Indirect expropriation occurs when a state takes effective control of, or otherwise interferes with the use, enjoyment or benefit of, an investment, strongly depreciating its economic value, even without a direct taking of property. But there is no commonly accepted definition of indirect expropriation; ascertaining whether it has occurred will depend on the facts and on the treaty language, and on how both are interpreted by the dispute settlement body.
This raises sustainable development concerns. Measures taken for a public purpose, such as health or environmental protection, could be considered an indirect expropriation, since they may affect the value of an investment. RTIAs’ expropriation provisions generally do not prevent states from expropriation per se. Rather, they provide that any expropriations, among other things, must be lawfully done and compensated.
The possibility of having to compensate investors for regulations that affect their bottom line leads to the concern that the fear or threat of an indirect expropriation claim by an investor could chill government regulation in the public interest. These problems have led some states to avoid including indirect expropriation altogether and rather require compensation only for direct expropriate, when a transfer of property actually occurs.27
When states decide that indirect expropriation should be covered by an international agreement, some have established more precise details on the definition. It is, for example, possible to draft provisions that specify the role and place of the criterion of injurious effect and of other criteria of expropriation.
In accordance with some national approaches to expropriation, states could also envisage introducing the criterion of state appropriation along with that of injurious effect.28 In other words, the treaty may require that the injurious effect on the investment must have been accompanied by some economic benefit to the state. This might exclude, for example, a situation where a state prohibited the use or production of a toxic substance, but would include the declaration of a privately owned area as a nature reserve.
It is important to note that simply recognizing the state’s sovereign right to regulate (see Section 5.3.1) may not be sufficient to address the definition of indirect expropriation, since expropriation provisions do not prohibit regulation; they simply demand that expropriation be compensated. Similarly, it is not enough to create a presumption in favour of certain regulatory measures; it should be specified that some types of measures—known as “police power” measures—are not expropriation, whatever their adverse impact on the investments. Most formulations characterize police power measures as being non-discriminatory and in the public interest.
If the negotiating parties consider including the indirect expropriation clause29 in the agreement, they could adopt one or more options listed below, which have incorporated some sustainable development considerations.30
Option 1:Carefully craft the definition for “indirect expropriation”
May safeguard state’s policy space to implement legitimate regulations of general applicability for sustainable development purposes
“An action or a series of related actions by a Member State cannot constitute an expropriation unless it interferes with a tangible or intangible property right or property interest in a covered investment.
The provision on Expropriation addresses two situations:
a. the first situation is where an investment is nationalised or otherwise directly expropriated through formal transfer of title or outright seizure; and
b. the second situation is where an action or series of related actions by a Member State has an effect equivalent to direct expropriation without formal transfer of title or outright seizure.
The determination of whether an action or series of actions by a Member State, in a specific fact situation, constitutes an expropriation of the type referred to in sub-paragraph (X) (on indirect expropriation), requires a case-by-case, fact-based inquiry that considers, among other factors:
a. the economic impact of the government action, although the fact that an action or series of actions by a Member State has an adverse effect on the economic value of an investment, standing alone, does not establish that such an expropriation has occurred;
b. whether the government action breaches the government’s prior binding written commitment to the investor whether by contract, licence or other legal document; and
c. the character of the government action, including, its objective and whether the action is disproportionate to the public purpose referred to in (the provision on Expropriation).
Non-discriminatory measures of a Member State that are designed and applied to protect legitimate public welfare objectives, such as public health, safety and the environment, do not constitute an expropriation of the type referred to in sub-paragraph (X) (on indirect expropriation)
(ASEAN-China Investment Agreement, Annex 2)
How Commonly Used
“The determination of whether an action or series of actions by a Party, in a specific fact situation, constitutes an indirect expropriation, requires a case-by-case, fact-based inquiry that considers, among other factors:
- the economic impact of the government action, although the fact that an action or series of actions by a Party has an adverse effect on the economic value of an investment, standing alone, does not establish that an indirect expropriation has occurred;
- the extent to which the government action interferes with distinct, reasonable investment-backed expectations; [footnote omitted] and
- the character of the government action.
Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health [footnote omitted], safety and the environment, do not constitute indirect expropriations, except in rare circumstances.” (TPP, Annex 9-B)
How Commonly Used
Option 2:Include criterion of state appropriation
Requires the injurious effect on the investment to have resulted in economic benefit to the state
“The determination of whether a Measure or a series of Measures have an effect equivalent to expropriation requires a case-by-case, fact-based inquiry, and usually requires evidence that there has been: …
(iii) an appropriation of the Investment by the Host State which results in transfer of the complete or near complete value of the Investment to that Party or to an agency or instrumentality of the Party or a third party;” (An earlier version of the draft Indian Model BIT, published in April 2015)
How Commonly Used
For example, when negotiating Agreements on Cooperation and Facilitation of Investments, “the Brazilian government’s position was … to restrict the expropriation concept only to direct expropriation, and its compensation in accordance with the Brazilian Constitution….” See Morosini, F. and Badin, M. (2015, August). The Brazilian Agreement on Cooperation and Facilitation of Investments (ACFI): A New Formula for International Investment Agreements? Investment Treaty News, 6(3), p.5, footnote 6.
This argument has been put forth by a number of authors. See Nikièma, S. (2012, March). IISD Best Practices Series: Indirect expropriation. See also Newcombe, A. (2007). The boundaries of regulatory expropriation in international law. In P. Kahn, & T. W. Wälde (Eds.), New Aspects of International Investment Law (pp. 441–445). Leiden/Boston:, Martinus Nijhoff Publishers.
Indirect expropriation is sometimes excluded. For example, the Brazilian parliament has directed the government to limit any expropriation provision to direct expropriation only.
For some other options, see UNCTAD’s Investment Policy Framework for Sustainable Development (2015), p. 99 (Policy Options for IIAs, Section 4.5).