Ukraine, the lack of which will set up significant obstacles to his ability to achieve significant justice by enforcing any judgment he obtains.

It can easily be envisaged that, as a result of a history such as this, overseas investors in Ukraine who do 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 injustice.

What is the solution?

Progress in Ukraine has been made, as measures are being implemented to control corruption. In January 2023, a series of law enforcement activities were carried out, directed at investigating corruption, and succeeding in dismissing or forcing the resignation of 15 government officials^[7].

But much more is needed before the country can sufficiently assure foreign investors and businesses that their investments will not be dishonestly plundered and expropriated without compensation. This sentiment is reflected in the conditions that the EU last year imposed as part of the seven accession conditions Ukraine must achieve to progress with EU membership^[8].

British investors will need to consider the risk environment very carefully. The seeming availability of 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), may suggest high costs and difficulty in enforcing any international arbitration award, even if successful. 

Clearly, there is still much work to be done to accelerate the requisite 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 with a view to delivering maximum benefit to the people of Ukraine.