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«ISBN 92-64-01164-1 International Investment Law: A Changing Landscape A Companion Volume to International Investment Perspectives © OECD 2005 ...»

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ISBN 92-64-01164-1

International Investment Law: A Changing Landscape

A Companion Volume to International Investment Perspectives

© OECD 2005

Chapter 2

“Indirect Expropriation”

and the “Right to Regulate”

in International Investment Law *

In recent times, disputes related to nationalisation of investments that marked

the 70s and 80s have been replaced by disputes related to foreign investment

regulation and indirect expropriation. Foreign investors increasingly make

claims for compensation based on governmental regulations, such as placing restrictions on the legal use of property that do not actually remove the owner’s title to the property but nevertheless substantially affect its value or the owner’s control. There is some concern that concepts such as indirect expropriation may be applicable to regulatory measures aimed at protecting the environment, health and other welfare interests of society.

How has state practice defined and articulated the difference between an indirect expropriation requiring compensation and a governmental measure impacting an investment but not requiring compensation? How have arbitral tribunals drawn the line? Has the doctrine shed any additional light on this distinction?

This survey provides factual elements of information on jurisprudence, state practice and literature related to “Indirect Expropriation” and the “Right to Regulate”. It presents the issues at stake and describes the basic concepts of the obligation to compensate for indirect expropriation, reviews whether and how legal instruments and other texts articulate the difference between indirect expropriation and the right of the governments to regulate without compensation and attempts to identify a number of criteria emerging from jurisprudence and state practice for determining whether an indirect expropriation has occurred.

* This survey was prepared by Catherine Yannaca-Small, Investment Division, OECD Directorate for Financial and Enterprise Affairs, and benefited from discussions, comments and a variety of perspectives in the OECD Investment Committee. The document as a factual survey, however, does not necessarily reflect the views of the OECD or those of its member governments. It cannot be construed as prejudging ongoing or future negotiations or disputes pertaining to international investment agreements.

INTERNATIONAL INVESTMENT LAW: A CHANGING LANDSCAPE – ISBN 92-64-01164-1 – © OECD 2005

“INDIRECT EXPROPRIATION” AND THE “RIGHT TO REGULATE” IN INTERNATIONAL INVESTMENT LAW

Introduction It is a well recognised rule in international law that the property of aliens cannot be taken, whether for public purposes or not, without adequate compensation. Two decades ago, the disputes before the courts and the discussions in academic literature focused mainly on the standard of compensation and measuring of expropriated value. The divergent views1 of the developed and developing countries raised issues regarding the formation and evolution of customary law. Today, the more positive attitude of countries around the world toward foreign investment and the proliferation of bilateral treaties and other investment agreements requiring prompt, adequate and effective compensation for expropriation of foreign investments have largely deprived that debate of practical significance for foreign investors.

Disputes on direct expropriation – mainly related to nationalisation that marked the 70s and 80s – have been replaced by disputes related to foreign investment regulation and “indirect expropriation”. Larg ely prompted by the first cases brought under NAFTA, there is increasing concern that concepts such as indirect expropriation may be applicable to regulatory measures aimed at protecting the environment, health and other welfare interests of society. The question that arises is to what extent a government may affect the value of property by regulation, either general in nature or by specific actions in the context of general regulations, for a legitimate public purpose without effecting a “taking” and having to compensate for this act. One leading commentator suggests that the issue

1. A number of developed countries endorsed the “Hull formula”, first articulated by the United States Se cretary of State Cordell Hull in response to Mexico’s nationalisation of American petroleum companies in 1936. Hull claimed that international law requires “prompt, adequate and effective” compensation for the expropriation of foreign investments. Developing countries supported the Calvo doctrine during the 1960s and 1970s as reflected in major United Nations General Assembly resolutions. In 1962, the General Assembly adopted its Resolution on Permanent Sovereignty over Natural resources which affirmed the right to nationalise foreign owned property and required only “appropriate compensation”.

