Since the 2011 ousting of Libyan leader Muammar Gaddafi, foreign investors have been worried about physical and legal security in the new Libya. Some may be tempted to judge the new government’s legal bona fides on the basis of whether it will pay a whopping $935m debt recently incurred by Libya in an international arbitration with a Kuwaiti project developer.

That would be a mistake.

Advertisement

The outcome of that arbitration is so unusual that Libya ought to resist paying the sums awarded by the arbitrators, and instead explore all avenues for appeal.

The controversy arises out of a 2006 contract granted by Libyan tourism authorities to a Kuwaiti conglomerate, Al-Kharafi and Sons, for the construction of a resort complex on the coast of Libya. Through no apparent fault of its own, and much bungling by local officials, the investor was unable to take possession of a leased land plot and commence construction.

After authorities cancelled the contract in 2010, the Kuwaiti firm demanded a modest $5m in compensation for its losses on the venture. When no compensation was forthcoming, the Kuwaiti firm turned to international arbitration. Two of the three arbitrators sided with Al-Kharafi and ruled that Libya was liable for breaching its commitments to the Kuwaiti firm.

But when it came time for arbitrators to calculate damages, the Kuwaiti firm had upped its demands to $2bn dollars in compensation, citing its lost opportunity to turn a profit in Libya over the next 80-plus years.

Generally speaking, international arbitrators are reluctant to compensate investors for future 'lost profits' in cases such as this one where the relevant investment projects is not a 'going concern' with a track-record of profitability.

However, in a surprising March 2013 ruling, two of the three arbitrators decided that the Kuwaiti firm had lost a “real and certain opportunity” to run a profitable enterprise in Libya, and should receive a $900m payment from the Libyan treasury. In their written ruling, arbitrators speculated that their ruling would have a salutary impact on the investment climate in the Arab world.

I beg to differ.

The worrying lesson of the Al-Kharafi arbitration appears to be that an investor that runs into administrative bungling at the very outset of a project – before shovels, much less tourist toes, touch sand – should expect a windfall payment.

If that were the prevailing legal rule, rational governments would close their borders to foreign investments altogether so as to avert the risk of disappointing any incoming investors – and finding themselves saddled with crippling debts arising out of the most embryonic of projects.

Precisely because the Al-Kharafi case is an outlier in the world of arbitration, Libya should fight to appeal the ruling. However, as a sign of good will, and as an acknowledgement of its mistreatment of the Al-Kharafi group, the government should also compensate the Kuwaiti firm for the sums that it put into the early phase of the unrealised project. 

Luke Eric Peterson is the editor of InvestmentArbitrationReporter.com an online reporting service tracking FDI disputes between foreign investors and states.