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Indirect Expropriation

I. Definition

1.

Virtually all investment treaties contain provisions on the protection of investments from expropriation by a State.1 Two forms of expropriation can be distinguished: direct, which entails “forcible appropriation by the State of the tangible or intangible property of individuals by means of administrative or legislative action”2, and indirect. 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. 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. Mexico3 and in Santa Elena v. Costa Rica.4

II. Treaty practice

2.

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, and, traditionally, bilateral investment treaties (BITs) have also contained similarly worded provisions.5

3.

More recent examples include free trade agreements6 and BITs,7 which provide more detailed definitions and/or lists of exhaustive examples for indirect expropriation,8 or exclude indirect expropriation from the scope of investor-state dispute settlement altogether.

4.

Under most investment treaties, contractual rights can also be subject to – direct or indirect – expropriation.9 However, there are scholars who argue that contractual rights – as a general rule – cannot be expropriated, as they do not constitute property.10

III. Jurisprudence

a) General test applied by tribunals when establishing indirect expropriation

5.

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.11 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.

6.

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”).12 This interpretation was applied by tribunals in the Metalclad v. Mexico13 and Pope and Talbot v. Canada14 cases, and has, subsequently, been relied on by numerous other tribunals.15 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”).16 Further, several tribunals have given various degrees of relevance to the intent of the host state in their analysis of the measures.17 18 A post-factum rationalization of the host state’s intention, however, has been considered inapposite.19

7.

Continued exercise of control20 by the investor over the investment, and the duration of the measure21 affecting the interests of an investor are also factors that tribunals often take into consideration.22

8.

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).23 24

b) “Police power” of the state as a carve-out

9.

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’”.25 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”.26 Tribunals in subsequent cases have also referred to the Saluka27 and Methanex28 decisions.

10.

A more nuanced application of the police power exception can be found in the Tecmed v. Mexico case.29 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.30 31

11.

A further important caveat, based on recent jurisprudence,32 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.

IV. Creeping expropriation

12.

Indirect expropriation should not be conflated with creeping expropriation, which is a form of indirect expropriation that takes place incrementally or step by step.33

V. Overlap with other related standards of protection

13.

A further point of potential confusion is the overlap between the analysis of indirect expropriation and fair and equitable treatment (FET) standard. For example, the concept of legitimate expectations of an investor is primarily linked to the FET standard, but it has been dealt with by tribunals under indirect expropriation claims as well.34 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 FET standard as well.35 36

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