Romania's evolving legal framework for private sector development

WPS bulz Policy Research WORKING WPs et';2 L Socialist Economies Reform Country Economics Department and the Legal Department The World Bank March 1992 WPS 872 Romania's Evolving Legal Framework for Private Sector Development Cheryl W. Gray Rebecca J. Hanson and Peter G. Ianachkov Romania started almost from scratch in 1990 to build a legal framework for a market economy and has made substantial progress. To bring that framework to life, institutions must enforce the laws and be able to resolve any disputes that arise, the public must accept that the laws are binding, and the laws must be filled in with detailed regulations and individual case practice. This takes time. Policy Research Working Papers disseminate tFe fndings of work in progress and encourage the exchange of ideas among Bank staffand allothetr interested in development issues. Thesepapers, distnbuted by theResearch Advisory Staff.carry the names oftheauthors,reflect only theirviews.and should be used and cited accordingly. Thc findings, interpretations, and conclusions are heauthors' own.1They should not be auributed totheWorld Bank, its Board of Diructors, its management, or any of its member couitines.  Policy Research Socialist Economies Reform WPS 872 This paper-a product of the Socialist Economies Reform Unit, Country Economics Department, and the Europe and Central Asia Division, Legal Department - is part of a larger effort in the Batik to understand the process of legal reform in transitional economies. Copies are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact CECSE, room N6-035. extension 37188 (March 1992. 27 pages). As the economies of Central and Eastern Europe constitution but also extensive new legislation nove from central planning and state ownership covering real and intellectual property, compa- to market-driven development of private sector nies, and foreign investment. It has revived the activity, they are undertaking comprehensive pre-war civil code as a basis for contract law, change in the "rules of the game" - the legal and is moving to modernize its bankruptcy code. framework for economic activity. The only area surveyed in which little legal reform has occurred is antimonopoly law. At a minimum, markets require a system of property rights and rules for exchanging those Challenges remain in both law and practice. righLs. In practice, property rights in most The broad principles of private ownership, free countries are defined by the constitution and by- market exchange, and equal treatment of public laws regulating the ownership and use of real, and private firms are well recognized and have personal, and intangible property, as well as been largely achieved, at least on parer. But a shares in going concems. Company, forcign tendency toward centralized, bureaucratic investment, and bankruptcy laws, among others, control remains - for example, in excessive govem entry into and exit from productive requirements for approval and uneconomic limits activities. General rules of market exchange are on certain activities. Moreover, implementation laid out in contract and competition law, while will clearly Lake a long time - probably consid- more specific rules of market exchange in erably longer than in the other reforming coun- particular sectors may be govemed by more tries - because there is little or no institutional detailed sector-specific laws and regulations. framework for enforcement and dispute resolu- tion. Gray, Hanson, and lanachkov analyze the evolving legal framework for private sector By themselves, laws are merely paper: a development in Romania. The Romanian gov- legal framework comes to life only when legal ernment has worked intensively in the last two and administrative institutions can enforce the years to create a legal framework for a market laws and readily resolvc the disputes they economy. Many gaps remain in current laws, and inevitably spur - and when the public accepts problems still exist, but the effort has been that the laws are binding. Moreover, the laws are impressive given the starting point. In some by nature only frameworks. Their content must Central and Eastern European countries (includ- be filled in with detailed regulations and indi- ing Hungary and Poland), private property and vidual case practice. Developing a body of private markets were suppressed but not extin- regulation and case practice takes time. Borrow- guished during 40 years of socialism. But ing concepts from industrial market economies Romania started virtually from scratch in 1990 to - helped by legal exchange programs and legal build a market economy and the legal framework technical assistance from abroad - could speed required for it. It has adopted not only a new the process. The Policy Research Working Prper Series disseminates the fmdings of work under way in the Bank. An objective of the series is to get these fmdings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necessarily represent officia' Bank policy. Produced by thc Policy Research Dissemination Center  CONTENTS I. Constitutional Law 2 II. Rights to Real Propertv 5 Land 6 Buildings 7 III. Rights to Intellectual Propertv 8 Patents 9 Trademarks 11 Copyright 12 IV. Company Law 13 ChAracteriatics of a Joint Stock Company 14 Characteristic of a Limited Liability Company 16 Characteristics of the Partnership Forms 16 Procedures for Setting Up a Company 17 V. Foreian Investment Law 18 Form and Ownership 18 The Approval Process 18 Profit Repatriation 19 Tax Incentives 20 VI. Contracts 1 VII. Bankruptcy 21 VIII.Antimonovoly Law 23 IX. Judicial Institutions 23 Courts 23 Arbitration 24 Lawyers 25 Legal Education 25 X. Conclusion 25 General References 27  1 As the economies of Central and Eastern Europe move from central planning and state ownership to market-driven development of private sector activity, they &re undertaking comprehensive changes in the "rule of the game"--i.e. the legal framework for economic activity. At a minimum markets require a set of property rights1 and a system of rules for exchanging those rights. Thus at a minimum the legal framework in a market economy must: (1) define the set of property rights in the system, (2) set the rules for the entry and exit of actors into and out of productive activities, and (3) establish rules for market exchange. Each of these three functions typically involves numerous areas of law. In addition to basic principles laid down in the constitution. property rights are defined in practice in most market economies by a wide array of laws regulating the ownership and use of real, personal, and intangible property, as well as shares in going concerns. Company, foreign