D. No procedural issues.

There are no procedural issues that require discussion in connection with this claim
determination.

E. The Investor has complied with its duties under the Contract.

By finding no validity to the Claim, we need not address whether the Investors have
complied with their duties under the Contract, including, but not limited, to adequate notice to OPIC
of a potential claim for expropriation coverage.

V. Conclusion

Based upon the foregoing determinations, OPIC finds that the Claim lacks validity and that
the Insured is not entitled to compensation.

OVERSEAS PRIVATE INVESTMENT CORPORATION

By: (Hh S { J, ae

Peter S. Watson

Its: President and Chief Executive Officer

Date: i2[2]04

20


In the circumstances of this case, KPMG determined in its forensic audit of the Foreign
Enterprise seven months earlier that such equity required a negative adjustment of $6.5 million, not
only to adjust the Foreign Enterprise’s balance sheet at September 30, 2000 for the $1.6 million in
funds stolen from the Foreign Enterprise, but also for bad loans in the amount of $3.1 million,
inadequately secured collateral in the amount of $1.4 million and other overvalued capital assets of
the Foreign Enterprise in the amount of $400,000. These amounts when viewed in light of the
allegations put forward by the GCC Report confirm the independent assessment of the EBRD that
not only fraud and misappropriation dissipated the Foreign Enterprise, but also poor management
and inadequate financial controls. In our view, their relative magnitudes suggest the latter more than
the former. In any case, such findings call into question the reliability of all of the balance sheets of
the Foreign Enterprise previously prepared by its management, confirmed by its auditors, and
submitted by the Insured for our review. As the Insured has observed, even from the inception of the
business, the mismanagement and fraud began to occur. Moreover, audits conducted by the
Insured’s legal counsel as well as the findings of the GCC Report indicate that the Investors knew or
should have known of the proliferation of mismanagement and fraudulent activity as early as
November 1998. Section II at 1. The Insured suggests that it was unaware of such activity until
August 2000, which only further calls into question the quality of management prevalent in the
Foreign Enterprise.

In addition, the aforementioned actions were reasonable regulatory actions taken by the NBG
pursuant to its authority to regulate the banking sector of Georgia.

When the government takes over an institution . . . , it does not appropriate for itself
such value as may be in the institution; rather, it seeks to preserve that value by
forestalling dissipation of it by improvident (or fraudulent) management. It is true
that the government seeks to preserve the value of the institution and its assets for the
benefit of the depositors in the first instance and not for the benefit of the owners
except as [to] lower-priority claimants. But that does not mean that anything has
been taken away from the owners. They know that the depositors’ claim on the value
of the institution is prior to theirs, and that value in the institution must be applied
first to make the depositors whole. '*

The Georgian government’s failure to prosecute the culpable personnel did not directly
deprive the U.S. Investors of their fundamental rights to the insured investment; it was the culpable
personnel who caused the U.S. Investors to lose the insured investment. The Foreign Enterprise
remained a going concern even after the full scope of the fraud was discovered and assessed, and
was positioned to survive such losses with the financial support and encouragement of the NBG, had
the U.S. Investors been able and willing to participate in a recapitalization of the Foreign Enterprise
in order for it to meet the minimum capital requirements of the NBG. Even if the culpable
individuals had been prosecuted, it does not follow that a successful prosecution would have led to
recovery of the Foreign Enterprise’s losses. For such recovery to occur, the Foreign Enterprise
and/or the U.S. Investors would have had to file a suit for civil damages, prevail in the suit and
collect, and there is nothing in the Claim to suggest that they took such action.

* Curtis, id., at 381.

14


temporary administrator. However, an alternative proposal by the EBRD was adopted: the EBRD
would arrange for an emergency forensic audit to be conducted by KPMG - and the NBG would
allow the Foreign Enterprise to access its statutory deposits, to draw on a standby liquidity line of $1
million, and to grant temporary relief from its mandatory reserve requirements - so that the Foreign
Enterprise could continue to operate while the investigation into wrongdoing at the bank went
forward.

On September 27, 2000, the Interior Affairs Ministry opened a criminal investigation on the
misappropriation of $1,017,862 from the Foreign Enterprise by Mr. Mourgulia (see Interior Affairs
Ministry Decision, at 1).

On October 16, 2000, the U.S. Investors, represented by Messrs. Lloyd and DiBenedetto, met
with the EBRD, Mr. Farmer and KPMG in London to discuss the findings of the KPMG audit. At
the meeting, KPMG related that liquidity in the Foreign Enterprise was lacking and that therefore its
financial position was tenuous. In fact, KPMG’s forensic audit revealed a capital deficit of
approximately $5 million (see Bank Assessment Memorandum, Tab 18). The EBRD said it might
be willing to help recapitalize if the U.S. Investors took decisive action, but at this point it believed
that the best action was to merge with a strong Georgian bank.

The parties present at the meeting also discussed the ongoing theft and fraud investigation.
They recognized that any recoveries would depend on clear and vigorous support by the Georgian
authorities. Mr. Lloyd followed with a letter to the NBG dated October 25, 2000 indicating that he
and the other U.S. Investors were not impressed with the actions of the Georgian government to such
date in bringing those responsible for fraud to justice, especially since, in their view, recovery would
have increased the capital of the Foreign Enterprise and improved its capital ratios.

The U.S. Investors failed to develop a timely recovery plan pursuant to the KPMG
recommendations. In his October 25 letter, Mr. Lloyd expressed gratitude for the extension and
offer of cooperation by the NBG to the Foreign Enterprise but informed the NBG of the inability of
the U.S. Investors to put additional capital in the Foreign Enterprise. Mr. Farmer expressed the view
at the time that many Western regulators would have already taken action against an institution in
similar financial straits. However, he remained hopeful that a turnaround would be possible,
pending recapitalization and notwithstanding certain elements of the KPMG report.

On or about November 13, 2000, the EBRD took the position that the NBG should place the
Foreign Enterprise under a regime of temporary administration in the interest of ensuring fairness
and transparency in Georgia’s banking system. The EBRD expressed its concern to the NBG that
any future plan regarding the Foreign Enterprise would have to recognize that its equity no longer
had any value. In its view, even if the bank remained open to maximize recoveries, the probability
was high that the Foreign Enterprise would still fail, with those depositors who withdrew earlier
unfairly gaining preference over those who withdrew later. By late November 2000, the EBRD had
concluded that Foreign Enterprise had been the victim of mismanagement and internal fraud and that
its own loan and equity investments were unrecoverable.

However, the NBG appeared to take a different view, expressing confidence in the ability of
the new management team of the Foreign Enterprise and the belief that remaining open under this


Because the former argument is well documented and supported by the record, and the
alternative argument lacks any compelling evidentiary basis, it is most likely that unreasonable
actions of stockholders and officials such as Messrs. Shanidze and Mourgulia were the preponderant
cause of the failure of the Foreign Enterprise. Thus the provocation exclusion pursuant to Section
4.03(a) of the amended Contract applies and the Insured’s claim would not be payable even if the
requirements of Section 4.01 of the Contract were deemed fulfilled.

b. The unreasonable actions are attributable to the Investor and would be the
preponderant cause of the purported expropriation.

