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Indirect Expropriation in International Investment Law - Premium Essay Help | Premium Essay Help
The concept of indirect expropriation gained infamous recognition in foreign milieu with the BIT provisions innate of the 1993 North American Free Trade Agreement (NAFTA). International investors relied on the provisions in order to gain an opportunity in filing sophisticated court cases against governments based on allegations of indirect expropriation[4]. This is because indirect expropriation protected investors in cases that were outside the official infringements of their privileges. Nevertheless, indirect expropriation precedes NAFTA. As such, it is important to explore the considerably relevant background of the notion, its appearance within the international structure and its influence based on its interpretation by arbitral tribunals as well as its impact on the amendable activity of the government in regulation. Thus, focus will delve on the measure’s difference from other regulatory techniques and its concept based on state practice and obvious and pertinent arbitral awards.
Based on formal UNCTAD sources, 2701 investment treaties exist globally[5]. Most of these treaties incorporate an article on expropriation, encompassing both forms, which include direct and indirect expropriation. A re-evaluation of these treaties, the BITs and the FTAs, illustrates that the clauses that deal with expropriation can be categorised into two classes, direct and indirect expropriation, based on the terms used.
Articles safeguarding investors against the vice of expropriation have progressed to cover indirect expropriation. In general, indirect expropriation takes place where there is evidence of interference in the utilization, satisfaction or gains acquired from a property by the host country. In addition, the articles function even where the property is free and where the property’s legal title is unaffected. In practicum, safeguarding against indirect expropriation indicates that an international investor filing an allegation against the host country, files on the justification that the country is dispossessing him or her, partly or entirely, of his or her property, even if the country has not actually detained the asset while applying its regulatory authority. Under such defence, an investor can litigate for financial loss resulting from an action by the country, which distresses the property[6].
NAFTA, which is an FTA that does not comprise BIT interventions, comprises a chapter based on investment protection authored in the same manner as a BIT[7]. NAFTA signified a vital phase for safeguarding foreign investments. Under this accord, international investors were able to impinge on the ability of governments to regulate their properties[8]. In addition, NAFTA provided knowledge based on the effects of safeguarding investments to international investors against expropriation. Regardless, the clauses within the BITs or the chapters of international investment within the FTA are too vague or broad, which coerces arbitrators to interpret the scope of protection of international investments. Nevertheless, the notion of indirect expropriation has conceived novel concerns based on its scale and use in explaining indirect expropriation. Indeed, it has become increasingly hard to delineate the governmental measures that possess a negative effect on property rights.
Indirect Expropriation as a Regulatory Measure
The difference between indirect expropriation and other regulatory measures is based on the criterion that classifies the measure as a means of regulating states under international investment regulations. Usually, the criterion for determining indirect expropriation is provided by tribunal laws. The criterion are categorised into three main factors that determine indirect expropriation and differentiate from the rest of other investment regulatory measures. These factors include unfavourable or damaging effect, proportionality and justifiable public interest[9].
Unfavourable or Damaging Effect
The limited criterion of Unfavourable or Damaging Effect on investment, also referred as the Sole Effect Doctrine, describes the effect amounting from the legal taking of an investment on the foreign investor by the State. The effect of this specific factor on the measure of indirect expropriation has awarded renowned status in the determination of a probable legal taking. In addition, the Unfavourable Effect factor has made the adverse effect realised from a State measure on the investor as the main factor in determining possibility or insufficiency of an instance of legal taking[10].
The notion of Proportionality is delineated as that which discovers equilibrium amid a pair of conflicting interests. Regarding this case, the conflicting interests are represented by the Private and the Public. The objective of proportionality aims at ascertaining that the forfeiture forced on private interests is in proportion to the event of pursuing public interests. Regardless of the fact that proportionality is a relatively strange notion within international investment law, the notion focuses on protection of investments and has been utilised in indirect expropriation instances[11].
Justifiable Objective
Several tribunals have utilised the criterion of the Justifiable Objective the measure is structured to provide in lieu of the principle of the measure’s harmful effect on the investment. The Unfavourable Effect rationale and the Justifiable Objective principle prove similar in the context of assuming that definite reasonable host country measures with particular traits do not possess indirect expropriation rights, even in the event that they sternly damage an investment. These justifiable measures also indirectly expropriate the property of an investor and as such, do not offer the entire reimbursement to the investor since they deny him of the right to gain full compensation[12].
