The sovereign client.

Buchheit, Lee C.

Sovereign states routinely hire outside (often foreign) advisers on matters of great significance and sensitivity, such as privatization programs, external debt management activities, foreign public relations campaigns and so forth. In the eyes of some observers, this behavior is tantamount to the relinquishing of a sovereign function that ought properly be performed by a government for the government. To others, it is a perfectly sensible response to a sophisticated international marketplace in which sovereign states are treated just like any other commercial actor. Unless the sovereign cultivates the necessary professional expertise among its own officials, or hires it as needed from outside consultants, the sovereign may find itself at a serious disadvantage in its international commercial dealings. This article discusses why sovereign states retain outside advisers, the possible benefits and drawbacks of doing so and the constraints under which such advisers must operate.

Sovereigns as Commercial Actors

Sovereignty is out of fashion. To the extent that the word sovereign connotes complete freedom from external control or constraint, it inappropriately describes states or governments in the last decade of the 20th century. A state's freedom to make war, and the methods by which a war may be prosecuted, are theoretically constrained by various international agreements and principles of public international law.[1] The coercion of other states by non-violent means (sometimes referred to as "economic aggression") may also be inconsistent with norms of international law.[2] Even a state's ability to abuse its own citizens with impunity - long thought to be the last bastion of sovereign prerogative - may in aggravated circumstances give rise to international concern and possibly to intervention.[3] The title of "sovereign state," like that of "Kentucky colonel," should therefore be understood as a flattering misnomer.

The area in which the erosion of sovereign dignity has been most visible is that of international commerce. Until the middle of this century, a sovereign could enter into contracts with foreign counterparties for the sale or purchase of goods or services, or for the borrowing of money, with the comforting knowledge that the counterparties could not enforce those agreements in foreign courts. During this period, most countries recognized an "absolute" theory of sovereign immunity under which sovereigns could not be sued in foreign courts without their consent.[4] Unless the aggrieved counterparty could persuade its own government to apply overt pressure, the counterparty had to content itself with seeking redress through diplomatic means, moral suasion or prayer.[5]

In this century, sovereign participation in international commerce has become commonplace. Indeed, in the state-controlled economies of Eastern Europe and the former Soviet Union, virtually all foreign commerce and finance was conducted in the name of the state. The idea that sovereigns could carry on these essentially private activities under an umbrella of complete immunity from legal process, therefore, gradually lost favor. The alternative was a "restrictive" theory of sovereign immunity, under which foreign sovereigns were denied immunity for commercial activities carried on outside the sovereign's own territory.[6] The United States began to recognize this restrictive approach in 1952, and it was eventually codified in 1976 in the Foreign Sovereign Immunities Act.[7] The United Kingdom adopted similar legislation, the State Immunity Act, in 1978, and most countries now have similar rules.[8]

As a result of these changes, sovereigns can now be held legally accountable for the performance of their commercial contracts with foreign counterparties in the same manner as private parties. If they breach those contracts, judgments may be given against the sovereigns in foreign courts and, subject to certain exceptions, a sovereign's property held abroad may be subject to attachment in order to satisfy such a judgment.[9]

These two factors - the regular appearance of sovereign states (including their agencies and instrumentalities) in international commerce and their ability to be held legally accountable for the performance of commercial contracts - have induced many governments to seek advice from foreign consultants in matters affecting their cross-border trade, financing, investment and external debt management. The advisers may include, among others, investment/merchant bankers, accountants, lawyers, economists, public relations firms, lobbyists, engineers and technical consultants. The projects on which outside consultants may be engaged can involve financial matters (loan agreements, bond issues, privatization programs, asset sales, debt renegotiations and so forth); engineering assistance (such as infrastructure and other construction projects); economic policies; and even legislative/regulatory advice (for example, drafting legislation that regulates domestic securities markets).

