Patricia Koza in Warsaw -

"I really hope and want the dispute between the insurer PZU and Eureko to end as soon as possible, of course by compromise, as we have no interest in continuing this or any other little business wars," the daily Parkiet reported Minister of Finance Zyta Gilowska as saying Tuesday.

Such comments may seem odd to some foreign investors such as Dutch-based financial group Eureko, whose ill-fated acquisition of a stake in state-controlled PZU (Powszechny Zaklad Ubezpieczny) is one of several examples of how the government of Jaroslaw Kaczynski on the contrary appears determined to engage in such business wars by backing out of done deals, renegotiating other agreements and even resorting to harassing foreign partners.

"There is no political will in the government to privatize whatever is left," says Jaroslaw Iwanicki, a partner in international law firm Allen & Overy based in Warsaw. "It does affect the image of the country."

In recent months the government has sought to change the terms by which global steel giant Mittal acquired Poland's biggest steel holding PHS; battled foreign shareholders in national airline PLL LOT over who should be its new CEO; and backed out of deals to sell two chemical plants to German chemical giant PCC, and a power complex to Spain's Endesa.

Topping the list of disputes is the seven-year battle by Eureko to get Poland to honour its commitment to sell it a majority stake in Polish insurer PZU, one of the biggest domestic companies by revenue and a key player on local financial markets. PZU dominates between 40% and 50% of the domestic market depending on segment, and the government holds 55% of PZU, which is now informally valued at from 16 to 24 times its worth just eight years ago.

Doomed from the start

Eureko's troubles began almost immediately after a deal was signed in 1999 that gave it 33% of shares in PZU for $666m, valuing the company at $2bn. The rest of the deal called for PZU to be floated on the Warsaw bourse and for Eureko to buy another 21% to gain majority control. But subsequent governments shrugged off the promise and the dispute has grown increasingly bitter.

Eureko finally sought relief in an arbitration court, and in 2005 won its case when a three-judge panel ruled that the Polish state made an "abrupt about face" by reversing its privatization strategy on PZU, in a "draconian and fundamental way" that violated several protections contained in the Dutch-Polish investment treaty.

The second phase of the case, expected to convene this autumn, will determine payment of damages, which Eureko calculates at PLN8.8bn (€2.3bn).

Instead of seeking an out-of-court settlement with Eureko on the compensation issue, the Polish government has appealed the ruling on several fronts. Those appeals that have been considered so far have all been rejected as unfounded - including one challenging the impartiality of one of the judges because his personal law practice occupies the same building as another law firm handling a separate arbitration case against Poland.

The ruling is not the only challenge to Poland's strategy. In 2004 the European Commission ruled illegal a Polish law that gave the government the right to block Eureko's investment in PZU on grounds it threatened national security.

Poland didn't given up. In June 2006, it dismissed Cesary Stypulkowski, who had headed PZU since 2003 and initiated an ambitious restructuring and reform strategy, and replaced him with Jaromir Netzel, a political appointee with no previous experience in insurance matters.

After four months with Netzel at the helm, Eureko announced it was withdrawing its representatives from the company's management boards. It cited "scandalous, groundless and illegal statements by Mr. Netzel" about Eureko as well as "intimidation" and "threatening Eureko's representatives."

"This course of action is akin to a witch hunt of experienced professionals," the company said in a statement. Spokeswoman Lorrie Morgan explained, "Under the circumstances, we felt there was little else we could do."

After the management change, Standard and Poor's downgraded PZU to "negative" from "stable" for both its life and non-life units, a rating that still stands.

"Even though the new management team has been in control for nearly a year and remains fully committed to reform, the risk remains of political intervention, and that is reflected in the rating," says S&P analyst Tatiana Grineva in London.

The political interference has also impacted on PZU's nominal share price. While the company isn't traded publicly, for the past year a share traded among employees has not gained in value and is stuck at PLN300 (€78.34) per share despite record profits in 2006, according to Marcin Mazurek of Intelace Research.

Even so, that implies a company valuation of PLN26bn (€6.79bn) – probably the main reason the government won't give up without a fight. In fact, a formal valuation by Secus Asset Management last year came up with a figure twice as high, weighing in at PLN48.1bn.

Earlier this month, the Eureko board decided to make one of its prime strategic goals a resolution of the PZU dispute, and designated its vice president for European strategy, Ernst Jansen, to devote his full attention to it. Eureko is "currently in tentative discussions with the State Treasury," according to its spokeswoman.

The question is whether any compromise can be reached at all.

Last year the two warring parties reached agreement under which PZU was to have been listed on the Warsaw bourse, with neither side obtaining a majority stake. However, the deal was torpedoed in parliament by deputies already upset by the foreign domination of the financial services market; more than 70% of Poland's banking sector is foreign-owned.

Lawyers and analysts note that most state-owned enterprises, or SOEs, that were destined for privatization have already been sold, so the potential for other disputes involving the state is low.

But Andrzej Tokaj, managing partner in Warsaw of the Canadian law firm Magnusson which advises foreign clients, said Poland has managed to attract foreign investment with little effort so far, but now the competition is tightening and Poland's image is of even greater importance. Poland recorded a record €10.9bn in foreign investment in 2006, and expects to attract a similar amount this year.

"Other new countries in the EU are offering fresh opportunities," he says. "I hope Polish agencies realize this is becoming a much more competitive environment."

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