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Investment opportunities and risk in modern Kurdistan - International Law Office

International Law Office

Company & Commercial - Iraq

Investment opportunities and risk in modern Kurdistan

September 13 2010

Introduction
Historical background
Legal and political background and risk factors
Kurdish laws and regulations
Security background and further risk factors
Comment


Introduction


The area of Northern Iraq under the control of the Kurdistan regional government today enjoys a surprisingly accessible and secure business investment climate. Compared to middle and southern Iraq, the Kurdish area is relatively safe, protected and governed by a general rule of law which owes its genesis to nearly two decades of semi-autonomous rule by the varying Kurdish factions, general natural resources, isolated natural setting and an international vision of the future, with the twin capitols of Erbil and Sulamaniya inter-connected as major Middle Eastern cities and acting as commercial and productivity hubs. Moreover, due to a shared vision of prosperity between ethnic Kurds and a developed security and intelligence system, modern Kurdistan is developing much faster socially and economically than the rest of Iraq. It maintains its own parliament, ministries and international airports and provides an unheralded level of internal security for its inhabitants. Many international corporations are establishing operations in Erbil (the regional capital) instead of Baghdad. Investment opportunities, along with the secure, stable environment, alleviate not only the security threat poised to foreign corporations, but more importantly, the cost of security, which is often prohibitive for many international corporations seeking to conduct business in Iraq.

Historical background

Iraqi Kurds have been recognised politically as a distinct ethnic group in Iraq since the 1920 Treaty of Sevres. This recognition, which includes a right to self-determination, was accepted by the Iraqi government in its statement of May 30 1932 on admission to the League of Nations, and again in the Interim Constitution for the Republic of Iraq issued in 1958, which provides that Arabs and Kurds are partners in the Iraqi state. On March 11 1970 an agreement was reached between the government and the Kurdish leadership which recognised autonomy for the Kurdish people within the boundaries of the Kurdistan region. Despite this, under the leadership of Saddam Hussein, the Iraqi government carried on a campaign of ethnic cleansing and genocide. Throughout this era of Iraq's history, Kurds people were unable to exercise their rights to self-determination and the Kurdish leadership was splintered and ineffective.

With the passing of Security Council Resolution 688 on April 5 1991, which established a safe haven for the Kurds in northern Iraq, Kurdish leadership was able to develop and a degree of self-determination took place. On May 19 1992 the Kurds elected their first parliament, and passed a constitution for the Kurdish Autonomous Region in October of the same year. As the remainder of Iraq continued to suffer under United Nations sanctions imposed following Iraq's invasion of Kuwait in August 1990, autonomous Kurdistan - comprising the provinces of Erbil, Dohuk and Suleimaniyah - enjoyed relative peace and tranquility and began to develop economically and politically. With the downfall of Hussein's regime in April 2003, Kurdistan has essentially a running head start to political and economic development. And while federal Iraq endured a civil war, Kurdistan was relatively economically and politically immune from the uncertainties that befell the rest of the country.

Legal and political background and risk factors

Kurdish political system
Kurdistan is currently the only recognised semi-autonomous region within the new federal republic. According to Article 112 of the 2005 Constitution, "the federal system in the Republic of Iraq is made up of a decentralized capital, regions and governorates, and local administrations". One or more governorates may organise into a region based on a request by either: (i) one-third of the council members of each governorate intending to form a region; or (ii) one-tenth of the voters in each of the governorates intending to form a region.

Presently, Kurdistan has its own constitution and is formally recognised in the Constitution. Article 113 of the federal Constitution provides that it "shall approbate the region of Kurdistan and its existing regional and federal authorities, at the time this constitution comes into force".

Article 137 provides that:

"legislation enacted in the region of Kurdistan since 1992 shall remain in force, and decisions issued by the government of the region of Kurdistan - including court decisions and agreements - shall be considered valid unless it [sic] is amended or annulled pursuant to the laws of the region of Kurdistan by the competent entity in the region, provided that they do not contradict with the constitution."

The Kurdish regional government presently consists of:

  • a legislative authority (the Kurdish National Assembly);
  • an executive authority headed by the president, and comprising a prime minister and a cabinet of ministers; and
  • a judicial authority, made up of the several courts located in the Kurdistan region.

