CROSS BORDER INVESTMENT

INTERNAL ASSESSMENT I

“INDIRECT EXPROPRIATION” AND THE “RIGHT TO

REGULATE” IN INTERNATIONAL INVESTMENT LAW

Name: Adrianna Lillyan Thangkhiew

PRN: 17010125260
Div: C, BA.LLB (2017-22)
Introduction

The right to regulate entitles the State to act in the public interest. 1 Depending on the manner in
which such right is exercised, arbitral tribunals have held that regulatory measures that lead to
the taking of property may or may not constitute a compensable expropriation. 2 The idea of
“police powers” has been used interchangeably with the State's right to regulate in the context of
a regulatory action.

Many tribunals have held that under customary international law, States have the right to
regulate, regardless of whether such right is expressly stated in the applicable investment treaty. 3
A number of recent investment treaties also state that appropriate public-interest measures do not
constitute expropriation, except in rare circumstances.4

Direct expropriation conflicts, which dominated the 1970s and 1980s and were mostly tied to
nationalisation, have been supplanted by challenges over foreign investment restrictions and
“indirect expropriation.”

With the first cases brought under NAFTA, there is growing worry that concepts like indirect
expropriation could be used to regulatory measures aimed at preserving the environment, health,
and other societal welfare interests.

The question is to what extent a government can impact the value of property for a valid public
purpose by regulation, either broad in nature or specific actions in the context of general
regulations, without causing a “taking” and having to compensate for it.

Despite a number of international court decisions, the distinction between the idea of indirect
expropriation and government regulatory measures that do not require compensation has not
been well defined and is dependent on the facts and circumstances of the case. While a case-by-
case analysis is still required, some criteria for assessing whether an indirect expropriation
1
Cox, J., Chapter 7: Regulatory Expropriation, in Cox, J. (ed.), Expropriation in Investment Treaty Arbitration,
Oxford University Press, 2019, pp. 152-210.
2
Escarcena, S.L., Chapter 7: The Applicable Standard, in Escarcena S.L. (ed.), Indirect Expropriation in
International Law, Edward Elgar, 2014, pp. 184-224.
3
Henckels, C., Indirect Expropriation and the Right to Regulate: Revisiting Proportionality Analysis and the
Standard of Review in Investor-State Arbitration, 15(1) Journal of International Economic Law, 2012, pp. 223-255.
4
Mostafa, B., The Sole Effects Doctrine, Police Powers and Indirect Expropriation Under International Law, 15
Australian International Law Journal, 2008, pp. 267-296.
requiring compensation has occurred have emerged from a review of various international
accords and arbitral cases.

The Basic Concepts of Obligation for Compensation of Indirect Expropriation

Expropriation of foreign investments is not prohibited by customary international law if certain

circumstances are met. These are the following conditions: the investment must be made for a
public purpose as defined by law, in a nondiscriminatory manner, and with recompense.

Expropriation, or “wealth deprivation,” can take several forms: direct expropriation, in which an
investment is nationalised or otherwise directly expropriated through formal transfer of title or
outright physical seizure; indirect expropriation, in which an investment is nationalised or
otherwise directly expropriated through formal transfer of title; and indirect expropriation, in
which an investment is nationalised or otherwise directly expropriated through formal transfer of
title. Other phrases used alongside expropriation include “dispossession,” “taking,”
“deprivation,” and “privation.”5 A seizure of legal title to property is clearly defined as a
compensable expropriation under international law.

Even if the property is not seized or the legal title to the property is not altered, expropriation or
deprivation of property can occur when a state interferes with the use of that property or the
enjoyment of the advantages. Indirect, “creeping,” or “de facto” expropriation, or measures
“tantamount” to expropriation, are steps adopted by the government that have a similar effect to
expropriation or nationalisation.

As previously said, there is no widely acknowledged and unambiguous definition of indirect

expropriation or what distinguishes it from non-compensable regulation, despite the fact that this
is a critical subject for both investors and governments.

5
Dolzer and Stevens, “Bilateral Investment Treaties”, ICSID 1995 at 98.
Legal Texts under Indirect Expropriation

Indirect expropriation protection has been provided in a variety of international agreements.

Indirect expropriation or measures that are tantamount to expropriation are provided for in all
applicable treaties and draft treaties. With the exception of the European Convention on Human
Rights and Fundamental Freedoms (hereafter the European Convention on Human Rights), the
recently concluded US-Free Trade Agreements, and the new model US and Canada BITs, the
majority of them remain silent on the treatment of non-compensable regulatory measures.

Legal texts which address non-compensable regulation

Article 1 of Protocol 1, which was signed in 1952 and came into force in 1954, contains the
relevant principles for the purposes of the European Convention on Human Rights.

Article 3 of the 1967 OECD17 Draft Convention on the Protection of Foreign Property, states
that “No Party shall take any measures depriving, directly or indirectly, of his property a
national of another Party”6 unless four conditions are met according to recognized rules of
international law.

The NAFTA provision was nearly identical to the MAI Negotiating Text. The MAI
Commentary, on the other hand, noted that the text was meant to encompass “creeping
expropriation” by extending protection to “actions having equal effect” to expropriation. The
distinction between indirect expropriation and general regulations was addressed by MAI
negotiators in the Chairman’s Report (Chairman’s Report)7, which was presented at a later stage
of the negotiations.

Article 3 (Right to Regulate) and an interpretative remark to Article 5 (Expropriation and

Compensation)22 are provided in Annex 3: Article 3 “Right to Regulate”

OECD Draft Convention on Foreign Property, 12 October 1967 pp. 23-25.

