“The law of state responsibility is mired in confusion and uncertainty which the labours of the International Law Commission have done little to resolve.”

B Y   K E V I N  K.  H O

23 April 2001

There are two strands at work that have led to the charges of ‘ineffective’ efforts on behalf of International Law Commission and by other similar multilateral efforts at establishing a standard international code regulating the law of state obligation in regards to foreign investment protection. The main issue of contention this paper will focus on is not whether or not states can expropriate foreign-owned assets in their countries, but rather, how much compensation foreign investors should receive. The first strand at work here is series of judicial arbitrations, opinions and rulings that have gradually turned themselves into the prevailing rule over the question of compensation. Secondly, states have chosen not to establish a fast and hard convention governing investment protection because they enjoy the ambiguity associated with lack of agreement over the question of ‘just’ versus ‘full’ compensation and the discretion this ambiguity gives states when dealing with questions of foreign investment. There is no question that states compensate when they have done wrong, but here too the question of how much to compensate is also a primary concern. This essay will examine how these two notions came into being by examining the series of cases and events that have led to this ambiguous state of affairs to arise. In trying to establish a clear pattern of ambiguity, this essay purports to examine the situation in a chronological fashion and then argues that the timing of compensation claims and the consequences of globalisation have culminated to mute the efforts of the ILC in favour of bilateral investment protection schemes instead.

When dealing with state-to-state claims and compensation questions, it should be kept in mind that when foreign state A takes up a claim against state B, A is oftentimes representing interests of their individuals or of companies and investment interests emanating from A. This example illustrates the established tradition that states may take up the claims of their nationals who have had assets expropriated in another country. This assumption of an individual’s claim by a state moves the question to an international forum. Brownlie frames his discussion exhaustion of local remedy by outlining the “legal interests” that states have on behalf of its nationals and by ascribing it to the immunity associated with diplomatic tradition.[1]

 

If nationals are subjected to injury or loss by an agency for which another state is responsible in law, then, whether the harm occurs in the territory of a state or res communis, i.e. the high seas or outer space, or in terra nullis, the state of the persons harmed may present a claim on the international plane.[2]

 

Brownlie delineates between the types of state expropriation. Confiscation is defined as the unlawful taking of foreign-owned, or alien, property. Taking control of other resources (i.e., farmland, factories, monopolies, and other natural resources) as part of a larger program of social or economic reform is thought of in terms of expropriation.[3] The principle of a state taking up a claim of its national stems from diplomatic procedures and from a few cases such as the Norwegian Shipowner’s Claims case (1922) and of the Chorzów Factory case (1928). According to principles of sovereignty and customary law, states can expropriate property, but must compensate for it and there must be legally accepted reasons for their actions. The generally accepted conditions are listed within UN Resolution 1803. Despite the fact that the resolution addresses other issues relating to natural resource control, it makes clear that there are certain conditions that must be met before a lawful expropriation can be made.[4]

 

Nationalization, expropriation or requisitioning shall be based on grounds or reasons of public utility, security or the national interest which are recognized as overriding purely individual or private interests, both domestic and foreign. In such cases the owner shall be paid appropriate compensation, in accordance with the rules in force in the State taking such measures in the exercise of its sovereignty and in accordance with international law. (emphasis added.)[5]

 

Customary law notions of supreme state competence within its borders were also being established at the same time as those notions of diplomatic protection. Eventually, the questions over the protection of and the due compensation for the loss of foreign-owned property within a country (at the hands of the other country) came to bear. The oft-cited ruling in the Chorzów Factory case of 1928 became the standard that successive international arbitrators and tribunals have used when addressing the question of whether a state deserves ‘full’ compensation or partial ‘just’ or ‘appropriate’ compensation.[6]

 

The essential principle contained in the actual notion of an illegal act—a principle which seems to be established by international practice and in particular by the decisions of arbitral tribunals—is that reparation must, 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 that act had not been committed. Restitution in kind, or, if this is not possible, payment of a sum corresponding to the value which a restitution in kind would bear [must be made]…(emphasis added.)[7]

 

Clearly, a “corresponding” sum implies that states must compensate fully. This notion was expanded upon in 1938 when the United States and Mexico came into conflict over nationalised U.S. oil company holdings in Mexico. At the time, the U.S. Secretary of State, Cordell Hull, sent a diplomatic letter to his Mexican counterpart in order to resolve the stalemate that subsequently became known as the “Hull Formula” that help shape U.S. and other international approaches to the law of state expropriation.[8] The formula demanded the “prompt, adequate, and effective” payment of compensation for the taken oil fields. This was taken to mean full, and not partial, compensation. The tradition of full compensation was continued in the immediate post-WWII period with states often having to pay full value for destroyed property and assets. In the 1950s there was a bout of Middle Eastern oil state initiatives that led to several arbitrations involving the question of state expropriation and national land use rights dealing with the continental shelf. The ARAMACO, Sapphire, Abu Dhabi and the Qatar rulings all had a few factors in common. Since there were no local remedy provisions that satisfied the involved parties, each submitted their claim to an international arbitration. The rulings issued appealed to the “general principles of justice,” in their decisions meaning that the arbitrators preferred to use the Chorzów full compensation precedent when deciding these cases.[9]