The Investor acted unreasonably through the negligent administration of its duties as the
controlling shareholders of the Foreign Enterprise and thereby created the circumstances for the
subsequent chain of illegal actions and mismanagement that ultimately led to the insolvency and
liquidation of the Foreign Enterprise. For example, the GCC Report alleged that consulting
payments purportedly made to law firms and other entities affiliated with certain U.S. shareholders”
were veiled dividends, and that it was the policy of the Foreign Enterprise not to pay out dividends
to any of the shareholders at that time. Furthermore, the GCC Report found that Mr. Leigh Durland
instituted a change in the credit extension policy that was never approved by the Supervisory Board
of the Foreign Enterprise. No General Meeting of Shareholders was convened from 1995 to 1996,
and no financial statements were submitted for its approval from 1996 to 1998. Finally, the Insured
knew or should have known that the Internal Affairs Ministry placed the Foreign Enterprise under
investigation in November 1998. However, the Insured took no immediate action in response to the
investigation.

The negligent mismanagement directly led to the permissive environment in which certain
senior managers of the Foreign Enterprise and other shareholders defrauded and mismanaged the
institution to the point of insolvency. Therefore, it may be concluded that negligent actions
attributable to the Investor provoked the failure and liquidation of the Foreign Enterprise. The
Insured’s claim thus would not be payable under the Contract in even if the requirements of Section
4.01 of the Contract were deemed fulfilled.

2. Organizational Defects.

Section 4.03(c) of the amended Contract, as amended by section 10.04 of the same, also
provides that no compensation for expropriation shall be payable if . . . “(c) the action is taken as a
consequence of the failure of the foreign enterprise to comply with the organizational requirements
of the foreign goveming authority.” The minimum capital requirement is a fundamental
organizational requirement, because it promotes the safety and soundness of the financial sector.“
Indeed, upon the Foreign Enterprise’s formation and as a condition precedent to its registration by
the NBG, it was necessary for the shareholders to capitalize the Foreign Enterprise in an amount
sufficient to qualify as a bank or other financial institution subject to the NBG’s regulation. It was

3 Although the GCC Report does not clearly associate a specific U.S. shareholder to any of these purported affiliates, it
identifies them as Armlender & Associates, Baker & Botts, Befinance Security, Casey Inc., Hahn & Hessen, and Junction
Investors.

>4 Malloy, Michael, “Colloquium: Can 10b-5 for the Banks? The Effect of An Antifraud Rule on the Regulation of Banks,”
Fordham Law Review, May 1993: 61 Fordham L. Rev. 23.

18


unless such act or acts are reasonable regulatory actions taken by Georgian governing authorities
pursuant to their regulatory oversight of the financial sector.

1. The acts constituting total expropriation are attributable to_a foreign governing
authority which is in de facto control of the part of the country in which the project is
located.

The placement by the NBG of the Foreign Enterprise under temporary administration prima
facie fixed the date of the taking of effective control over the U.S. Investors’ insured investment in
Absolute Bank. See March 26, 2001 Letter from Mr. Lloyd (forwarding to OPIC a copy of the
NBG’s notice to the Investors of its decision to place the Foreign Enterprise under temporary
administration and to put the U.S. Foreign Enterprise effectively out of business). This act led to a
series of subsequent actions by the NBG and its temporary administrator, Mr. Nozadze, namely, to
conduct an audit of the Foreign Enterprise’s books, to determine that the Foreign Enterprise was
insolvent, to transfer the assets and liabilities of the Foreign Enterprise to Cartu, and ultimately to
liquidate the Foreign Enterprise. All of these actions demonstrate that the National Bank of Georgia
was in effective control of the U.S. Investors’ insured investment in the Foreign Enterprise.
Furthermore, because it has exclusive authority for regulating the banking sector in Georgia, the
actions demonstrate that the NBG was in de facto control of the area where the Foreign Enterprise
was located. Therefore, the actions alleged to constitute the total expropriation of the Foreign
Enterprise are attributable to a foreign governing authority that is in de facto control of the part of
the country in which the project is located.

The Insured suggests that the NBG was party to a criminal conspiracy with various other
Georgian governing authorities and former officials of the Foreign Enterprise from the very
beginning of the Foreign Enterprise’s formation. That is, the Insured alleges that the aforementioned
individuals conspired to expropriate the U.S. Investors’ insured investment in the Foreign Enterprise,
and provides in support a statement of its former president, Mr. Farmer, that (1) prior to his
administration, Foreign Enterprise personnel had bribed NBG personnel in the form of fictitious
loans made to entities related to or associated with such NBG personnel in exchange for high,
uneamed, undeserved and falsified CAMEL ratings, and (2) the NBG had debited approximately
$300,000 from the Foreign Enterprise’s account and transferred such sum to the Finance Ministry in
response to a purportedly fraudulent court order showing judgment against the Foreign Enterprise in
favor of the Finance Ministry. I] at 1-2. Even if the Insured had submitted incontrovertible proof of
the NBG’s actions or complicity therein, none of these actions was sufficient on its own, or together,
to cause the Foreign Enterprise to fail and lead inevitably to its insolvency and the decision of the
NBG to take over its administration and eventually liquidate the investment. As the record before us
amply demonstrates, the Foreign Enterprise was grossly mismanaged and its resources plundered by
former officials of the Foreign Enterprise well before the NBG was forced to take the decision to
place the Foreign Enterprise under temporary administration.

The Insured further claims that the failure of Georgian governing authorities to pursue and
prosecute the culpable former officials of the Foreign Enterprise inevitably led to the Foreign
Enterprise’s insolvency and the NBG’s decision to take over administration of the Foreign
Enterprise. However, even if the Interior Affairs Ministry took these actions and secured the return
of the approximately $1.6 million in stolen funds, the Foreign Enterprise would have still been

10


Irakli Managadze, President, NBG, to Louis Lloyd, Belfinance, dated March 20, 2001). The U.S.
Investors failed to comply with this demand (apparently making an additional investment of
$262,000 only), and on March 23, 2001, pursuant to Decree No. 77, the NBG appointed Levan
Nozadze temporary administrator of the Foreign Enterprise. On March 26, 2001, the President of
NBG notified Mr. Lloyd and the U.S. shareholders about the takeover. The following day the NBG
announced publicly that the Foreign Enterprise was under temporary administration because certain
shareholders and managers had failed to repay or recover $4 million in bad loans and that
approximately $1.2 million was embezzled from the Foreign Enterprise.* It stressed that neither the
US. Investors nor the current administration took part in any wrongdoing.

On the day he was notified of the takeover, Mr. Lloyd again wrote OPIC and forwarded a
copy of the NBG’s notification and Decree No. 77. In his letter of March 26, 2001, Mr. Lloyd stated
that the U.S. Investors had made an additional investment of $262,000 a few months earlier with the
promise by the Georgian government that the individuals who were guilty of fraud would be brought
to justice and the $1.5 million they had stolen would be returned. However, the Internal Affairs
Ministry allegedly engaged in delaying tactics in order to extract bribes, according to Mr. Lloyd, and
the U.S. Investors likewise received no cooperation from any government official in this matter.

By letter dated March 29, 2001, OPIC acknowledged receipt of Mr. Lloyd’s March 26, 2001
letter and referred to its initial response to Mr. Lloyd of November 21, 2000. OPIC confirmed its
understanding that the Insured intended to file a claim, explaining, however, that a claim for business
income loss under a related contract of insurance (No. E336) could only be made in conjunction with
a claim for political violence and concluding that it was unclear how the events described in Mr.
Lloyd’s letters of November 16, 2000 and March 26, 2001 would amount to an act of political
violence. In the March 29" letter, OPIC reminded the Insured that on November 7, 2000 it had been
faxed information on how to present a claim to OPIC, including under the Contract. In their
correspondence with one another, a claim for expropriation was neither alleged by the Insured, nor
understood by OPIC.