6

7
The Multilateral Agreement on Investment (Report by the Chairman of the Negotiating Group)
DAFFE/MAI(98)17, 4th May 1998.
“[a] A Contracting Party may adopt, maintain, or enforce any measure it deems necessary to
ensure that investment activity is carried out in a way that is sensitive to health, safety, or
environmental issues, provided that such measures are consistent with this agreement.”

Legal texts which include indirect expropriation without addressing non-compensable

regulation

Indirect expropriation provisions in bilateral investment treaties are brief and generic, focusing
on the effect of government action rather than the distinction between compensable and non-
compensable regulatory acts. Treaties signed by France, for example, relate to “measures of
expropriation or nationalisation, or any other measures having the impact of direct or indirect
dispossession.”

Expropriation also involves measures “having the effect of nationalisation or expropriation,”

according to the UK treaties. Other treaties, such as those signed by Sweden, relate to “any direct
or indirect measure” or “any other measure against investments of the same character or impact.”

Article 1110 of NAFTA protects against the expropriation of foreign investments with the
following language:

No Party may nationalise or expropriate an investment of another Party’s investor in its territory,
either directly or indirectly, or take an action that is akin to nationalisation or expropriation of
such an investment, unless:

 for a public purpose;

 on a non-discriminatory basis;
 in accordance with due process of law and Article 1105 (1)15 and
 on payment of compensation in accordance with (subsequent paragraphs specifying
valuation of expropriations and form and procedure of payment).
Criteria determining whether an indirect expropriation has occurred

The legal texts have sought to address directly how to identify valid non-compensable rules that
affect the economic value of foreign investments from indirect expropriation that requires
compensation, as described above. Scholars acknowledged the distinction's existence but did not
elaborate on the grounds for making the distinction.

The two most prominent sources of such decisions were the Iran-United States Claims Tribunal
and decisions arising under Article 1, Protocol 1 of the European Convention for the Protection
of Human Rights.8 From cases based on NAFTA and bilateral investment agreements, a new
body of jurisprudence has emerged in recent years. Simultaneously, a new generation of
investment agreements has emerged, including investment chapters of Free Trade Agreements,
which include criteria to distinguish between indirect expropriation and non-compensable
regulation.

One of the problems in the Sea-Land 9 case was the alleged confiscation of a bank account. The
Tribunal found no substantial deprivation of or interference with the claimant's account rights
and dismissed the claim, stating that the “account remains in existence and available in rials, at
Sea-Land’s disposal.”

In S.D. Myers10, a US firm that ran a PCB cleanup facility in the US, Canada was accused of
violating NAFTA Chapter 11 by prohibiting the export of PCB trash to the US. The Tribunal
further differentiated regulation from expropriation based on the degree of interference with
property rights: “expropriations tend to include the deprivation of ownership rights; regulations
are a lesser interference.”

Conclusion

Instead of relying solely on the “sole effect” on the owner, tribunals have frequently considered
the intent and proportionality of government actions in determining whether compensation was
necessary. As a result, a number of cases were decided on the basis of the recognition that

8
Handyside v. United Kingdom, 24 Eur. Ct. H.R
9
Sea-Land Service Inc. v. Iran, 6 Cl. Trib. Rep. 149 (1984)
10
S.D. Myers Inc. v. Government of Canada, (2004) 244 FTR 161
governments have the right to protect the environment, human health and safety, market
integrity, and social policies, among other things, through non-discriminatory actions, without
providing compensation for any incidental deprivation of foreign-owned property.

Only a few international accords have stated this distinction so far. New investment agreements,
especially investment chapters of Free Trade Agreements, have recently added explicit wording
and criteria to aid in establishing whether an indirect expropriation requiring compensation has
occurred. These standards are similar to those that emerge from arbitral decisions.
Bibliography

1. Cox, J., Chapter 7: Regulatory Expropriation, in Cox, J. (ed.), Expropriation in

Investment Treaty Arbitration, Oxford University Press, 2019, pp. 152-210.
2. Escarcena, S.L., Chapter 7: The Applicable Standard, in Escarcena S.L. (ed.), Indirect
Expropriation in International Law, Edward Elgar, 2014, pp. 184-224.
3. Henckels, C., Indirect Expropriation and the Right to Regulate: Revisiting Proportionality
Analysis and the Standard of Review in Investor-State Arbitration, 15 (1) Journal of
International Economic Law, 2012, pp. 223-255.
4. Mostafa, B., The Sole Effects Doctrine, Police Powers and Indirect Expropriation Under
International Law, 15 Australian International Law Journal, 2008, pp. 267-296.
5. Dolzer and Stevens, "Bilateral Investment Treaties", ICSID 1995 at 98.
6. OECD Draft Convention on Foreign Property, 12 October 1967 pp. 23-25.
7. Pellet, A., Chapter 32: Police Powers or the State's Right to Regulate, in Kinnear, M.,
Fischer, G. et al. (eds.), Building International Investment Law: The First 50 Years of
ICSID, Kluwer Law International, 2015, pp. 447-462.
8. Rajput, A., Regulatory Freedom and Indirect Expropriation in Investment Arbitration,
Kluwer Law International, 2018.
9. Titi, A., The Right to Regulate in International Investment Law, Nomos, 2014.
10. UNCTAD’s Investment Policy Framework for Sustainable Development (2015), p. 99
(Policy Options for IIAs, Section 4.5).