This compensation standard was considered an attempt to bridge differences between developed and developing states. In 1974, the UN General Assembly decisively rejected the Hull formula in favour of the Calvo doctrine in adopting the Charter of Economic Rights and Duties of States. While Article 2(c) repeats the “appropriate compensation” standard, it goes on to provide that “in any case where the question of compensation gives rise to a controversy, it shall be settled under the domestic law of the nationalising State and by its tribunals…”. Nowadays, the Hull formula and its variations are often used and accepted and considered as part of customary international law.





44 INTERNATIONAL INVESTMENT LAW: A CHANGING LANDSCAPE – ISBN 92-64-01164-1 – © OECD 2005

“INDIRECT EXPROPRIATION” AND THE “RIGHT TO REGULATE” IN INTERNATIONAL INVESTMENT LAW

of definition of expropriation in this context may become the dominant issue in international investment law.2 Despite a number of decisions of international tribunals, the line between the concept of indirect expropriation and governmental regulatory measures not requiring compensation has not been clearly articulated and depends on the specific facts and circumstances of the case. However, while case-by-case consideration remains necessary, there are some criteria emerging from the examination of some international agreements and arbitral decisions for determining whether an indirect expropriation requiring compensation has occurred.

The present survey provides factual elements of information on jurisprudence, state practice and literature on this matter. It presents the issues at stake and describes the basic concepts of the obligation to compensate for indirect expropriation (Section 1), reviews whether and how legal instruments and other texts articulate the difference between indirect expropriation and the right of the governments to regulate without compensation (Section 2) and attempts to identify a number of criteria which emerge from jurisprudence and state practice for determining whether an indirect expropriation has occurred (Section 3).

1. Basic concepts of the obligation to compensate for indirect expropriation Customary international law does not preclude host states from expropriating foreign investments provided certain conditions are met. These conditions are: the taking of the investment for a public purpose, as provided by law, in a non-discriminatory manner and with compensation.

Expropriation or “wealth deprivation” 3 could take different forms: it could be direct where an investment is nationalised or otherwise directly expropriated4 through formal transfer of title or outright physical seizure.

In addition to the term expropriation, terms such as “dispossession”, “taking”, “deprivation” or “privation” are also used.5 International law is

2. Dolzer, “Indirect Expropriations: New Developments?” Article of the Colloquium on Regulatory Expropriation organised by the New York University on 25-27 April 2002;

11 Environmental Law Journal 64.

3. “Wealth deprivation” is a term which according to Weston avoids most, if not all, of the major ambiguities and imprecision of the traditional terminology. See B. Weston “‘Constructive Takings’ under International Law: A Modest Foray into the Problem of “Creeping Expropriation”, Virginia Journal of International Law, 1975, Vol. 16, pp. 103-175 at 112.

4. In general, expropriation applies to individual measures taken for a public purpose while nationalisation involves large-scale takings on the basis of an executive or legislative act for the purpose of transferring property or interests into the public domain.

5. Dolzer and Stevens, “Bilateral Investment Treaties”, ICSID, 1995 at 98.

INTERNATIONAL INVESTMENT LAW: A CHANGING LANDSCAPE – ISBN 92-64-01164-1 – © OECD 2005

“INDIRECT EXPROPRIATION” AND THE “RIGHT TO REGULATE” IN INTERNATIONAL INVESTMENT LAW

clear that a seizure of legal title of property constitutes a compensable expropriation.

