‘Spoils of War’ in Investment Disputes


Unlike other contentious issues under international investment arbitration such as expropriation and jurisdiction, discussions regarding calculation of damages and compensation are often overlooked and remain unearthed. In most investor-state dispute settlement (“ISDS”) cases related to expropriation, the foreign investor submits a monetary claim, seeking damnum emergens (direct damages) and lucrum cessans (lost profits) as a result of loss of investment due to the host-state actions. To counter this, the host-states challenge the standard of compensation and the method for valuation by the investors in order to reduce their liability, if any. According to Article 43 of the Convention on the Settlement of Investment Disputes between States and Nationals of Other States, 1966 (“ICSID Convention”), the tribunal can call upon the parties in dispute to produce documents or other relevant evidence, which often includes expert damage reports. Recently, the International Centre for Settlement of Investment Disputes (“ICSID”) awarded its highest ever award to the tune of $8.7 billion in Conoco Philips vs. Venezuela (2019), which brings major concerns in investment disputes regarding the credibility of ISDS tribunals. However, to preclude foreign investors from claiming unreasonable and excessive damages, investment tribunals have time and again refused to compensate them in cases where the damages claimed are highly speculative or insufficiently proven.

Therefore, it becomes important to understand the various standards of damages and methods of valuation which are used in international investment disputes especially in cases of expropriation and how an investor must present claim to successfully recover damages from the host-state.

International Law Standards for Compensation

States are vested with a sovereign right to expropriate property held by nationals or aliens for economic, political, social or other reasons. Such expropriation is lawful in case the pre-requisite conditions for expropriation are fulfilled. Of late, irrespective of the recognised differences between lawful and unlawful expropriation, the different standards of compensation for both have come to be realised.

The issue of standard of compensation has been a controversial issue between capital-exporting countries and capital-importing countries and has led to formulation of conflicting standards of compensation as a natural consequence, the most prominent of which are the Hull Formula (named after U.S. Secretary of State, Cordel Hull) and the Calvo Doctrine (titled after the Argentinian Diplomat and jurist, Carlos Calvo). The former calls for a prompt, adequate, and effective compensation while the latter stresses on exhaustion of local remedies of host-states to claim compensation. Needless to say, the basis of these standards lies within the geo-political differences between these countries. However, the difference between the two factions has lost its relevance, in the wake of proliferation of investment treaties expressly providing the standard of compensation (at least for lawful expropriation).

In addressing the blanket loss of investment owing to an unlawful expropriation, the most widely accepted standard for compensation was formulated in the landmark judgment of the Permanent Court of International Justice in Factory at Chorzow (1927), which first conceptualised the full reparation standard. This principle is recognised as a customary international law norm and is envisaged under Article 31(1) of ILC Articles on State Responsibility (2001), which states that an internationally wrongful state ‘is under an obligation to make full reparation for the injury caused’. Since under investment disputes, the claim is usually for compensation, as restitution is not possible, Article 36 states that full reparation includes compensation for damages and the resultant lost profits. Such compensation is based on the value of investment as on the date of award or the date of expropriation, whichever is higher. Another influential principle is the standard of ‘appropriate’ compensation as propounded by the United Nations General Assembly Resolution on Permanent Sovereignty over Natural Resources (1962) and the World Bank Guidelines on the Treatment of Foreign Direct Investment (1992) (“World Bank Guidelines”), which state that compensation in cases of expropriation will be ‘appropriate’ if it is adequate, effective and prompt depending on the ‘fair market value’ of the expropriated asset.

Conversely, in case of a lawful expropriation, the lack of consensus does not pose a major problem in determining the standard of compensation in investment disputes. This is due to the fact that most modern investment disputes arise out of bilateral investment treaties (“BITs”) or multi-lateral investment treaties such as the Energy Charter Treaty (1991), the North Atlantic Free Trade Agreement (1994) etc., which contain provisions regarding payment of compensation in cases of expropriation on the basis of the ‘fair market value’ or ‘genuine value’ of the investment. ISDS generally rely on the provisions of the investment treaty governing compensation, such as in CME Czech Republic vs. Czech Republic (2003).

