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Chorzow's Standard Rejuvenated: Assessing Damages in Investment Treaty
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Chorzów’s Standard Rejuvenated
Assessing Damages in InvestmentTreaty Arbitrations
Chorzów’s Standard Rejuvenated
Manuel A. Abdala and Pablo T. Spiller*
Journal of International Arbitration
Michael
Moser
Dominique
HascherJournal of International ArbitrationVolume 25 Issue 12008
Whereas damages in treaty arbitration disputes are usually valued at the date when the measures trigger a
violation, Chorzów’s compensation standard provides the alternative to value as of the date of the award.The
latter is critical when investors continue to operate the business, such as in indirect expropriation as well as unjust
and inequitable treatment cases. Implementing Chorzów’s standard to indirect takings allows the use of ex-post
information to capture any elevated value due to improved business conditions. In addition, it deters states from
acting opportunistically, by not allowing them to profit from foreign investors when business conditions are
expected to improve.Arbitration panels should properly implement Chorzów’s standard with renovated thrust.
I. Overview
Bilateral InvestmentTreaties (BITs) typically have a compensation clause referring to
valuation of the affected investments. Such reference customarily advocates conducting a
fair market valuation at (or just prior to) the time of expropriation.When state measures
involve partial expropriation or unjust and inequitable treatment,1
however, valuing damages
at the time of the enactment of the first state measures ignores subsequent events that
may be relevant for damage valuation purposes,and thus would most likely result in inadequate
compensation.2
Reisman and Sloane (2003)3
detected this issue in the context of consequential and
creeping expropriation cases.The authors recommend decoupling the “date of expropriation”
from the “date of valuation” on a case-by-case basis.They also advocate that “as a
general principle, the moment of valuation should be the date on which assessing the fair
* Manuel A. Abdala is Director at LECG in Washington, D.C.; <mabdala@lecg.com>. Pablo T. Spiller is the
Jeffrey A. Jacobs Distinguished Professor of Business & Technology at the Walter A. Haas School of Business in University
of California, Berkeley, Research Associate, National Bureau of Economic Research, Cambridge, Man., and
Director at LECG in Emeryville, Cal.; <spiller@lecg.com>.We are grateful for useful comments from Craig Miles,
Michael Reisman and Richard Sloane. Maria Luisa Mitchelstein, economist at LECG, provided valuable research
support. Drs Abdala and Spiller have participated as expert witnesses in multiple international arbitration cases.The
opinions expressed here are exclusively their own.
1
Manuel A.Abdala & Pablo T. Spiller, DamageValuation of Indirect Expropriation in International Arbitration Cases,
14 Am. Rev. Int’l Arb. 449 (2003), define indirect expropriation from an economic perspective as:“Indirect expropriation
cases are those where, by means of administrative or legislative procedures, the State provokes a unilateral
change in contract conditions such that the investor is unable to recover the expected quasi rents of the business
under the original contractual framework.” In this article, the term partial expropriation is also applicable to other
types of measures, such as “creeping expropriation” and “consequential expropriation.” For a definition of these
terms, see, among others,W. M. Reisman and R.D. Sloane, Indirect Expropriation and itsValuation in the BIT Generation,
74 Br.Y.B. Int’l L. 115 (2003).
2
Abdala & Spiller, supra note 1, at 447–60.
3
See Reisman & Sloane, supra note 1, at 150.
104 journal of international arbitration
market value of a foreign investment for purposes of calculating compensation will enable
a tribunal to give full effect to Chorzów Factory’s imperative.”4
The thrust of this article is that Chorzów’s compensation standard, by allowing damages
to be computed as the greater of the fair market value at the time of the measures
and the fair market value at the date of the award (plus historical lost profits during the
interim period), is well suited for investment treaty violations involving indirect expropriation
and unjust and inequitable treatment. Although widely cited in arbitration
awards, the Chorzów standard is not always very well understood, nor is it commonly
implemented in practice.A proper implementation of Chorzów’s compensation standard
has many advantages for the analysis of this type of cases.
First, it explicitly uses ex post information (also referred to as hindsight information)
allowing us not only to calculate the residual value of the investment after the measures,
but also to capture any elevated value due to improved business conditions which investors
were deprived of due to the state measures. Secondly, it provides incentives for states
not to act opportunistically with measures against foreign investment when business conditions
are expected to improve, thus acting as a deterrent element.5
Finally, its use will
provide accurate and adequate damage estimates, given the use of ex post information that
unravels actual damages as time passes by,critical information that panels must not ignore.
