Prof. Markus Krajewski University of Erlangen-Nürnberginvestmentpolicyhub.unctad.org/Upload/Documents/Morocco 2013 (10... · Prof. Markus Krajewski University of Erlangen-Nürnberg

Direct and indirect expropriation

Prof. Markus Krajewski

University of Erlangen-Nürnberg

Investment policies towards sustainable development and inclusive growth

10-13 December 2013, Rabat, Morocco

Outline

I. General principles

II. Expropriation in international investment agreements

1. Examples of expropriation clauses

2. Types of expropriation

3. Challenges of the notion of “indirect expropriation”

4. Conditions of a legal expropriation

5. Compensation as remedy

III. Problems with current approach and reforms

Direct and indirect expropriation 2

I. General principles

● National sovereignty over natural resources

● Fundamental principle of public international law

● Recognised in

● UNGA Resolution 1803 (XVII), Permanent Sovereignty over Natural

Resources (1962)

● Article 2 UNGA Resolution 3281 (XXIX), Charter of Economic Rights

and Duties of States (1974)

● Art. 1 International Covenant on Economic, Social and Cultural

Rights (1966)

● Art. 18 Energy Charter (1994)

● ICJ, Armed Activities in Congo (DRC / Uganda), 2005


● Protection of individual property

● Customary international law

● Human right to property

● Art. 17 Universal Declaration of Human Rights

● Art. 14 African Charter on Human and Peoples' Rights

● Art. 31 Arab Charter on Human Rights

Private property may be expropriated, but only for

legitimate reasons and against some form of compensation

Tension between public policies and property protection

Völkerrecht I (6) 4

● Rising importance of further principles

● Right to regulate economic and social affairs

● exercise of state sovereignty

● fulfilment of human rights obligations

● Standards of good governance

● Proportionality

● Impartiality

● Non-discrimination

● Transparency

Tension between regulation and protection of individual rights


II. Expropriation in international investment agreements

● Almost all IIAs contain expropriation protection clauses

● General regulatory structure reflects standards of public

international law

● expropriation is not prohibited

● but subject of conditions and consequences of expropriation

● Open – and contested – questions

● What is expropriation?

● Which are the conditions and consequences of expropriation?


1. Examples of expropriation clauses

Article 5 BIT Finland-Nigeria (2005)

(1) Investments by investors of a Contracting Party in the territory of the

other Contracting Party shall not be expropriated, nationalised or

subjected to any other measures, direct or indirect, having an effect

equivalent to expropriation or nationalisation (hereinafter referred to as

"expropriation"), except for a purpose which is in the public interest, on a

non-discriminatory basis, in accordance with due process of law, and

against prompt, adequate and effective compensation.


(2) Such compensation shall amount to the value of the expropriated

investment at the time immediately before the expropriation or before

the impending expropriation became public knowledge, whichever is the

earlier. The value shall be determined in accordance with generally

accepted principles of valuation, taking into account, inter alia, the

capital invested, replacement value, appreciation, current returns, the

projected flow of future returns, goodwill and other relevant factors.

(3) Compensation shall include interest at the commercial rate

established on market basis for the currency of payment from the date

of dispossession of the expropriated property until the date of payment

and shall be paid and made transferable without delay to the country

designated by the claimant concerned and in any freely convertible

currency accepted by the claimant.


Article 5 (2) BIT Germany-Lebanon (1997)

Neither of the Contracting Parties shall take, either directly or indirectly,

measures of expropriation, nationalization or any other measures having

the same nature or the same effect against investments of investors of

the other Contracting Party, unless the measures are taken in the public

benefit, on a non-discriminatory basis, and under due process of law,

and provided that provisions be made for effective and adequate

compensation.


Such compensation shall be equivalent to the value of the expropriated

investment immediately before the date on which the actual or

threatened expropriation, nationalization or comparable measure has

become publicly known. The compensation shall be paid without delay

and shall carry the usual bank interest until the time of payment; it shall

be effectively realizable and freely transferable. Provisions shall have

been made in an appropriate manner at or prior to the time of

expropriation, nationalization or comparable measure for the

determination and payment of such compensation. The legality of any

such expropriation, nationalization or comparable measure and the

amount of compensation shall be subject to review by due process of

law.


