Opening a pandora’s box in investment arbitration: Redefining the murky boundaries of compensable indirect expropriation and non-compensable regulation

Abstract

The concept of expropriation has developed over the years to include not only the outright taking, but also regulations whose effect is tantamount to expropriation. This is referred to as indirect expropriation. As a result of this concept, regulations whose effect deems the investment redundant would still require the investor to be compensated. However, at the same time, there is need to appreciate that states have the right to regulate. This right stems from their sovereignty. Consequently, when a state enacts a regulation in the exercise of this right, they do not need to pay compensation to investors. This illustrates two competing interests: on one hand, regulations which are equivalent to expropriation and require compensation and on the other, there are regulations which are within the states’ right to regulate that do not require compensation. How is this distinction drawn? This remains a problematic issue in investment law to date.This study seeks to draw this distinction. Following a through in-depth analysis of the concept of indirect expropriation and the states right to regulate, this study will demonstrate that the three approaches established by arbitral tribunals fail to correctly draw this distinction. The sole effect approach fails to take into consideration the states right to regulate, while the police powers approach fails to consider the investors protection against expropriation. Furthermore, the tribunals taking up the proportionality approach also fail to capture important factors which also makes drawing the line between these two concepts problematic. To address this conundrum, this study will propose a proportionality test with specific factors that ought to be considered. These include a genuine public welfare purpose, reasonableness, procedural justice and investor’s legitimate expectations. These factors cater for both the interests of the investors and the states. Undoubtedly, such an analysis will create a fairer outcome in drawing the distinction between the two concepts. This will not only create certainty but also help in legitimising the system.