This article is organized as follows. In part II we analyze the economic similarity
between expropriation and unjust treatment. In part III we briefly describe Chorzów’s
compensation standard. In part IV we discuss opposing views on the use of ex post information
in international arbitration cases and show how critical it is to take into account
ex post information in indirect expropriation and unjust and inequitable treatment cases,
and provide some illustrations. Finally, partV contains our concluding remarks on the relevance
of Chorzów’s standard and recommendations as to how to apply it to the most
common types of investment treaty disputes observed nowadays.
II. Expropriation and Unjust Treatment from an Economic Perspective
Economists see expropriation as the taking by the state of an asset or revenue stream
that originally belonged to a private entity. Unjust treatment, in turn, is seen as measures
4
Id.The authors also conclude that:“To calculate compensation for consequential and creeping expropriations
carried out within the legal universe of a BIT, tribunals can no longer be content to evaluate the fair market value of
an expropriated investment as of the date when an accretion of governmental acts and omissions has so dramatically
devalued that investment as to render it‘practically useless’or its value‘irretrievably lost.’Because these principles may,
in practice, threaten the stable and mutually beneficial normative framework for reciprocal foreign investment that
states design BITs to create and maintain, international tribunals seeking to award compensation for investments
expropriated consequentially or by a creeping series of measures ‘tantamount to’ expropriation may benefit from an
alternative principle.Above all,any standard adopted to determine the appropriate date from which to calculate compensation
should effectively deter, not reward, consequential and creeping expropriations. In this regard tribunals
seized with cases raising these issues may find it both useful and appropriate to disaggregate the moment of expropriation
and the moment of valuation—to distinguish the ‘moment of expropriation’, which goes to the question of
liability (i.e. whether an accretion of measures has ripened into a compensable expropriation), from the ‘moment of
valuation’, which goes to the question of damages.”
5
Id. at 148:“BITs and comparable multilateral investment treaties should, as a matter of both the intent of their
drafters and the policies that animate them, be construed to deter, not reward, unlawful expropriations of all kinds.”
CHORZÓW’S standard rejuvenated 105
or omissions by a state which deprive an investor of a revenue stream or impose additional
costs to the exploitation of an investor’s assets. Whereas outright expropriation
involves the physical taking by the state of a particular asset or revenue stream, indirect
expropriation, on the other hand, is subtler and translates into the reduction of expected
returns to investors without the state taking over ownership or control of the asset.
Unjust treatment, from an economic perspective, has the same economic and financial
consequences for the affected investment as an indirect expropriation situation.
By reducing, or siphoning away, cash flows via administrative or other measures,
unjust treatment and indirect expropriation measures deprive the investor not only of the
enjoyment of its business according to its intrinsic potential—absent the state measures—
but also from selling it at any point in time at or after the date of the measures, at a value
consistent with such potential.The new beneficiary of the revenue stream may be the
state, as would be the case with non-payment of services, or third parties, like consumers,
as would be the case with the manipulation of utility tariffs. In the latter case, the state
still benefits as it may achieve a particular political objective—low natural gas and gasoline
prices, for example, albeit at the expense of energy producers.
Unjust treatment and indirect expropriation are probably the most common
type of claims observed in investment treaty disputes in the last decade.6
Indeed, it is
unjust treatment or indirect expropriation that the economic theory of privatization and
regulation perceives as the main risk faced by investors in sectors such as energy,water and
sanitation, telecommunications, toll roads, ports, airports and construction contracts in
general.7
Although Chorzów is a case of outright expropriation, its compensation standard, as
we will see below,has important applications to cases of indirect expropriation and unjust
treatment.
III. Logic of CHORZÓW’s Two-Scheme Compensation Standard
The most cited Chorzów’s compensation principle is the sentence that reads:
6
Until April 1998, only 14 international arbitration cases had been brought before ICSID involving BITs.
However, since the late 1990s, the number of cases has increased to at least 219 by November 2005, with 132
brought before ICSID (including ICSID’s Additional Facility) and 87 before other arbitration forums. See UNCTAD,
Investor State Disputes Arising from Investment Treaties: A Review, in UNCTAD Series on International Investment
Policies for Development 4–5 (2005). See also UNCTAD,World Investment Report 71 (2005).