Art. III (1) BIT US-Egypt (1986)

No investment or any part of an investment of a national or company of

either Party shall be expropriated or nationalized by the other Party or

by -a subdivision thereof-or subjected to any other measure, direct or

indirect, if the effect of such other measure, or a series of such other

measures, would be tantamount to expropriation or nationalization

(….hereinafter referred to as "expropriation") - unless the expropriation

(a) is done for a public purpose;

(b) is accomplished under due process of law;

(c) is not discriminatory;

(d) is accompanied by prompt and adequate compensation, freely

realizable; and

(e) does not violate any specific contractual engagement.


Compensation shall be equivalent to the fair market value of the

expropriated investment on the date of expropriation. The calculation of

such compensation shall not reflect any reduction in such fair market

value due to either prior public notice or announcement of the

expropriatory action, or the occurrence of the events that constituted or

resulted in the expropriatory action. Such compensation shall include

payments for delay as may be considered appropriate under

international law, and shall be freely transferable at the prevailing rate of

exchange for current transactions on the date of the expropriatory

action.


2. Types of expropriation

● Regarding scope

● Nationalisation: Industry- or sector-wide taking of property

associated with transfer to state

● Expropriation: Taking of specific property or asset transferred to

state or other economic actors

● Regarding formal effects

● direct expropriation: Forced and formal transfer of legal title

and/or physical seizure of property

● indirect expropriation: deprivation of investment without formal

transfer of title or physical dispossession


● Direct expropriation

● Historical development

● Key issue of investment protection in 19th/20th century

● Diminished practical importance since 1980s

● Today: “New” expropriations as reaction to financial and banking

crises or in context of re-nationalisation of key natural resources

● Assessment

● Requirement of compensation for direct taking of property generally

accepted standard of international law

● reflects principles of good governance and rule of law

● normally not an undue restriction of governmental regulatory power

or discretion

● But: Restriction on sovereignty over natural resources


● Indirect expropriation

● Historical development

● accepted in some early 20th century cases as part of customary

international law

● practical relevance rose in 1990s

● indirect expropriation included in most BITs

● Today: Next to fair and equitable treatment and national treatment

violations most common claim in investor-state dispute settlement

cases

● Assessment

● contours and relationship with regulatory autonomy remain unclear

● may have “regulatory chill effect”


3. Challenges of the notion of „indirect expropriation“

● Objective: Protection against governmental measures

● which have the same / similar effect than direct expropriation

● without constituting a direct expropriation

● But: What is the effect of an expropriation? What is equivalent?

● Terminological variety

● indirect, de facto, factual expropriation

● disguised expropriation

● measures tantamount / equivalent to expropriation

Meaning usually interchangeable


● Special forms of indirect expropriation

● Creeping expropriation: series of activities which constitute

expropriation only if considered together

● slow and incremental encroachment of ownership rights

● series of acts which culminate in expropriation

● Regulatory taking

● indirect expropriation based on regulatory measures (health, safety,

environmental law, planning requirements, cultural policies etc.)

● but not bona fide regulation based on legitimate purposes

Where to draw the line?

● Interference with contractual rights

● only if based on official authority

● not normal non-fulfilment of obligations


● Examples of indirect expropriation

● excessive, i.e. confiscatory or arbitrary taxation

● denial or revocation of operating licenses

● interference with management

● arrest and deportation of foreign managers

● imposition of new government-appointed managers

● refusal of access to raw material and infrastructure

● lack of due process, transparency, discrimination and interference

with legitimacy expectations may indicate expropriation (potential

overlap with fair and equitable treatment)


● Typical elements of indirect expropriation

● interference with property / protected investments or rights

● by measure or series of measures of a public authority

● to the extent that value of investment is significantly reduced /

control over property is significantly decreased

● without formal change of legal title or physical dispossession

● Two key aspects of indirect expropriation

● no formal dispossession or transfer of title (mater of formality)

● significant interference with value of investment (matter of degree

/ intensity)

● Disputed: Relevance of governmental intention or

objective (“Sole effects” doctrine)


● Problem of the continuum


formal change

of legal title =

direct

expropriation

“normal” reduction of

value =

bona fide regulation,

no expropriation

significant

reduction of

value

= indirect

expropriation

increasing level of interference

compensation no compensation

● Reducing ambiguity and breath of indirect expropriation

● Conditions which are presumed to lead to indirect expropriation

● Discriminatory measures

● Breach of state‘s binding commitments

● Unjustifiable arbitrariness

● Measures which are presumed to be bona fide regulation

● Reasonable measures taken in exercise of state powers

● to protect public policy goals (social, environmental etc. concerns)

