The doctrine of “legitimate expectations” and the State’s right to regulate - Quick Consulting

The doctrine of “legitimate expectations” and the State’s right to regulate Introduction

Arbitration is a common and exceedingly used way to settle disputes between states and investors. Investor state dispute settlement (ISDS) utilizes arbitration due to the many advantages it brings. Apart from the advantage of arbitration being habitually faster than courts, the parties normatively agree on the arbitrator, respectively arbitrators, and thus can trust the fact the arbitrator will be professional, fair and impartial. In recent years, majority of awards issued by arbitral tribunals, deal with “legitimate expectations” of investors opposing the host states, either at the least being invoked by the claimant (the investor) as part of the fair and equitable treatment principle, on its own as a standard treatment or the tribunal dealing with the question itself. Even though the doctrine is also present in the context of expropriation, in this essay I will solely look at it from the fair and equitable treatment side.

The doctrine of “legitimate expectation” poses many questions in international investment law, the main of which is that of its interpretation. A definition of the doctrine doesn’t exist in any legal order. This makes it difficult to interpret and apply on individual cases. In the essay I will nonetheless look at types of “legitimate expectations” that have been constructed through the years depending on where the investor sees his legitimate expectations originate or derive from. Contractual commitments, unilateral representation of the state and the right to a stable regulatory framework are the three main fields, where it might be claimed the host state breached the legitimate expectations of the foreign investor. Later on I shall examine which situations occurred in which cases and the practical affect it has on awarding tribunal decisions.

The state’s right to regulate is another important topic, closely associated with the fair and equitable treatment principle and the doctrine of “legitimate expectations”. It means the host state is able to create, enforce, amend and abolish its own law, directive or any other legal source. One opinion is that the “legitimate expectations” doctrine prevents this in the way that states can be asked to compensate investors whenever regulatory measures become expropriation measures or violate legitimate standards of treatment. This would suggest the states’ right to regulate is limited and make it very difficult to make changes to their national laws and provisions or any other kind of amendments in their legal order which would have negative impact on the investors, including those changes having negative impacts on the national natural and judicial persons at the same time as well. That is to say “legitimate expectations” cannot mean the investors can rely on the states’ laws and provisions not to change in certain situations. This opinion as well as the opposing one will be discussed later on in the essay.

Legitimate expectations under the fair and equitable treatment

The fair and equitable treatment (FET) standard is one of the fundamental principles of international treaties. It is strongly connected to the fact that international treaties are to be interpreted and dealt with in good faith.[1] The standard traditionally ensures the same, not different or better treatment of foreign investors as the national ones by the host state. Foreign investors however need a little bit more protection by law in their field due to the fact they are at a disadvantage by not participating in the national political system. Foreigners don’t engage in electing legislators, nor have other means of expressing their political preferences about the national legal system. This is why doctrines like “legitimate expectations” in compliance with the fair and equitable treatment are being applied when dealing with international investments.

However, the standard is now the demand to “[…] consistent and transparent behaviour, free of ambiguity that involves the obligation to grant and maintain a stable and predictable legal framework necessary to fulfil the justified expectations of the foreign investor.”[2] Opinion of a number of academics is that:

“States have tried before to curtail the expansive interpretation of FET by explicitly stipulating that it does not require treatment that goes beyond the customary international law minimum standard of treatment of aliens and does not create additional substantive rights.”[3]

And therefore it is necessary to establish what the standard, and together with it the legitimate expectation doctrine is, its basic rights and obligations and a separate clause proclaiming the limits.

Term “legitimate expectations”

As stated above, there is not a legal definition of the term in any legal order, national or international which would clearly state what exactly it is that the investors’ may legitimately expect of the host states and as such what claims they can bring before a judge or an arbitration tribunal. It originated and has been elucidated in United Kingdom’s case law, being based instinctively on natural justice, its principles and the attempt at fair approach. As such has been adopted into many of national legal systems. Transposition into international levels occurred naturally through arbitral case law and has been viewed as a part of the fair and equitable treatment without ever having a legal basis. This causes the necessity of tribunals to interpret the meaning themselves. This happens mainly through awarding arbitral decisions where the stated tribunal clearly and intelligibly explains what kind of legitimate expectations has or has not been breached by the state damaging the investor and why these were regarded as such.