On April 17, 2001, the NBG’s temporary administrator assigned the Foreign Enterprise’s
assets and liabilities to Cartu Bank, pursuant to Article 59.1(a) of the National Bank Law. On this
same day, Mr. Farmer expressed concern to the NBG and its U.S. Agency for International
Development (U.S. AID) advisors that a neutral party did not attest to the financial condition of the
Foreign Enterprise as a basis for the sale of its assets to a third party. Mr. Farmer explained that
these developments were contrary to the agreement that had been reached three weeks earlier that an
audit was necessary at least before the transfer of ownership, in order to properly attest to balance
sheet values and thereby provide some defense against future claims by the existing shareholders.
The NBG agreed to comply.

According to the NBG, upon the appointment of the temporary administrator, Mr. Nozadze
proceeded to conduct an inventory of the Foreign Enterprise’s assets and liabilities and to seek out
an acceptable investor to acquire substantially all of such assets and liabilities (i.c., except an
unidentified loan). The NBG has represented to OPIC that such actions were not only authorized
under Article 34 of the Law of Georgia on the Activities of Commercial Banks, but also consistent

5 “NBG Temporary Administration Proceeded to Work in Absolute Bank,” Black Sea Press, dated March 27, 2001.


new leadership was the best way to recover loans and protect depositors. In the NBG’s view, the
Foreign Enterprise was an important player in the country’s banking system because of its reputation
as one of the better banks in Georgia, owing to its Western shareholding and management.

On November 16, 2000, Mr. Lloyd wrote a letter to OPIC for the purpose of notifying it that
the U.S. shareholders were intending to pursue some action against the EBRD and the government
of Georgia because the Foreign Enterprise had been “subjected to massive fraud, political
intervention (summarily revoking provisions in the original banking license), failure to pursue the
fraud and corruption that has taken place by the [Internal Affairs Ministry] and the local police,
failure to monitor properly the fraudulent activities of other parties who were representing certain
government officials, fraud on the part of the EBRD in administering and supervising a loan
program, and failure of the local U.S. authorities in keeping the U.S. shareholders apprised of the
massive amount of corruption which exists at every level of business and government.” He did not
allege that any of these difficulties amounted to an expropriatory event, nor did he claim that the
Insured’s investment had been expropriated.* Instead, Mr. Lloyd indicated that the Insured would
need time to compile all of the necessary information to support an unspecified claim. He
specifically mentioned his coverage for loss of business income and the fact that the U.S. Investors
were experiencing such losses (see letter from Belfinance Haussmann to OPIC, dated November 16,
2000).

On December 4, 2000, the NBG decided to issue a cease and desist order, creating a regime
whereby the Foreign Enterprise came under the authority of the NBG. On February 9, 2001, Mr.
Lloyd met with the President of the NBG in London, where it was made clear that a recapitalization
plan had to be presented by the end of the month or the NBG would appoint a temporary
administrator to control the Foreign Enterprise. The deadline subsequently passed without the
presentation of any plan from the U.S. Investors and the other shareholders. In looking back over
this period, the NBG observed that it had worked with the Foreign Enterprise and its principal
officers and sponsors (i.e., Messrs. Lloyd and Farmer as well as a Mr. David Mapley) as it attempted
to identify additional sources of investment, but noted that the current shareholders could or would
not step forward to recapitalize the Foreign Enterprise and that no other proposed investors were
willing to make any investment commitments.

On March 16, 2001, Mr. Lloyd communicated by letter with President Eduard Shevardnadze,
informing the President that no progress had been seen after six months of investigation and no
charges had been brought against the culpable individuals. He expressed the belief that the alleged
perpetrators of the crimes against the Foreign Enterprise were manipulating Georgian governmental
and judicial authorities in order to avoid the consequences of past actions and to cover up at all costs
the problems caused by theft and false accounting. Mr. Lloyd made these allegations apparently
unaware of the Interior Ministry’s ongoing criminal investigation of Mr. Mougulia.

On March 20, 2001, the NBG notified the U.S. Investors of its intent to transfer the Foreign
Enterprise into temporary administration immediately in order “to minimize the Foreign Enterprise’s
impact on the remaining commercial banks operating in Georgia,” unless the Foreign Enterprise
could produce a signed and unconditional letter of intent by an investor or group of investors to
invest $5 million in cash in the Foreign Enterprise by March 21, 2001 (see Letter No. 522/06 from

“Tt also appears that Mr. Lloyd was unaware of the ongoing criminal investigation of Mr. Mourgulia.


therefore necessary to comply with this requirement at the creation of this financial institution. In
addition to the initial minimum capital requirement, financial sector regulators require that adequate
amounts of capital be maintained after the inception of the institution; the amount required changes
with the needs of the financial sector. Such flexibility underlies the fact that “regulatory emphasis
on continuing capital adequacy requirements appears to provide a more effective method of
monitoring the safety and soundness of depository institutions [than minimum capital requirements
upon formation],””> and by extension, the financial sector.

In the Republic of Georgia, the NBG is empowered to establish for commercial banks the
minimum amounts of subscribed and paid in capital stock and establish rules for the creation of
unimpaired capital and reserves.”° The NBG can also revoke the banking license of a bank that fails
to comply with the minimum amount of capital and reserves required by regulation of the NBG.”
Here, the Foreign Enterprise met the minimum capital requirement established by the NBG at its
inception, evidenced by the successful registration of the Foreign Enterprise on January 27, 1994.
However, it failed — despite repeated opportunities — to comply with the requirement as it evolved.
As a result, the Foreign Enterprise became insolvent, was placed under temporary administration,
and eventually was liquidated by the NBG. Had the Insured or other shareholders been willing or
able to recapitalize the Foreign Enterprise in compliance with the minimum continuing capital
requirements, it is unlikely that the Foreign Enterprise would have been placed under temporary
administration and ultimately liquidated. Therefore, liquidation of the Foreign Enterprise by the
NBG is explained in large part by the failure of the Foreign Enterprise to comply with the
organizational requirements of the foreign governing authority. Consequently, the Insured’s Claim
would not be payable as it would be excluded pursuant to the provisions of section 4.03 of the
amended Contract even if the requirements of Section 4.01 of the Contract were deemed fulfilled.

Cc. Amount of Compensation.

We note that the Insured has (i) failed to claim any amount of compensation, as it was
required to do under Section 8.01 of the Contract, as amended; (ii) failed to provide financial
statements for the period when the date of the purported expropriatory event was likely to have
occurred; (iii) none of the financial statements provided by the Insured was prepared in accordance
with U.S. generally accepted accounting principles; and (iv) no adjustments were made to the most
recent financial statement, as required under Section 5.03 of the Contract, notwithstanding the
findings of the KPMG forensic audit.

Under Section 1.06 of the Contract, the aggregate amount of compensation available to the
Insured in the event of a finding of full expropriation is limited to the active amount of coverage.
This active amount was originally established by the parties to the Contract at $1,710,000, but was
reduced at the Insured’s election, to $1,244,000, effective June 19, 1999, and then to $500,000,
effective June 19, 2000. However, because we find no validity to the Claim, the Insured is not
entitled to such compensation, and the aforementioned deficiencies in its Claim are moot.

Id. at 42.
26 art 9, Commercial Banking Law of the Republic of Georgia.
?7 art. 6(1)(c), Commercial Banking Law.

19


difficulties it was facing in completing this effort. Mr. Lloyd also alleged that the NBG had
improperly and illegally seized approximately $300,000 from the Foreign Enterprise during a legal
dispute between the Foreign Enterprise and the Ministry of Finance (the “Finance Ministry”).
Furthermore, Mr. Lloyd expressed the belief that the Foreign Enterprise could have avoided a default
if the governmental authorities had simply pursued the culpable individuals.

