Kartik Sharma[1]
Introduction
The determination of the adequate standard of compensation for expropriation remains a widely contested issue in International Investment law. Expropriation is prohibited in International Investment Treaties (IIAs) except for situations where certain criteria are met. State parties can lawfully expropriate foreign investors’ properties only if they meet the listed conditions of legality. Normally, these include: (i) the taking should be for a public purpose, (ii) carried out in a non-discriminatory manner, where (iii) due process of law was followed, and (iv) it was accompanied by prompt, effective and adequate compensation. If these four criteria are adhered to, it is a lawful expropriation; otherwise, the expropriation is unlawful. A question arises with respect to the fourth requirement, i.e. the payment of compensation. If an expropriation that meets conditions (i) to (iii) but fails to satisfy the fourth condition (iv), is it to be considered a lawful or an unlawful expropriation? The answer becomes relevant because unlawful expropriation attracts the customary principle of full reparation (deriving from the Chorzow Factory ICJ judgement).
Tribunals have displayed varying opinions on this issue. This blog seeks to examine the controversy and analyse the different arguments. On a first look, an expropriation merely lacking compensation in accordance with treaty standards ought to be considered wrongful. However, this response complicates matters for the application of the police powers doctrine, which is relevant in the context of an alleged indirect expropriation. The reason being that a correct invocation of the doctrine negates the need to pay compensation for measures that could otherwise have been considered compensable. Such a consequence is in contrast to a situation where the tribunal orders a state to fulfil the compensation condition (iv) to render it a fully lawful expropriation. The reason being that the police powers doctrine’s elements are very similar to (i)-(iii) conditions of lawful expropriation.
Provisionally Lawful
Some investment tribunals have found that an indirect expropriation merely lacking compensation, should not be considered an unlawful expropriation, but provisionally lawful. Instead, they have noted that the tribunal itself had to determine whether an expropriation occurred and whether this triggered the duty to compensate. Tidewater v Venezuela is one such often-discussed arbitral award. The tribunal read Chorzow Factory as drawing a distinction between lawful expropriations that merely lack fair compensation and compensations that are unlawful for a violation of other procedural and substantive criteria (para 130). It drew upon other scholarship to distinguish expropriation per se from expropriation only lacking compensation. An expropriation only missing fair compensation will have to be considered provisionally lawful. This is because the majority of cases involve situations where the host state did not pay compensation owing to its conception of its own acts as not being expropriatory. A contrary interpretation will lead tribunals in such cases to treat every expropriation as unlawful, which implies that the customary rule of compensation will displace the treaty standard. For the tribunal, this would render expropriation provisions in investment treaties redundant (para 138). Accordingly, “[e]xpropriation only wanting fair compensation has to be considered as a provisionally lawful expropriation, precisely because the tribunal dealing with the case will determine and award such compensation” (para 141).
Brigette Stern expressed similar views in her dissent in Quiborax SA v Bolivia. According to Ms. Stern, “[a]n expropriation only lacking fair compensation should be treated in the same manner as a lawful expropriation” (para 10 of the Dissent Opinion). She cited Mobil v Venezuela and Tidewater in support of her assertion.
The contrary position to the above is that prompt and adequate compensation is a necessary element to establish lawful compensation. An absence to offer or pay the compensation is in breach of the treaty provision for lawful expropriation and renders it unlawful. In Georg Gavrilovic and Gavrilovic d.o.o. v Republic of Croatia (paras 947-949) and C.D. Holding Internationale v Hungary, (paras 410-411), the tribunals held that the absence of compensation by itself is sufficient to render an indirect expropriation unlawful. Damages for unlawful expropriation will be governed by the Chorzów Factory rule (C.D. Holding para 512) where compensation must wipe out the consequences of the illegal act.