The arbitral tribunal during the Tecmed case[4] was the first tribunal dealing with international matter to consider “legitimate expectations” doctrine as part of the fair and equitable standard while deciding[5]. It derived the doctrine from the good faith principle which is applied in vast amount of international law areas, mainly in constructing and abiding international treaties, as it helps states and nations to cooperate. In its decision, although the term “legitimate expectations” was not used, the tribunal set the basic principles of the doctrine, stating that:

“The foreign investor expects the host State to act in a consistent manner, free from ambiguity and totally transparently in its relations with the foreign investor, so that it may know beforehand any and all rules and regulations that will govern its investments, as well as the goals of the relevant policies and administrative practices or directives, to be able to plan its investment and comply with such regulations. Any and all State actions conforming to such criteria should relate not only to the guidelines, directives or requirements issued, or the resolutions approved thereunder, but also to the goals underlying such regulations. The foreign investor also expects the host State to act consistently, i.e. without arbitrarily revoking any preexisting decisions or permits issued by the State that were relied upon by the investor to assume its commitments as well as to plan and launch its commercial and business activities. The investor also expects the State to use the legal instruments that govern the actions of the investor or the investment in conformity with the function usually assigned to such instruments, and not to deprive the investor of its investment without the required compensation.”[6]

By which it basically attempted to engender a kind of a standard which could be used for future investment treaties and disputes resolutions from those originated. This, however, came to a lot of critique, not only from other arbitral tribunals but also professionals in the international law and investment areas. One of the opinions, as seen by Australian professor Zachary Douglas is that “the Tecmed ‘standard’ is actually not a standard at all; it is rather a description of perfect public regulation in a perfect world, to which all states should aspire but very few (if any) will ever attain.”[7]

The original interpretation of the term is very broad and results in incorporating any kind of breach of an investment contract as a breach of the “legitimate expectations” doctrine, and thus arbitral tribunals concluding it as a breach of a treaty. This approach requires the host state to act in such a manner of clarity, stability and certitude, making sure the foreign investor knows at all times, with an overview and beforehand about every law or other regulation in the part of the legal system concerning his field of investments.[8] In the Tecmed case, the state replaced the unlimited license of the investor’s actions with a time limited license, leading to the claim that the change in trading and legitimate space of the investment violates the fair investment treaty between Spain and Mexico. “In this perspective, doctrine, based on un-changeability of the regulations and policies of the host state, provide the investor with inherent right of legitimate expectations, unless state finds a reason to alter it. In addition, the trust of the investor for stabilization the investment has been taken into account.”[9]

The term of the doctrine was later altered into a more specified concept in the case Thunderbird v. Mexico. The tribunal had to decide whether an official letter of assurance from the officials was enough to bring about the legitimate expectations claim. The Thunderbird Gaming Corporation made its investment based on being assured by the state that its regulation doesn’t concern machines provided by the corporation. Mexico later revoked the assurance by declaring the machines as “gambling equipment” and closing down the gaming facilities which caused the company to suffer damages. The arbitral tribunal concluded that the claimant is not able to claim the breach of legitimate expectations in this circumstance and collectively established that:

“Having considered recent investment case law and the good faith principle of international customary law, the concept of ‘legitimate expectations’ relates, within the context of the NAFTA framework, to a situation where a Contracting Party’s conduct creates reasonable and justifiable expectations on the part of an investor (or investment) to act in reliance on said conduct, such that a failure by the NAFTA Party of honour those expectations could cause the investor (or investment) to suffer damages.”[10]

It is not to say that this can be applied to any case and dispute without having a look at the details and specific attributes of certain case. The failure to keep a promise needs to be analysed from different aspects. The next part of the paper will try to look at those fields and the different particularities.