investment, and bankruptcy laws are among the subset of laws that govern entry and exit into and out of productive activities. General rules of market exchange are laid out in contract and competition law, while more specific rules of market exchange in particular sectors may be governed by more detailed sector-specific laws and regulations. This paper analyzes the evolving legal framework for private sector development in Romania.2 The Romanian government has worked intensively in the past two years to create a legal framework for a market economy. While problems exist vith the current laws, and numerous remaining gaps remain, on the whole the effort ha^ been impressive given the short time- span and the tightly-controlled centralization of the former regime. Unlike some other countries of Central and Eastern Europe (such as Poland As used in this context, the term "property rights" includes rights to real, personal, and intellectual property. a The paper does not address laws regarding corporatization and privatization of state-owned enterprises, areas where Romania has made significant progress in adopting a legal framework. Although very important to the development of a private market economy, these areas of law are regarded as transitional. This paper, and the larger project of which it is a part, is designed to focus on the legal framework needed for operation of a private market economy in the longer-run. Laws regarding corporatization and privatization are discussed in detail in numerous documents written by World Bank staff and other organizations.  2 and Hungary), where private property and private markets were suppreosed but not entirely extinguished during 40 years of socialism, Romania started virtually from scratch in 1990 to construct a market economy and corresponding legal framework. Challenges remain in both law and practice. The broad principles of private ownership, free market exchange, and equal treatment of public and private firms are well recognized and have been largely achieved, at least on paper. Yet there continues to be a trend toward centralized, bureaucratic control--as evidenced, for exsmple, in excessive requirements for approvals to do many thing., as well as uneconomic limitation, on certain activities. Furthermore, implementation will clearly take a long time (probably considerably longer even than in the other reforming countries), because the institutional framework for enforcement and dispute resolution is weak or nonexistant. Developing expertise in the legal community through training and practice is crucial if the evolving legal framework is to beccme a guiding and binding force in everyday transactions. Constitutional Law The most fundamental law in any country defining the nature of its economy and the support to be given to public and private sectors is the constitution. A draft constitution was introduced in Parliament on July 9 and was approved on November 21, 1991 after approximately 2 months of debate. It had been preparod by a constitutional commission composed of wembers of the two chambers of the Parliament and outside constitutional experts. The document is long, containing 152 articles organized into seven main sections (or "Titles")--(1) General Principles; (2) Fundamental Rights, Liberties, and Duties; (3) Public Authorities; (4) Economy and Public Finance; (5) The Constitutional Court; (6) Revising the Constitution; and (7) Final and !iporary Provisions. Title I is generally noncontroversial from an econow - viewpoint, but it has aroused strong debate from minority groups and mor., ;chists because of Article 1, which declares Romania a "national state, sovereign and independent, unitary and indivisible. The form of government of the Romanian state is the republic." Title 2 contains many sections defining rights and duties of citizens. The list of rights contains those that are common and expected in democratic societies, including freedom of expression, assembly, religion, and movement, and freedom from arbitrary arrest and imprisonment. On the economic front, the draft guarantees private property rights and equal protection of all private property regardless of owner, and it forbids uncompensated expropriations (Article 41). However, an accompanying provision that "the contents and limitations of (this right) are established by law" leaves wide room for government to restrict private property rights. Foreigners are explicitly forbidden from owning land in Article 41(2), a provision which--though apparently deeply rooted in  3 htitory and culture--may nevertheless hinder foreign involvement in the economy.3 Some rights guaranteed in the Constitution could prove expensive for the government to fulfill. One is the right to free education granted in Article 32: "State education (including by implication higher education) is free by law." On economic grounds it would be preferable to put scares public re-urce into free primary and secondary education, allc'wing some cost recovery in higher education. Another potentially expensive guarantee is in Article 43: "The state is obligated to ensure a decent living standard for the citizenry through measures of economic development and social protections Citizens are entitled to a pension, paid maternity leave, health care in state medical facilities, unemployment relief, and other forms of social assistance envisaged Ly law." All of these rights are granted subject to Article 49, which providoe that "the exercise of certain rights or freedoms may be restricted only by law and only if the restriction is required ... in order to defend national security, public order, health, or morals, and civic rights and freedoms ...." This rather open-ended provision could create some uncertainty by leaving a window open for arbitrary government interference in the free exercise of economic rights. ; Among other things, it makes secured foreign leuLding difficult, because foreign lenders are not able to foreclose on secured property and take possession. Instead, they must depend on local auctions in a thin market to recover value from the security iuterest. In practice foreign lenders forego the security and instead require local bank guarantees, which often in turn require explicit or implicit public guarantees. The rights of 100 percent foreign-owned companies incorporated in Romania are not clear with regard to land ownership. Some government officials claim that these companies are allowed to own land, because they are not technically "foreigners" but are instead Romanian legal persons. In such case, the prohibition would relate only to foreign individuals and would not affect foreign investment. Yet allowing fozeigners to avoid this prohibition (and buy unlimited