Cuba’s Proposed Law on Expropriation
Cuba proposed in March a new law (the “Proposed Law”) establishing procedures for expropriating private activity for public need and social benefit. This Proposed Law describes itself as a supplement to the provisions of the foreign investment law (Ley 118), relating to expropriation under the country’s foreign investment regimen and generally providing procedural guarantees and property protections to those forcefully expropriated.
In addition, the Proposed Law purports to implement Article 58, paragraphs 2 and 3 of the Constitution of Cuba adopted in 2019 (the “New Constitution”) by establishing the basis for determining a public need and social benefit, appropriate guarantees, and a procedure for expropriation and indemnification.
It is no doubt an advance that a process has been developed to deal with aspects of the expropriation of private property, such as defining what is an expropriation, establishing jurisdiction in the courts for hearing disputes, and establishing when an expropriation is allowable, and providing for compensation. In order to attract foreign direct investment to a country with a history of expropriations without compensation, the State has focused on new legislation that would clarify what property rights could be expropriated in the future and under what terms.
However, there are numerous features of the Proposed Law that could potentially undercut future economic development and freeze out foreign capital.
Who Can Initiate?
The Proposed Law authorizes various governmental entities to initiate and carry out an expropriation:
- The Council of Ministers or its Executive Committee;
- The chief of the organisms of the Central Administration;
- A provincial governor;
- The Council of Municipal Administration; and
- The directors for the special development zones, such as the Mariel Development Zone.
It is conceivable that a given property or private activity could be simultaneously subject to expropriation by a number of different administrative or regulatory bodies, as any of these persons or bodies may determine that it is needed for a public or social benefit. The Proposed Law does not address how priority is determined among the entities in terms of a conflicting expropriations and how the property owner can defend against competing bodies.
Who Will Approve?
The Proposed Law gives Cuba’s courts jurisdiction to adjudicate the process of expropriation. While providing for adjudication in the courts is an advancement over prior legislation, most foreign investors may continue to be leery of Cuban courts, as they would not consider the judges “independent” as that term is understood under the standards of most developed economies. For example, in the U.S., federal court judges are appointed for life in order to insulate them from interference from other governmental bodies. In many European countries, judges are civil servants who may not be fired except under very limited circumstances. In contrast, judges in Cuba report to the legislature and in certain instances the legislature can overrule their decisions.
When seeking to invest in a foreign nation, the company making the investment is sure to take into account the risk of expropriation and whether it can protect its property and contract rights under the local courts from expropriation by the State. Courts that report to another governmental entity and could be overruled by that entity would be viewed by the foreign investor as a risk factor. A bilateral investment treaty between Cuba and the company’s home country would ameliorate these concerns, but Cuba does not have such treaties in effect with most of the developed economy countries.
Criteria for Legality of the Expropriation
The key question under the Proposed Law is what is a “public need” or a “social benefit”? What is the criteria that the court will use in determining whether the expropriation meets the legal requirements?
The Proposed Law has a series of broad definitions for the terms “public need” and “social benefit”, so that those terms would include most of the activities that in a market system would fall within the private sector.
For example, Article 17 of the Proposed Law deems construction of schools, public health buildings, and infrastructure to be a public service. Of course, in market systems public schools, most health buildings and most roads are owned by the government and they all exist to provide a public service. However, their construction is typically contracted out to the private sector. Similarly, many administrative activities for hospitals are contracted to private sector entities that carry out those activities more efficiently and at reduced cost. By designating these activities as a whole as potential objects of expropriation, the Proposed Law goes well beyond the criteria for allowable expropriations in developed economy countries.
A plain reading of the language suggests that the government would be entitled, for example, through the expropriation process, to all of the funds invested by a private contractor and its machinery and equipment regardless of whether the project construction has been completed and the private contractor has been paid. Similarly, it seems the government could expropriate software provided by a private vendor and used in hospital administration, as the Proposed Law covers all activities providing public services as a subject of potential expropriation.
The Proposed Law also designates as a public need or social good the goods and activities necessary to produce consumer goods. Does this mean that the small and medium enterprises who manage to attract foreign capital to produce those goods for local and national consumption could at any time lose their properties and investment? Foreign capital is sure to be wary of this provision when considering funding a small business in Cuba.