By letter, dated April 1, 2002, OPIC replied that - notwithstanding the contents of his letter -
Mr. Lloyd did not explain why such events substantiated a claim for expropriation nor did he
provide any supporting evidence. In addition, OPIC informed Mr. Lloyd that he had failed to
explain why or how all of Article VIII of the Contract was satisfied, that the information furnished
thus far was insufficient to support an expropriation claim, and that OPIC was unable to determine
whether an extension to file an expropriation claim was appropriate or necessary. In his reply dated
April 2, 2002, Mr. Lloyd reaffirmed the intent of the Insured to file a claim according to our format
and to file a claim for expropriation, political violence, or both. He also challenged the application
of our six-month deadline rules for filing a valid claim given the difficulties of assembling the
necessary information to support such claim.

As noted above, the Insured filed the Claim on or about October 16, 2002. By letter dated
April 18, 2003, OPIC informed the Insured that on the basis of the information supplied to date, it
was unable to establish the validity of the Claim and that it would have to deny the Claim within
sixty days thereof unless the Insured was able to supply additional information. By letter dated June
14, 2003, counsel for the Insured claimed to take issue with every premise and conclusion of our
preliminary determination and accepted our invitation to meet personally for an in-depth discussion
of the issues. OPIC representatives met with Mr. Lloyd and the Insured’s counsel to discuss the
Claim, and agreed, inter alia, to work together to develop additional information necessary to
establish and process the Claim.

To this end, OPIC obtained letters of authorization in October 2003 from the Insured to
obtain information and other documents bearing on the Claim from the EBRD and KPMG, and
through December 2003, established the terms by which such organizations would be willing and
able to share such information. Also, in late October 2003, OPIC further investigated the Insured’s
Claim by meeting with various officials and individuals with knowledge of the Foreign Enterprise’s
business and demise described at the outset of this Memorandum, and by reviewing files made
available to us. As a result, OPIC understands that, since the events described in the Insured’s
Claim, the Foreign Enterprise has been liquidated.

Wl. Determinations Under the Contract

A. The actions taken by Georgian governing authorities in relation to the U.S.

Investors’ insured investment in Absolute Bank do not constitute total expropriation
within the meaning of the Contract.

Article IV of the Contract determines the scope of expropriation coverage. It provides, in
Section 4.01 and as modified by Section 10.02, that compensation is payable for total expropriation,
subject to certain exclusions and limitations, if an act or series of acts satisfies four requirements,


Expropriation Claim of Belfinance Haussmann, L.L.C.
Georgia ~ Contract of Insurance No. E307

I The Claim

By cover letter dated October 16, 2002, with attachments at Tabs 1-34, (1) Belfinance
Haussmann, L.L.C., (2) Financial Management Associates, L.L.C., (3) Econo Capital Investments,
L.L.C., and (4) Beffen Brothers, L.L.C. (collectively, the “U.S. Investors” or the “Insured”) filed
with OPIC a claim (the “Claim”) for the total expropriation of its investment made in a joint venture
company, The Stock Company Absolute Bank (Absolute Bank) (the “Foreign Enterprise”). Louis
B. Lloyd has represented to OPIC that he is authorized to act on behalf of Belfinance and the other
U.S. investors as President of Belfinance and otherwise through one or more powers of. attomey.

OPIC finds that the Insured has failed to establish the validity of its claim that Georgian
governmental authorities committed violations of international law that deprived the Insured of
fundamental rights in its investment insured under the above-referenced contract (the “Contract”).

IL. Statement of Facts

In January 1994, the Foreign Enterprise was registered with, and issued a general license by,
the National Bank of Georgia (the “NBG”) to conduct an array of banking services in the Republic
of Georgia. Nodar Dzhavakishvili, Chairman of the NBG, was the NBG official responsible for
registering the Foreign Enterprise.? The then President of the Republic of Georgia, Eduard
Shevardnadze, also granted the Foreign Enterprise the right to act as the official financial agent of
the Republic of Georgia.

A group of U.S. investors organized by Mr. Georgi Shanidze was assigned a majority interest
(57%) in the Foreign Enterprise in December 1994. In addition, the Foreign Enterprise was
authorized by the shareholders to place an additional 10,000 shares representing 25% of its
authorized capital with a strategic investor such as the European Bank for Reconstruction and
Development (the “EBRD”).

’ The Claim does not purport to set forth a statement of facts and OPIC does not accept the Insured’s Claim as a statement of
facts. At the same time, OPIC has no reason to believe that the attachments to the Insured’s Claim are unreliable, and, to the
extent they are quoted from and relied upon herein, OPIC accepts them. However, OPIC does not believe that the Claim and
the attachments thereto present a complete and undistorted basis upon which to make its determinations. Consequently,
OPIC has developed additional sources of information from its files on this matter as well as its contacts with and
information from the U.S. State Department in Washington, DC, as well as the U.S. Embassy, the U.S. Agency for
International Development, and the National Bank of Georgia, each in Toilisi, Georgia, With the encouragement and
permission of the Insured, OPIC developed additional information from its contacts with and/or review of files of
PriceWaterhouseCoopers and the European Bank for Reconstruction and Development in London, United Kingdom.

? Mr. Dzhavakishvili later served as a consultant to the Georgian Consulting Company (GCC), a privately held company and
owner of a minority interest in the Foreign Enterprise since December 1994. Mr. Dzhavakishvili was not affiliated with the
NBG at the time of the GCC Report described below.


takings (for the most part). The circumstances of insolvency necessitate a
readjustment of private rights in order to distribute loss of economic value fairly, as
well as other socially desirable purposes. The government may undertake such
readjustment without violating the takings clause . . . Regulatory disposition of
financially troubled banks . . . is an exercise of the bankruptcy power . . . [T]hey are
subject to regulatory regimes administered by specialized agencies, which among
other responsibilities, supervise the reorganization or liquidation of banks . . . that
became insolvent. . . [T]he regulatory structure applicable to depository institutions
recognizes priority claims in cases of insolvency . . . Depositors take priority over
owners. A substantial part of the general regulatory effort with respect to depository
institutions is directed towards preserving an institution’s value for the benefit of its
depositors. |?

The NBG’s decisions to take control of the Foreign Enterprise - to transfer its assets and
liabilities to a third party in the interests of protecting depositors, and to avoid instability in the
banking sector of Georgia — were necessitated by a public purpose. The NBG is the sole institution
responsible for protecting the interests of local depositors and ensuring stability in the banking sector
of Georgia. When notifying the U.S. Investors of its intent to place the Foreign Enterprise under
temporary administration, the NBG explained that it was planning to take this action in order to
minimize the Foreign Enterprise’s impact on the remaining commercial banks operating in Georgia.
Section II at 5. Indeed, the NBG had resisted taking such action eight months earlier when it became
clear that protection of the interests of local depositors might have required it. Instead, the NBG
made a credit line available to the Foreign Enterprise and permitted it to access its capital reserve
account at the NBG Bank. This was essentially a drawn-out effort by the NBG to help stabilize the
Foreign Enterprise and avoid any negative impacts on the Georgian banking sector and on the
interests of local depositors of the Foreign Enterprise. It cannot fairly be alleged that the NBG took
measures against the Foreign Enterprise in a capricious or precipitous fashion. In fact, their initial
actions were quite lenient and carried out in an apparent effort to facilitate the Foreign Enterprise’s
attempts to stabilize its operations. The regulatory actions of the NBG thus served a public purpose.