Not all governments need to rely on outside advisers to the same extent. Some countries will have large and very sophisticated government departments in charge of activities such as external borrowing (the Kingdom of Sweden comes to mind) or privatization (the United Kingdom is a good example). Less developed countries (LDCs) may not have the same in-house capabilities, and these countries may need to look to outside consultants to fill these gaps. One group of investment bankers, for example, has been described as "an auxiliary civil service on permanent red alert" in recognition of their ability to place a team of trained professionals at the disposal of their LDC clients on short notice.[10] The remainder of this article will discuss principally the role of such outside private-sector advisers to LDC clients.[11]

The Benefits

There are a number of reasons why a sovereign might elect to retain a foreign consultant to assist in the design, negotiation or implementation of a project.

Expertise

Presumably, foreign consultants will be selected principally for their expertise in the relevant area, an expertise built up over time by working on similar projects for other clients in other parts of the world. In many cases, it simply would not be possible for the government's own personnel to replicate this breadth of experience. Government officials will often spend their careers working for a single employer - the government - whereas outside consultants will have many clients, allowing them to develop a first-hand familiarity with different techniques in different settings.[12]

Information

A government embarking on an important cross-border project such as raising capital, privatizing state-owned enterprises or selling assets will have a great thirst for market information. How much, the government may ask, should we expect to pay or to charge? What is the market reputation of the counterparty? What kinds of covenants or indemnities are common? Are there alternative methods or places of borrowing, buying or selling that will be more advantageous to the government?

Foreign consulting firms are often the only source for current market information of this kind. Many of these firms devote considerable resources toward the tasks of researching, compiling and analyzing raw data in order to give their clients instant access to comparative information that will permit a client to evaluate the commercial attractiveness of proposals that it receives or makes. Occassionally, it is possible for a sovereign to obtain some of this information from multilateral financial institutions or development organizations, but those entities typically collect and analyze information in an historical context. They do not purport to follow market developments on a current, hour-by-hour basis.

Presence

A consultant such as a law firm or financial adviser may provide the sovereign with a convenient base of operations in the place where the other parties to the project reside. Communication is often funneled through the adviser, particularly if telephone and postal communication within the sovereign's own jurisdiction is difficult.

Credibility

There is no doubt that the name of a world-class financial, legal or technical consultant can give the sovereign and the project instant credibility in the eyes of prospective counterparties and their advisers. Consultants are well aware that professional reputation is one important reason why sovereign clients engage them for these assignments, and they take great care to preserve their reputations. Counterparties often take considerable comfort from the presence of a high-caliber adviser on the sovereign's side of the table, and this can facilitate the project and reduce its overall cost.[13]

In certain circumstances, the consultant will be expected to render a formal opinion or certification as part of the transaction. Legal opinions regarding the valid and binding nature of the sovereign's obligations, for example, are customary in financing contracts governed by foreign law.[14] Investment banks are sometimes called upon to render "fairness opinions" in certain types of merger and acquisition transactions, and accountants may be asked to reconcile (and certify) local financial statements with internationally accepted accounting principles. Counterparties in certain types of transactions will rountinely require such opinions from the outside advisers to the government. The desire of the counterparties to establish an adequate "due diligence" record is part of the motivation for this; the other part is a belief that an outside adviser familiar with market practices and foreign legal/accounting standards will be able to explain to its sovereign client the basis for procedural or documentary requests that the counterparty may make during the course of the transaction.

Cross-cultural issues

Cross-cultural differences can place invisible barriers between parties to a commercial negotiation. It is not just a question of language. Negotiating styles and business expectations may differ significantly from country to country.[15] Even the nuances of body language, acceptable vocabulary, seating arrangements and appropriate after-hours entertainment are matters on which the foreign consultant may be able to offer some behind-the-scenes counseling. One objective in rendering this advice is to ensure that the recipient of a proposal or argument understands the matter in the same way as the party that is making the proposal or argument. Another is to avoid giving unintentional offence or misleading the counterparty as a result of culturally influenced behavior patterns.