Therefore, the applicable standard in case of investment disputes depends on the provisions of the investment treaties between the parties. While a lack of such provision in a treaty is highly unlikely, in such cases the tribunal looks into the international law standards to determine the appropriate standard for compensation.

Valuation of Damages in Investment Disputes

While the position regarding the standard of compensation is well settled, valuing the assets, liabilities, business, goodwill and the profitability is a herculean task in determining the quantum of damages. Depending on the facts of each case, ISDS tribunals apply the most appropriate valuation method.

Valuation on the basis of liquidation value is the most common approach to quantify damages. Using this method, the assets and liabilities of a business are evaluated, similar to a liquidation proceeding. The World Bank Guidelines suggest that this method is most suitable for businesses which are not going concern and demonstrate lack of profitability.

Other methods include determining the replacement value, which refers to the amount required to replace the individual’s assets in their actual state as of the date of expropriation, or the book value method, which is the real value of the investment minus accumulative depreciation in accordance with generally accepted accounting principles. Both these methods are rarely applied and heavily criticised by commentators on the grounds of doing injustice to the business’ goodwill, contractual rights, intellectual properties and potential profitability.

In the landmark case of Occidental vs. Ecuador (2012),  ICSID rejected the liquidation value method over the discounted cash flow (“DCF”) to calculate profits which the investor would have reasonably been expected to earn but for the host-state’s action. The DCF method is based on empirical economic and business studies while taking into account the future cash flows and helps in determining an enterprise’s present value on the basis of projections of future profits. It relies on the principle that the value of an income-producing capital asset can only be determined by considering the profits it is able to generate in the future. The World Bank Guidelines provide that the DCF method is the most suitable in cases in which a business is a going concern and consistently profitable. In Amoco vs. Iran (1987), the Iran-US Claims Tribunal stated that a going concern business must demonstrate certain ability to earn revenues so as to be considered to be keeping such ability for a prolonged period of time. Moreover, businesses must have prior presence in the market for a minimum period of time to be recognised as going concern as stated by ICSID in AAPL vs. Sri Lanka (1990).

While the DCF method is universally adopted and provides flexibility depending on the facts of each dispute, it suffers from its own limitations. Most investors in ISDS cases, exaggerate details regarding their profitability to claim enormously high compensation. They may provide insufficient evidence regarding their profitability or may inappropriately calculate the claimed amount using this mechanical formula by incorrectly considering the risk factors and the change in circumstances in the future. Therefore, ISDS tribunals must exercise diligence and appreciate evidence in toto so as not to be punitive while awarding damages and not overburden states to pay a large lump sum of money to an already wealthy investor. Moreover, the suitability of the DCF method, as a forward-looking approach, in cases of lawful expropriation is still unclear, as lawful expropriation entails only direct damages as per the Chorzow factory case. However, the understanding of ICSID in Amoco vs. Iran (1987) in holding future prospects as a going concern value and a part of the fair market value can act as a guiding light.

Concluding Remarks

While the mantra to calculate adequate and effective compensation remains unclear in investment disputes, there is ample jurisprudence to suggest that for every penny claimed by the investor, there must be sufficient and reasonable evidence. In modern ISDS cases related to expropriation, the investors claim for humungous amounts as ‘lost profits’ using the full reparation standard and the DCF method, which clouds their credibility. To this end, investors provide adequate documentation, proper expert reports, witnesses proving their profitability and financial health. The host-state may rely on compliance documents, investigative reports along with its own reports and witnesses to disprove the investors’ claims. The investors must make sure that the damage is claimed for an existing right, otherwise their claims will be precluded under Article 42(2), ICSID Convention. Moreover, on successful admission of claims, the investor may be seduced to recover interests on the principal amount, which brings to the fore issues such as the determination of the type of interest (simple or compound), the date from which the interest is to be calculated, and the pre- or post-award interest. However, the scope of damages under investment arbitration must be restrictively interpreted so as not to overburden the state, maintain uniformity and consistency and not disturb the promotion of economic cooperation and development between countries.

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