Indirect Expropriation

Virtually all investment treaties contain provisions on the protection of investments from expropriation by a State.¹ Two forms of expropriation can be distinguished:

1. Direct expropriation, which entails “forcible appropriation by the State of the tangible or intangible property of individuals by means of administrative or legislative action,”² and
2. Indirect expropriation. In case of an Indirect expropriation, the investor’s legal title to its investment often remains unaffected and it may have physical control of its property, but the investment will still be deprived of its economic use.³

While there is no generally accepted definition for what indirect expropriation entails, formulations that were widely cited by tribunals in subsequent cases can be found in Tecmed v. Mexico⁴ and in Santa Elena v. Costa Rica.⁵

Under Article 13 of the Energy Charter Treaty (1994), indirect expropriation is characterized as “a measure or measures having effect equivalent to nationalization or expropriation.” The wording of the North American Free Trade Agreement (NAFTA) (1992) is analogous,⁶ and, traditionally, bilateral investment treaties (BITs) have also contained similarly worded provisions.⁷

More recent examples include free trade agreements⁸ and BITs,⁹ which provide more detailed definitions and/or lists of exhaustive examples for indirect expropriation,¹⁰ or exclude indirect expropriation from the scope of investor-State dispute settlement altogether.¹¹

Under most investment treaties, contractual rights can also be subject to – direct or indirect – expropriation.¹² However, there are scholars who argue that contractual rights – as a general rule – cannot be expropriated, as they do not constitute property.¹³

Tribunals appear to accept that almost any legislative, regulatory or administrative action by the State would amount to a “measure” to which investment protection standards may apply.¹⁴ The threshold to be applied for establishing that such measure qualifies as an indirect expropriation of an investor’s property is a much more controversial topic.¹⁵

Under the prevailing - but by no means universal - view, a holding on indirect expropriation should primarily - or even exclusively - be based on the effects of the measure on the economic value or the substantial property interests of the investor (the so-called “sole effect doctrine”).¹⁶ This interpretation was applied by tribunals in the Metalclad v. Mexico¹⁷ and Pope and Talbot v. Canada¹⁸ cases, and has, subsequently, been relied on by numerous other tribunals.¹⁹

When assessing the effects of the measure, tribunals generally found that a mere diminution of the investment’s value is not sufficient to constitute expropriation. In order to rise to the level of indirect expropriation, the loss of value, deprivation or government’s interference with the investor’s rights and property must be substantial, significant or important, having an effect of neutralizing or annihilating the control or property rights of the investor (“substantial deprivation test”).²⁰

Continued exercise of control²¹ by the investor over the investment, and the duration of the measure²² affecting the interests of an investor are also factors that tribunals often take into consideration.²³

Further, several tribunals have given various degrees of relevance to the intent of the host State in their analysis of the measures. Some tribunals gave consideration to the host State’s intent,²⁴ while others considered that the host State’s intent was not to be taken into consideration.²⁵ A post-factum rationalization of the host State’s intention, however, has been considered inapposite.²⁶

Although case-law is not uniform, some tribunals have accepted the possibility of an expropriation of particular rights that formed part of an overall business operation (partial expropriation).²⁷ Other tribunals, however, have adopted a different view in this regard.²⁸

In Saluka v. Czech Republic, the Tribunal considers that “a State does not commit an expropriation […] when it adopts general regulations that are ‘commonly accepted as within the police powers of States’.”²⁹ The tribunal in the Methanex v. United States case adopted a similar, if slightly more stringent test, when it stated that “a non-discriminatory regulation for a public purpose, which is enacted in accordance with due process and, which affects, inter alios, a foreign investor or investment is not deemed expropriatory and compensable unless specific commitments had been given […] that the government would refrain from such regulation.”³⁰ Tribunals in subsequent cases have also referred to the Saluka³¹ and Methanex³² decisions. Some tribunals took into account the language of the treaty.³³

A more nuanced application of the police power exception can be found in the Tecmed v. Mexico case.³⁴ Here, the tribunal refused to treat regulatory administrative actions as a general exception to indirect expropriation, instead it focused on whether the allegedly expropriatory actions are proportional to the public interest presumably protected thereby.³⁵ Some tribunals have expressed their opinion in the contrary.³⁶

A further important caveat, based on recent jurisprudence,³⁷ is that the inclusion in the treaty language of any specifically worded exceptions might bar the state from relying on general exceptions - such as the exception of police powers - under international law.

Indirect expropriation should not be conflated with creeping expropriation, which is a form of indirect expropriation that takes place incrementally or step by step.³⁸

A further point of potential confusion is the overlap between the analysis of indirect expropriation and fair and equitable treatment standard.³⁹ For example, the concept of legitimate expectations of an investor is primarily linked to the fair and equitable treatment standard, but it has been dealt with by tribunals under indirect expropriation claims as well.⁴⁰ Conversely, the effect of a given measure on the value of the investment should primarily be relevant for an indirect expropriation claim, however, tribunals have assessed it under the fair and equitable treatment standard as well,⁴¹ while other tribunals disagreed with this approach.⁴²