Making it lawful via the award: problems with this approach
The approach accepting expropriation lacking compensation as provisionally lawful leads to a dogmatic problem, namely a conflation between primary and secondary obligations under international law. If a treaty provision clearly lays down X number of conditions for indirect expropriation to be lawful, the state party has to satisfy them beforehand as part of its primary duty to adhere to its treaty commitments. What the Tidewater approach essentially does is to make the arbitral award a part of the process of making the state’s actions lawful. X-1 conditions were satisfied by the state beforehand. Now the award deems it provisionally lawful. The tribunal then orders the state to satisfy the remaining one condition and finally the expropriation becomes lawful.
That is not what the arbitral tribunal has to do. As Khachvani also notes, the majority of modern IIAs require the tribunal to decide the lawfulness of the state’s conduct and then award damages if a treaty breach is established. Tidewater tribunal’s mandate was to judge the legality of the expropriation (as a matter of the state’s primary duty), and if found unlawful, order the state to provide reparation as a matter of secondary obligation. This secondary duty flows from the norms of international law of state responsibility. The Chorzow standard is an articulation of that secondary duty only. A mix-up of these primary and secondary duties renders the compensation criterion for a lawful expropriation nugatory and goes against the text of the treaty. As to the Tidewater tribunal’s observation regarding the very disputed nature of expropriation being at the crux of controversy, that does not support the provisionally lawful finding. It is indeed true that the tribunal firstly looks at whether the impugned state acts amount to indirect expropriation or not (when a state takes effective control of, or otherwise interferes with the use, enjoyment or benefit of, an investment, strongly depreciating its economic value, even without a direct taking of property). After establishing the existence of indirect expropriation, a tribunal has to consider the legality criteria outlined in the expropriation provision to assess whether the expropriation is lawful or not. If compensation as per the provision was not paid, then it will be considered unlawful.
Both Khachvani and Ratner in their scholarship go to make more fundamental arguments about the whole lawful-unlawful expropriation debate. Khachvani, as already stated, considers just compensation to also be a part of legality conditions to be fulfilled beforehand. He then shows how different forms of unlawful expropriations arise out of different types of illegal acts and the non-fulfilment of various conditions. The customary rule of reparation should be applied in a contextual fashion, leading to varying quantum analyses depending on the degree and scope of the unlawfulness. Ratner terms the whole lawful-unlawful distinction as being antiquated and sketches a new framework that maps the remedies onto the nature of the expropriatory act vis-à-vis the four legality criteria in investment treaties.
There are practical consequences to the unlawful vs. provisionally lawful categorization here. A caveat is made before proceeding: international practice and scholarship so far has been unable to provide a decisive differentiation between the amount of compensation payable for lawful vs. unlawful expropriations.
Many treaties use the well-known Hull formula of ‘prompt, adequate, and effective’ compensation for lawful expropriations. The calculation metric often used then is the fair market value of the expropriated investment immediately before the expropriation took place, which is the date of expropriation (see Article 6 of US Model BIT of 2012).
However, while applying the full reparation rule for unlawful expropriations, the valuation date has often, but not always, been taken to be the date of the award. In ADC v Hungary, the tribunal favoured the date of award as the benchmark since “[t]his is what is necessary to put the Claimants in the same position as if the expropriation had not been committed” (para 497). Similarly, in Siemens v Argentina, the tribunal held the investor to be entitled to “[n]ot just to the value of its enterprise as of May 18, 2001, the date of expropriation, but also to any greater value that enterprise has gained up to the date of this Award, plus any consequential damages” (para 355). The Vivendi tribunal (para 8.2.5) had opined that the reparation standard allows for higher recovery than the compensation standards laid down in the investment treaties. However, Professor Stern in her dissent in Quiborax v Bolivia termed the ADC’s approach as an ‘ultra-minority’ view, something that the ADC tribunal itself in her view admitted (owing to the increase in value of the expropriated property). The majority of cases of unlawful expropriation as per Stern had adopted the expropriation date to calculate damages. In Rumeli Telekom v Kazakhstan, the tribunal held the correct approach to be the “award such compensation as will give back to Claimants the value to them of their shares at the time when the expropriation took place” (para 793).