Therefore, the investor does not receive full compensation at the property’s market value based on the superseding interest that led to the asset’s depreciation. However, the main checkpoint encompassing the Justifiable Objective is based on proportioning the compensation amount. This is because the criterion makes regulations on public interest financially sustainable for the host State, and in the event discourages private initiative.
Basis of Indirect Expropriation
Regardless of the fact that the notion of indirect expropriation achieved magnitude and significance after its incorporation within Chapter 11 of the NAFTA, the concept originated from various historical marks. These antecedents comprise the International Tribunals’ Decisions, Codification Attempts, Incorporation of the Notion within Treaties and Richard Epstein’s underpinning of the concept[13].
The International Tribunals’ Decisions
Various decisions by International Tribunals influenced the notion of indirect expropriation. One of the foremost influences based on indirect expropriation arose from the controversy between the Kingdom of the Two Sicilies and the United Kingdom in 1838. During this period, the Kingdom of Two Sicilies contracted a monopoly of mining and distribution of Sicilian sulphur to a sole firm. This decision by the Kingdom of Two Sicilies excluded all other firms from mining and distributing the sulphur overseas. British nationals owned a part of these excluded firms. Regardless of the fact that the British firms owned deposits and reserves of the mineral, the law restricted the companies from dealing their sulphur based on the conditions of the monopoly[14].
However, after constant demands from the United Kingdom in 1840, the Sicilian authorities annulled the monopoly contract. An international commission comprised of five commissioners was set up to resolve the allegations of the British nationals gravely aggrieved by the effects of the monopoly on their properties and investments. As such, the commission granted reimbursement to the proprietors of the sulphur mines, the suppliers and those that had purchased the sulphur before the enforcement of the monopoly accord in Sicily. The reason utilised by the international tribunal regarding their decision surmised that offering a monopoly contract to one firm affected property rights of the investors and thus created economic depravity[15].
Regardless of the fact that the Kingdom of Two Sicilies had not actually acquired the indentures and sulphur mines of the British firms, compensation was inevitable. Therefore, based on this precedent case, an indirect intervention was enough to warrant investors to ask for for economic reimbursement on the grounds of economic depravity[16].
Another instance arose from the controversy involving a nitrate plant based within the Polish city of Chorzow. In 1915, the Germans expressed interest in Polish Upper Silesia. At this time, the German government completed an agreement with the contractor, Baryische Stickstoffwerke A.G. Based on the agreement, the contractor was supposed to build a nitrate plant in Chorzow in Upper Silesia[17]. The contract also outlined that the German government would be the proprietor of the plant. In addition, the contract offered that the contractor would administer nitrate functions from 1915 to 1941. Through a specific corporate entity, the contractor obtained the privileges to utilise the patents, licenses and experiences stemming from the nitrate functions at the plant in Chorzow.
In 1919, the German government transferred the name of the plant to a novel German company named Oberschlesische Stickstoffwerke A.G. The transfer of the title meant that the new German firm assumed the notion of Title Holder. As such, the novel proprietor gained all the contractual privileges that the contractor owned such as utilisation of licenses and patents and handling of factory operations. In 1920, the Polish government provided a ministerial decree. The ministerial decree authorised a representative of the Polish government to gain control over operations within the nitrate plant and acquisition of the patents, licenses and movable property. The Permanent Court of Justice affirmed that the Polish government had illegally expropriated the contractor’s contractual rights by possessing the Chorzow plant and commencing operations[18].
Another instance arose from the disagreement surrounding the International Claims Commission and the Government of Hungary in 1950. Ascertained in the United States of America by the 1949 International Claims Act, the International Claims Commission granted reimbursement to American citizens whose property was subject to acquisition or nationalization by an international government. The Foreign Claims Settlement Commission assumed these rights in 1954. In the 1950s, the Commission made various decisions based on direct expropriations or expropriations that arose from standards implemented by governments that possessed an effect on property rights. A case that involved the notion of indirect expropriation at the time was the Alberta Bela Reet[19].