Training

Many sovereign clients view the employment of outside advisers as an opportunity to familiarize their in-house professionals with international practices and documentation in the relevant area. The objective, over time, is to wean the government from the use of outside consultants, particularly on routine matters, by honing the skills of the government's own employees. Some outside professional advisers are willing to conduct formal training seminars for government personnel or to accept government officials into internships with the foreign consultants' offices.(16) These requests are usually welcomed by the foreign consulting firms because they tend to cement and expand client relations. The most stable client relationships are ones in which the client believes that it is receiving good value for its money. It is therefore safer for the consultant to assist the client in developing the in-house capacity to deal with more routine assignments and to present itself as the one to call when highly specialized expertise is required.

Political Cover

If subjected to domestic political criticism over a commercial decision, government officials frequently find it useful to be able to say that the decision was taken in accordance with the advice of an outside professional consultant. There are natural limits to this cover: No government official wants to give the impression that important decisions affecting the country or its economy have been delegated entirely to foreign consultants. However, sometimes the recommendations of such a consultant can be helpful in deflecting charges of undue influence, inadequate investigation or incompetence in the area concerned.

Advice that originates from an outside consultant should not be influenced by domestic political pressures within the client's country. Indeed, this is an important reason why sovereigns solicit advice from foreign professionals.(17) Even if the same level of professional competence could be found in the private sector within the client's country, there may be a concern that a local adviser inevitably will be associated with one or another domestic political camp.(18)

The Costs

A sovereign considering the retention of outside advisers must consider the following costs.

Fees

A matter of great concern to government clients (and most other clients for that matter) is fees. World-class consultants are expensive. These organizations hire the best professionals in their respective fields, spend large amounts of money on training and equipment (computers, word processing, telecommunications, etc.) and lease office space in some of the most expensive cities in the world. All of this has one single purpose - to provide clients with an extremely high standard of professional assistance - but it eventually translates into fee structures that some clients find daunting. Naturally, selected engagements may be accepted on a less-than-normal fee basis (for example, in order to break into a new practice area), but no world-class finn will survive as such if it routinely accepts unremunerative assignments or dilutes the professionalism of its work product to match a low level of expected remuneration.

Two factors make fee arrangements with sovereign clients different from those with private clients, and they both relate indirectly to politics. First, professionals who charge $300 an hour for their time may sound like a bargain in New York, London or Paris, but it doesn't necessarily play that way in Ruritania where per capita annual income might be less than $1,000. Second, the unfortunate government official who must explain the fee of an outside consultant to a group of hostile local legislators will soon find how difficult it is to prove the negative. The official may find himself saying things like, "But for the presence of these advisers, the project would have cost more to negotiate," or "But for them, we would not have been able to negotiate such favorable terms," or "But for them, we might have made a costly mistake in the design or implementation of the project." Although these statements may be perfectly true, it usually is not possible to quantify savings that result from mistakes that were not made.

Undue Reliance

A principal danger for a government in contracting out all important professional assignments involving foreign counterparties is that the government's own personnel may not receive needed training and experience in these areas. It is obviously preferable for the government ministries to have individuals on their staffs who are skilled in such tasks and to rely on outside consultants only in special circumstances. However, talented government employees may leave government service for the private sector if they believe that this is the only way to participate actively in challenging professional assignments. Given the usual pay disparities between the public and private sectors, this risk of a brain drain out of the government is always present, and it can be exacerbated by a government's heavy reliance on outside consultants for important projects.