7
See Paul L. Joskow & Roger C. Noll, Regulation in Theory and Practice: An Overview, in Studies in Public
Regulation (Gary Fromm ed., 1981);Anthony W. Dnes, Franchising, Natural Monopoly and Privatization, in Regulators
and the Market: An Assesment of the Growth of Regulation in the UK (CentoVeljanovski ed., 1991);
Keith J. Crocker & Scott E. Masten, Regulation and Administered Contracts Revisited: Lessons from Transaction-Cost Economics
for Public Utility Regulation, 9 J. Regulatory Economics 5 (1996); Pablo T. Spiller, Regulatory Commitment and
Utilities’ Privatization: Implications for Future Comparative Research, in The Research Agenda in Political Economy
( J. Banks & E. Hanusheck eds., 1993); Pablo T. Spiller & William Savedoff, Commitment and Governance in Infrastructure,
in Can Privatization Deliver? Infrastructure for Latin America (F. Basañes, E. Uribe & R. Willig eds.,
1999); Brian Levy & Pablo T. Spiller, Regulations, Institutions, and Commitment: Comparative Studies in
Telecommunications (1996).
106 journal of international arbitration
reparation must, as far as possible, wipe out all the consequences of the illegal act and re-establish
the situation which would, in all probability, have existed if that act had not been committed.8
Translated into monetary compensation, in lieu of restitution, this principle has
been related to compensation equivalent to the fair market value of the expropriated
investment.
Chorzów also stipulates that:
Restitution in kind, or, if this is not possible, payment of a sum corresponding to the value which
a restitution in kind would bear; the award, if need be, of damages for loss sustained which would
not be covered by restitution in kind or payment in place of it.9
And as it relates to the computation of damages, that they are “not necessarily limited to
the value of the undertaking at the moment of dispossession.”10
Thus, by its emphasis on wiping out all the consequences of the acts of dispossession,
Chorzów is attempting to restore the damaged party to the situation it would be in today (that
is, at the time of computing damages) had the relevant measures not been implemented.
Chorzów’s compensation standard seems to have been misinterpreted due to some
confusion concerning the concepts of damnus emergens, the value of the expropriated
investment, and lucrum cessans or lost profits. In particular, it has been argued that there
could be double counting if the value of the expropriated investment already includes the
future lost profits that such investment can generate; and it is argued, when making a distinction
between lawful vs. unlawful expropriation, that there is a punitive element in
Chorzów’s damage decision. Neither argument is correct.As it relates to double counting,
since the lost profits concept developed in Chorzów is applicable only when valuing the
enterprise as of the time of the award, the lost profits apply to a past, interim period, and
have no overlap with expected future profits that determine the value of the expropriated
investment.Thus, there is no double counting in its recommendation.
As it relates to the distinction between lawful and unlawful expropriation, we have
analyzed Chorzów’s compensation standard from a damage expert point of view, and,
as will become clear below, have found no punitive element.11
Chorzów’s compensation
criterion does not add any punitive element to the two alternative valuation exercises
posed to their experts. Rather, the optional element addressed two possible criteria to
determine full restoration by comparing the (actualized) value of the asset at the time of
expropriation with the current value of the asset, had it not been expropriated, plus any
lost profits for the interim period since the expropriation date to the date of current
8
See Factory at Chorzów (Claim for Indemnity) (Germany v. Pol.), Judgment on the Merits, 1928, P.C.I.J.
(ser.A) No. 17, at 47 (September 13).
9
Id.
10
Id.
11
Although we have seen contracts in which the term “lucrum cessans” is used or construed as a punitive element,
and thus resulting in total compensation value that may exceed fair market value, this is certainly not the case
in Chorzów’s decision, as lucrum cessans refers to the interim period between the date of expropriation and the date of
the award.Thus, there is neither double counting nor any punitive element in Chorzów’s decision.
CHORZÓW’S standard rejuvenated 107
valuation. Indeed, as Reisman and Sloate (2003) correctly note,12
the loss in value of the
investment is the same regardless of the legality of the act.Thus, in what follows, we discard
any interpretation that presupposes a distinction, from an economic perspective,
between lawful and unlawful expropriation.
