Compensation for expropriations in a world of investment treaties: beyond the lawful/unlawful distinction.

Author:Ratner, Steven R.
 
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For much of the last century, global actors have sparred over the international legal rules governing the compensation a state should pay a foreign investor when it expropriates the latter's property. The competing claims have had many dimensions, including the content of customary international law and the line between bona fide regulations and expropriations. In the modern age of international investment agreements (IIAs), a debate continues over another key issue: When a state expropriates a foreign investment in violation of an IIA, where should a tribunal look for the standard of compensation--to the amount the treaty requires the state to pay when it expropriates, or to an external standard for violations of international law generally? Each is alluring to a tribunal for its legal visibility--one spelled out in the very text under examination, and one stemming from a venerable international court case. But they may point to significantly different results for the investor and the host state. And investor-state tribunals remain wildly inconsistent, even incoherent, in their choice and use of those standards. It remains a significant source of disagreement in contemporary investor-state arbitration. (1)

Today's debate arises from the basic terms of modern IIAs. They typically ban host states from expropriating foreign investors unless--or, we might say, permit such expropriations only if--the state meets four conditions. These treaty conditions are, to simplify, that the taking be (a) for a public purpose; (b) carried out in a nondiscriminatory manner; (c) in accordance with some kind of legal process; and (d) accompanied by payment of (usually) full compensation for the value of the expropriated asset, usually specified as of the date of the expropriation, often with more details regarding acceptable valuation techniques and interest. (2) For the sake of simplicity, we can call the first three process conditions, as they govern the manner of the expropriation, and the fourth as a payment condition, as it governs the monetary output of the process. The state can force a surrender of the property by paying the investor an amount specified by a third party, i.e., in the treaty; yet it must follow certain criteria and cannot just pay the investor to waive those process rights. (3) Satisfaction of those four criteria legitimates the transfer, but compensation alone does not. (4)

So now consider these scenarios where states expropriate:

(1) The host state expropriates consistent with all four treaty criteria, in which case the investor is unlikely to sue under an IIA (and should lose if it does).

(2) The host state expropriates in conformity with the three process conditions, but it does not pay the investor anything, or at least less than full compensation, which can prompt investor-state arbitration.

(3) The host state expropriates in conformity with only some of the process conditions, while also not paying, which can also lead to arbitration.

(4) The host state violates any or all of the process conditions while paying full compensation, a possibility that could, but probably will not, lead an investor to litigate over the flawed procedures.

Multiple layers of complexity can be added, including simultaneous violation of other IIA provisions. And the host state will often deny that it is expropriating at all, in which case the tribunal will need to make that threshold determination.

The inconsistency and incoherence in the case law arises, then, over whether the compensation should be based on the formula in the treaty ((d) above)--an internal standard; or customary international law, in particular that reflected in the International Law Commission's Articles on State Responsibility (ASRs)--an external standard. Under the latter, the state, for its violation of the treaty, must pay full reparation, which may be more than the amount in the treaty. Tribunals disagree over these options, but do not consider approaches beyond them.

To date, the jurisprudence has been dominated by an anachronistic and analytically unhelpful distinction between the compensation or damages to be paid for so-called "unlawful expropriations" and those for so-called "lawful expropriations"--concepts traceable to the venerable Chorzow Factory case reflexively cited by tribunals. (5) Historically, the former has referred to expropriations that violate certain legal commitments the state has made (in treaties, or even contracts) and the latter to expropriations that respect those commitments. But the case law is replete with diverse definitions of the two terms. More important, tribunals disagree on whether the state expropriating "unlawfully" or "illegally" should have to pay more to the investor than when it expropriates "lawfully" or "legally"--and in particular whether the former triggers damages under customary law, whereas the latter leads only to the amount in the treaty.

To return to our four scenarios, tribunals in particular disagree as to whether Scenario 2 or Scenario 3, or both, are "unlawful expropriations" due to the state's violation of the treaty's requirements, whereas Scenario 1 is a "lawful expropriation" because the state has followed the treaty; and the consequences of that distinction for damages. Among the most significant decisions to make and monetize the distinction is Yukos v. Russia, a case under the Energy Charter Treaty that regarded Russia's seizure of claimants' shares of the Russian oil giant as "unlawful" under Scenario 3 (indeed, it found none of the process conditions to be met) and awarded investors 50 billion dollars. (6) Scholars have parsed the case law, but a normative theory for treating the various scenarios for violations, including any relevance to the lawful/unlawful distinction, remains elusive.

The fluidity in the law is also part of larger debates over the kinds of state action international investment agreements should regulate. The political economy of investment law has shifted from one focused on investor protection--in particular, Northern investment in the South--to one with greater attention to host state prerogatives ("policy space"), respect for human rights, and duties on (and not merely rights for) business entities. Consequently, the characterization of a state's taking of property and the consequences for the state from alternative characterizations of the taking assume great importance. How we compensate the investor in the context of takings will also affect our approach to remedies for other violations of IIAs, where the treaties are silent. This debate crosses the regimes of international investment law and state responsibility, raising important questions about the nature of international legal obligations and the consequences of their breach.

This article, then, attempts to cut through the confusion surrounding the choice of remedies for expropriations based on standards internal to an IIA or external to it, and the concomitant lawful/unlawful panacea, and to offer a theoretical framework for determining the remedies for them. The lawful/unlawful dichotomy--and the assumption that the distinction maps onto two alternative and exclusive remedies--is antiquated and normatively deficient. It is a story of tribunals grasping for familiar, but outdated, legal concepts that lack any analytical punch for determining compensation and that reflect a rigid sort of doctrinal thinking. Indeed, when IIAs and custom are viewed as a whole, it becomes clear the law does not point to a simple choice of one internal or external standard. We instead need to develop a new approach by considering explicitly the purposes of the rules for compensation for expropriation in the context of the contemporary foreign investment process.

I develop this thesis as follows. Part I looks back to the origin of the current doctrinal muddle, namely the multiple understandings attached to, and consequences of, "lawful" and "unlawful" expropriations. Part II provides the normative framework for analyzing various doctrinal approaches, setting forth five generally accepted goals for any remedies for expropriation. Part III examines the principal alternatives for determining damages in the event of treaty-violative expropriations and how each fares in terms of advancing the goals for remedies. Part IV then takes my preferred position for a new approach--one that keys the remedies to the nature of the expropriatory act vis-a-vis the four criteria in investment treaties--and considers its implications for damages. Part V considers the possibility of extending this framework to remedies for other IIA violations. I conclude with a few observations about the implications of my approach for the relationship between host state obligations and remedies in international investment law more generally.

Finally, a word on the scope of this study: The question of internal versus external standards for compensation is one of a number of issues facing the international law of expropriation. To keep the focus on this issue, I will need to bracket other issues, already the subject of significant scholarship, including the contours of the law on indirect expropriation (regulatory takings), the possibility of a lesser payment to the investor after large-scale expropriations, the deference due to local procedures for providing compensation, and the types of property that may or may not be subject to expropriation.

  1. A LOOK BACK AT A CONFOUNDING DISTINCTION

    The current state of the case law originates in, and still cites with regularity, a line of cases that emphasized the distinction between lawful and unlawful expropriations. Those cases are often cited by advocates, invoked by courts, or endorsed by scholars, many times with little appreciation of the different meanings the two key terms assumed over time.

    1. The Pre-IIA Era

      1. From Chorzow Factory to the Oil Expropriation Cases. If we had to assign a birth date...

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