Buffer

A consultant may advise its sovereign client behind the scenes, or the consultant may be used as the spokesperson for the client in direct negotiations with third parties. In this latter role, consultants occasionally attract the ire of commercial counterparties, who argue that the interposition of the consultant between the government and the other parties to the transaction can erode the counterparties' confidence in the government's own commitment to the project.(19)

Political Criticism

As noted above, it is important that at all times the sovereign client keep control over important decisions on which outside advice has been sought. If a particular decision turns out badly, or turns out right but nevertheless attracts politically motivated criticism, it is far better for the government to say that it made the decision based on a recommendation from a consultant than to say that the government abdicated its decisionmaking authority in favor of a foreigner, however talented or renowned that foreigner may be.(20)

The very presence of a foreign adviser in a project such as a highly visible privatization may raise some nationalistic hackles. It can be portrayed by the opposition as anything ranging from neo-colonialism to a demonstration of the government's low regard for locally trained professionals to an admission by the government of the professional shortcomings of its own officers. Perhaps the preeminent target of this sort of criticism has been the International Monetary Fund (IMF) - an organization that routinely dispenses advice and criticism about economic matters to its member countries. However, when that advice is reflected in "performance targets" in an IMF economic stabilization and adjustment program, local residents may turn against both the advice and the adviser if the prescribed policies begin to erode living standards.(21)

The Constraints

In some respects, sovereign clients are similar to the corporate clients of outside financial or legal advisers; in other respects they are quite different. The basic professional relationship, however, is the same.(22) The adviser performs services as and when requested. The client retains the ultimate decision-making authority; the adviser merely advises. Legal commitments to third parties are made by the client. For example, a financial adviser, acting in that capacity alone, does not guarantee the commercial obligations of its clients.

Nevertheless, important differences between corporate clients and sovereign clients are visible throughout the professional relationship.

Selection

Corporate clients usually select their financial or legal advisers based on a combination of expertise, reputation and price. Of these, price is often not the conclusive factor for a corporate client with a significant project. One can always find lower-cost providers of a service. Corporate officers, however, do not relish the prospect of explaining to the management, the board of directors or the stockholders that a major project went awry as a result of a desire to economize on the fees of outside advisers.

In contrast, sovereign clients are frequently required to follow procurement procedures when engaging outside professional advisers in the same manner as they do for the acquisition of goods or non-professional services. These procedures may call for public invitations to tender sealed bidding arrangements and so forth. If the retention of professional advisers is treated as a procurement exercise, the fee structures of the bidding firms may take on much greater significance. In the end it comes down to this: expertise, skill and judgment are in some measure subjective factors, but the numerals that appear next to a price quotation convey the impression of being an objective standard.

Engagements

These same government procurement policies may specify that the outside consultant's engagement be reduced to a written contract, even if none is customary in the industry. Lawyers, for example, often do not have written service agreements with their regular corporate clients, the rationale being that a lawyer's services may be discontinued by the client at any time and for any reason. A sovereign client, because it acts in a quasi-fiduciary capacity for public funds, frequently will ask that the terms of a professional engagement be memorialized in a contract.

Political Defensibility

The most pervasive difference between corporate and sovereign clients is the political environment within which the latter must operate. In many countries, the actions of government officials are subject to the formal oversight authority of legislative bodies and the informal oversight function of the domestic press. The existence of a political opposition in the country may mean that certain people have a vested interest in publicizing the real or alleged shortcomings of the incumbent administration. In practical terms, government officials - particularly when they are carrying out projects that have some commercial component - must do so with one eye firmly fixed on the political defensibility of their actions. Whether the objective is to embarrass the incumbent administration or to sell the evening newspaper, criticism directed at government officials is frequently merciless and sometimes outright malicious.

The sovereign client's need for political defensibility can have a strong influence on the outside adviser's performance of its assignment. Every adviser to sovereign clients at one time or another will watch a client make an apparently illogical decision, if the boundaries of logic are limited simply to orthodox financial or legal considerations. The missing premise needed to understand most of these decisions is politics. Take, for example, the situation of a central bank governor with a large component of floating rate external debt, or an energy minister who needs to avoid fluctuations in the price of oil imports. The conventional remedy to these problems would be some sort of hedging transaction in which the floating rate debt is effectively transformed into a fixed rate obligation or the price of oil is assured for a specified period. The difficulty with every hedging arrangement, however, is that at the transaction's maturity it is very easy to see which side won or lost the bet. It may not matter that the strategy was sound, the motives pure and the execution flawless. If the government wound up paying more for the debt or for the oil than it would have had no hedging been arranged, the government official responsible for the decision to hedge may be called upon to explain the action to a group of skeptical critics.