A. CHORZÓW’s three basic questions
Below, we provide our interpretation, from a damage expert’s point of view, following
strictly the fundamental questions posed by the Chorzów Panel to their experts.
In Chorzów the experts were asked to answer three basic questions. Question IA
asked the experts to compute the fair market value of the factory at the time of expropriation,
updated to the time of indemnification (i.e., the date of the award).13
Observe
that the tribunal’s instruction is to update the valuation from the date of expropriation to
the date of the award based on the actualized value “in Reichsmarks current at the
present time.”14
Question IB asked the experts to value the lucrum cessans for the interim period
between the date of expropriation and the date of indemnification.15
Observe, however,
that compensation for lucrum cessans would not apply if the standard of valuation is the fair
market value as of the date of expropriation. In this case, the fair market value of the
affected assets would already include all future lost profits, from the date of expropriation
to the end of the project, not just to the date of the award. On the other hand, if the
standard of valuation is fair market value as of the date of the award, then lucrum cessans
for the interim period between the date of expropriation and the award ought to be added
to the compensation, as otherwise the investor would not be properly compensated.
Finally, Question II asked the experts to compute the fair market value of the factory
as of the date of indemnification (or date of the award).16
Question II, then, leaves aside
the situation as of the time of expropriation, and instead focuses on a valuation of the
assets as of the time of the expert assessment in the absence of the measures.Observe,that
12
See Reisman & Sloane, supra note 1, at 136.
13
See Chorzów, supra note 8, at 51. Question IA is as follows:“What was the value, on July 3rd, 1922, expressed
in Reichsmarks current at the present time, of the undertaking for the manufacture of nitrate products of which the
factory was situated at Chorzów in Polish Upper Silesia, in the state in which that undertaking (including the lands,
buildings, equipment, stocks and processes at its disposal, supply and delivery contracts, goodwill and future prospects)
was, on the date indicated, in the hands of the Bayerische and Oberschlesische Stickstoffwerke?”
14
This instruction seems to suggest updating the valuation by the loss in value of the currency, i.e., the inflation
rate,rather than by time value of money.In high interest rate environments,this particular instruction would discriminate
against granting damages based on the valuation as of the date of expropriation.
15
See Chorzów, supra note 8, at 51. Question IB is as follows: “What would have been the financial results,
expressed in Reichsmarks current at the present time (profits or losses), which would probably have been given by
the undertaking thus constituted from July 3rd, 1922, to the date of the present judgment, if it had been in the hands
of the said Companies?”
16
Id., at 51–52. Question II is as follows: “What would be the value at the date of the present judgment,
expressed in Reichsmarks current at the present time, of the same undertaking (Chorzów) if that undertaking
(including lands, buildings, equipment, stocks, available processes, supply and delivery contracts, goodwill and future
prospects) had remained in the hands of the Bayerische and Oberschlesische Stickstoffwerke,and had either remained
substantially as it was in 1922 or had been developed proportionately on lines similar to those applied in the case of
other undertakings of the same kind, controlled by the Bayerische, for instance, the undertaking of which the factory
is situated at Piesteritz?”
108 journal of international arbitration
Question II allows for the reasonable development of the undertaking,not just maintaining
the assets as they were as of the time of expropriation, but also including a reasonable
investment program.17
It is straightforward then to interpret Chorzów as determining that damages ought to
be computed as the highest value between the answer to IA and the resulting sum of the
answers to questions II and IB.18
In Chorzów,then,it is clear that wiping out all the effects of
the measures through monetary compensation can be achieved by two alternative means:19
(i) granting the fair market value as of the date of the expropriation brought forward
and expressed in current currency.
(ii) granting the sum of the fair market value as of the date of the award, plus the
profits that the investor would have probably obtained in the interim period,
between the date of expropriation and the date of the award brought forward
and expressed in current currency.
Chorzów’s standard, then, has a powerful economic logic. It is equivalent to transferring
to the expropriating state the ex post risks (up to the time of the award) associated
with the expropriated asset. In other words, if the asset would have increased in value in
the absence of the measures, the state ought not to benefit from its expropriating actions,
and thus, the windfall ought to belong to the investor. On the other hand, if the asset
would have lost value in the absence of the expropriation, the state ought not to benefit
by paying a lower compensation, and thus, it should absorb the loss in value.The compensation,
in this case, ought to be valued as of the date of expropriation.
