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
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● 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
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● 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
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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?
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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.
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(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.
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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.
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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.
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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.
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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.
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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
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● 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
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● 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”
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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
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● 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
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● 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)
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● 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)
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● Problem of the continuum
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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
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● Clarifying the continuum
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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
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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
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● 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
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● 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
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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
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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.
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● 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.
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● 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.
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