A government official who looks forward to a long career in public service and a secure pension may therefore adopt the Italian adage si non fa, non falla (if one does nothing, one does not make mistakes). Decisions may be made (or, very often, not made) based on a desire to minimize political exposure. Opportunities may be foregone due to fears on the part of individual government officials that allegations of impropriety or incompetence will be leveled against them. In short, a sovereign client is occasionally prone to self-inflicted wounds in a variety of contexts for reasons that may not be immediately apparent. An outside adviser who does not appreciate this dimension of a sovereign client's behavior will age very quickly with frustration.

A government's desire for "transparency" in transactions involving private counterparties may become the deciding factor in how the transaction is structured. In the privatization of a state-owned enterprise, for example, the government may have to choose between privatizing by auction, negotiating sale of the company or publicly floating the shares of the enterprise. Of these methods, a negotiated sale obviously invites criticism by the suspicious-minded. Some countries have decided to abandon that method of privatization, largely because it is susceptible to allegations of impropriety and undue influence.(23)

Once the government has decided upon a transaction or a program, the outside adviser may be expected to preserve, protect and defend that action against both the government's domestic and foreign critics. This may require assisting the government in the preparation of press releases, presentations to the legislature or public relations campaigns.(24) It is not at all unusual for professional advisers sitting in London, New York or elsewhere to draft speeches destined to be given by Ruritanian ministers on Ruritanian television to the Ruritanian citizenry.

Conclusion

Retaining outside advisers to assist a government in aspects of its cross-border commercial dealings can yield important benefits to the sovereign client. Indeed, given the complexity and sophistication of many international business transactions, a government may have little choice but to hire the professional assistance it requires from the private sector. The principal drawbacks to retaining such advisers are cost and political exposure. The first of these can be addressed, at least in part, by focusing the consultant's mission at the outset of the engagement. This avoids time-consuming - and inevitably costly - meandering by the consultant through various tasks in search of its own job description.

As for the domestic political implications of a government resort to foreign advisers on a sensitive project, these will of course vary from country to country and perhaps from project to project within the same country. If the government is awake to the possibility of a politically motivated challenge to the involvement of an outside consultant, however, the consultant's assignment can be tailored to minimize this risk, and the positive features of engaging an outside adviser (professionalism, impartiality and market reputation) can be emphasized before the government is put on the defensive about the matter.

