Key takeaways
Political risk insurance (PRI) is a specialised form of insurance designed to protect investors and businesses from the risk of loss to their investments as a result of government action. There may be certain circumstances where PRI could respond to loss caused by the imposition of tariffs, export/import restrictions and other similar regulatory measures, although it is unlikely that measures which are general in nature would lead to a successful claim under expropriation cover. In light of the increased use of such regulations as a tool of foreign policy, policyholders should therefore seek to negotiate policy terms with these sorts of measures in mind.
PRI is a specialised form of first-party insurance designed to protect investors from loss to their investments as a result of government conduct. The most common types of cover include: (i) confiscation, expropriation or nationalisation; (ii) forced abandonment (typically after a waiting period); (iii) deprivation (ie loss of use and possession of assets, which also typically applies after a waiting period); (iv) currency inconvertibility; and (v) political violence. It is important to note that PRI is not intended to cover economic or commercial risk. For example, if market conditions were simply to decline, this would typically be excluded under such a policy. PRI coverage is traditionally linked to geographical areas where there has historically been a higher risk of government conduct negatively affecting foreign investments. However, the landscape of political risk is changing, with such risks increasingly emerging in countries considered as reliable investment destinations, prompting businesses to adapt their supply chains and risk mitigation tools accordingly.
Complexity of global supply chains
Supply chains support the efficient flow of goods and services. Disruptions can arise from various factors such as price fluctuations, transportation failures, natural disasters, labour shortages, and, critically, from government conduct.
The international drive towards globalisation of trade of recent history has caused supply chains to grow increasingly complex. This, in turn, makes them vulnerable to disruption, and growing fragmentation of the globalist movement is now placing further strain on them. The result is that insurance has become central to managing these risks. However, not all insurance will adequately address evolving political risk. For example, business interruption insurance is fairly well known, but is typically triggered by physical damage which may not be present when supply chain issues arise from government conduct.
Government conduct that can affect supply chains
In recent times, we have seen governments increasingly employ protectionist economic measures, some of the key ones being tariffs and “counter-tariffs” (ie retaliatory actions taken by foreign governments). For example, on 11 April, China raised its duties on imports of US goods from 84% to 125%, while US tariffs on Chinese imports have ballooned to a 125% reciprocal tariff, a 20% tariff to address the fentanyl crisis, and s 301 tariffs on specific goods, between 7.5% and 100%. Tariffs such as these, paid on a class of imports or exports, add cost to the supply chain by raising the price of goods for either the manufacturer/vendor or recipient.
Similarly, import and export related controls have, in recent years, become a customary tool of foreign policy. These can restrict or place procedures around the supply of goods to or from certain countries. Quotas may also be imposed which constrain trade volumes. These too can impair supply chains.
Recognition of such measures in PRI and international investment law
PRI recognises the concept of “indirect expropriation”. This occurs when government conduct diminishes the value of an investment without a formal seizure of property, effectively depriving the investor of the economic benefits of their investment. However, PRI policies often contain a “regulatory change” exclusion which will exclude cover for loss resulting from non-discriminatory regulation by a host government or similar authority. Other duties, taxes, penalties and fines will also likely be excluded, save where they are the result of an otherwise covered act, ie an act of expropriation.
The challenge for policyholders therefore lies in demonstrating that a specific host government measure imposed amounts to indirect expropriation and/or that such a measure has had a selective and discriminatory impact on their business. Such claims can be challenging, as under international law, expropriation can be lawful if it is for a public purpose and executed on a non-discriminatory basis, in accordance with due process and on payment of prompt, adequate and effective compensation. Investment arbitration practice indicates that legitimate objectives pursuant to which governments remain free to regulate include taxation and the imposition of tariffs. Nevertheless, if a measure such as a tariff or tax is sufficiently restrictive, it could amount to indirect expropriation.