“One test suggested for determining whether regulation programs are intended to achieve
expropriation is whether they are applied only to alien enterprises,”"? Even before the NBG’s
actions with respect to the Foreign Enterprise and certainly thereafter, many banks in Georgia had
been taken over and liquidated for failure to observe the NBG’s minimum capital reserve
requirements, without regard to whether they were foreign-owned. Section II at 6. “A challenged
regulation might be compared with the practice of major legal systems; the fact that a given
regulation is supported . . . by an international agency to guide . . . behavior . . . may be seen as
evidence of its legitimacy.”'* Indeed, the NBG was encouraged not only by the EBRD, but also by
the International Monetary Fund and other multilateral institutions to strengthen the banking sector
by shutting down insolvent banks, as well as increasing minimum capital reserve requirements going
forward. Section ILA at 3, 4. “A State is not responsible for loss of property or for other economic
disadvantage resulting from . . . any other action that is commonly accepted as within the police

" ©, Curtis, The Takings Clause and Regulatory Takeovers of Banks and Thrifts, 27 Harv. J. on Legis. 367, at 371-72 (1990).
3 The Restatement of the Law, Third, The Foreign Relations Law of the United States, section 712, Reporters’ Note 6, at
211.

"Id. at 212.

12


insolvent with a capital deficit of nearly $5 million as determined by KPMG. In such circumstances,
it would have been irresponsible for the NBG to continue to resist the imperative of placing the
Foreign Enterprise under temporary administration. In fact, in a memorandum to the EBRD dated
November 9, 2000, Mr. Farmer himself admitted that Western regulatory counterparts of the NBG
likely would have already taken action against the Foreign Enterprise.’ However, the NBG appeared
willing to defer temporary administration to allow the Foreign Enterprise ample time to recover until
it became clear that the U.S. Investors were unwilling or unable to provide the Foreign Enterprise
with additional capital. Moreover, most of the allegations of a widespread government conspiracy to
defraud the Investors largely rely on undocumented statements by the Insured, and to date cannot
otherwise be substantiated. For example, there is nothing-in the record to suggest that the NBG
discouraged the Internal Affairs Ministry from pursuing and prosecuting culpable government
officials or that the NBG or any of its officials benefited by the Internal Affairs Ministry’s decision
not to prosecute.

2. The acts are violations of international law (without regard to the availability of local

remedies) or material breaches of local law unless the acts are reasonable regulatory

actions taken by Georgian governing authorities pursuant to their regulatory
oversight of the financial sector.

“A state is responsible under international Jaw for injury resulting from (1) a taking by the
state of the property of a national of another state that (a) is not for a public purpose, or (b) is
discriminatory, or (c) is not accompanied by provision for just compensation.”® In each of these
circumstances, international Jaw provides that the compensation must be paid. However, “a state is
not responsible for loss of property or for other economic disadvantage resulting from bona fide
general taxation, regulation, forfeiture for crime, or other action of the kind that is commonly
accepted as within the police powers of the state, if it is not discriminatory.”!° Thus, “Tijt is often
necessary to determine, in the light of all of the circumstances, whether an action by a state
constitutes a taking and requires compensation under international law, or is a police power
regulation . . . that does not give rise to an obligation to compensate even though a foreign national
suffers loss as a consequence.”!!

When a state takeover of an insolvent depository institution is directed towards preserving
such institution’s value for the benefit of its depositors, it is presumptively an action within the
state’s police powers and it is not compensable because it is exercised for a public purpose.

[B]ankruptcy trustees acting under the supervision of the bankruptcy courts routinely
take control of enterprises formerly controlled by the enterprises’ owners; such action
is not a taking for which the owners must be compensated. The trustees, under the
supervision of the courts, engage in wholesale modification and cancellation of the
rights of owners and creditors; these modifications and cancellations are also not

® See, e.g., Curtis, id., at 377 (“Indeed, the continued private operation of a capital-deficient institution, with its risks of
failure and drain on society’s resources, can be likened to a “noxious use” of property, which can be suppressed without
activating the takings clause”).

° The Restatement of the Law, Third, The Foreign Relations Law of the United States, section 712, at 196-97.

° Id., comment g, at 201.

"' Id., Reporters’ Note 6, at 211.

11


with international practice. Moreover, the NBG has asserted that this approach was preferred to the
option of last resort, i.e., outright liquidation through public auction.

On May 25, 2001, the Internal Affairs Ministry issued its decision to cancel the criminal case
against and prosecution of Mr. Mourgulia, finding that Mr. Mourgulia had committed the crime of
misappropriation of $1,017,862 under Article 220 of the Criminal Code of Georgia and caused
significant damage to the Foreign Enterprise in the amount of $567,862. However, because Mr.
Mourgulia’s crime was not deemed a grave offense, he had no prior convictions, confessed to and
expressed regret for his crime, and at the same time he voluntarily compensated the damage and was
not viewed as a danger to society, the Interior Affairs Ministry closed the criminal case against and
prosecution of him (see Interior Affairs Ministry Decision, at 4-5).

On May 31, 2001, the NBG announced that it had revoked the Foreign Enterprise’s banking
license and had adopted a decision to liquidate the Foreign Enterprise. The NBG grounded its
decision on Article 59 of the National Bank Law and Articles 30, 25, and 36 of the Commercial
Banking Law. By letter dated June 27, 2001, OPIC followed up its March 29, 2001 letter, requesting
an update from the Insured on the status of its investigation regarding a potential claim and its
intentions to file a claim and noting that OPIC had not received any response from the Insured to its
March 29, 2001 letter. In response, Mr. Lloyd informed OPIC by letter dated June 28, 2001 that “it
is taking us a great deal of time to gather the appropriate information that we believe is necessary,
however, we intend to move forward with a claim as soon as we feel that we have all the
documentation in place.” Mr. Lloyd’s letter did not indicate whether the Insured had challenged or
was planning to challenge any of the decisions of the NBG, nor did it claim any expropriation of its
investment, nor did it request any assistance from OPIC to advocate in its behalf. Simultaneous with
this letter, however, the Insured certified to, inter alia, that “the Investor has taken all reasonable
measures to preserve property, to pursue available administrative and judicial remedies, and to
negotiate in good faith with governing authority of [the project country] in its sovereign capacity and
otherwise, and with all other potential sources of compensation.” If, indeed, the actions of the
government of Georgia up to that point in time were expropriatory, Mr. Lloyd should have requested
OPIC’s assistance to forestall, if not avoid altogether, the revocation of the Foreign Enterprise’s
license and the Foreign Enterprise’s liquidation. Moreover, when these actions were taken, he did
not seek to challenge them, as he and the other U.S. Investors had standing under Georgian law to
do.

By August of 2001, the NBG had revoked the licenses of six commercial banks, including
the Foreign Enterprise.° The NBG also announced that any interested party could appeal its decision
to the Tbilisi Circuit Court within six months of notification thereof; three of the six commercial
banks affected sought such recourse.’

