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M. Campbell Herbert

Associate - Freshfields Bruckhaus Deringer

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Damages: Effective Loss

I. Introduction 


The basic principle in international law is that States must make full reparation for injuries caused by their internationally wrongful acts. Such reparation requires the State to “as far as possible, wipe out all the consequences of the illegal act and reestablish the situation which would, in all probability, have existed if [its] act had not been committed”.1 See further Damages: General concept.


Under that principle, compensation will generally reflect (a) the effective loss (i.e., the actual losses suffered, or damnum emergens), and (b) lost profits (or lucrum cessans).2

II. Effective loss


Effective loss refers to the actual or direct costs incurred by the investor (also referred to as “sunk” or “wasted” costs).3 In this way, effective loss is similar to the reliance measure of damages that exists in common law,4 and is reflective of the amounts invested and expenses incurred by the investor in making the investment5 (including, in some circumstances, costs associated with the negotiation of a project or other "pre-investment" expenses).6


Unlike lost profits, effective loss is, in principle, always recoverable7 and serves as a minimum for compensation.8

III. Evidential threshold


As effective losses are losses that have already occurred, quantifying and evidencing them is usually straightforward. In most cases, effective losses will, at least in part, take the form of external costs (purchase of equipment, legal fees, other supplier costs etc.), which are readily measurable and supportable with invoices,9 financial statements and other books and records might also serve as sufficient evidence.10 Effective losses might also include internal costs, such as employee wages, or some proportion of the investors fixed costs. Whilst harder to ascertain, these costs are rarely speculative in nature.

IV. Scrutiny of amounts


The degree of scrutiny to which the costs comprising a party’s effective loss have been subjected is mixed.


Some tribunals have shown a willingness to look only to establish what the investor spent, and refrain from making any determination as to the judiciousness or providence of that spending.11 Others, however, have imposed limitations, and made adjustments to reflect what a reasonable third party might have paid.12 Similarly, while some Tribunals have historically shown limited concern with whether the costs were paid by the Claimant provided the Claimant can demonstrate that the costs bore some connection with the investment,13 other tribunals have refused to include such costs in an award.14

V. When is Effective Loss an appropriate measure of compensation?


Subject to any specific limitation provided for in the investment contract (or governing law) or treaty, compensation measured on the basis of effective loss will be most appropriate where the investment is not income generating at the time of the valuation, or there is significant uncertainty as to its prospects with the result that any attempt to use a forward-looking valuation method (such as discounted cash flow) would be too speculative.15 A significant disparity between the valuation provided by a (speculative) discounted cash flow (or other forward-looking analysis) and the effective loss will not alone provide a reason to prefer effective loss,16 however some tribunals have taken such disparity into consideration alongside other factors when assessing whether discounted cash flow (or the resulting valuation) is appropriate.17


Tribunals have also signalled a wiliness to accept effective loss in circumstances where there has been depreciation in the value of the investment such that the market value of the investment is less than its cost.18


Cox, J., Expropriation in Investment Treaty Arbitration, Oxford University Press, 2019, Chapter 13, paras. 13.82, et seq.

Kantor, M., Valuation for Arbitration: Compensation Standards, Valuation Methods and Expert Evidence, Kluwer Law International, 2008, Chapter 2, Section VIII.

Marboe, I., Calculation of Compensation and Damages in International Investment Law, Oxford University Press, 2017, Chapter 3.

Ripinsky, S. and Williams, K., Damages in International Investment Law, British Institute of International Comparative Law, 2008, Chapter 4, section 4.3.4 and Chapter 7.

Sabahi, B., Compensation and Restitution in Investor-State Arbitration: Principles and Practice, Oxford University Press, 2011.

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