This tendency to award full compensation did not go unchallenged however. While arbitration activity ceased for a little more than a decade from 1963 to 1974, international debates and action on the issue went into high gear. It was not until the early 1970s that there were again international arbitrations involving state appropriation. Meanwhile the U.N. General Assembly, newly emboldened by the proliferation of newly independent states from the 1950s and ’60s, was extremely active in promoting state’s rights, particularly those of developing countries. Norton attributes this assertiveness and challenges to customary law to a number of reasons.

 

Many of these states refused to consider themselves bound by a law in whose formulation they had not participated and which, they maintained, did not reflect their own cultural and legal traditions. The law of expropriation attracted their special animus since it purported to place strict limits on how they could deal with foreign investors in control, at the time of independence, of many of the new states’ natural resources.[10]

 

In the 1960s and ’70s the assertiveness of newly independent countries came to bear in several multi-lateral institutions. From the non-aligned movement in the GATT to the UN General Assembly, the developing countries were trying to change the terms of the international system. One of those attempts was movement by developing countries to declare themselves members of the so-called New International Economic Order (NIEO) with the passage of Resolution 3281 in December 1974. which built upon and references  the declaration of Permanent Sovereignty over Natural Resources of Resolution 1803 passed in 1962.[11] On the question of compensation Resolution 3281 clearly comes down on the side of state discretion in the matter.

 

To nationalise, expropriate or transfer ownership of foreign property in which case appropriate compensation should be paid by the State adopting such measures, taking into account its relevant laws and regulations and all circumstances that the State considers pertinent. In any case where the question of compensation gives rise to a controversy, it shall be settled under the domestic law of the nationalizing State and by its tribunals, unless it is freely and mutually agreed by all States concerned that the other peaceful means be sought on the basis of the Sovereign equality of States in accordance with the principle of free choice of means (emphasis added.)[12]

 

 

Again, it can be seen in the case of dispute, that even this document defers to arbitrational methods that had previously already established and, perhaps, subconsciously adopted the notion of full compensation but the emphasis on state’s rights and discretion within the resolution’s language is quite evident. However, despite these very public statements regarding the laws related to state responsibility and compensation when it came to actual rulings, it should come as no surprise that a series of oil-related cases during the 1970s pushed the standard of compensation back towards the notion of full compensation being appropriate rather than the notion of partial compensation being adequate, especially in illegal takings. Therefore, when Libya nationalised oil fields belonging to British Petroleum, Texas Overseas Petroleum Company (TOPCO) and of the California Asiatic Oil Company (CALASIATIC) three claims were filed and decided between 1971 and 1974. Under the BP Arbitration Judge Lagergren ruled that the taking of BP’s assets was “discriminatory in character,” as the taking was politically motivated, and since there was no offer of any compensation that the taking was also “confiscatory.”[13] Since there was no clear local remedy in this case Lagergren made an appeal to the “case law of international tribunals,”[14] in this case, and therefore, concluded in cases of clearly unlawful expropriation that the standard of compensation was full if he was referring to the ARAMACO, Sapphire, Abu Dhabi, Qatar and the Chorzów cases. In the TOPCO and the CALASIATIC rulings, Judge Dupuy also relied on the Chorzów case saying that it was the preferred remedy as well. Dupuy deferred to Chorzów especially since there was already a written agreement in force when the assets were seized since the principle “good faith” between states and foreign investors had to be upheld.[15] 

Even in cases that were more conciliatory towards the NIEO initiatives, the prospects for partial compensation becoming customary law were dimmed. In the 1977Libyan American Oil arbitration, a sympathetic arbitrator, Mahmassani, said that previous case law was dated and that he would defer to GA resolutions and award “equitable compensation.”[16] However, when he incorporated lost profits in that calculation, he ended up awarding a sum close to the full value of the expropriated assets.[17] The questions of the validity of GA resolutions and of whether or not lost and potential profits should be calculated in settlements were addressed in the American Independent Oil Company v. Kuwait case (AMINOIL).[18] When Kuwait terminated its concession to AMINOIL and nationalised its assets in 1977, a tribunal took up AMINOIL’s claim and in addition to determining that the taking was lawful, added the dimension of adding in future profits the “going concern” in their settlement. This type of “appropriate” compensation would include future cash flows and incorporate a “reasonable rate of return” in its final figure. Moreover, the tribunal, though using the notion of “appropriate” and not necessarily ‘full’ compensation went out of its way to reject GA resolutions to codify an international standard because of the lack of unanimity in the resolutions’ passage.[19] Therefore, even for lawful expropriations the sums awarded also have to include future and potential profits – lucrum cessans­­ – in addition to assessed appropriate compensation.