By letter dated January 17, 2002, OPIC followed-up its letter of June 28, 2001 to request a
status report on the Insured’s investigations regarding its potential claim and its intentions to file
such a claim, reminding the Insured there were specific time limits for the filing of any claim. In
response, Mr. Lloyd identified three possible claims, including expropriation, by letter dated January
21, 2002, noting that the Insured had begun collating the necessary supporting information and the

® “Review of Georgia’s Banking System,” Black Sea Press, dated October 5, 2001.
7 May 31, 2001


Memorandum, the NBG closely monitored the Foreign Enterprise. At the same time, the NBG
permitted the Foreign Enterprise to use deposit reserves to preserve its liquidity, opened a standby
line of credit of $1 million and permitted deferral of the creation of loan reserves for a period of one
year. Memorandum regarding Assessment of Absolute Bank’s Position from Derek Farmer,
President, Absolute Bank, to Charles Wrangham, EBRD, dated November 9, 2000 (the “Bank
Assessment Memorandum”, Tab 18).

In looking back over the early to mid-2000 period, the NBG had determined that the Foreign
Enterprise’s earnings were falling as a result of its problems with the underlying portfolio, based on
the Foreign Enterprise’s own internal analysis dated September 2000 showing net losses in 1999 for
seven out of 12 months and a substantial drop in net profits of $516,952 in January 1999 to net
losses of $368,045 in December 1999, and in 2000, a further substantial drop to net losses of
$1,144,285 by September 8, 2000). The NGB also observed a substantial decline in the Foreign
Enterprise’s reported figures for total assets and loans outstanding, with interest income, for
example, decreasing from $10 million in January 1999 to $6.5 million by September 8, 2000).

In response to the Memorandum of Understanding, Mr. Farmer sought the advice of the
EBRD. Ina facsimile dated August 14, 2000, Mr. Farmer wrote to the EBRD to express his concern
that there was no clear direction by the U.S. shareholders concerning the position to be taken with
the NBG regarding the future of the Foreign Enterprise. Moreover, Farmer explained that his main
concer continued to be the Foreign Enterprise’s negative equity, followed closely by the poor
capital to assets ratio of the Foreign Enterprise. Mr. Farmer thus expressed the belief that the
Foreign Enterprise had to either recapitalize or liquidate.

In response to Mr. Farmer’s facsimile, and by letter dated August 22, 2000, the EBRD stated
that the Foreign Enterprise actually had three options: (1) to do nothing; (2) to increase the capital;
or (3) to liquidate the Foreign Enterprise in an orderly fashion. According to the EBRD, an increase
of capital was the best option under the circumstances. To do nothing would put both the Foreign
Enterprise at risk of temporary administration by the NBG, and would have negative consequences
for the Georgian financial sector. Through liquidation the shareholders could avoid making an
additional contribution of capital, but at the cost of recognizing that the original investment was lost.
Liquidation would allow the Georgian government to avoid panic among the Foreign Enterprise’s
depositors, and consequently would allow Georgia to avoid a negative impact on the national
financial sector as a whole.

In the EBRD’s view, the Foreign Enterprise’s portfolio was of very low quality, resulting
from incompetence and malpractice in the lending functions of the Foreign Enterprise and dating
back to at least 1996. The Foreign Enterprise had a negative net asset value; it was illiquid and was
in a fragile position that could rapidly deteriorate at any time. If the shareholders did not
recapitalize, the EBRD believed that the NBG would strip the Foreign Enterprise of its banking
license and would be justified in such an action.

On September 7, 2000, Mr. Farmer and EBRD representatives met with the NBG to discuss
the Foreign Enterprise’s financial problems. (This meeting appears to have been rescheduled on at
least two occasions in order to allow for the shareholders to reach agreement on a strategy.) The
management of the Foreign Enterprise and the EBRD had proposed to the NBG that it appoint a


4. The violations of law are not remedied and expropriatory effect continues for six
months,

There were no violations of law to remedy in connection with the U.S. Investors’ Claim.

The above conclusion is reinforced by the U.S. Investors’ failure to pursue any action to
challenge any of the aforementioned decisions of the NBG, including the NBG’s placement of the
Foreign Enterprise under temporary administration, the transfer of its assets and liabilities to a third
party in apparent violation of the public auction requirement, and its decision to liquidate the Foreign
Enterprise; nor is there any assertion in the Claim or any indication in the supporting information
that the Investors had hired local counsel to investigate the possibility of challenging such actions.
Indeed, upon announcing its decision to revoke the license of the Foreign Enterprise, the NBG also
made it publicly known that any interested party could appeal this decision to the Tbilisi Circuit
Court within six months of notification thereof. Section II at 6. Although three of the six
institutions thus regulated by the NBG made an appeal, published reports do not indicate that the
Foreign Enterprise was among them.

B. Applicable Exclusions

Even in the unlikely event that one or more of the regulatory actions undertaken by the NBG
and the governing authority of Georgia were deemed to fulfill the requirements of Section 4.01 of
the Contract, it would be excluded from the scope of expropriation coverage by one or both of the
following exclusions and no compensation should be payable to the Insured.

1. Provocation.

Section 4.03(a) of the Contract, as amended by Section 10.03 of the same, provides that no
compensation for expropriation shall be payable if “the preponderant cause is unreasonable action (i)
attributable to the Investor or (ii) attributable to another stockholder, or a controlling officer of or
controlling investor in another stockholder, of the foreign enterprise that is reasonably related to or
in furtherance of the business or activities of the foreign enterprise."

a. The unreasonable actions are attributable to another stockholder or controlling
officer or Investor of another stockholder.

As was previously discussed, Messrs. Shanidze and Mourgulia engaged in a number of
illegal and malfeasant activities ranging from fraud to defalcation. Messrs. Shanidze and Mourgulia
were in a position of both ownership and managerial control over the Bank and its business dealings
when the Foreign Enterprise was mismanaged and defrauded. In addition to being a controlling
officer of the Foreign Enterprise from its inception, Mr. Shanidze was also a stockholder of the
Foreign Enterprise, both directly and indirectly through his ownership of Armlender. Mr. Mourgulia
was also a shareholder of the Foreign Enterprise from the date of his purchase of shares on or about
March 23, 2000 until September 22, 2000.

15


law itself would require even if the Bank had authentically suffered an ‘insolvency’ (which it did
not) and the government had thus undertaken the seizure in good faith (which it did not).””°

There is no denying the fact that corruption has been deeply rooted not only in Georgian
government but also business circles even before the dissolution of the Soviet Union. However, any
emerging market that is “marked by civil war, ethnic secessionism, and economic deterioration”, as
Georgia was characterized to be in the Foreign Enterprise’s Preliminary Business Plan, dated July 1,
1994, should be expected to pose potential investors to the risks of fraud, malfeasance and other
corruption in its financial sector (see Tab 2, at 2-3 and 26). In fact, Mr. Lloyd was substantially
aware of risks of this nature when he disclosed to OPIC during its underwriting of the Contract, inter
alia, that (1) Soliko Khabeishvili, the Foreign Enterprise’s first Chairman, and the head of the
Eduard Shevardnadze Fund for Democracy and Revival, one of the Foreign Enterprise’s key
Georgian shareholders, was a “known crook”, (2) officials of its other Georgian shareholders had
allegedly been involved in financial crimes or abuse, and (3) President Shevardnadze seemed to be
unable to crack down on organized crime.”!

In short, even if there were any evidence to support the Insured’s allegations of a corrupt
governmental role in the Foreign Enterprise’s failure, it has failed to show how such actions directly
caused its losses and that such actions were the preponderante cause of its losses. In the first
example, the Insured refers to a swom statement of the Foreign Enterprise’s first president and
asserts that unnamed personnel of the Foreign Enterprise had used the Foreign Enterprise’s funds
annually to pay bribe monies in the form of fictitious loans to NBG inspectors in order to obtain
favorable CAMEL ratings in an effort to hide and unsound and insufficiently collateralized loans
(Claim, at 4-5). It fails to identify such personnel and loans; it also fails how the extension of such
loans was a preponderant cause of the Foreign Enterprise’s failure. It then proceeds to suggest that
the Insured was disabled from uncovering the extent of the fraud and malfeasance for lack of reliable
CAMEL ratings, as if it had no other means to ensure the observance of financial, managerial and
legal control over the Foreign Enterprise and its activities.

