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The scramble by american and British construction and engineering companies to win a piece of the action in Iraq raises questions about the perils of contracting abroad and the management of political risk. In truth, when one considers the risks a company exposes itself to, post-war Iraq is probably not a good example of a dodgy country, as the contracts there will be awarded by the US rather than the Iraqi regime.

The same could not be said of pre-war Iraq, which explains why few Western construction companies did business there. The reasons are obvious. Bechtel had been building a petrochemical complex near Baghdad when Iraq invaded Kuwait in 1990. It managed to extricate its employees, but had no further involvement with the project. It was ironic, then, that Bechtel was awarded the first big contract for rebuilding. That contract was let by the US Agency for International Development, and as the US will have a continuing role in setting up an Iraqi government, one suspects that the political risks facing Western companies will not be that great, at least in the short term. The real threat may come from civil disorder and terrorism.

Elsewhere, in the developing world especially, the liberalisation of economic policy has created unprecedented opportunities for Western firms. But they come with increased risks: changes in laws, increased taxes, burdensome regulations and red tape and, on occasion, the expropriation or nationalisation of an asset without compensation. The fact that there may be no independent judiciary to help you means you may have no effective redress if the host state intervenes improperly.

For Western companies thinking of investing in a foreign country, it is important to consider at the outset how that investment will be protected against such an intervention. In recent years, in order to promulgate trade between countries and protect companies' investments, there have been an increasing use of bilateral investment treaties, or BIT. A BIT is entered into between two states and provides for the protection of the investment of a company from one contracting state made in the territory of the other contracting state.

The fact that there may be no independent judiciary to help you means you may have no effective redress if the host state intervenes improperly

Such treaties protect and encourage British investment overseas. The UK government has concluded 94 BITs with other countries, of which 85 are in force. There is – not surprisingly – no BIT with Iraq, but there are BITs in place with, for example, Croatia, El Salvador, Cuba and Nigeria, to name a few places that have faced political conflict in recent years. BITs protect foreign investors against the type of behaviour mentioned above and provide for settlement of disputes.

There are other methods of protecting oneself against political risk. lnsurance in particular has hitherto played a key role in decision-making when investing overseas. However, with the hardening of the world's insurance markets after 11 September 2001, political risk insurance is not always affordable and this has placed greater emphasis on BITs. Indeed, many companies will not now do business in an unstable political environment if a BIT is not in place. This can create frustration where a company has knowledge of a particularly profitable opportunity but no BIT is in place; some astute firms have found a way round this by setting up subsidiaries in a third country that does have a BIT with the nation in question.

From a dispute lawyer's point of view, the most interesting aspect of BITs is that they allow proceedings to be issued against the host state in respect of treaty violations. This means that a dispute may be referred to international arbitration, despite the fact that the contract itself may provide for litigation in the local courts or some other form of dispute resolution. The usual forum for arbitration under BITs is the International Centre for Settlement of Investment Disputes, which is part of the World Bank. Arbitration under a BIT supplements what the parties may have agreed in the underlying contract. Indeed, often it comes as a shock to the host state to find itself in an ICSID arbitration when it may not even have been party to the underlying contract or had believed – wrongly – that it would have the protection of local judges that it could get at. Not surprisingly, the host state will often, usually unsuccessfully, dispute the jurisdiction of ICSID.