Chorzów’s compensation principle has important efficiency implications, which we
elaborate below. First, it reconciles the use of ex post information in computing damages
in international arbitration cases. Secondly, it puts states on notice that treaty violations
will not grant them economic windfalls. Finally, we show below that for the most common
type of treaty violations (i.e., cases of indirect expropriation and unjust treatment),
the main contribution of Chorzów is its emphasis on the use of ex post information.
17
Id., at 53:“if the normal development presupposed by question II represented an enlargement of the undertaking
and an investment of fresh capital, the amount of such sums must be deducted from the value sought for.”
18
Id., at 70–71. Lord Finlay’s dissenting opinion in Chorzów raised some interesting issues. Lord Finlay said that
if the damaged party chose monetary compensation rather than restitutio in integrum, then monetary compensation
should be based on the value of the undertaking at the time of expropriation. Indeed, he stated:“A Party who has
given up his right to restitutio in integrum is not entitled to claim damages on the footing that it is right that he
should have the enhanced value, if any: that he would have got if he had pressed his claim for restitution.”The fact
that a party prefers monetary compensation to physical restitution may have nothing to do with the basic principles of
Chorzów’s damage assessment methodology but rather with the fact that restitution may imply taking over a degraded
facility. Indeed, absent this element, the fair market value should represent the true value of the (fully-functional)
factory, and thus the damaged party should be indifferent between restitution in kind and monetary compensation.
Notice that Lord Finlay’s other methodological concerns are standard staple in damage assessment. In particular, Lord
Finlay’s concerns about asset obsolescence, intangibles, creation of new business developments, and uncertainties
about future cash flows can be fully controlled for by modeling a“but-for”scenario in a discounted cash flow exercise,
using all available ex post information.
19
A recent application of Chorzów’s two-scheme standard can be found in ADC Affiliate & ADC & ADMC
Management v. Republic of Hungary, ICSID Case ARB/03/16, decided on October 2, 2006, by the Hon. Charles
Brower, Prof.Albert Jan van der Berg, and Neil Kaplan CBE QC (President).
CHORZÓW’S standard rejuvenated 109
IV. Use of EX POST Information in International Arbitration Cases
Contrary to common practice in general damage valuation cases,20
several authors
advocate the exclusion of ex post information when assessing damages in international
arbitration cases. Lieblich (1991)21
argues, for example, that under customary international
law, at least in cases of lawful takings, the value of the expropriated property should
be measured in light of the facts and circumstances known to exist as of the date of the
taking (i.e., no use of ex post information or post-expropriation events). Similarly,
Comeaux and Kinsella (1997)22
also recommend the exclusion of ex post information, by
citing the INA v. Iran panel stating that:
Fair market value may be stated as the amount which a willing buyer would have paid a willing
seller for the shares of a going concern, disregarding any diminution of value due to the nationalization
itself or the anticipation thereof, and excluding consideration of events thereafter that
might have increased or decreased the value of the shares.23
When it comes to damage valuation, however, BITs normally refer to the concept
of fair market value of the affected investment “just prior to” or “at the moment of”
expropriation.24
This concept has meant that in practice expropriation damages25
may be
computed by looking at the fair market value at the date on which the assets were taken
away from the investor,using solely the information and expectations as of such date,thus
potentially excluding or limiting the use of ex post information in determining damages.
The underlying logic for excluding ex post information is simple. Had the investor
been able to sell the asset just prior to the measures (rather than being subject to them) it
would have received the asset’s market value at the time of the measures.Adequate compensation,
then, ought to be based on the value of the investment at the time of the
measures, plus interest to the date of compensation.Thus, it is claimed that any upside or
downside in value that takes place after the asset has been subjected to the measures
20
The use of ex post information in computing damages is generally accepted in U.S. courts.This is usually
referred to as using the “book of wisdom.” See Michael K. Dunbar & Michael J.Wagner, Differences Between Economic
Damage Analysis and BusinessValuation, inThe Handbook of BusinessValuation and Intellectual Property Analysis
331 (Robert F. Reilly & Robert P. Schweihs eds., 2004).