In the second example, the Insured relies on the same swom statement to assert that the
Interior Affairs Ministry declined to pursue or prosecute any persons associated with the fraud and
malfeasance unless the Foreign Enterprise’s officers agreed to pay bribe monies and relates the
Insured’s information and belief that the Interior Affairs Ministry did not pursue or prosecute such
persons because at least some part of the embezzled funds were used to re-elect President
Shevardnadze (Claim, at 6). In the course of our investigation of the matter, however, we have
determined that the Interior Affairs Ministry did, in fact, open a criminal investigation of at least Mr.
Mourgulia and his role in this matter, but exercised its discretion not to prosecute him because he
and his associates had secured the return of $567,863 of the over $1 million embezzled from the
Foreign Enterprise.

In any case, the Insured assumed the above risks at the time it made its investment.”

® See Section IILA.2.

2! Notes from telephone conversation with Louis Lloyd on March 29, 1995, taken by OPIC.

2 «There can be no assurance that political, economic, social or other developments in Georgia . . . will not have a material
adverse effect on the Bank.” Business Plan, at 2 and 26.

17


In response, the Foreign Enterprise conducted a series of audits to investigate the Sevelich
transactions and other loans. The audits and investigations found the Internal Affairs Ministry’s
allegations were not without grounds. For example, one report found that two officials of the
Foreign Enterprise, Georgi Antadze and Michael Gvatua, had not only shown absolute disregard for
important elements of the Foreign Enterprise’s credit policies and practices with respect to this
portfolio, but also probably conspired with one another to defraud the Foreign Enterprise. In
addition, the brother-in-law of Mr. Shanidze took title to collateral transferred from Sevelich in
connection with at least four of the seven loans approved by Messrs. Antadze and Gvatua. In all,
one audit found fourteen instances of interested party loans given by the Foreign Enterprise. Also,
the Foreign Enterprise’s lending officers had routinely asked for bribes when approached for loans,
and the motor pool (whose manager was a friend of the Shanidze family) and other staff of the
Foreign Enterprise had submitted inflated expense reports for reimbursement. Thirty loans were
given by the Credit Department of the Foreign Enterprise that violated the Foreign Enterprise’s
credit policy, and only 20 of the 66 total loans (corporate and individual) were reported as properly
secured as of March 30, 2000. Moreover, $1,054,663 of the loan portfolio was disbursed without
proper approval. At least one of the investigations found that Mr. Shanidze was the instigator of the
illegal activities undertaken at the Foreign Enterprise. Accordingly, sometime in the course of 1999,
the Foreign Enterprise removed Mr. Shanidze as its Chairman of the Board.

Subsequently, in June 2000, the EBRD’s nominee resigned his seat on the Board of
Supervisors of the Foreign Enterprise. In thé course of the following month the Board of
Supervisors formally appointed Mr. Derek Farmer as the new President of the Management Board of
the Foreign Enterprise. The Foreign Enterprise’s new management made substantial efforts to
recover the loans. At the time, Mr. Farmer expressed his intent to follow-up the suggestion of the
NBG and refer the case to the Economic Crimes Division of the Intemal Affairs Ministry to ensure
that a criminal investigation occurred. To this end, Mr. Farmer briefed the U.S. Ambassador for
Georgia concerning the Foreign Enterprise’s difficulties (Exhibit 20). The Ambassador purportedly
agreed to write to the President of the NBG as well as the heads of the relevant ministries in order to
express his concerns about the allegations of misconduct at the Foreign Enterprise and to request the
full support of the Georgian authorities. These efforts appeared to cause Nikolai Mourgulia, the
Foreign Enterprise’s Deputy Finance Director, with the assistance of his supporters, to return
$630,618 of the more than $1 million he had embezzled with the assistance of nine employees in
various departments of the Foreign Enterprise.”

Prior to the internal investigations conducted by Mr. Farmer, on August 9, 2000, the NBG
sent a proposed Memorandum of Understanding to Farmer requiring the Foreign Enterprise to
acknowledge that the latter was experiencing serious problems with its capital, asset quality,
revenues, and liquidity and that such problems could lead to the Foreign Enterprise’s insolvency. It
furthermore asserted the NBG’s right to regulate a failing Foreign Enterprise, and threatened further
action if certain stabilization and recapitalization measures were not pursued. Pursuant to the

3 Translation of Decision of the Interior Affairs Ministry “On Cancelling the Criminal Case [against] and the Criminal
Prosecution [of Nikolai Mourgulia,” dated May 25, 2001 (signed by D. Katsarava, Major Investigator of the Investigation
Department and approved by Z. Kuloshvili, Chief of the Investigation Department, and R. Megrelidze, Deputy Chief of the
Investigation Department), with the endorsement of the Chief of the Department for Procedural Oversight over the
Investigation of the General Prosecutor’s Office of Georgia (R. Zhgenti), dated May 25, 2001 (the “Interior Affairs Ministry
Decision”). OPIC obtained a copy of the translated Interior Affairs Ministry Decision from the U.S. Embassy in Tbilisi,
Georgia by facsimile dated October 6, 2004.


In early 1995, the Foreign Enterprise commenced operations. Since then and at least
through 1998, the Foreign Enterprise succeeded in attracting high quality customers, including many
top-ranked companies, donor agencies, embassies and high-worth individuals, due in no small part to
its significant Western ownership and management. In the process, the Foreign Enterprise
developed a portfolio of real estate and small-and medium-size enterprise loans while retaining
earnings for further investment in the business without paying a dividend.

However, allegations of mismanagement within the Foreign Enterprise began to surface as
early as November 1998. A report prepared by Mr. Dzhavakishvili of the Georgian Consulting
Company (the “GCC”), a Georgian shareholder in the Foreign Enterprise, alleged that payments
made to consulting companies and legal firms purportedly affiliated with the principals of certain
U.S. shareholders served to make an end-run around the Foreign Enterprise’s policy to retain
earnings and essentially conceal that dividends were being paid to such shareholders only (the “GCC
Report”). The GCC also alleged that Leigh Durland, the then President of the Foreign Enterprise,
had instituted a change in credit policy without the requisite approval of the Supervisory Board. In
addition, the GCC raised concerns that no General Meeting of Shareholders had been convened in
1995 and 1996, and no financial statements for these years had been submitted for the approval of
the General Meeting of Shareholders within the required timeframes. Whether these allegations are
true or not, they reflect Georgian shareholder concern about the propriety of the Foreign Enterprise’s
business dealings with affiliates of its controlling U.S. shareholders and dissatisfaction about
financial management and corporate governance at the Foreign Enterprise.

As a result of the GCC Report, both the NBG and the Ministry of Internal Affairs (the
“Internal Affairs Ministry”) commenced an investigation on the Foreign Enterprise. This is the first
instance known to OPIC when the Internal Affairs Ministry began to target the Foreign Enterprise
for investigation.

