Although it is unsettled whether a failure to pay such compensation in and of itself renders an expropriation unlawful, international law requires that lawful expropriation be accompanied by payment of “just compensation” or “prompt, adequate, and effective compensation.” Many investment treaties articulate the measure of just or adequate compensation as being the “fair market value” of the investment immediately before the expropriation took place or became known (whichever is earlier), plus interest.
II. The distinction between lawful and unlawful expropriation
A. Requirements for lawful expropriation
International law recognises a State’s right to expropriate foreign-owned property,1 but investment treaties typically provide that States may not do so except: (a) for a public purpose; (b) in a non-discriminatory manner; (c) in accordance with due process of law; and (d) on payment of prompt, adequate and effective compensation.2 These requirements are said to have "crystallised sufficiently to represent customary international law."3
B. Whether failure to pay compensation in and of itself renders an expropriation unlawful
Some awards have held that a failure to pay compensation alone renders the expropriation unlawful,4 while other authorities support the view that expropriations that would otherwise be lawful upon payment of compensation are unlawful only sub modo or provisionally.5 At least one investment tribunal considered that a State’s failure to negotiate the payment of compensation in good faith was decisive to a finding that the expropriation was unlawful.6 Along these lines, some commentators have argued that the seemingly divergent positions taken by tribunals may be reconciled by a good-faith requirement.7
III. Compensation owed for lawful expropriation
A. The distinction between treaty-based compensation and the customary international law standard of full reparation
By and large, subject only to a few exceptions,8 the authorities draw a distinction between: (a) treaty-based compensation, which applies to lawful expropriation; and (b) the customary international law standard of full reparation, which applies to unlawful expropriation.9 In practice, the amount payable under the two standards may often coincide.10 The distinction is relevant, however, with respect to potential compensation for any subsequent increase in value of the investment and consequential damages, both of which are arguably available only for unlawful takings.11 Moreover, in at least one instance, a tribunal’s application of the customary international law standard to an expropriation deemed lawful—with the alleged failure properly to apply the treaty-based standard—was the cause for annulment of the award.12
B. Prompt, adequate and effective compensation
Modern treaty practice is, by and large, concordant in establishing “prompt, adequate and effective” compensation as the standard governing lawful expropriations.13 (The classic statement of that position was articulated by United States Secretary of State Cordell Hull in a note sent to the Mexican Ambassador in 1938 in connection with the expropriation of property owned by United States nationals as part of Mexico’s land reform programme, and the “prompt, adequate and effective” language is thus often referred to as the “Hull formula.”)14 “Prompt” means within a reasonable time.15 Effective compensation must be realizable, requiring payment in the currency of the claimant’s nationality or some other freely convertible currency.16 Adequate compensation is typically stated in terms of (a) the “fair market value” of the investment, (b) assessed immediately before the expropriation took place or became known (whichever is earlier), plus (c) interest to the date of payment. Treaties and other authorities also refer, among other concepts, to “actual value,” “full value,” “market value,” “just price,” “real value,” “genuine value,” or “real economic value”—although, by and large, these concepts are treated as being equivalent in practice to the more prevalent measure of fair market value.17
IV. Fair market value and valuation methods
Fair market value is defined as the price at which a hypothetical sale transaction between willing and well-informed parties acting at arm’s length in an open and unrestricted market would occur.18 The fair-market-value measure does not impose a specific valuation method.19 Broadly speaking, depending on the circumstances of the case, tribunals may adopt income-, market-, or asset-based approaches to determine Fair market value.
A. Income-based valuation methods
The primary income-based method is the discounted-cash-flow analysis (“DCF”), which is widely used to value cash-generating assets.20 It is commonly said that the discounted-cash flow method is appropriate only for “going concern[s] with a proven record of profitability.”21 But the appropriateness of DCF often turns on whether the available data allow for reasonably reliable projections of expected future cash flows,22 and tribunals have embraced the discounted-cash flow method to value even early-stage investments with no operating record—in particular in the extractive industries.23 Tribunals also tend to distinguish between the standard of evidence that applies to the fact of loss and the extent of damages, requiring a lesser degree of certainty with respect to the latter: provided that future profitability is proven, tribunals typically require the claimant to establish the amount of lost profits with only reasonable certainty.24 In determining the discount rate, authorities are divided on whether country risk associated with potential expropriatory action should be included and, if so, to what extent. At least three conceivable approaches have been adopted:
The Saint-Gobain v. Venezuela tribunal’s split on this issue is emblematic of the unsettled state of the law.28
B. Market-based valuation methods
Market-based methods value the investment in question relative to comparable assets or transactions.29 Despite the apparent simplicity of market-based methods, identifying suitable comparable assets can be challenging, and that limitation may often render their use impractical.30 Adequate comparables may in some cases include past transactions involving the same assets,31 although such transactions may be of little use in other cases.32 Tribunals sometimes look to market valuations to check the reasonableness of the discounted cash flow method.33
C. Asset-based valuation methods
For income-producing assets, investment tribunals typically disfavour asset-based valuation methods (which include “book value,” “replacement value,” and liquidation value”).34 The ILC Draft Articles on State Responsibility, for instance, note some of the limitations of the book-value approach.35 Tribunals may nevertheless resort to these backward-looking measures where the expropriated enterprise is not profitable or an award of lost profits is otherwise deemed too speculative, choosing instead to award compensation on a reliance basis (e.g., sunk costs).36
V. Valuation date
It is with respect to the choice of valuation date that the distinction between lawful and unlawful expropriation can impact recovery most significantly.37 Where the expropriation is lawful, fair market value is to be assessed as at the date immediately before the expropriation occurred or became known (whichever is earlier).38 In contrast, under the customary international law standard applicable to unlawful takings, the majority view is that an investor may be entitled to enhanced damages equal to the increased value of the investment as at the award date.39 Some authorities oppose, however, that notion.40
Compensation for expropriation comprises the payment of interest from the date of dispossession.41 Most treaties that explicitly address the issue provide for payment of interest at a commercially reasonable rate for the currency in which payment is made.42 While the earlier authorities favoured simple interest,43 the prevailing practice today is to award interest on a compound basis.44 At least one award recognised a “jurisprudence constante” in favour of compound interest, but nevertheless awarded pre-award interest on a simple basis owing to the circumstances of the case.45
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