21
See William C. Lieblich, Determining the EconomicValue of Expropriated Income-Producing Property in International
Arbitration, 8 J. Int’l Arb. 59, 72 (1991):“In valuing an expropriated business, however, the valuation date should be
the date on which the expropriation took place,which conforms to the customary international law rule that,at least
in cases of lawful takings, the value of the expropriated property should be measured in the light of the facts and circumstances
known to exist as of the date of the taking.”
22
See Paul E. Comeaux & Stephan N. Kinsella, Protecting Foreign Investment Under International
Law: Legal Aspects of Political Risk 89 (1997).
23
INA Corp. v. Government of the Islamic Republic of Iran,Award No. 184-161-1,August 13, 1985, 8 Iran–
U.S. Cl.Tnb. Rep. 373 (1985).
24
See, e.g., United States–Republic of Turkey BIT, art. III:“Compensation shall be equivalent to the fair market
value of the expropriated investment immediately before the expropriatory action was taken or became known.”
See also United States–Jamaica BIT, art. III; United Kingdom–Albania BIT, art. 5; and France–Chile BIT, art.V. See
also 2004 United States Model BIT, art. 6.
25
Expropriation damages can be defined as damages arising from wealth deprivation of a particular asset. See
Burns H.Weston, ConstructiveTakings under International Law:A Modest Foray into the Problem of Creeping Expropriation,
16Va. J. Int’l L. 103, 112 (1975).
110 journal of international arbitration
should not be accounted for, since compensation will make the investor indifferent
between selling just prior to the measures or being subject to them.26
Notice that this exclusion is contrary to damage valuation theory, which resorting
to different approaches,27
accepts the possibility of using events that take place after the
date at which the asset has been damaged as a valid method to compute damages.28
It is
also contrary to Chorzów’s standard, because in between the time of the enactment of the
measures and the resolution of the case exogenous events may have happened that would
have changed the value of the affected assets in the absence of the measures. Such exogenous
events could relate to changes in demand, interest rates, input or output prices.
These changes could have a large impact on what would have been the value of the assets
in the absence of the measures.
In practice, however, the use of ex post information in computing damages has been
accepted in some international arbitration cases. In AMCO Asia Corp. v. Indonesia, for
example, the arbitral award was issued ten years after the expropriation had taken place
(the investor’s license was revoked in 1980 and the arbitral award was issued in 1990). In
the award, the panel states that available ex post information for the period 1980–89 is to
be used for the quantification of damages.29
Most recently, in CMS v.Argentina, the panel
considered ex post information to determine the residual value of the CMS investment
that had been treated unjustly.30
The simple logic of excluding ex post information fails to consider several basic factors,
in particular:
(a) the difficulty in assessing the starting date at which the measures caused relevant
loss in investment value;
(b) the difficulty in assessing expectations of value at the time of the measures;
(c) the ongoing control and ownership by the investor, in cases of indirect expropriation
and unjust and inequitable treatment cases, which requires the assessment of
the asset’s residual value post-measures; and
(d) the fact that states may expropriate or treat investments unjustly (i.e., taxing
them heavily) precisely when business conditions are expected to improve or
have already improved.
26
Observe that in the case of lawful expropriation, the government has the prerogative to do so provided it
grants adequate compensation.
27
There are three categories of damage approaches: (1) the “before and after” approach; (2) the economic
modeling approach, also known as “but-for vs. actual”, and (3) the yardstick approach. See Dunbar and Wagner, supra
note 20, at 334. See also Shannon P. Pratt, Robert F. Reilly & Robert P. Schweihs,Valuing a Business: The
Analysis and Appraisal of Closely Held Companies 869 (2000).
28
In the “before and after” approach, damages are computed as the difference between the value of the asset
before it was damaged and the value of the asset after the damage was done. See Dunbar & Wagner, supra note 20, at
334.
29
See AMCO Asia Corp. et al. v. Republic of Indonesia, ICSID Case ARB/81/1, Award, June 5, 1990, para.
105:“But as to valuation techniques, for 1980–1989 theTribunal will not use the perspective of what the reasonable
businessman in 1980 could foresee, because for this period it can use known data for relevant factors, including the
year-by-year inflation rate, as provided to the Tribunal by the World Bank, from Laporangan Minggu, Bank Indonesia,
as well as actual exchange and taxation rates.”