Contractual commitments

Contracts are the main tool of law that ensures stability and predictability between parties, in our circumstances investors and states. It is necessary to distinguish between contractual obligations and those that the host state has that are deriving from international law. This way makes it possible to determine which kind of expectations being breached the foreign investor may claim. Cases concerning these problematics are quite consistent in rulings and differentiate situations clearly.[11] Contractual expectations are namely protected under national law and as such, they can be claimed in front of a national court due to the contract breach, however cannot be seen as protected by a bilateral investment treaty (BIT) and claimed in an ISDS before an international arbitral tribunal. As is stated in Parkerings v. Lithuania case:

“It is evident that not every hope amounts to an expectation under international law. The expectation a party to an agreement may have of the regular fulfilment of the obligation by the other party is not necessarily an expectation protected by international law. In other words, contracts involve intrinsic expectations from each party that do not amount to expectations as understood in international law. Indeed, the party whose contractual expectations are frustrated should, under specific conditions, seek redress before a national tribunal.”[12]

On the other hand, contractual obligations deserve the utmost level of protection as it is the parties themselves who agreed to the terms set and committed to them. In the case of MTD v. Chile, the Chilean government body signed a contract with the investor approving their planned investment in building a city in an area supposed to be rezoned before the plans could proceed. Chilean authorities in charge of agriculture and rezoning areas however later, after the investment had been made, declined the process of rezoning to take place, on the grounds it would be in against the law. The Tribunal concluded that approval of an investment by the FIC (the Chilean Government body) for a project that was against the urban policy of the government was a breach of the FET obligation by Chile. [13] The expectations held by the claimant arose from a contractual obligation and were in this case reasonable.

Unilateral representation of the state

There have been cases in the past where the investor brought claims to an arbitral tribunal where the breach of legitimate expectations was based on a certain promise or assurance made by the host state which was then later changed, not fulfilled or simply ignored by the state’s administration. In this context, we are talking about promises made in another way than by a contract which was discussed above.

In some cases the legitimate expectations are based on specific assurances by the host state. They can be given either before the first step in the investment process or later on after the investment is made. If the investor relied on assurances given after the investment process has started and adjusted his following investment decisions, expectations that are worthy of international protection might have been created.

In the Metaclad v. Mexico case, the U.S. corporation received a permit from the Mexican government to build a hazardous landfill in Mexico. After the constructions began, the corporation received a notice that it was acting unlawfully without a municipal construction permit, which was denied after the corp. applied for it. In the meantime, an Ecological Decree was drafted and passed, proclaiming the area where the site was built as a protected natural zone. These actions by the host state were found to be in violation of the fair and equitable treatment, because the corporation legitimately expected to be granted a permit as previously assured by the government. The tribunal stated that:

“Metalclad was entitled to rely on the representations of federal officials and to believe that it was entitled to continue its construction of the landfill. In following the advice of these officials, and filing the municipal permit application
Metalclad was merely acting prudently and in the full expectation that the permit would be granted.”[14]

The Frontier Petroleum v. Czech Republic case was different. The claimant received two letters sent by the Czech Ministry of Industry and Trade, in which the Ministry implied that the state would have the possibility to enter into negotiations with the investor. The tribunal found this to be merely a “signal to Claimant that there was a possibility that the state could negotiate” and that the two letters “did not provide an adequate basis for the Claimant to rely on some form of representation or expectation.”[15]

State’s right to regulate and the right to a stable regulatory framework

Each state should be able to carry out its own legislative and executive power as a sovereign subject of international law. As stated by the tribunal in the previously mentioned Parkerings v. Lithuania case,

“It is each State’s undeniable right and privilege to exercise its sovereign legislative power. A State has the right to enact, modify or cancel a law at its own discretion. Save for the existence of an agreement, in the form of a stabilization clause or otherwise, there is nothing objectionable about the amendment brought to the regulatory framework existing at the time an investor made its investment.”[16]

“The “legitimate expectations” of the investor may be taken into account in the interpretation of the standard. However, this is possible only where clear, specific representations have been made by a Party to the agreement in order to convince the investor to make or maintain the investment and upon which the investor relied, and that were subsequently not respected by that Party. The intention is to make it clear that an investor cannot legitimately expect that the general regulatory and legal regime will not change.”[17]

The claims brought to tribunals concerning this kind of situation vary from case to case. Specifically, in some cases the dispute was settled in favour of the claimant, investor, and the state’s regulations thus repelled by this means, e.g. the LG&E v. Argentina case, where the “tribunal cited to the developing jurisprudence on the stability requirement as providing ‘an emerging standard of fair and equitable treatment in international law’. It found that, by violating or taking away the guarantees embodied in the relevant laws and regulations, Argentina ‘completely dismantled the very legal framework constructed to attract investors’”.[18] On the other hand, there have been situations, where the tribunal found a lack of reasonableness on the investor’s side which led to his claim being unjustifiable, for example in the already discussed Thunderbird v. Mexico case, where the tribunal, in my opinion rightly decided that “whatever standard is applied in the present case however–be it the broadest or the narrowest–the Tribunal does not find that the Oficio generated a legitimate expectation upon which EDM could reasonably rely in operating its machines in Mexico”.[19] Reasonableness is a key aspect of dealing with the right of regulation and the legitimate expectations of investors.

