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Dr Caroline Breton

Associate Researcher - University Paris Nanterre

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Compensation Standards

I. Main compensation standards

A. Compensation for lawful expropriation

1.

When the violation committed by the responsible State is a lawful expropriation, investment treaties commonly provide for the use of the value of the investment, or more precisely its fair market value (i.e. the reasonable price that would have been paid on a competitive market by the buyer to the seller of the asset, acting at arms length),1 as a standard to calculate the quantum of compensation. In this case, the quantum of compensation is mainly delimited by the nature and extent of the damages caused to the investor and shall correspond to the amount of damages calculated on the basis of the value of the investment.2 See further Valuation methods. The date chosen for the valuation of the investment (date of the violation or date of the award) is of crucial importance (regardless of the violation involved). Indeed, the investment is valued on the basis of the information available on the valuation date. In accordance with an ex ante approach, information subsequent to the valuation date is not taken into account. Under an ex post approach, information subsequent to the valuation date is also taken into account. The choice of the approach necessarily affects the value of the investment itself and the amount of compensation granted and is, for this reason, regularly debated before tribunals.3 

B. Compensation for unlawful expropriation

2.

When the applicable treaty is silent regarding compensation standards, the principles of customary international law defined by the International Court of Justice in the Factory at Chorzów case4 and codified in Articles 31 and 36 of the ILC Articles are in principle applicable.5 In accordance with the principle of full reparation, compensation must fully repair the damage caused by the wrongful act of the host State by putting the investor back in the financial position in which he would have been had the wrongful act never occurred.6 See further Damages in Investment Arbitration. However, no indication is given by customary international law as to the methodology for calculating the amount of compensation for the purpose of ensuring that this reparation is indeed full, i.e. the quantum of compensation. The principles of customary international law have been applied in particular in cases of unlawful expropriation,7 8 which may be more favourable to the investor’s compensation than if the provisions of the investment treaty had been applied, the compensation not necessarily being limited to the market value of the expropriated property.9 Nevertheless, in other cases, the standards of compensation prescribed in the investment treaty for lawful expropriations have also been applied to unlawful expropriations,10 in particular when the tribunal considered that the distinction between lawful and unlawful expropriations made no practical difference.11

C. Compensation for breaches of other standards of protection depriving the investor of the value of its investment

3.

Similarly, when the violation at stake is a breach of other standards of protection than expropriation (for example, a breach of fair and equitable treatment) which has effects equivalent to an expropriation (i.e. the total loss of value of the investment or its significant devaluation), the measure of compensation is often calculated on the basis of the (fair market) value of the investment, usually on the basis of the applicable treaty’s compensation clause concerning lawful expropriations (especially if there is also a violation related to an expropriation).12 However, compensation is not necessarily limited to the value of the investment if other categories of damages are reparable apart from the loss of the investment (e.g. incidental expenses incurred as a result of the wrongful act).

D. Compensation for breaches of other standards of protection having other effects

4.

When the violation does not have an effect equivalent to an expropriation, tribunals decide on the amount of compensation based on the nature and extent of the damages claimed by the investor. In this case, the quantum often corresponds to the amount of losses actually suffered as a result of the violation,13 which covers various categories of damages (e.g. reimbursement of expenses incurred by the investor14 or of taxes or tax rebates from which the investor should have benefited,15 payment of the price stipulated in the contract for services provided by the investor;16 or compensation for losses relating to dividends held by shareholders based on the amount of lost dividends according to the actual loss method).17 Depending on the specific circumstances of the case, the quantum may also include lost profits causally linked to the violation.18 When the applicable treaty does not specify the compensation standard to use for non-expropriation violations, some tribunals have refused to apply the fair market value methodology used for expropriation.19

II. Damnum emergens and lucrum cessans

5.

The damnum emergens corresponds to the actual losses suffered by the investor (i.e. total loss or partial diminution in the value of the investment, loss of capital spent on the investment, incidental expenses incurred as a result of the unlawful act); while the lucrum cessans is equivalent to the loss of profits. See further Lost Profits. The unlawful act may simultaneously give rise to damnum emergens and lucrum cessans or damnum emergens may cause lucrum cessans.20 By covering damnum emergens and lucrum cessans, compensation tends to conform to the principle of full reparation. 

6.

In addition to constituting a category of losses, damnum emergens understood as opposed to lucrum cessans is also used as a variable to determine the extent of compensable damages and the quantum of compensation. Therefore, in the event of a breach of contractual obligations,21 the amount of compensation is determined according to the damnum emergens and the lucrum cessans. The compensation must place the party to whom it is granted in the financial position in which it would have been if the contract had been performed in accordance with what the parties had foreseen at the time of its conclusion. In order to be full, compensation includes the damnum emergens (e.g. the value of physical assets or the expenses relating to the execution of the contract incurred by the investor) as well as the lucrum cessans (e.g. the net profit that the contract would have generated if the wrongful act had not occurred).22 Damnum emergens does not generally raise any difficulties and is, by its nature, always recoverable23 as it is easy for the investor to provide evidence of the expenses incurred. However, the lucrum cessans shall be “the direct fruit of the contract and not too remote or speculative”,24 which is more difficult to prove.

III. Interest

7.

Interest is a sum paid or payable “as compensation for the temporary withholding of money.”25 It is therefore the loss of enjoyment of a sum of money owed by the host State to the investor as compensation that is compensated: “[t]he object of an award of interest is to compensate26 the damage resulting from the fact that, during the period of non-payment by the debtor, the creditor is deprived of the use and disposition of that sum he was supposed to receive.” There are two categories of interest: pre-award interest (compensating the investor for the period between the time when damages were caused by the unlawful act and the date of the award) and post-award interest (compensating the investor for the period between the date of the award and the date when the award is paid). See further Interest rates.

8.

Few BITs provide for the payment of interest as part of expropriation compensation provisions.27 In the absence of any such provision and outside cases of expropriation, tribunals may refer to Article 38 of the Articles of the ILC, which provides that “interest on any principal sum due (…) shall be payable when necessary in order to ensure full reparation.”28 conditional upon the award of compensation by the arbitral tribunal and is calculated on the basis of the amount of such compensation. The award of interest is not automatic and only occurs if it is necessary to ensure full reparation in order to put the investor back in the position it would have been in had the State not committed a wrongful act.29

9.

Neither investment treaties nor customary international law precisely define the rate or method of calculating interest. However, some BITs refer to the interest at the rate provided by the law of the host State;30 to the interest at the applicable commercial rate established on the market basis for the currency of payment;31 or to the London Interbank Offered Rate32 (which is often used because it is considered as “a reasonable risk-free commercial rate”).33 Many, however, provide only guidelines by indicating that interest should be calculated at the normal or reasonable commercial rate.34 Unless otherwise agreed by the parties or specified in the applicable investment treaty, arbitral tribunals enjoy a considerable margin of discretion that is limited only by the need to obtain a fair or reasonable rate.35 See further Interest rates.

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