● Specification of how to determine indirect expropriation

● Requirement of fact-based step-by-step analysis

● Considering economic impact

● Character or purpose of government action


● Clarifying the continuum


formal change

of legal title =

direct

expropriation

• Reasonable

measures

• to protect public

policy goals

= no indirect

expropriation

• Discrimination

• Breach of

commitments

• arbitrariness

= indirect

expropriation

compensation no compensation

increasing level of interference

• Step-by-

step

• consider

various

factors

= (no) indirect

expropriation

4. Conditions of a legal expropriation

● Legal structure

● Expropriation not prohibited (unlike discriminatory treatment or

violation of FET)

● but subject to conditions

● Typical conditions of legal expropriation in IIAs

● non-discriminatory basis

● for a public purpose

● due process of law

● compensation

● judicial review of decision


5. Compensation as legal remedy

● Standards in IIAs

● prompt = without undue delay

● adequate = market value of the investment expropriated

immediately before expropriation

● effective/freely realizable = in freely convertible currency

● including interests

● judicial review of decision and calculation of compensation

= “Hull” formula


● Calculation of compensation

● involves highly complex factual considerations

● typical method is discounted cash method which looks at

projected income

● not replacement value

● But

● How to reflect effects of regulation on value of investment?

● Example: Implementation of strict environmental policy leads to

● normal reduction of investment value no compensation

● significant reduction of investment value (= indirect expropriation)

full compensation


● Other standards for compensation

● „Appropriate“ compensation (e.g. Art. 2 Charter of Economic

Rights and Duties of States)

● taking into account its relevant laws and regulations and all

circumstances that the State considers pertinent

● in case of controversy: settlement under the domestic law of the

nationalizing State and by its tribunals

● “Equitable” compensation (e.g. new South African Expropriation

Bill 2013)

● Striking balance between private and public interest

● Market value “predominant factor”

● But also current use, extend of state investment and “purpose” of

expropriation


III. Problems with current approach and reforms ● Problems

● Unclear definition of indirect expropriation in treaty language and

arbitration practice may negatively affect regulatory autonomy

● Legal remedy (full compensation) does not correspond to nature

of continuum

● Remedies

● Defining indirect expropriation / distinguishing from regulatory

measures

● Limiting amount of compensation


Textual proposals from UNCTAD‘s IPFSD

Textual proposal

● 4.5.0 Provide that an

expropriation must comply

with/respect four conditions:

public purpose, non-

discrimination, due process and

payment of compensation

Explanation

● IIAs with expropriation clauses

do not take away States’ right to

expropriate property, but protect

investors against arbitrary or

uncompensated expropriations,

contributing to a stable and

predictable legal framework,

conducive to foreign investment.


● 4.5.1 Limit protection in case of

indirect expropriation (regulatory

taking) by

- establishing criteria that need to

be met for indirect expropriation to

be found

- defining in general terms what

measures do not constitute

indirect expropriation

(nondiscriminatory good faith

regulations relating to public

health and safety, protection of

the environment, etc.)

- clarifying that certain specific

measures do not constitute an

indirect expropriation

(e.g.compulsory licensing in

compliance with WTO rules).

● To avoid undue constraints on a

State’s prerogative to regulate in

the public interest, an IIA may

set out general criteria for State

acts that may (or may not) be

considered an indirect

expropriation. While this does

not exclude liability risks

altogether, it allows for better

balancing of investor and State

interests.


● 4.5.2 Specify the compensation

to be paid in case of lawful

expropriation:

- appropriate, just or equitable

compensation

- prompt, adequate and effective

compensation, i.e. full market

value of the investment (“Hull

formula”).

● 4.5.3 Clarify that only

expropriations violating any of

the three substantive conditions

(public purpose, non-

discrimination, due process),

entail full reparation.

● The standard of compensation

for lawful expropriation is

another important aspect. The

use of terms such as

“appropriate”, “just” or “fair” in

relation to compensation gives

room for flexibility in the

calculation of compensation.

States may find it beneficial to

provide further guidance to

arbitrators on how to calculate

compensation and clarify what

factors should be taken into

account.


Questions and answers

Thank you very much for your attention!

Contact: [email protected]