“The idea that legitimate expectations, and therefore FET, imply the stability of the legal and business framework, may not be correct if stated in an overly-broad and unqualified formulation. The FET might then mean the virtual freezing of the legal regulation of economic activities, in contrast with the State’s normal regulatory power and the evolutionary character of economic life. Except where specific promises or representations are made by the State to the investor, the latter may not rely on a bilateral investment treaty as a kind of insurance policy against the risk of any changes in the host State’s legal and economic framework. Such expectation would be neither legitimate nor reasonable.”[20]

Many other prospects have to be considered when determining whether a state is changing regulations necessarily due to important social, economic, environmental, demographic and other reasons or simply because they want to update their laws. Political characterization is also a viable justification of legal framework to change. Lithuania is one example, where the political structure, and together with it legal system, was transforming from previously soviet into democratic and more “western-European” model and where the tribunal bore this in mind and on the basis of this decided against the claimant. The investor should have been aware of the hardly unpredictable changes in law that might occur in the near future and considered the risk he was taking. The circumstances bestowed couldn’t have inclined a stable legal environment. Investing in the state anyway, the claimant chose to take a business risk and could have sought to protect his investment by including a stabilisation clause or other means into the investment agreement presented, hence securing his position with the unlikeliness of unwelcomed changes happening.[21]

Another illustration would be the Methanex v. USA. The claimant attempted to claim a breach of his legitimate expectations allegedly causing injuries when a ban of a usage of certain chemicals was imposed in California. The tribunal despite the claims declared the expectations as not being legitimate on the grounds that the investor entered a political environment where the use and impact of chemicals were monitored continuously by governmental environmental and health protection institutions at state and federal level and commonly prohibited or restricted for environmental or/and health reasons.[22]

It can surely be said that there are a number of reasons why a state may make amendments to legislature and to consider them when issuing an award, in contrast to blindly decide in favour of investors to protect their business from change.

Arbitration is a common and exceedingly used way to settle disputes between states and investors. Conclusion

The “legitimate expectations” doctrine functions as a protection of foreign investors against the host state to provide safe and secure place for investments. Even though it has no legal basis and isn’t usually explicitly mentioned in any treaties or agreements, it has become commonly known and accepted as part of the fair and equitable treatment standard. It can safeguard accords made by the parties so that the investors feel less at risk when deciding if to invest in a certain state or not. The host state is bound to uphold the deals made in an treaty or an agreement as well as make sure it doesn’t act in a way the other party couldn’t have foreseen and cause the investor damages or loss of profit due to such actions. The state needs to be careful when amending laws and regulations and not only those, which were guaranteed specifically in writing not to change. These securities were however, also in my opinion, considered in a very broad aspect in the past years which made it hard for number of states to carry out their legislative powers in the fashion they would wish to without being brought before an arbitral tribunal for the breach of legitimate expectations.

The tribunals frequently interpreted the doctrine in an extensive manner and decided in favour of the investors. This led to the question of what still is and what is no more reasonable, where to draw the line between legitimate and immoderate expectation and where the protection of foreign investors end and the state’s right to regulate its own legislature starts. It is important to determine if there were promises made by the host state before the investment initiated or after and the way. Contractual agreements sometimes evoke the breach of legitimate expectations but cannot be viewed as such casually without further investigation of the certain situation. Promises made by the state’s administrative system, the executive branch or any other officials have a similar outcome. The right to a stable regulatory framework is sometimes seen by the investor as the right of counting on the regulations not to change at all, especially when it would mean amendments not in their favour. The situation must however be assessed accordingly to the circumstances of each and every host state individually, including social, economic, environmental and demographic aspects, together with the overall development of the country. The investor’s own conduct also plays a role in the judgments of expectations being legitimate and reasonable or excessive. I believe it is the investor’s duty to analyse all the risk he is taking before investing in a foreign state and be prepared for sudden adjustments or revisions of the state’s legal framework, principally in developing countries, not to mention the responsibility of investors to be outright about what kind of business they are starting with all of the specifics in the open. Otherwise their expectations legitimate cannot be considered legitimate and protected under international law and the fair and equitable treatment standard as such. Nevertheless I am not stating that the state can amend any kind of law without taking into consideration the foreign investors active in its zone. It is the state’s obligation to stand by the promises they made, in which ever manner, to the greatest extent possible.