There is a dearth of PRI precedent as disputes are typically resolved through confidential arbitration. However, we can look to past investment arbitral practice to provide some insights into how similar measures have been treated. By way of example, in the case of Pope & Talbot Inc. v Canada (Interim Award, 26 June, 2000), in the context of the North America Free Trade Agreement (NAFTA), the Tribunal found that:
“Indeed, much creeping expropriation could be conducted by regulation, and a blanket exception for regulatory measures would create a gaping loophole in international protections against expropriation.”
For those reasons, the Tribunal rejected Canada's argument that the export control regime it had imposed, as a regulatory measure, was beyond the coverage of Art 1110 of the NAFTA. However, the Tribunal nevertheless did not find “that those regulatory measures constitute an interference with the Investment's business activities substantial enough to be characterized as an expropriation under international law”. Specifically, the Tribunal found that:
“While it may sometimes be uncertain whether a particular interference with business activities amounts to an expropriation, the test is whether the interference is sufficiently restrictive to support a conclusion that the property has been 'taken' from the owner … Indeed, at the hearing, the Investor's Counsel conceded, correctly, that under international law, expropriation requires a 'substantial deprivation'. The Export Control Regime has not restricted the Investment in ways that meet these standards.”
By way of further example, in the case of Marvin Feldman v Mexico (ICSID Case No ARB(AF)/99/1) (Award) (16 December 2002), the investor claimed that the alleged denial of tax rebates on exported cigarettes amounted to indirect expropriation. The Tribunal found that this was not the case on the basis (inter alia) that the Claimant's investment “remains under the complete control of the Claimant”. Of particular interest, the Tribunal articulated in para 103:
“In the past, confiscatory taxation, denial of access to infrastructure or necessary raw materials, imposition of unreasonable regulatory regimes, among others, have been considered to be expropriatory actions. At the same time, governments must be free to act in the broader public interest through … reductions or increase in tariff levels, imposition of zoning restrictions and the like. Reasonable governmental regulation of this type cannot be achieved if any business that is adversely affected may seek compensation … .”
In our view, there may be certain circumstances where PRI cover could respond to the imposition of tariffs and similar regulatory measures. Generally speaking (and subject to the specific policy wording) this may be the case where the policyholder can demonstrate that regulatory action is discriminatory/selective and has a direct adverse impact on their operations. The policyholder may also need to establish that the circumstances surrounding the tariff or regulatory measure are beyond their reasonable control and that the resulting effects significantly hinder their ability to conduct business, leading to a cessation or significant limitation of activities.
It is therefore unlikely that tariffs which are general in nature would lead to a successful claim under a PRI policy's expropriation cover but, in light of the increased use of tariffs as a tool of foreign policy, policyholders should negotiate policy terms with these sorts of measures in mind.
Alternatives to expropriation coverage
In our experience, selective discrimination cover may provide a more fruitful source of coverage in this scenario. It should specifically be noted that whilst the Tribunal in Marvin Feldman v Mexico found that there had been no expropriation, it did find that Mexico had breached its obligations under Art 1102 of the NAFTA, being the right to non-discrimination. Specifically, the Tribunal found that the Claimant had made a prima facie case that it had received differential and less favourable treatment than a domestic export trading company.
Moving beyond tariffs, with respect to export/import restrictions, similar considerations apply when seeking to establish such regulations as an act of expropriation. It is therefore important to consider other potential heads of cover under a PRI policy. Specifically, deprivation of use/possession and/or particular import/export embargo covers can be included and, in our view, are more likely to respond.
Finally, in all cases it is important to understand that traditionally, PRI policies are purchased to protect against the conduct of host state governments. However, with both tariffs and import/export restrictions, we have recently seen that the conduct of home state governments can be as impactful as host state governments. It is therefore important to ensure that any PRI policy that is purchased to help mitigate supply chain disruption is specifically drafted with this in mind.
Next steps
PRI can be a useful tool for mitigating supply chain disruption in an era of geopolitical tension. Businesses must assess their exposure and ensure their insurance coverage evolves with the risk landscape. This will help companies navigate the challenges posed by political instability and safeguard their operations in an uncertain world.
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