Various cases related to the Iranian Islamic revolution throughout the 1980s reaffirmed this trend that started in the 1970s.[20] While these cases do not need to be examined in full detail, the trends towards “correct legal standards” that meant “appropriate” compensation included future profits meant that a standard of de facto full compensation had been adopted. Even as late as 1987, the U.S. issued a third “Restatement” on the Foreign Relations Law of the United States, that used the 1938 Hull formula as its guiding standard, calling for “just compensation” but really meaning “in the absence of exceptional circumstances…. an amount equivalent to the value of the property taken…. paid at the time of taking…. and in a form economically usable by the foreign national.”[21]

Therefore, from these cases we can see that a timeline of judicial precedents was established and a series of non-binding UN resolutions were ignored. The NEIO declaration was never tested or implemented and the previous judicial standard was returned to. However, through bilateral agreements the de facto norm of full compensation emerged. Codifying it, though, becomes more of a question of politics and of saving face. It should be born in mind and is agreed that the notion of ‘full’ compensation is a vacuous one at best. Oftentimes there is no comparable industry nor is there a comparable market to make ‘fair market’ assessments for expropriated assets.[22] Writing in 1991, Norton best digests 100 years of international legal activity.

 

The explanation for these inconsistencies [between judicial precedent and international statements by the UN General Assembly] appears to be both political and jurisprudential. The end of the postcolonial era and the now widely accepted need to encourage investment in the Third World have substantially eroded the rationale for a partial compensation standard that appeared so compelling to many observers just a short time ago. More importantly, perhaps, recent tribunals have repeatedly referred to judicial and arbitral precedents affirming a full compensation standard as authoritative sources of law for their decisions. They have rejected as sources of international law nonconsensus General Assembly resolutions, lump sum settlements and other forms of state practice.[23]

 

It is important to stress that GA Resolutions 3281 and 1803 did not pass unanimously, a point that the judges in the AMINOIL arbitration used and the point that Norton attributes to the rejection of these resolutions as sources of international law, despite efforts of those like Mahmassani. This rejection makes it even more ironic that the two resolutions make an appeal to the other sources of international law when settling disputes. Therefore, a subsidiary source of law had to be found, and that is of judicial precedent. Norton speaks to how these precedents have formed a life of their own, and how they’ve become the preferred remedy as has already been demonstrated by the above chronology.

 

A ‘lineage’ of judicial and arbitral precedents also vests an opinion with a kind of legitimacy unique to international law. In the absence of an international legislature or an applicable treaty, an international tribunal is open to the criticism of ‘judicial legislating.’ By following past rulings, arbitrators can credibly maintain that they are playing only the interstitial role more generally accorded them in international lawmaking. Although each of the earlier precedents may have constituted ‘judicial legislation’ at the time it was rendered, over time such precedents have a tendency to coalesce into a source of legitimacy.

 

Of course in addition to the notion of ‘judicial legislation’ it can be argued that the absence of an international law gives a certain level of flexibility. In response to the forces of economic globalisation most developing countries that were formally members of the NIEO came to realise that domestic economic development was tied to foreign direct investment from countries that had previously had an interest in securing full compensation for the expropriation of their assets. Recognising the need to draw in more foreign capital, many countries stopped nationalising foreign-held assets in their countries and began to sign bi-lateral agreements that ensured foreign investment protection.

Indeed, Akinsanya speaks of the “feeling of insecurity” on the part of many foreign investors who chose not to invest in developing countries until they could secure agreements protecting their investments. Akinsanya concludes that this insecurity is the major deterrent to the flows of foreign direct investment to developing countries.[24] This apprehension obviously stems from the fear of “creeping” state expropriation, which started to grow when the developing countries of the world banned together to form the NIEO. In addition to NIEO language dealing with the fundamental declaration that states had full sovereignty over their natural resources and economic activities, NIEO language dealing with nationalisation and expropriation compensation standard was particularly assertive.[25] As legal scholar Burns Weston noted, the core issue addressed by section two of Resolution 3281 that interested most developed countries was language that dealt with reconciling the change of value of foreign-owned assets (both deemed and actual) and how to compensate foreigners for expropriated property.[26] As discussed previously in this essay, the deemed sources of international law started to conflict with themselves, as already noted judicial precedents said one thing, while UN GA resolutions espoused “appropriate compensation,” not necessarily meaning ‘full’ compensation as the arbitrations had already held.[27]