2005 Constitution
Even though its federal capital is in Baghdad, the Kurdish National Assembly has the power to legislate law in Kurdistan (defined as the governorates of Duhok, Erbil and Sulaminya), and the cabinet and several ministers have the authority to put in place appropriate executive regulations and instructions to give effect to laws. These laws are binding to the extent that they do not conflict with federal laws which are issued by parliament in Baghdad. The 2005 Constitution provides for exclusive powers retained by the federal government, shared powers with the regions, and exclusive powers devolved to the regions.

Article 107 of the Constitution enumerates the exclusive powers of the federal government as follows: (i) formulating foreign policy and diplomatic representation; negotiating, signing and ratifying international treaties and agreements; negotiating, signing and ratifying debt policies and formulating sovereign economic and trade policy; and (ii) formulating and executing national security policy, including creating and managing armed forces to secure protection, guarantee the security of Iraq's borders and defend Iraq.

Article 110 of the Constitution provides that the shared authorities between the federal and regional authorities are to administer: (i) customs in coordination with the governments of the regions and governorates that are not organised in a region, and (ii) regulate the main sources of electric energy and its distribution.

Any authority not within the exclusive federal authorities or the shared federal/regional authorities is devolved to the regions exclusively.

Kurdistan investment guarantees
Presently Iraqi foreign investment law, promulgated as Coalition Provisional Authority (CPA) Order 39 in 2003, permits foreign investment in Iraq, including 100% ownership of capital, guarantees against nationalisation and expropriation, and freedom to transfer profits, interest and dividends abroad. Order 39 does not, however, offer any investment incentives and specifically provides that "foreign direct and indirect ownership of the natural resources sector involving primary extraction and initial processing remains prohibited". Order 39 further prohibits foreign investment in real estate (providing only for 40-year leases), banking and insurance. The Kurdish cabinet passed its own foreign investment decrees in 2003 and 2004 with fewer restrictions on investors, greater incentives, but maintaining the prohibition on investment in the natural resources sector. Presently a number of major infrastructure and industrial projects are underway in Kurdistan or already present pursuant to those decrees, including the construction of the first Build Own Operate power plant in the Suleimaniyah governorate, and a $367 million International Finance Corporation-backed cement plant. The Kurdistan National Assembly is currently debating a new broad-reaching foreign investment law for Kurdistan, which is eagerly anticipated by investors as both the security and political climate in the rest of Iraq continues to keep investors wary of large-scale investment.

The Kurdistan Region Investment Promotion Decree (89/2004) replaces Decree 129/2003, which first highlighted Kurdistan as an attractive destination for investment in Iraq. The decree continues the authority of the Kurdistan Region Investment Promotion Board and provides incentives and guarantees to investors.

Among the incentives to investors are:

  • free land grants for strategic projects;
  • land grants at attractive prices for non-strategic projects;
  • exemptions from taxes and duties for five years from the actual entry into production of industrial projects, or opening for business of service industries;
  • import of equipment and vehicles free of duties and taxes; and
  • a three-year exemption on taxes and duties on the importation of raw materials.

Among the guarantees are:

  • 100% foreign ownership of investment capital;
  • guarantees against nationalisation or expropriation; and
  • freedom to transfer abroad profits, interests and dividends from the investment project.

While the Baghdad Ministry of Trade and the rest of the political establishment in greater Iraq places obstacles in the path of investors, fearing that foreign investment and 100% foreign ownership of capital will destroy national industries, the board has been actively promoting Kurdistan as a substantially lower risk investment destination. Despite this, there is still political risk associated with investing in Kurdistan, as at least some of the guarantees provided by the decree are matters that fall within the exclusive authority of the federal government. Without ratification of such investment guarantees by the federal government, foreign investors in Kurdistan may not be able to invest as freely as represented by the Kurdistan regional government. A number of investors have sought to obtain cross-guarantees from the federal government in order to mitigate this risk, with some success.

Kurdish laws and regulations

Kurdistan continues to apply the Iraqi Civil Code, the Commercial Code, the Companies Law and most other Iraqi laws and regulations. Where such laws were amended by the CPA, the laws are in force in Kurdistan as amended. Despite this, there is a lack of transparency as to which laws are in effect in Kurdistan, and particularly as to their application and enforcement. Kurdish laws are not reported in the Iraqi Official Gazette, and obtaining information on the development of laws in Kurdistan is difficult. In some cases, despite the existence of a federal law or regulation on a subject, the Kurdistan regional government has seen fit to legislate further or decree its own laws and regulations, which has the effect of adding burdens on foreign companies operating countrywide.