Expropriation or deprivation of property 6 could also occur through interference by a state in the use of that property or with the enjoyment of the

6. In the context of international law, “property” refers to both tangible and intangible property. Under Article 1139 of the NAFTA, the definition of “investment” covers, among other things, “real estate or other property, tangible or intangible [emphasis supplied], acquired in the expectation or used for the purpose of economic benefit or other business purposes.” Likewise, most BITs contain a relatively standard definition of investment that also covers intangible forms of property: “intellectual property and contractual rights.” Source UNCTAD “Bilateral Investment Treaties in the Mid-1990s” 1998. See also the recently concluded US FTAs with Australia, Chile, Dominican Republic-Central America, Morocco and Singapore: “An action or series of actions by a Party cannot constitute an expropriation unless it interferes with a tangible or intangible property right or property interest in an investment.” The Iran-United States Claims Tribunal stated that “[the claimants] rely on precedents in international law in which case measures of expropriation or takings, primarily aimed at physical property, have been deemed to comprise also rights of a contractual nature closely related to the physical property…” It has consistently rejected attempts made by Iranian respondents for a narrow interpretation of “property” and has confirmed that shareholder rights and contractual rights can be the object of expropriation Starret Housing Corp. v. Islamic Republic of Iran, 4, Iran-US Cl. Trib. Rep. 122, 156-57 (1983), Amoco International Finance Corporation v. Iran, Award No. 310-56-3 (14 July 1987), 15 Iran-US C.T.R. 189-289. Under the Protocol 1 of the European Convention on Human Rights, the concept of property is very broadly defined by reference to all the proprietary interests of an individual. It covers a range of economic interests: “movable or immovable property, tangible and intangible interests, such as shares, patents, an arbitration award, the entitlement to a pension, a landlord’s entitlement to rent, the economic interests connected with the running of a business and the right to exercise a profession…” One of the first instances in which the violation of an intangible property right was held to be an expropriation, was the Norwegian Ship-owners’ case. Although the United States contended that it had requisitioned only ships and not the underlying contracts, the Tribunal found that a taking of property rights ancillary to those formally taken had occurred and required compensation. Nor. v. US, 1 R.I.A.A. 307, 332 (Perm. Ct. Arb. 1922). In the 1926 case of German Interests in Polish Upper Silesia – the Chorzow Factory case – the Permanent Court of International Justice found that the seizure by the Polish government of a factory plant and machinery was also an expropriation of the closely interrelated patents and contracts of the management company, although the Polish government at no time claimed to expropriate these.

F.R.G. v. Pol., 1926 P.C.I.J. (ser. A) No. 7 (May 1925).

However, certain intangible property rights or interests, by themselves, may not be capable of being expropriated, but may be viewed instead, as elements of value of business. In the 1934 Oscar Chinn case, the Permanent Court did not accept the c onten tion th at good will is a prope rty r ig ht ca pable, by itse lf, of being expropriated. The P.C.I.J. found that a granting of a de facto monopoly did not constitute a violation of international law, stating that “it was unable to see in [claimant’s] original position – which was characterised by the possession of customers – anything in the nature of a genuine vested right” and that “favourable business conditions and good will are transient circumstances, subject to inevitable changes”. 1934 P.C. I. J. Ser A/B, No. 63. In two more recent NAFTA cases, 46 INTERNATIONAL INVESTMENT LAW: A CHANGING LANDSCAPE – ISBN 92-64-01164-1 – © OECD 2005

“INDIRECT EXPROPRIATION” AND THE “RIGHT TO REGULATE” IN INTERNATIONAL INVESTMENT LAW

benefits even where the property is not seized and the legal title to the property is not affected. The measures taken by the State have a similar effect to expropriation or nationalisation and are generally termed “indirect”, “creeping”,7 or “de facto” expropriation, or measures “tantamount” to expropriation.

However, under international law, not all state measures interfering with property are expropriation. As Brownlie has stated, “state measures, prima facie a lawful exercise of powers of governments, may affect foreign interests considerably without amounting to expropriation. Thus, foreign assets and their use may be subjected to taxation, trade restrictions involving licenses and quotas, or measures of devaluation. While special facts may alter cases, in p r in c ip l e such m e a s ur es are n ot u n lawfu l a n d do n ot c o n sti tute expropriation”.8 Similarly, according to Sornarajah,9 non-discriminatory m e as ure s 10 re lated to a nti-trust, c ons umer protec tion, sec urities, environmental protection, land planning are non-compensable takings since they are regarded as essential to the efficient functioning of the state.



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