Author

Dr Rimantas Daujotas

Disputes Partner - Motieka & Audzevicius PLP

Prompt, Adequate and Effective Compensation

I. Definition

1.

Expropriation is the action of a foreign state in taking the property rights of an individual in the exercise of its sovereignty. Most international laws allow Expropriation with a limitation that the expropriated company must be compensated, and States have established a guarantee for foreign investors against the Expropriation of their investments without compensation. The word “compensation” is, in view of its derivation from the Latin verb compensare, properly defined as “counterbalance, rendering of an equivalent, requital, recompense.”1 

2.

It must be noted that different standard of compensation applies to lawful and unlawful expropriation. Most of the 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.2 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.3 4 

3.

In international investment law there is a long-standing debate about the proper standard of compensation for takings. The first alternative is prompt, adequate, and effective compensation: often interpreted as the fair market value of the investment including expected profits. The second is appropriate compensation: a value that can range from full compensation to much less depending on the circumstances.5 

II. General treaty practice

4.

Virtually all investment treaties in force today contain an expropriation provision. At time of writing, only 8 of 2577 mapped investment treaties do not provide for an expropriation and compensation clause.6

5.

A significant number of investment treaties adopt the standard of “prompt, adequate and effective” compensation.7 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).8 For some, the Hull formula refers to full compensation; that is to say, full compensation for losses suffered and lost profits. Typically, BITs adopting this standard do not make a distinction between lawful and unlawful expropriation.9

III. "Prompt" compensation

6.

Compensation is considered to be prompt if paid without delay.10 Compensation shall be paid “as quickly as possible”11 or within a “reasonable time”12 or “in due time.”13 Thus, the payment does not  have to happen at the exact moment of expropriation, but the parties must engage in good faith negotiations on payment from the outset.14

7.

Some treaties lay down a specific period of time within which the payment of compensation must be made.15 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.16 

8.

The relevant timeframe should be assessed in light of the specific experience of each State and the normal procedures in place to make an effective payment. In many countries, a normal time to make such transfer would be between three and six months,17 however there may be exceptional cases where a State faces circumstances such as foreign exchange restrictions or related constraints.18 

9.

When rendering an award, international tribunals treat an absence or delay of compensation, or the absence of the relevant offer thereof, as a failure to fulfil the criterion for the promptness or legality of expropriation and award damages for this unlawful act.19

10.

When an investment tribunal is faced with a request to determine whether there has been a treaty breach, it must take into account the time expended in the international proceedings for judging the promptness of compensation. This is so because the initiation of an international arbitration by the claimant does not absolve the respondent State from its primary obligation to provide prompt and adequate compensation.20

IV. "Adequate" compensation

11.

Compensation is considered to be adequate if it has a reasonable relationship with the market value of the investment concerned.21 Some treaties refer to the methods of valuation to be used or considered in order to assess the value of an expropriated investment.22 For example, this approach has been followed in the Republic of Korea - Mexico Bilateral Investment Treaty (BIT) (2000), and the Canada - Peru BIT (2006). Some International Investment Agreements (IIAs) also require that the value of an investment be determined “in accordance with generally recognized principles of valuation”.23

12.

Full compensation, which is equated with the Hull formula24 of prompt, adequate, and effective compensation, is often interpreted as the fair market value25 of the investment including expected profits when appropriate.26

13.

Supporters of this standard, particularly when a breach is involved, cite language from Chorzow Factory,27 which can be read to articulate this measure, and from the Draft Articles on Responsibility of States for Internationally Wrongful Acts.28 After Chorzow, the measure has been used in a number of cases involving international law investment standards.29 The Chorzow tribunal also reflected a long-accepted view of the purpose of remedies “to redress the wrong by creating the situation that would have existed had the wrong not occurred”.30

14.

In spelling out what constitutes adequate compensation, treaties frequently make reference to an investment’s market value,31 just price,32 genuine value,33 or real economic value.34 Destruction of the economic value of the investment must be total or close to total.35 Loss of control is alternative to destruction of value.36

15.

Some treaties additionally mention equitable principles. Such a reference gives arbitrators a mandate to grant compensation that they deem fair in the circumstances.37

16.

The question of value demands separate and detailed inquiry, which must take into account the possible inflation of claims or the timing of the assessment which may influence the valuation and, hence, the amount of compensation.38

17.

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.39

V. "Effective" compensation

Bibliography

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.

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