In 1949, the Hungarian government restricted the assignment of liens or sale in the occupancy of a dwelling abode as well as its courtyard. As such, the Commission asserted that the prohibition on the liberated utilisation of property was an indirect expropriation regardless of the non-transfer of title to the government. The Commission, in various instances, further asserted that transferring the title of the property to the country did not create basis for it to gain recognition as a critical prerequisite for expropriation. Therefore, prohibitions on the privileges to utilise a particular property by rules issued by the host country as well as coerced sales classified as expropriations[20].
The Poehlmann versus Kulmbacher Spinneri case in 1952 also set a precedent for the notion of indirect expropriation. Regarding this case, A German civilian was married to a Jewish woman. The German civilian was also the owner of a considerably popular hotel in Kulmbach. At the time when the Nazis gained power, it became publicly deplorable for members of the party to make merry and reside in hotels and restaurants. As an alternative, they started socially disapproving the venue. As a result, the business began declining forcing the owner to sell the hotel. The United States Court of Restitution unanimously agreed that the hotel was impounded and therefore directed reimbursement in support of the hotel owner[21].
The Codification Attempts
From the start of the 1950s, the principles comprising the precedent cases involving indirect expropriation began codification. One of the main texts that were drafted after the foremost BIT was the Harvard Draft Convention on the International Responsibility of States for Injuries to Aliens in 1961[22]. The General Assembly of the United Nations asked the International Law Commission to codify the standards of International Law administering state liability[23]. Irrespective of the fact that the Harvard Draft was not designed to protect foreign investments, the Draft swathed the problem. For instance, section 3 of Article 10 in the Draft provided for instances that defined the acquisition of property[24].
According to the article, seizure of property involved the absolute seizure of a property. In addition, the article expanded on the seizure of property such that the definition of apprehension of property involved interference with satisfaction, utilisation or disposal of the respective property. As such, the definition asserted that seizure of property involved interference that affected the proprietor’s right to utilise, enjoy, dispose and be satisfied of his or her property within a specified period after the commencement of such intrusion. Simply, the Harvard Draft asserted that prohibiting the right to utilise, benefit from or dispose of a property without practical justification amounts to seizure of property[25].
The notion of indirect expropriation also obtains unequivocal appreciation in Paragraph 5 of the Harvard Draft. Paragraph 5 segregates the notions of direct expropriation and indirect expropriation and legal seizure of property. According to Paragraph 5 of the Harvard Draft, legal seizure of a foreigner’s property or denial of utilisation or gratification of property of a foreigner, which arises from effecting tax regulations, a deviation in the currency value, an action by the State authorities in the sustenance of morality or from the legitimate exercise of rights by the State is legal[26]. As such, the difference between ‘denial of utilisation or gratification of property’ and ‘legal seizure of a foreigner’s property’ provides identical importance to both direct and indirect expropriation.
The 1967 OECD Draft Convention on the Protection of Foreign Property also set a codifying precedent for the notion of indirect expropriation. The OECD Draft originated from the actions of the Council of the Organization for European Cooperation. The Draft focused on underpinning economic cooperation[27]. Article 3 incorporated a restriction against indirect expropriation. It asserted that no entity should use measures that deprive directly or indirectly the property of a citizen of another entity unless if the measures are vested in the public’s interest, non-discriminatory or accompanied by reimbursement[28]. Other codification attempts included the 1980 US Bilateral Investment Treaties Program and the 1988 Free Trade Agreement of Canada and the United States (FTACUS), which set the pace for the definition of indirect expropriation[29].
The North American Free Trade Agreement (NAFTA) was the foremost mutual Free Trade Agreement that incorporated similar BIT clauses within Chapter 11 of investment security. According to Article 1110 of Chapter 11, no entity may expropriate or nationalise an investment of an alien within its demarcations directly or indirectly except in the instances of public purpose, on a non-discriminatory basis, in accordance with law or on reimbursement[30]. In addition, Richard Epstein’s theory provided a rationale that focused on partial seizures. According to Epstein, partial seizures take place when possession, utilisation and disposition of property are deprived. As such, every part of the package of ownership is secured and cannot be aggrieved. In addition, the property’s host state lacks the right to extract or diminish the occurrences of ownership regardless of the gravity of the modification[31].
