Foreign Investment in Farmland and Water: 10 Steps for Better Contracts

An impressive body of knowledge now exists on what works and what does not in terms of foreign investment in agriculture generally, and farmland in particular. The previous article in this edition of ITN presented a new study by the World Bank and United Nations Conference on Trade and Development (UNCTAD), which surveyed 39 large-scale agribusinesses in sub-Saharan Africa and South East Asia and their approaches to social, economic and environmental responsibility.[1] While the overall picture shows benefits, particularly in terms of job creation, a number of negative impacts emerged. Most notably over competing land rights, but also badly managed resettlement programs, insufficient consultation with local communities, an absence of proper assessments of environmental impacts, particularly with respect to water, and a lack business planning to ensure profitability. Importantly, many of these negative impacts could have been resolved through better contracts between states and foreign investors. This means better preparations prior to negotiations, improvements in negotiating and drafting contracts, and more robust monitoring and evaluation of projects after the contract is signed.

So what would a better contract look like? The International Institute for Sustainable Development studied seventy contracts between states and foreign investors involving long-term leases of farmland. We have come up with our own model contract that we believe answers many of these concerns. Below are ten steps to follow when drafting a contract from a sustainable development perspective. These are drawn from a more detailed and comprehensive guide to drafting investment contracts.[2]

It is important to note at the outset that where States have the necessary domestic laws and regulations in place, there may be no need for a contract between the state and a foreign investor. Domestic law will govern all issues that may arise in relation to foreign investment, including the issuing of licenses and permits for agricultural operators. However, many states do use investment contracts to lease farmland.

Step 1: Prepare the negotiating environment

This is the precursor to success for any investment project. It involves: (1) identifying the country’s agricultural needs (which areas and crops to prioritize); (2) understanding the economics behind the proposed project (and knowing the value of your natural resources); (3) clarifying the role of domestic law in relation to the contract; and (4) preparing the negotiating team.

In addition, the long-term success of an investment project is closely tied to acceptance by and integration with the local community, as evidenced by the findings from the World Bank-UNCTAD study. This is derived through the process of negotiation and by a sense within the community that their interests are taken seriously. Negotiating teams and investors should have appropriate meetings with the local community to ensure a coherent result that the community supports. It is also important to understand the needs of the investor to be able to respond properly to the negotiating demands.

Step 2: Conduct business feasibility studies

Business feasibility studies principally address the economic and technical viability of the proposed project. But they should also address the key social and environmental factors. Studies should be conducted and verified by an independent third party before the contract is signed. The results of the study will assist the investor in developing its business plan. The study should be presented and approved by the government prior to concluding contract negotiations, and its milestones incorporated into the contract itself.

Research now shows that the failure to properly conceive the project and determine its viability is the main cause of the high failure of agricultural investments. A World Bank survey of 179 projects found that 50 per cent were classified as failures or moderate failures in financial terms because the “concept was fatally flawed, for example wrong location, wrong crop, or over-optimistic planning assumptions.”[3]

Step 3: Conduct impact assessments

In principle, before an investment contract is signed and implemented, an environmental and social impact assessment (ESIA) should take place. The contract can then be revised and adapted based on the findings of the ESIA. The possibility of an ESIA leading to a decision to abandon the project should not be ruled out. In practice, however, ESIAs are often done after the contract is signed but before the investor starts construction and operations.

The investor should use the results of the ESIA to develop an Environmental and Social Management Plan. The investor should not be granted the licenses necessary to start production until these steps are complete. Unfortunately, even when ESIAs are required by law they are often not undertaken.[4] As the World Bank-UNCTAD study reported, investors who did not conduct proper assessments found themselves dealing with costly and time-consuming disputes.

The results of ESIAs and subsequent management plan must be incorporated as legally binding obligations in the contract. The contract should also contain a requirement for annual reporting on the implementation of the management plan, with the reports to be made public and accessible to local communities

Step 4: Allocate land tenure and water rights

Disputes over land are now clearly considered the most problematic aspect of land investments. Where land and water tenure systems are well developed and where those rights are clear and vested in local owners or users, they will be entitled to have a say in how the land and water will be allocated to the investor. The problem is that, in many developing States where investment contracts for agricultural land are being signed, land and water rights are not formally recognized, vague, based on local customs or simply non-existent. The issue of land and water tenure for local owners and users must be clearly identified before the contract is signed, through a combination of land reforms, consultation with local communities, and proper compensation when resettlement is deemed necessary.