Complicating the Police Powers doctrine
The next line of enquiry is this: What does the provisionally lawful-unlawful debate do to the existence and operation of the Police Powers (PP) doctrine? Arguably, PP is left hanging in a zone of contradiction where its invocation would become unclear.
The PP doctrine grants a state an inherent right to undertake regulatory measures in furtherance of public interest and such acts, even if they cause losses to the investor, will not be termed as wrongful. In the specific context of indirect expropriation, a state’s exercise of its leeway under the PP doctrine will be out of the ambit of expropriation itself, and hence not compensable. Carvasso notes that some IIAs have given the doctrine a textual grounding, either as part of the expropriation provision, as a stand-alone clause, or as an annexure. For instance, in Annex 14-B of the United States-Mexico-Canada Agreement (USMCA), para 3(b) states that “Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as health, safety and the environment, do not constitute indirect expropriations, except in rare circumstances”. This is an exemption provision that articulates a carve out from the very definition of indirect expropriation. Logically, it comes one step before the legality criteria. The practical result will be this: any measure that is deemed an exercise of a state’s police powers is not even an indirect expropriation. Hence the very question of compensation will not arise, leave aside the debate over whether the treaty standard of compensation or the reparation rule will apply.
There is a glaring issue here, which is also identified by Riffel in his piece. The elements of this exemption are also duplicated in the lawful expropriation criteria listed in an IIA’s main expropriation provision. Non-discrimination and public purpose objectives are also a part of the conditions for lawful expropriations. The distinction between compensable expropriatory acts and non-compensable regulatory measures (under the PP doctrine) becomes difficult to figure out. One may however want to distinguish between ‘public purpose’ and ‘public welfare’. Yet both terms seem open-ended enough to lead to confusions. Tribunals have sort of recognized this state of discomfort. In Vivendi v Argentina (II), the tribunal observed that “[I]f public purpose automatically immunises the measure from being found to be expropriatory, then there would never be a compensable taking for a public purpose” (para 7.5.21). Riffel goes on to articulate different conceptions of the non-discrimination condition in both circumstances and also shows how the ‘designed and applied’ test can be used to carve out non-discriminatory regulatory measures from the scope of indirect expropriation itself.
Nevertheless, we are left with two diverging situations. If the Tidewater tribunal’s approach is taken, any expropriation that satisfies all conditions but lacks compensation will be termed as provisionally lawful and compensation as per treaty provisions will be ordered by the tribunal. The same action if evaluated through the PP doctrine’s lens may turn out to be a carve-out from the very scope of indirect expropriation and hence non-compensable one. Contrarily, if the criticism of approach followed in Tidewater is accepted, the expropriatory measure will necessitate reparation as part of the relief for the unlawful expropriation. But the state here will prefer to couch its acts under the doctrine of PP in order to characterize it as non-compensable in the first place. How will the tribunal then decide, between terming it as an unlawful expropriation and a non-instance of expropriation?
Conclusions
The PP doctrine puts the state in a peculiar situation. The state may have thought of its action as not amounting to expropriation because of the doctrine’s defence it would seek to invoke. Consequently, it would not even attempt to pay any compensation. However, the tribunal may choose to discard the doctrine and undertake its analysis in accordance with the treaty text on expropriation. It will hold the expropriation to be either provisionally lawful or unlawful, depending on the approach it takes (as discussed in the blog). A good faith offer of compensation by the state (even if it does not match the treaty standard) has been argued by some to render an expropriation lawful. Irrespective, the state will have to pay compensation, which will differ as per the calculation method the tribunal chooses to employ. I have given a brief overview of the differing compensation standards for lawful vs. unlawful compensations. Scholars like Ratner have illustrated that the jurisprudence around the assessment of compensation is in dire need of clarity. Solutions towards clarity in this aspect of compensation will then have an impact on the way states conduct their expropriatory actions, because the consequences that flow from the expropriation will nudge the states’ future actions in respect of how they engage with the investors while dealing with their properties.
[1] LL.B. candidate at the National Law School of India University (NLSIU), Bangalore