Indirect Expropriation and Civic Policy
The security of property based on acts of indirect expropriation defines the difference in the measures against the act in comparison to other regulatory measures. Consequently, protection against indirect expropriation in FTAs and BITs-like clauses can induce a risk on the regulatory capacity of states, specifically within areas of communal interest such as environmental law, labour, human and civil liberties and taxes. The considerable amounts of finances that a government forced to reimburse for indirect expropriation of an alien investment can possess an adverse influence on the state’s household policy. Various incidents have taken place foreigners have restricted governments from performing by intimidating them with potential lawsuits. The arbitral tribunals regularly handle these lawsuits.
These tribunals, such as those beneath NAFTA, UNCITRAL and US/Canadian investment agreement regulations, operate in terms of confidentiality[32]. Thus, it is impossible for civilians of the host country to know precisely the number of allegations that are put against governments, the nature of the allegations and the financial implications that come with the allegations. As such, the tribunals are usually sited overseas and are conducted in the presence of privately selected arbitrators. Thus, they function as means of circumventing public courts and eliminate supervision and involvement of local populace. The arbitrators have occasionally been accused of depending on foreign investment regulations rather than using other applicable laws. This situation is compounded whereby wrong law statements within arbitration possess the ability to endure consequent legal challenges[33].
Based on the arbitration regulations and State laws where the arbitral award is supposed to gain enforcement, appeal cannot be carried out based on legal fallacy as a ground. As such, the arbitral tribunal or the courts lack the power to correct the mistakes[34]. Various instances offer insight into the exertion of pressure by international investors in challenging a state’s internal policies as well as its regulatory action.
Ethyl Corporation vs. Canada
A legislation effected by the Government of Canada in 1997 prohibited import and internal transport of MMT due to health concerns. MMT was an additive manufactured by Ethyl Corporation. At that time, Ethyl was the sole producer of the compound. The Canadian government’s chief concern was based on MMT’s compound, manganese. According to the state, breathing manganese induced the possibility of acquiring impairments akin to Parkinson’s disease. The firm claimed breach of the obligation to non-discriminate on basis of nationality and expropriation. Furthermore, Ethyl contested that the prohibition induced expropriation of its rational property privileges and goodwill. The Canadian government consented to reimburse the firm by paying US$ 19 million and issued a statement authenticating that MMT is safe[35].
Metalclad Corporation vs. Mexico
The case between Metalclad Corporation vs. Mexico illustrates the challenging of governments’ environmental measures by investors and reimbursement by the government for public guidelines. A U.S. corporation, Metalclad, functioning through its Mexican ancillary, obtained a permit from the Federal Government of Mexico. The permit allowed the firm to build landfills for dangerous wastes in Guadalcazae. The location of the landfill had unsteady soil, which allowed unrestricted contamination and filtration of cavernous waters. The location was also characterised by biological multiplicity. After 5 months, the firm, which had already commenced construction, obtained a notification from the Municipality of Guadalcazae, which required the firm to possess an extra permit[36].
The firm obtained the permit but the Municipality rejected the legal document. In addition, the Governor directed a decree asserting that the location was secured natural vicinity. Metalclad conducted proceedings in front of the International Centre for Settlement of Investment Disputes (ICSID) alleging violation of NAFTA’s article 105, Minimum Standard of Treatment, and article 1110, expropriation by the Government of Mexico. The tribunal concluded that the actions by the Local government and the decree issued by the Governor classified as indirect expropriation. Respecting the tribunal’s decision, Metalclad’s investment was lost and thus the Mexican government reimbursed the firm US$ 16.7 million.
Tecnicas Medioambientales Tecmed, S.A. vs. Mexico
A Spanish firm, Tecmed, had two subsidiaries and obtained a landfill in 1996. However, the Mexican government refused to renew the firm’s license to function the landfill based on violation of environmental laws in 1998. The firm contested that the means assumed by the government comprised indirect expropriation and breached the right to offer equal and fair treatment to every NAFTA national. The ICSID tribunal concluded that the means used by the Mexican government characterized indirect expropriation measures because the landfill was blocked. The tribunal also held that Tecmed receive US$ 5.5 million from the Mexican government[37].