Step 5: Determine financial and other incentives

Financial incentives and tax breaks are a common feature of many countries’ investment promotion strategies and often enacted in domestic laws and regulations. Their effectiveness is highly debated, but there is an emerging consensus that few incentives achieve their economic goals despite the fact that they have significant costs to governments. The cost of incentives, in terms of denying developing countries much needed tax revenues, can undermine government efforts to invest in the local economy, in improved access to social services or in environmental conservation. Annual rental payments on land, for example, allow the State to establish a market value on the land that is being leased out and ensure that it becomes productive. This discourages speculative holding of land and water rights.

Step 6: Avoid stabilization provisions

A common demand of investors, particularly in developing countries, is the inclusion of stabilization provisions. These are clauses in investment contracts that freeze domestic laws at the time the contract is signed. The effect is that governments either have to preclude the application of, or compensate investors for, new or changed laws and regulations that affect the investments. Broad stabilization provisions that include all regulatory functions (such as environment, labour, health and safety) are now widely considered to be unacceptable. There is, however, some support for limited stabilization provisions for certain fiscal issues, in order to avoid arbitrary or discriminatory acts by the government. If a narrow tax stabilization clause is included, it should not override or conflict with domestic law, but may form part of the fiscal bargain.

Step 7: Specify the investor’s development obligations

This is the part of the contract where the investor undertakes legally binding commitments to contribute to creating employment, training the local workforce, establishing processing industries, transferring appropriate technology, purchasing local goods and services, and selling part of the production to the local market, among others. The more specific and detailed a contract is on what can be expected from the investor in terms of development contributions, the higher the chance that the project will lead to the expected benefits.

This section can also include a Community Development Agreement (CDA), which creates a framework for engagement between the investor and local community. The CDA might allocate a percentage of profits from the project to a Community Development Fund for a range of economic and social activities, which the community defines. It can also create a framework for ongoing dialogue and discussion with the community in the event of conflict or grievances, and for periodic reviews of the project’s impacts.

Step 8: Identify environmental parameters

It is important to refer to relevant environmental legislation in the contract, particularly domestic water management laws and clear water use and allocation rights for the investor. Where environmental laws are not fully developed or where there are gaps, the contract can temporarily fill the gap, using international standards of practice. This is important because the current global regime of investment treaties and contracts provide foreign investors with legal guarantees, which can include the right to draw water for agricultural purposes. Finally, periodic reviews of water allocation rights will help avoid conflicts with other water users.

Step 9: Choose an appropriate dispute settlement mechanism

From a host state perspective it is advisable to refer to domestic courts, tribunals or mediation centers, as the forum of choice for disputes arising under the contract. International arbitration should not be encouraged over domestic processes. In instances where international arbitration may be necessary, it should be preceded by an effort to settle the dispute amicably first, and through domestic processes prior to international arbitration.

Step 10: Ensure reporting, monitoring and evaluations

Designing the right contract is only the starting point. Implementing the commitments is a much tougher and longer-term challenge, particularly with limited capacity, as is often the case in many developing countries. Setting aside a percentage of the income from the project for implementation issues will help ensure that the government has capacity to monitor and evaluate the project effectively. Setting out clear reporting requirements and indicators in the contract will ensure the government can regularly track whether the investor is fulfilling its commitments. Transparency is a key part of the process.

Conclusion

Investment contracts for farmland operate within a complex legal environment with multiple layers of laws and regulations. Understanding this environment and the relationship between the different sources of law will allow negotiators to draft contracts that create benefits for all stakeholders involved, while remaining compatible with existing legal frameworks at the domestic, regional and international levels. A significant amount of groundwork is needed prior to entering into negotiations. This groundwork is essential for the long-term viability of the project. Finally, operating within an open and transparent environment will minimize the risk of corruption and ensure greater acceptance by those affected.

Author: Carin Smaller is an advisor on agriculture and investment at the International Institute for Sustainable Development.