amounts of Romanian land) simply by incorporating in Romania would seem to undercut the rationale behind the prohibition. Another view holds that 100 percent foreign-owned firms can buy the land they need for their operations, but not other land. This view, however, does not flow naturally from any interpretation of the provision. ' This advice is typically given by the World Bank to developing countries, where the annual public cost of university students is on average 26 times that of primary school students, and where university students tend to be from higher-income households and are therefore more able to pay for the education. It also holds for industrialized countries, where university education is also more expensive than primary or secondary education. Romania should be careful to allocate its scarce public resources to the sectors with the greatest social returns, typically primary and secondary educationg selective scholarships can be granted to university students unable to pay tuition themselves.  4 Tit12 3 lays out thi structure of the public sector, with chapters on the Parliament, the Pr.tsident, the Government, the Public Administration, and the Judiciary. Although not strictly esonomic in character, these provisions lay the ground rules for economic policy making. The structure is designed to create a balance of power among the various branches. The executive branch ("government") designs and introduces most legislation, and both chambers of parliament must approve it and the President sign it for it to become law. The President appoints the Pr.me Minister and cabinet with the approval of Parliament and can be impeached for wrongdoing by a majority vote of Parliament. Parliament is composed of two chambers, the Chamber of Deputies and the Senate.' Parliament supervises the government through its approval of initial ministerial appointments, its power to express no confidence or censure, and its right to request information and explanations of governmental activity. With regard to the judiciary, there has been intensive debate regarding itn pavers in overseeing the constitutionality of Parliamentary acts. The Ministry of Justice favored ex-post judicial review by the Supreme Court, as existed prior to World War II.' The constitutional drafting comnittee, in contrast, favored broad powers of judicial review (both before and after a law is passed) by a separate Constitutional Court, and the Constitution provides for such a Court in Title 5. Under Article 144, the Court is empowered to review the constitutionality of laws before they are promulgated.' However, a ruling of unconstitutionality can be overriden if the law is again adopted in the same fe.a by at least two- 3 The President may ask the parliament to reconsider the law but may not veto it. ' Romania had a bicameral parliament under its 1923 constitution, which was replaced by a unicameral system under Ceaucescu. Thus the current proposal is in some sonse a return to pro-socialist traditions. Under the 1923 system the two chambers of parliament had different powers and different means of selecting members. While deputies were chosen by direct election, the senate had appointed as well as elected members in an effort to protect underrepresented interests. In contrast, under the current draft the two chambers have similar and equal powers; a law can be promulgated only after similarly-worded versions have been approved by both chambers. The draft does not specify how the members of each chamber are chosen. A proportional system was used in 1990, whereby each district's representation in each chamber was proportional to its share of the total population. Given the similarities between the two chambers, some observers question the justification for the current bicameral system (see Shafir, 1991). ' The right of judicial review over the consitutionality of laws was established in 1912 and included in the 1923 constitution. ' The Court is to review the constitutionality of laws if requested by the Presi"-nt, one of the presidents of the two chambers of government, the Supreme C..ctr, or at least 50 deputies or 25 senators. This is a preferable solution to the mandatory review (at least of "organic" laws) contained in an earlier draft of the constitution.  thirds of the members of each chamber,9 a provision that seriously weakens the power of judicial review over Parliamentary acts. The Court is also empowered to adjucate appeals brought before courts about the ccnstitutionality of laws and ordinances. thus presumably eliminating the Supr#ae Court's jurisdiction over constitutional questions. Title 4 deals with the economy and public finances. Article 134 defines Romania's economy as a market economy and orders the state to ensure free trade and protect competition. Under Article 135 the state protects property, whether public or private. Certain assets are reserved exclusively for public ownership and ara "legally inalienable", including "underground resources of any kind, the means of communications, the air space, water resources that can produce power or can be used for public purposes, beacnes, the territorial sea, the natural resources of the economic zone and tha continental shelf, as well as other assets envisaged by the law." While this article prohibits private ownership, the state can grant concessions for private sector involvement in the wide range of activities on such property, including mining and telecommunications. Despite the provisions indicated above that may compromise individual rights or impose difficult financial burdens on the state, the Constitution is a major step forward for Romania. Overall it provides strong support for the fundamental principles of private property, free market exchange, and careful limitation of the powers of the state. Rights to Real ProRerty Rights to real property have been in a state of extreme flux in komania for the past year, and there will not be much certainty for private investors until the ownership of these rights becomes more settled and dependable. As discussed f'lrtLer below, extensive amounts of land are being returned to former owners or given to the owners of the buildings that occupy such land. Other land and buildings are being kept in municipal hands, with the possibility of lease'0 and the future possibility of restitution or sale. The disposition of apartment buildings and other housing now in state hands is being intensely debated. And apart from basic questions of ownership of real property, land registration 9 Article 145. This ability of the Parliament to override the decisions of the Constitutional Cou.t is a major change from the initial draft, which made the Court's decisions mandatory in all cases. '