Methanex vs. United States of America
In this suit, the state government of California enforced a restriction on the sale or utilisation of MTBE in California. According to the government, MTBE comprised Methanol and thus assumed the probability of being a carcinogenic. A Canadian firm that manufactured Methanol, Methanex Corporation filed a case against the government of the United States in 1999. The company argued that the restriction breached NAFTA’s Chapter 11 as well as other breaches such as indirect expropriation. However, the company’s claims were refuted by an arbitral tribunal in 2005. As such, the firm was forced to reimburse the U.S government US$ 2989424. Regardless of the fact that the allegations were unsuccessful, this form of contention is utilised by firms to challenge and the considerable reimbursements paid in damages possesses an adverse effect on the regulatory ability of states[38].
Pope & Talbot Inc. vs. Canada
This case involved challenging the regulatory ability of states in macroeconomic guidelines. The dispute stemmed from the Softwood Lumber Agreement (SLA) held between the Canadian government and the government of the United States of America. The SLA was a section of general macroeconomic guideline and enforced a restriction on exportation of softwood lumber to the USA from Canada. To allow for compliance with the contract, Canada apportioned export quotas among manufacturers of softwood, which involved the adoption of unique procedures for issuance of sanctions to allow exportation of softwood lumber.
However, the Arbitral Tribunal surmised that Canada violated NAFTA’s Article 1105, Minimum Standard of Treatment. This is because the Canadian government refused to offer relevant information when asked, intimidated the investor by imposing sanctions and deprived the investor through incursion of preventable expenses and interruption. As such, the Tribunal ordered the Canadian government to reimburse the investor US$ 461600[39].
PSEG Global Inc. & Konya Ilgin Elektrik Uretim vs. Republic of Turkey
Turkey released the energy market and allowed private firms to produce electricity and vend it to the government. Additionally, the government provided incentives to the firms such as Treasury Guarantees. A U.S. firm, PSEG engaged into a Concession and Implementation Contract with the Turkish government. The objective of the government focused on providing a power plant that operated on coal and an adjoining coalmine. The final contract and chief commercial conditions were indistinct. In 2001, the Turkish government effected Law No. 4628. The legislation expunged the provision of Treasury Guarantees as inducements for the projects. Within the same year, PSEG commenced ICSID procedures within the Turkey-USA BIT on the basis that the arbitrary measures by Turkey disagreed with the BIT requirements to offer equal and fair treatment and protection.
The Tribunal concluded that the Turkish government breached the BIT’s provision of equal and fair treatment but refuted the other allegations. The Tribunal also held that changing the regulations did not breach the agreement. Regardless, the Turkish government was coerced to reimburse PSEG US$ 9061479 regarding the invested amount and 65 percent of the arbitration charges[40].
South Africa Mineral and Petroleum Act (MRDA), 2002
The 2002 Mineral and Petroleum Act (MRDA) of South Africa transferred the entire private privileges in the mineral wealth of the nation to the State. After this, the government possessed the ability to apportion licenses for exploitation. The Act was decreed within the Black Economic Empowerment (BEE) program. Several oil and mineral sector firms cautioned the government of South Africa on the breach of the BITs contracted between UK, Belgium and Luxembourg. Backed by the Italian government, Italian investors commenced an arbitration allegation against the South African government based on the conditions of the Investment Protection Treaty with Italy. Eventually, the government ceased furthering such modifications[41].
South Africa National Water Act, 1998
Regardless of South Africa’s decision in negating further racial-based reforms, the government enacted the National Water Act of the Republic of the South Africa. The Act was created to allow favouritism in the treatment of racial minorities within the country in the application of water licenses. The objective of the decree focused on providing impartiality and eliminating the adverse effects of the prejudiced guidelines that were in effect previously. Regardless of the Act’s fair intentions, the decree ended up breaching the BIT provisions based on national treatment.