An example of this is the licensing and operating requirements for private security companies. Despite the existence of federal regulations governing private security companies (CPA Memorandum 17), the Kurdistan regional government has decided to regulate private security companies operating in Kurdistan, rendering federal operating licences ineffective in the region and requiring a double registration, despite the fact that the requirements for registration under the Kurdish regulations mirror those in the CPA memorandum.

As the Iraqi National Assembly is constituted and begins to legislate, observers expect to see greater divergence between federal and regional laws, adding greater uncertainty and risk for investors, particularly those contemplating operations nationwide.

Security background and further risk factors

Despite the lingering presence of coalition military personnel and the rebuilding of the security forces, Iraq - and, to a certain extent, Kurdistan - continues to be one of the most dangerous places in the world to conduct business. Daily attacks of increasing sophistication and variety plague reconstruction efforts all across the country, and investors are advised to proceed with considerable caution. Since the fall of Hussein's regime, Kurdistan has been something of a safe haven, even as security conditions in the rest of Iraq ebbed and flowed. This is principally due to the homogeneity of the region, the effectiveness and loyalty of the Peshmerga and the regional security forces, as well as Kurdistan's geographic remoteness. Kurdish cities such as Suleimaniyah are frequently described by visitors in the same manner one would describe any other country, with freedom of movement, security, reliable electricity and better standards of living.

Presently, a principal concern regarding investment in the Kurdistan region is transportation to and between the major cities. The main airport in Kurdistan is in Erbil, while many investors choose to establish themselves in Suleimaniyah, which is widely considered to be the safest city in Iraq. Perhaps not coincidentally, the American University is located in Suleimaniyah. Kirkuk and Mosul remain dangerous, as do the highways between the major cities in the north. As an increasing number of investors choose to establish themselves in the north, it is conceivable that Kurdistan will become a target of insurgents and terrorists intent on disrupting foreign investment and reconstruction efforts. When insurgents and terrorists have been unable to infiltrate Kurdish population centres, they have been known to stage attacks on main and alternate supply routes between them.

Equipment and materials entering the north by land typically cross the Turkish border at Zakho and proceed south to their destinations. There have been numerous documented incidents at the border crossing, including the theft of oil and tool boxes from equipment, and the 'marking' of convoys carrying important equipment and materials for insurgent and terrorist groups for the purposes of possible attack on the highways.

Given this, before considering work in Kurdistan (as in Iraq in general), it is important to retain a professional, licensed, private security company to carry out an assessment and prepare a security plan to cover all aspects of the operations. This will include movements of people, equipment and materials, secure accommodation provision and emergency assistance. Private security companies typically modify their security posture depending on the area of operation, but this determination should be left to security operatives which have in-depth country knowledge and experience rather than to business managers or principals.

While there are over 100 foreign and Iraqi private security companies in Iraq employing more than 40,000 armed security operatives, less than half of these are licensed in Kurdistan. Security procedures across this industry vary from company to company, and it is important to select a private security company which can provide the kind of protection that the client needs (whether visible high-profile operations, or more discreet low profile arrangements).

Comment

Kurdistan is currently an attractive destination for investors and contractors interested in working in Iraq. With an established government and security force, the Kurdistan region is both safer and more investment friendly than the rest of Iraq. Despite this, there remains considerable political, legal and security risk associated with working in Kurdistan. Political and legal risk predominantly arises out of the potential for conflict between federal Iraqi laws and regional Kurdish laws. As the new Constitution has not yet entered into force, the extent of political and legal risk is not yet clear. The security risk associated with operating in Iraq must be considered before contemplating investment or contracting in Kurdistan. Because risk mitigation in this area is extremely expensive, and because the consequences of poor security are extreme, the services of a licensed, professional private security company should be retained to assist in the evaluation of opportunities in the north before investment.

For further information on this topic please contact Thomas W Donovan at Iraq Law Alliance PLLC by telephone (+964 7 901 919 425), fax (+20 2 760 4593) or email (thomas.donovan@iqilaw.com).


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