Resorting to outside advisers is presumably something sovereign clients would only do if they felt they had no other practical alternative. That it is now done with such frequency and in so many areas of commercial activity is therefore the most compelling evidence of the need for these services. To refrain from hiring needed outside professional assistance on the grounds that this may demean or impair the sovereignty of the government client suggests a notion of sovereignty that would have been familiar to Louis XIV but to very few people after him. The potential cost to the country of not obtaining the professional assistance it requires when entering the international marketplace far outweighs any bruises that this may inflict on some metaphysical notion of sovereignty. (1) See generally, Sydney Bailey, Prohibitions and Restraints in War (London: Oxford University Press, 1972). (2) See Richard Lillich, ed., Economic Coercion and the New International Economic Order (Charlottesville, VA: The Michie Company, 1976) chapters 1-6. (3) See Ian Brownlie, Principles of Public International Law, 2nd ed. (Oxford: Clarendon Press, 1973) pp. 547-58. (4) D.P. O'Connell, International Law, Vol. 2 (London: Stevens & Sons Limited, 1965) pp. 916-7. (5) For a detailed discussion of the potential remedies available to holders of defaulted sovereign bonds, see Edwin Borchard, State Insolvency and Foreign Bondholders, Vol. I (New Haven: Yale University Press, 1951) pp. 157-273. (6) See Christoph Schreuer, State Immunity: Some Recent Developments (Cambridge: Grotius Publications Limited, 1988) pp. 10-43. (7) See Department of State Bulletin, 26 (23 June 1952) p. 984. See also, William Bishop, "New United States Policy Limiting Sovereign Immunity," American Journal of International Law, 47, no. 93 (1953); Pub. L. No. 94-583, codified at 28 U.S.C. [section] 1330, 1332(a), 1391(f), 1441(d), 1602-1611. (8) The State immunity Act of 1978 is reprinted in Michael Gordon, Foreign State Immunity in Commercial Transactions (Salem, NH: Butterworth Legal Publishers, 1991) appendix C. (9) See generally, Joseph Dellapenna, Suing foreign sovereigns and their corporations (Washington, DC: Bureau of National Affairs, 1988) chapters 6 and 11. (10) Peter Koenig, "Country Advice: Tales of the Troika," Institutional Investor (March 1983) p. 369. (11) Advice is also available from the public sector. Multilateral institutions such as the World Bank and the International Monetary Fund, for example, provide a considerable amount of economic advice and training to their member countries. See Richard Goode and Andrew Kamarck, "The International Monetary Fund and the World Bank," in The Role of the Economist in Government, ed. Joseph Pechman (New York: New York University Press, 1989) pp. 231, 234-5. (12) Christine Bogdanowicz-Bindert, "The Role of Financial Advisors in Bank Debt Reschedulings," Columbia Journal of Transnational Law, 23 (1984) pp. 49, 51. (13) See Christopher Stoakes, "Sovereign Debt: The Lawyer and Rescheduling," Euromoney (October 1984) pp. 275, 277. (14) Christopher Stoakes, "The Risks and Benefits of Advising Sovereign Clients," International Financial Law Review, 3, no. 3 (March 1984) pp. 10, 13-14. (15) See David Victor, "Cross-Cultural Awareness," in The ABA Guide to International Business Negotiations: A Comparison of Cross-Cultural Issues and Successful Approaches, ed. James Silkenat and Jeffrey Aresty (United States: American Bar Association, 1994) pp. 15-22. (16) Cindy Collins, "Foreign Internship Programs: Mutually Beneficial for Intern and Law Firm," Lawyer Hiring and Training Report, 14 (August 1994) p. 1. (17) Anthony Sampson, The Money Lenders (New York: Penguin Books, 1981) p. 274. (18) This sword has two edges. An adviser that has the virtue of being above the political fray may have the defect of not being sufficiently familiar with the local political constraints on the government client. To reduce this risk, many large accounting, investment banking and law firms that specialize in country advisory work try to maintain a close familiarity with political and economic developments affecting their sovereign clients. (19) See Koenig, "Country Advice," p. 372, for a discussion of the hostile reaction of certain commercial bank creditors to the debtors' use of investment banking advisers in the context of sovereign debt restructurings. (20) Lauchlin Currie, The Role of Economic Advisers in Developing Countries (Westport, CT: Greenwood Press, 1981) p. 189-91. (21) See Lindley Clark, "The IMF Helps to Make the Debt Problem Worse," Wall Street Journal, 27 September 1983, p. 35; Anthony Spaeth, "IMF Austerity Affects Lives of Most Filipinos," Wall Street Journal, 19 December 1984, p. 32. (22) It is not unusual for clients to form long-term relationships with investment banks, accounting firms or law firms. Over time, the outside advisers in these situations gain a close familiarity with the client's business, history, objectives and commercial practices. Indeed, some of the client's institutional memory may well reside in its outside advisers. As the client hires new staff, the outside advisers with whom they work are expected (in a discrete way, of course) to ensure that the client's policies and ethical standards are being maintained in a consistent manner. (23) See Virginia Marsh, "Hungary Acts to Accelerate Privatization," Financial Times, 5 October 1994, p. 2. (24) See Andrew Cao and Mark Grader, "Advisors & Middlemen, Shaping the Privatization Process in Latin America," in Privatization in Latin America, a Latin Finance Supplement (March 1994) p. 38.