In summary, the different cases outlined previously are instances among the significant amount of recognised and unrecognised cases of arbitration in which alien investors have confronted the ability of governments to regulate based on regulatory seizures. The reimbursement payable has the effect of discouraging states and nations from controlling, protecting and enhancing privileges such as education, health, cultural heritage, food, security, environment, cultural life and housing, which comprise contemporary generational privileges. In addition, the reimbursements possibly affect developing countries from executing significant, widespread reforms such as agrarian modifications, reallocation of land and fortification of native land rights.
Regardless of the amount of diverse arbitrations, definitive regulations do not exist that offer a country full surety in determining whether a measure comprises regulatory taking or lacks regulatory taking. The approach defined by case to case, which is the modern means of providing such information, will continue being the only method that defines indirect expropriation.
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[1]Dolzer, R, & CH Schreuer, Principles of International Investment Law, Oxford, Oxford University Press, 2001, pg 36
[2] Muchlinski, P, F Ortino & CH Schreuer, The Oxford Handbook of International Investment Law, Oxford, Oxford University Press, 2008, pg 45
[3] Suvedi, S, International Investment Law: Reconciling Policy and Principle, Oxford, Hart, 2012, pg 167
[4] Sornarajah, M, The International Law on Foreign Investment, Cambridge University Press, Cambridge, 2010. pg 409
[5] United Nations Conference on Trade and Development, World Investment Report 2011: Non-equity modes of international production and development, United Nations Conference on Trade and Development, 2011, retrieved 12 March 2013, <http://www.unctad-docs.org/files/UNCTAD-WIR2011-Chapter-I-en.pdf/>
[6] Paulsson, J, & Z Douglas, “Indirect Expropriation in Investment Treaty Arbitrations”, Arbitrating Foreign Investment Disputes, pp.147
[7] Van Harten, G, Investment Treaty Arbitration and Public Law, Oxford University Press, Oxford, 2007, pg. 66.
[8] Brownlie, I, Principles of Public International Law, Oxford University Press, Oxford, 2003, pg 101.
[9] Yannaca-Small, C, “Indirect Expropriation” And the “Right to Regulate” In International Investment Law, Organisation for Economic Co-operation and Development, Paris, 2004, pg 18.
[10] Gantz, D A, The Evolution of FTA Investment Provisions: From NAFTA to the United States”, American University International Law Review, Washington, 2004.
[11] De Sousa, S, & C R Garavito, Law and Cosmopolitan Legality, Cambridge University Press, Cambridge, 2005, pg 56.
[12] Dezalay, Y & B G Garth, “Constructing Law out of Power: Investing in Human Rights as an Alternative Political Strategy”, in A Sarat & S Scheingold (eds.), Cause Lawyering and the State in a Global Era, Oxford University Press, Oxford, 2001, pg.391.
[13] Charlton, A, Foreign Direct Investment: Brief Note Prepared for IPD’s Financial Markets Task Force, A Charlton, 2006, retrieved 12 March 2013,
[14] Gorman, R A., JC Ginsburg, & R A Reese, Copyright: Cases and Materials, Foundation Press Thomson/West, New York, 2011, pg 26
[15] Epstein, RA, Takings: Private Property and the Power of Eminent Domain. Harvard University Press, Cambridge, 2009, pg 47
[16] Faundez, J & T Celine, International Economic Law, Globalization and Developing Countries, Edward Elgar, Cheltenham, 2010, pg 7
[17] Suda, R, “The Effect of Bilateral Investment Treaties on Human Rights Enforcement and Realization”, in O De Schutter (ed.), Transnational Corporations and Human Rights, Oxford, Hart, 2006, pg. 77.
[18] Leal-Arcas, R, International Trade and Investment Law: Multilateral, Regional, and Bilateral Governance, Edward Elgar, Cheltenham, 2010 pg 21
[19] Dine, J, Companies: International Trade and Human Rights, Cambridge University Press, Cambridge, 2005, pg 18
[20] Schreuer, C, & U Kriebaum, “The Concept of Property in Human Rights Law and International Investment Law”, Human Rights, Democracy and the Rule of Law: Liber Amicorum Luzius Wildhaber, S, 2007, pg.747
[21] Guardiola-Rivera, O, “Law in Other Contexts: Stand Bravely Brothers! A Report from the Law Wars”, International Journal of Law in Context, vol.4, 2, 2008, pg 113
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