The sole effects doctrine, police powers and indirect expropriation under international law.

• Author: Mostafa, Ben

Abstract

Indirect expropriation claims under international law are increasingly being seen as a threat to States' abilities to control property within their territory. The inconsistent manner in which these claims are being dealt with means that uncertainty prevails in this area for investors and States alike. This article considers the two main theories that have been proposed to resolve these problems: the sole effects doctrine and the police powers doctrine. It is argued that the sole effects approach should be preferred as not only is it more consistent with pre-existing law in this field, but it also appropriately balances investor and State rights. Adoption of the sole effects doctrine would lead to greater uniformity and predictability in the decisions made by tribunals in expropriation claims.

Introduction

The question of how to define indirect expropriation is currently at the forefront of international investment law. In part, this is due to the decline in formal expropriation and the proliferation of Bilateral Investment Treaties (BITs), which have resulted in the once highly controversial question of the required level of compensation becoming less significant. Two main doctrines have emerged regarding how to determine whether a governmental measure constitutes an indirect expropriation: the 'sole effects' doctrine and the 'police powers' doctrine. The sole effects doctrine requires that, when making this determination, reference be had only to the effect of the measure on the property allegedly expropriated. The police powers doctrine, of which there are a number of formulations, differs from the police powers doctrine, of which there are a number of formulations, differs from the sole effects approach by positing that the purpose, context and nature of the measure may all be relevant to the indirect expropriation question. Consequently, the sole effects approach is often seen as more investor-friendly, whilst the police powers test is viewed as favouring States' rights to regulate.

Currently, neither doctrine has consistently gained favour over the other in investment protection case law. This has led to a high degree of uncertainty for both investors and host States when disputes arise regarding regulations implemented by the host State which detract from investors' property rights. The uncertainty is compounded by the fact that the police powers doctrine itself is of unclear scope. Resolving this 'clearly ambiguous' (1) area of the law would be beneficial, as increased certainty as to where investors stand is likely to produce greater investor confidence and an increase in foreign direct investment (FDI).

The prevailing uncertainty regarding indirect expropriation at customary international law was one factor that the introduction of BITs, and indeed multilateral investment treaties, was intended to address. However, the vast majority of investment treaties do not define indirect expropriation. Consequently, arbitral tribunals considering what is meant by this concept under treaty law have often turned to customary international law, resulting in investment treaties generally being tainted by the uncertainty they were intended to avoid. However, a corollary is that, due to the large number of investment treaty disputes being ruled on by international tribunals, there is a greater body of jurisprudence which has the potential to clarify both treaty law and customary international law. Therefore, as considered below, the discussion in this article is, except where noted, generally applicable to both the application of investment treaties and customary international law.

To attempt to resolve the uncertainty in the area, I analyse both the sole effects and police power approaches. I begin by briefly outlining the tension between investor claims and States' sovereign rights to regulate. In doing so I note that whilst the difficulty in defining indirect expropriation is not a new one, a number of factors such as the desire of developing States to attract FDI, the increased ease with which investors can draw States into binding arbitrations, and increasing international pressures on States to implement domestic regulations have combined to bring this problem to the fore.

I then consider the role to be played by the police powers doctrine in resolving this tension. As the scope of this doctrine is unclear, I consider a number of potential formulations, each of which is aimed at defining the nature of State acts that may be regarded as falling with in its 'police powers'. The common point of each formulation is that governmental measures will either not be expropriatory, or will not require compensation is they are expropriatory, if they fall within the implementing State's police powers as defined. I critique these formulations as they fail to provide a principled approach to determining when an indirect expropriation has occurred, and, to an extent, appear to conflict with certain established notions in international investment law.

I argue that the police powers doctrine should not be seen as relevant in determining whether an indirect expropriation has taken place. Rather, the sole effects doctrine provides the better approach in this area. Not only is it consistent with the preponderance of case law, but it does not, as some suggest, threaten States' rights to regulate. Considered in conjunction with the broader investment law context, including the prohibition on discrimination, the international minimum standard of treatment and the potentially wider fair and equitable treatment standard, the sole effects doctrine provides for consistency in international expropriation claims whilst acceptably balancing State and investor interests.

1. The Tension Between Indirect Expropriation Claims and the Right of States to Regulate

1. The Right to Regulate

   Under customary international law, States have a 'clear right to regulate commercial and business activities' (2) within their territory. States' rights to regulate are recognised by investment case law, (3) which shows that these rights are also to be considered in the investment treaty context. The rights extend to issues including who may engage in business, what forms of business may be engaged in and under what conditions, and controlling capital markets and capital flows. (4) The power to take these actions stems from principles of sovereignty and the territoriality principle. (5) When this right is utilised it will not normally require any compensation to be paid to persons whose property is affected. (6) Were it otherwise, governments would be unable to perform a great many of their functions, as explained in US jurisprudence: '[g]overnment could hardly go on if to some extent values incident to property could not be diminished without paying for every ... change in the general law'. (7) The development of international human rights and environmental law also demonstrates the need for States' freedom to regulate, as changes are often required to States' domestic laws in order to comply with their international obligations. (8)

2. Development of the Doctrine of Indirect Expropriation and the Tension with the Right to Regulate

   The idea that expropriation can occur absent a change in legal ownership or seizure of property is not new to international law. Similarly, the difficulty in determining what constitutes an indirect expropriation is a problem that was recognised over 60 years ago. In 1941, Herz noted that where measures indirectly interfere with property rights 'it may often be very difficult to decide whether or not ... the limits of usual interference have been reached or transgressed' (9) so as to warrant a finding of expropriation. Similarly, other authors recognised this problem well before it became the 'single most important development' (10) in contemporary international investment law. (11) More recently the Iran-US Claims Tribunal produced a large body of jurisprudence substantially based on claims of indirect expropriation, (12) which despite their grounding in treaty law are often considered relevant to the scope of indirect expropriation under customary international law. (13) At present, claims of indirect expropriation are commonplace under BIT and multilateral treaty mechanisms allowing investors to bring claims directly against host States. (14)

   The rising attention received by indirect expropriation and its interaction with the right to regulate is due to several factors. First, from the nineteenth-century through to the twenty-first-century, States have taken an increasingly active role in regulating private property. (15) Secondly, there are an increasing number of international obligations that require States to regulate. (16) One example is the need for regulations arising from increased knowledge of the links between human activities and harm to the environment and human health. (17) Thus indirect expropriation claims have now been brought, albeit unsuccessfully, against Canada for measures which were, at least ostensibly, put in place to fulfil Canada's international environmental obligations relating to the transport of hazardous waste. (18)

   The final factor contributing to the rising tension between indirect expropriation and the right to regulate is the removal of barriers to claims being made against host States under international law. One prominent example of this is NAFTA, which allows investors of one State party to submit arbitration claims against other State parties. (19) Provisions having a similar effect can be found in many of the BITs in force at present. With over 2500 BITs in place, (20) the combined effect of these and other investment treaties is to greatly reduce the need to invoke the rules of diplomatic protection, thereby increasing the number of investment claims and the speed with which they reach arbitration.

   The position of the US and Canada, with their large footprints in the...