While this essay has focused on the narrow question of compensation, other factors of an ILC-sponsored standard law of state responsibility such as human rights and minimum legal protection standards are measures that some countries consider an affront to their sovereignty, even as they try to use an ILC-standard to assert greater discretion over compensation questions. Sornarjah states that it is “unlikely” for developing states to agree to a multilateral regime governing the law of state responsibility because of the binding nature of proposed ILC provisions (along with other multilateral agreements) as issues of sovereignty over natural resources, human rights and expropriation among other areas continue generate disagreement. With these factors in mind, then,  the preference towards bilateral treaty investment protection becomes apparent. Sornarjah elaborates.

 

Bilateral treaties, on the other hand, are different in that they are made on an ad hoc basis and their ability to give rise to general principles [of international law] is remote. Besides, such treaties could be negotiated in such a manner as to suit the mutual interests of the parties, whereas a multilateral treaty cannot be. The absence of any significant multilateral treaty on foreign investment protection and the increasing resort to bilateral investment treaties themselves are indications of an absence of a sufficient community of interests to make any customary international law in this area. Bilateral solutions become necessary simply because of an absence of a consensus to create multilaterally acceptable norms.[28]

 

The preference towards bilateral agreement is bound to generate speculation as to whether or not the collected body of these treaties constitutes a source of international law. Many scholars dismiss this notion out of hand. Sornarjah  highlights the differences in treaties and argues effectively, that like the GA Resolutions of the 1970s, a series of bilateral treaties tend not to become international law because of the lack of “free consent” by all states — both developing and developed – on specific and general principles governing investment and resource protection.[29] It should be kept in mind that bilateral treaties do not provide any guarantee that developed countries will actually invest significant amounts of capital in a given country. Indeed, a sacrifice of state sovereignty within a bilateral treaty to lure foreign investment into their countries is acceptable to leaders, but not so on a multilateral treaty level. Also Sornarjah adds that “divergence” in standards and the contents of many bilateral treaties prohibits them from becoming sources of international law.[30] Therefore, a subsidiary source, previous court rulings in the absence of municipal remedy, is what arbitrators must rely on. This is not to say that there haven’t been attempts to create multilateral institutions to handle disputes. The World Bank’s 1966 convention that established the International Centre for the Settlement of Disputes is evidence that states are willing to defer to an organisation set up to deal with dispute resolution. The agency and its agents are given immunities and privileges that are supposed to allow it to handle disputes, which it has done.[31] However, setting up a settlement body is one thing, but setting up a treaty that provides (if not legislates) international standards is much more difficult.

In conclusion then, it can seen that the lack of agreement over the International Law Commission’s efforts at codifying the reality the world sees stems from the familiar adherence state’s rights and also from North-South politicking. The flexibility this disagreement gives all states is also something that strengthens the prowess of state’s rights. Also, traditional fears of the loss of sovereignty As a result of this non-consensus, matters relating to state expropriation and of state responsibility have to be governed according to a second-best set of sources of international law, precedents that have built upon each other. Earlier attempts by the developing world have been dismissed by judicial authorities and scholars alike simply because international law requires the consent of each of its members it purports to govern, something that is not likely to happen soon in this area of international responsibility.

© MMI, Kevin K. Ho

Works Cited:

 

Adeoye Akinsanya. “International Protection of Direct Foreign Investments in the Third World,” in International and Comparative Law Quarterly, Vol. 36, January 1987, pp. 58-77.

 

Fiona C. Beveridge. “Taking Control of Foreign Investment: A Case Study of Indigenisation in Nigeria,” in International and Comparative Law Quarterly, Vol. 40, April 1991, pp. 302-333.

 

Ian Brownlie. Principles of Public International Law Fifth Edition, OUP.

 

Patrick M. Norton. “A Law of the Future or a Law of the Past? Modern Tribunals and the International Law of Expropriation,” in American Journal of International Law, Vol. 85, No. 3, July 1991, pp. 474-505.

 

M. Sornarjah. “Bilateral Investment Treaties,” in International Law on Foreign Investment (1994).

 

P.F. Sutherland. “The World Bank Convention on the Settlement of Investment Disputes,” in International and Comparative Law Quarterly, Vol. 28, July 1979, pp. 367-400.

 

Burns H. Weston. “The Charter of Economic Rights and Duties of States and the Deprivation of Foreign-Owned Wealth,” in American Journal of International Law, Vol. 75, No. 3, July 1981, pp. 437-475.