Due to the lack of legal or any kind of definition of the doctrine, it is up to the tribunals to decide about the legitimate expectations in each case by taking it all into account and thus balance the state’s right to regulate and the investors’ interests and prosperities.

[1] Article 31 of the Vienna Convention states that “A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.” United Nations, Vienna Convention on the Law of Treaties, 23 May 1969, United Nations, Treaty Series, vol. 1155, p. 331, available at: https://www.refworld.org/docid/3ae6b3a10.html [accessed 12 December 2018].

Arbitration is a common and exceedingly used way to settle disputes between states and investors. Notes

[2] LG&E Energy Corp., LG&E Capital Corp., and LG&E International, Inc. v. Argentine Republic, ICSID Case No. ARB/02/1, Award on 25 July 2007, para. 133.

[3] Response by a group of 120 academics, available at http://trade.ec.europa.eu/consultations-archive/isds/index.cfm?id=908631053251619314&type=2 [accessed 12 December 2018].

[4] Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award on 29 May, 2003.

[5] Potesta, M., Legitimate Expectations in Investment Treaty Law: Understanding the Roots and the Limits of a Controversial Concept, in ICSID Review (May 2013), p. 13.

[6] Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award on 29 May, 2003, para. 154.

[7] Nothing if Not Critical for Investment Treaty Arbitration: Occidental, Eureko and Methanex, Arbitration International Journal, Volume 22, p. 28.

[8] Zeinab, A. Investor’s legitimate expectations and the interests of the host state in foreign investment, Asian Economic and Financial Review, 2014, 4(12):1906-1918, p. 1909.

[9] Ibid.

[10] International Thunderbird Gaming Corporation v. Mexico, NAFTA/UNCITRAL, Award on 26 January 2006, paras. 147-148.

[11] Potesta, M., Legitimate Expectations in Investment Treaty Law: Understanding the Roots and the Limits of a Controversial Concept, in ICSID Review (May 2013), p. 17.

[12] Parkerings-Compagniet AS v. Lithuania, ICSID Case No. ARB/05/8, Award on 11 September

2007, para. 344.

[13] MTD Equity Sdn. Bhd. and MTD Chile S.A. v. Chile, ICSID Case. No. ARB/01/7, Award on 25 May 2004, para. 163, 166.

[14] Metalclad Corp. v. Mexico, ICSID Case No. ARB(AF)/97/1, Award on 30 August 2000, para. 89.

[15] Frontier Petroleum Services Ltd v. Czech Republic, UNCITRAL/PCA, Final Award on 12 November 2010, paras. 76, 455, 465.

[16] Parkerings-Companiet AS v. Lithuania, ICSID Case No. ARB/05/08, Award on September 11, 2007, para. 332.

[17] Public Consultation on Modalities for Investment Protection and ISDS in TTIP, document by the European Commission, 2014, available at http://trade.ec.europa.eu/doclib/docs/2014/march/tradoc_152280.pdf [accessed 12 December 2018].

[18] Potesta, M., Legitimate Expectations in Investment Treaty Law: Understanding the Roots and the Limits of a Controversial Concept, in ICSID Review (May 2013), p. 28-29. See LG&E Energy Corp et al. v. Argentina, ICSID Case No. ARB/02/1, Decision on Liability, 3 October 2006, para. 125.

[19] International Thunderbird Gaming Corporation v. Mexico, NAFTA/UNCITRAL, Award on 26 January 2006, paras. 147-148.

[20] EDF (Services) Limited v. Romania, ICSID Case No. ARB/05/13, Award on 8 October, 2009, para 217.

[21] Parkerings-Companiet AS v. Lithuania, ICSID Case No. ARB/05/08, Award on September 11, 2007, para. 335-336.

[22] Methanex Corporation v. USA, NAFTA/UNCITRAL, Final Award of the Tribunal on Jurisdiction and Merits, 3 August 2005, Part IV – Ch. D, para. 9.