Prompt, Adequate and Effective Compensation

Expropriation be defined as a sovereign act carried out by a State in which it takes the property rights of a foreign investor.¹ A majority of international investment agreements allow for expropriation as long as the investor is compensated for its loss.² The word “compensation” is, in view of its derivation from the Latin verb compensare, properly defined as “counterbalance, rendering of an equivalent, requital, recompense.”³

Different standards of compensation may apply to lawful and unlawful expropriation. Most BITs "only stipulate the standard of compensation that is payable in the case of a lawful expropriation, and these cannot be used to determine the issue of damages payable in the case of an unlawful expropriation since this would be to conflate compensation for a lawful expropriation with damages for an unlawful expropriation."⁴

Where the BIT does not contain any lex specialis rules that govern the issue of the standard for assessing damages in the case of an unlawful expropriation, the tribunal would usually apply the default standard contained in customary international law of restitutio in integrum.⁵ Furthermore, the state of necessity does not justify non-payment of compensation.⁶ Non-payment of compensation alone can be enough to qualify the expropriation as unlawful,⁷ however some tribunals have held a more nuanced approach.⁸ See further Compensation for lawful expropriation, Sections II and III.

Although compensation is required for takings, there is no defined standard as to how this compensation should be accounted for. One option takes into consideration the “fair market value of the investment including expected profits” which can be translated to “prompt, adequate and effective compensation.” The other option is “appropriate compensation,” where the compensation is fact specific and can “range from full compensation to much less."⁹ See further Compensation for lawful expropriation, Section IV and Compensation standards.

Most international investment agreements today contain a provision on expropriation.¹⁰ At the time of writing, only 8 of 2577 mapped investment treaties do not provide for an expropriation and compensation clause.¹¹

A significant number of investment treaties¹² and tribunals¹³ adopt the standard of “prompt, adequate and effective” compensation. This is the so-called Hull formula, meaning that the investor should be granted, as soon as the investment is made (prompt), an amount equal to the total value of its expropriated investment (adequate) in a freely transferable and exchangeable currency (effective).¹⁴ Typically, BITs adopting this standard do not make a distinction between lawful and unlawful expropriation.¹⁵

Compensation is considered to be prompt if paid without delay.¹⁶ Tribunals have expressed prompt compensation in various ways. Terms such as “as quickly as possible,”¹⁷ “reasonable time”¹⁸ and “in due time”¹⁹ seem to be used synonymously with "prompt" compensation.²⁰ Thus, the payment does not  have to happen at the exact moment of expropriation,²¹ but the parties must engage in good faith negotiations on payment from the outset.²²

Some investment treaties are more specific and provide the exact period of time within which the State must pay compensation²³ or at least fix the amount of compensation.²⁴ The International Law Commission has observed that "the payment of the agreed compensation necessarily depends on the circumstances in each case and in particular on the expropriating State's resources and actual capacity to pay; even in the case of 'partial' compensation, very few States have in practice been in a sufficiently strong economic and financial position to be able to pay the agreed compensation immediately and in full."²⁵

To this extent, the evaluation of “prompt” compensation is case specific and depends on the situation of each State. Three to six months may be normal for many States²⁶ but exceptional circumstances in which a State may not be able to compensate including “foreign exchange restrictions” must be taken into account.²⁷

Adequate compensation corresponds to the market value of the investment.²⁸ The exact method of valuation to use when calculating “adequate” compensation is provided for in some investment treaties.²⁹ While defining what constitutes adequate compensation, treaties frequently make reference to an investment’s market value,³⁰ just price,³¹ genuine value,³² or real economic value.³³ Other treaties require more generally that the compensation be valued “in accordance with generally recognized principles of valuation."³⁴

Those principles of valuation include full compensation or “restitutio in integrum”, which is calculated with the Hull formula³⁵ of prompt, adequate, and effective compensation. It corresponds to the fair market value³⁶ of the investment including expected profits when approprate.³⁷ See further Compensation for lawful expropriation and Compensation standards.

Further, some investment treaties refer to “equitable principles,” requiring tribunals to evaluate compensation fairly depending on the circumstances.³⁸

Certain circumstances such as inflation of claims or the timing of the assessment must be taken into account when assessing the amount of compensation required.³⁹ See further Valuation methods.

International efforts to establish valuation and timing standards has been underway for decades. The International Valuation Standards Council (IVSC) was formed in 1981 as the globalization of investments increased demand for professional valuation services of property interests. The goal of IVSC is to establish internationally accepted standards for reporting the value of property. Its standards cover:

1. an official set of definitions;
2. ethics and competency requirements for the valuing professional;
3. procedures for conducting the valuation; and
4. conventional wisdom regarding appropriate assumptions and models.⁴⁰

Lastly, compensation must be “effective,” meaning that the compensation must be payable, preferably in the currency of the investor’s nationality⁴¹ or in a freely convertible currency.⁴² A freely convertible currency is one that can be “immediately converted into other currencies on the foreign exchange market.”⁴³

Chinen, M.A., The Standard of Compensation for Takings, Minn. J. Int'l L. 25, 2016, p. 335.

Westberg, J.A., Applicable Law, Expropriatory Takings and Compensation in Cases of Expropriation; ICSID and Iran-United States Claims Tribunal Case Law Compared, ICSID Review, Vol. 8, Issue 1, 1993, pp. 1-28.

Fischer, J.M. Understanding remedies, LexisNexis, 2010.

Garcia, A., Fourth Report on International Responsibility, U.N. Doc. No. A/CN.4/119, 1959, para. 56.

Hyde, C.C., Compensation for Expropriations, American Journal of International Law, Vol. 33, Issue 1, 1939, pp. 108-112.

Kadir, M.Y.A., Hull Formula and Standard of Compensation for Expropriation in Postcolonial States, Kanun: Jurnal Ilmu Hukum, Vol. 19, Issue 2, 2017, pp. 231-248.

Kantor, M., Valuation for Arbitration: Uses and Limits of Income-Based Valuation Methods, Transnational Dispute Management (TDM) 4.6, 2007.

Khachvani, D., Compensation for Unlawful Expropriation: Targeting the Illegality, ICSID Review-Foreign Investment Law Journal, Vol. 32, Issue 2, 2017, pp. 385-403.

Pan, J., Valuation Standards for Calculating ICSID Awards, Pepp. Disp. Resol. LJ, Vol. 14, Issue 3, 2014, p. 355.

United Nations Conference on Trade and Development (UNCTAD), Expropriation, UNCTAD Series on Issues in International Investment Agreements II, 2012.

Dawson, F.G. and Weston B.H., Prompt, Adequate and Effective: A Universal Standard of Compensation?, Fordham Law Review, Vol. 30, Issue 4, 1961, p. 727.

Smith, K., The Law of Compensation for Expropriated Companies and the Valuation Methods Used to Achieve That Compensation, Law & Valuation, Professor Palmiter, Spring 2001.