Over seven months before its liquidation in 2001, the Foreign Enterprise was determined to
have an estimated negative equity of approximately $5 million, at least partly resulting from
fraudulent activity conducted by senior management of the Foreign Enterprise. From 1995 through
at least 2000, NBG inspectors had allegedly awarded the Foreign Enterprise undeserved, extremely
favorable ratings under the Capital, Assets, Management, Earnings and Liquidity (CAMEL)
inspection system in exchange for bribe monies paid out of the Foreign Enterprise’s funds by certain
of its personnel. That is, although the NBG had discovered certain deficits, deficiencies and
financial adversities caused by certain personnel of the Foreign Enterprise, it did not honor its legal
obligation to honestly report and account for its findings. The funds so paid to the [NBG] personnel
in exchange for their complicity were then recorded on the [Foreign Enterprise]’s books as loans
made to fictitious entities (see Second Statement of Derek Farmer, Tab 34).

The Internal Affairs Ministry’s audit focused on the Foreign Enterprise’s lending activities
with respect to a series of loans made in connection with a Georgian business named Sevelich. The
Internal Affairs Ministry appeared to believe that certain officials of the Foreign Enterprise had
knowingly engaged in fraud, forgery and other activities to support an effort to smuggle spirits from
Georgia to Russia. The Board of Supervisors of the Foreign Enterprise was informed of these
findings at their meeting in the second quarter of 1999.


powers of States, provided it is not discriminatory and is not designed to cause the alien to abandon
the property to the State or to sell it at a distress[ed] price.”!> The NBG’s actions were a result of the
Insured’s failure to provide additional capital to the Foreign Enterprise, despite the multiple
concessions and extensions granted by the NBG for recapitalization purposes. Nowhere does the
Insured suggest that the NBG’s regulatory actions were taken against the Foreign Enterprise to cause
the U.S. Investors to abandon the Foreign Enterprise or to sell its interest in the Foreign Enterprise at
a distressed price.

The actions taken by the NBG to place the Foreign Enterprise (a) initially under its
supervision and (b) later under the temporary administration and (c) still later to transfer its assets
and liabilities to a successor bank, and (d) finally to file for liquidation of the Foreign Enterprise are
not material breaches of local law because they were taken only after (w) the Foreign Enterprise had
failed to meet its minimum capital reserves, notwithstanding the NBG’s reduction in the Foreign
Enterprise’s minimum capital reserve requirements and the opening of a line of credit to the Foreign
Enterprise, (x) the Investor had failed to recapitalize the Foreign Enterprise, (y) the Foreign
Enterprise’s accounts had failed to show any remaining shareholders’ equity, and (z) the temporary
administrator had concluded that the Foreign Enterprise was insolvent, respectively. Whether the
decision by the NBG to transfer the assets and liabilities of the Foreign Enterprise was a breach of
local law because local law required the holding of a public auction and no such public auction was
held may be open to question. However, this breach of law was not material, because KPMG had
found a deficit of shareholders’ equity in the amount of more than $5 million more than seven
months before the NBG had reached essentially the same conclusion.

3. The acts directly deprive the U.S. Investors of fundamental rights in the insured

investment_unless the acts are reasonable regulatory actions taken by Georgian
governing authorities pursuant to their regulatory oversight of the financial sector.

None of the aforementioned acts of the NBG, singly or together, had the effect of directly
depriving the U.S. Investors’ of fundamental rights in the insured investment in the Foreign
Enterprise, because the U.S. Investors’ equity in the Foreign Enterprise had already been dissipated
(not only fully, but by a factor of three) and the shares of stock representing the U.S. Investors’
rights to such equity had no monetary value.'®

Compensation to be just must be equivalent to the property taken and must be paid at
the time of the taking or with interest from that date . . . There must be payment for
the full value of the property . . . Such property should take into account ‘going
concem value,’ if any, and other generally recognized principles of valuation."”

'5 Too v. Greater Modesto Insurance Associates, AWD 460-880-2 (Dec. 29, 1989), reprinted in 23 Iran-U.S. Cl. Trib. Rep.
378.

6 See, e.g., Charles N. Brower & Jason D. Brueschke, The Iran-United States Claims Tribunal 372-73 (1998) (citing Amoco
Int’] Fin. Corp., 15 Iran-U.S. Cl. Trib. Rep. at 164) (“Expropriation, which can be defined as a compulsory transfer of
property rights, may extend to any right which can be the object of a commercial transaction, i.e., freely sold and bought, and
thus has a monetary value.”).

‘7 The Restatement of the Law, Third, The Foreign Relations Law of the United States, section 712, comment d, at 198. See
also Curtis, id., at 380 (“[I]t is not owners’ equity as reflected on the books of the business but rather what the owners could
realize on the market. In each case the inquiry must be whether there is value present”).

13


Because illegal actions are unreasonable per se, any illegal act performed by the controlling
officers or stockholders of the Foreign Enterprise (and there are many such instances) can qualify as
an unreasonable action of the Foreign Enterprise pursuant to section 4.03(a) of the amended
Contract. There are numerous examples of such actions, the most egregious of which is Mr.
Mourgulia’s embezzlement of more than $1 million of the Foreign Enterprise’s funds.
Mismanagement, however, is not necessarily illegal, and therefore is less clearly unreasonable. Yet
in this case, there is ample evidence that the management practices were also unreasonable. For
example, the Foreign Enterprise failed to hold shareholder meetings as required by law, and top
management officials such as Messrs. Shanidze and Mourgulia disregarded important elements of
the Foreign Enterprise’s credit policies in approving and/or issuing loans.

These few examples of malfeasance and illegal activity are part of a history of
mismanagement and fraud that caused the Foreign Enterprise to fail. Many of the documents made
available for OPIC’s review support this position. Moreover, the Foreign Enterprise sought and
obtained emergency lines of credit from the NBG to cover its deteriorating financial situation
induced by the fraud and defalcation of some of its stockholders, including Armlender and Messrs.
Shanidze and Mourgulia. Therefore, actions attributable to the stockholders, and not the NBG,
induced the Foreign Enterprise’s insolvency and necessitated its liquidation.

Instead of recognizing these obvious and direct causes for the loss of its investment, the
Insured claims that the corruption that allegedly pervaded the entire Georgian government is the
preponderant cause of the Foreign Enterprise’s failure. Specifically, it makes the following claim:

the Georgian government and its agents, in concert, cooperation, and conspiracy with
others, knowingly condoned, further, facilitated, suborned and supported unlawful
schemes and devices through which the Bank’s assets were plundered and the Bank
was deliberately rendered “insolvent” and after knowingly and actively contributing
to such “insolvency”, the Georgian government and its agents then refused without
any legitimate or plausible basis or explanation to enforce such criminal law as might
have returned the Bank to solvency, and instead in bad faith, purportedly acting
pursuant to Georgian banking law, relating to the consequences of an “insolvency” to
which they themselves had actively contributed, seized and retained all of the Bank’s
assets, and transferred them to a co-conspirator.

To further buttress its generalized claim of pervasive corruption, the Insured describes two instances
in which (1) the Georgian Finance Ministry and the Georgian judiciary allegedly conspired with the
NBG to wrest $300,000 in funds from the Foreign Enterprise and (2) the NBG and the Georgian
judiciary unlawfully seized collateral that one of the Foreign Enterprise’s customers had pledged to
secure a $150,000 loan on which the customer defaulted,!” and concludes that “when, ultimately, it
undertook to seize the Bank’s assets, the Georgian government (acting through NBG, an official
organ and instrumentality of the Republic) disregarded such practices and procedures as Georgian

”° The first instance took place in the course of 2000 and the second instance took place during the second half of 1998, and
neither appears to support the Insured’s claim of a monolithic conspiracy of the Georgian government and its agents to
expropriate the Insured’s investment. They are, at best, peripheral to the Insured’s Claim and have been deemed immaterial.

16