There is, though, an even greater concern in the Proposed Law for the entrepreneurs in Cuba who are innovating and producing new products that could be patented at home and then abroad, generating foreign revenues for the country. It provides that title to the patent could be required to pass to the government if it makes the determination that it is a public need or a social good. Would anyone want to patent anything in Cuba with that cloud hanging over the invention? Foreign investors would not want to finance development of the invention if the patent could be so easily lost.
By means of contrast, in the U.S., the government, for example, may “expropriate” a patent under a very limited set of circumstances.
- First, under the Bayh-Dole Act of 1980, if the government has directly (or indirectly through significant financial contributions to a university) financed the research that resulted in the invention and the patent is not used by the patent holder, the government has “march in” rights and can force the patent holder to license the patent to a responsible applicant at a reasonable price. To date, the government has never enforced this right.
- Second, under § 1498 of the U.S. Federal Code, the U.S. government has a right to the non-exclusive use of patents owned by others without permission but only on the payment of just compensation.
In other words, the government may not take possession of a patent and deny the owner the right to use the patent. This is so as not to interfere with property rights, thereby discouraging private capital from investing in innovations for fear of expropriation, as innovation is a key driver of economic development.
In order to exercise its right of expropriation to meet a public need or provide a social benefit, the Proposed Law could do the following: Instead of providing the list of examples in Article 17 that raise more questions than provide clarity, the Proposed Law could include a standard that would be applied by the courts to determine whether an expropriation is proper. Such a standard could read as follows:
"Public need means an activity or project that provides important tangible and intangible gains to society that could not otherwise be obtained and that satisfies the expressed or observed needs of the public where the accrued benefits significantly outweigh reasonably foreseeable detriments of expropriation."
A standard of this kind could provide flexibility in the variety of circumstances in which any government will need to expropriate private property as conditions change, such as by rezoning real estate, building infrastructure and addressing public health.
What is Just Compensation?
The Proposed Law provides for just compensation. Article VI describes various ways that just compensation can be measured, including an agreed-upon amount, direct out of pocket costs and consequential damages:
- Including the diminution in value of the part of the asset that is not taken;
- Costs of transport; and
- Damages from the temporary interruption of commercial activity.
Hypothetical damages are not covered, which is consistent with most jurisdictions in the world. It is not clear however, whether an investor could receive the expected future returns from owning the property. In other words, it is unclear whether the owner is entitled to the property’s market value, since it is the expected revenue stream to be generated from the use of the property that makes other private actors willing to pay for the property and hence give it its market value.
As if the provisions discussed above do not give the government sufficient leverage against private capital, Article VIII of the Proposed Law gives the government power to expropriate at any time, without due process, if it deems there exists a national calamity or that it is necessary for civil order.
It is hard to imagine when a national calamity would require seizing property outright. First, a property owner would normally lend its property for the government to address a national calamity, which would affect everyone, including the property owner. Moreover, the government could declare a national emergency, use private property during the emergency, and thereafter compensate the property owner for the damages incurred by the government use. What national emergency would require immediate and permanent expropriation of private property? In wartime, presumably a declaration of war would be all that would be needed to support the government action.
These emergency expropriation powers of Article VIII also appear to contravene Article 94 of the New Constitution, which guarantees all persons due process of law and access to an independent tribunal. An emergency taking of title to the property indefinitely would seem to violate the constitutional protection of Article 94.
The Proposed Law reflects a fear that private capital will somehow take over the country’s economy. However, the government’s response has been to tip the balance so much in its favor and against the private capital that it risks greatly disincentivizing investment from abroad.
Extractive industries, such as oil and minerals, have ways to protect themselves from the risk of expropriation by the way they structure their contractual arrangements so as to minimize their actual capital investment. They also manage the risk of expropriation by obtaining third party insurance or guarantees and adjust the price they charge for their investment accordingly to cover the cost of the risk mitigation features.
Cuba needs foreign direct investment in almost all areas of its economy - investment capital that is truly put at risk - without the costly mitigation tools used by the extractive industries. However, the Proposed Law, as currently conceived, is unlikely to be attractive to foreign capital. Cubans abroad will likely continue to provide modest remittances to their friends and family in Cuba to start up enterprises. Significant investors of capital will likely wait until bilateral investment treaties are executed by their nations and Cuba, which will provide protections akin to what they expect domestically in developed market economies.