30
See CMS Gas Co. v.Argentina, ICSID Case ARB/01/8,Award, May 12, 2005.
CHORZÓW’S standard rejuvenated 111
In indirect expropriation and unjust treatment cases, however, it is often highly difficult
for a panel to assess the precise measure (and its corresponding date) that triggered
relevant loss in value. It is equally difficult to determine the expectations of the relevant
players concerning the evolution of key variables at the time(s) the investment was
affected.31
This, however, does not mean that buyers and sellers did not have well defined
expectations.When substantial time has passed since the enactment of the measures, it
becomes highly speculative for experts, and thus for panel members, to assess what these
well defined expectations were, apart from what actual ex post information has already
revealed. In those cases, using ex post information on the evolution of these key variables
may turn out to be the most reasonable assumption about the parties’ ex ante informa-
tion.32
The passage of time permits a direct insight and a more accurate representation as
to the extent of the harm, and thus of the quantum of the damage.
When the investor retains ownership over the assets at stake, as in indirect expropriation
and unfair treatment cases, there is an additional rationale for using ex post information
in computing damages. Indeed, in this type of cases there is always the need to assess
and compute the residual value, if any, of the investment—that is, the value of the investment
post-measures. Differing from the pre-measures value, often the residual value is
readily observable from economic and accounting information. Both experts and panels
are unlikely to discard observable information concerning fundamental variables, such as
macro-economics, exchange rates, production, product and input prices, input usage,
and so on, that is critical to determine the residual value of the investment.33
Panels will
be hard pressed to ignore ex post information in these cases; as such ex post evidence provides
clear grounds as to the determination of the quantum of the damage.34
BITs, as well as case law, have failed to address, explicitly or implicitly, how
damage methods must be accommodated to take into account the inherent fact that
the business continues to operate and thus there is a, potentially positive, residual
value to the investment.35
The use of ex post information is also important to prevent opportunistic takings by
states. Consider, for example, several policy decisions taken in energy-rich countries after
the surge of crude oil prices since the 2003 Iraq war. In Venezuela,Algeria and Bolivia,
governments imposed hefty taxes during 2003–06 and asked for contractual adaptation
31
Most often there are no well functioning derivative markets where expectations on the future evolution of
important variables can be ascertained.
32
Economists call this the “perfect foresight” assumption. See Ben J. Heijdra & Rick van der Ploeg, Foundations
of Modern Macroeconomics 8–9 (2002).
33
The residual value of the investment can also be affected by additional measures and mitigating actions by the
state, if any.
34
The consequences of excluding ex post information in these cases would be equivalent to the inaccuracies
that would result from determining property damages caused by a tropical storm using the weather forecast predicted
prior to the storm, as opposed to using the facts on how the storm actually hit the property.
35
See, e.g., United States–Turkey BIT, art. III; United States–Jamaica BIT, art. III; United Kingdom–Albania
BIT, art.V; and France–Chile BIT, art.V. See also 2004 United States Model BIT, art. 6. See also Abdala & Spiller,
supra note 1, and CMS v.Argentina, supra note 30, para. 409.
112 journal of international arbitration
of all existing crude oil and natural gas concession contracts.36
In Argentina, for the same
opportunistic reasons, export withholding taxes on crude oil prices were raised, despite
prior commitments to the contrary.37
In Jamaica, the same opportunistic taxation policy
was observed in the bauxite industry in the 1970s.38
By using ex post information, damage experts and panels can measure the extent of
the economic windfall taken by states that have acted opportunistically and imposed
measures on investments whose business conditions turned out to be better than
expected, or just perceived as being too profitable.
In sum, the use of ex post information in computing damages in international arbitration
cases is, then, not only appropriate but also unavoidable in cases of indirect expropriation
and unjust and inequitable treatment. Its use must be symmetrical and consistent
across the pre-measures and post-measures valuations. Furthermore, if Chorzów’s compensation
standards were to be properly implemented when assessing damages, rather
than just recited, the use of ex post information would likely become the norm for damages
calculation in these cases.We explore this proposition as well as its caveats with more
detail in the following sections.
A. Critical role of EX POST information in indirect expropriation
and unjust treatment
BITs do not contain explicit language as to how to measure compensation in indirect
expropriation or unjust and inequitable treatment cases. It is only recently that panels
have mentioned what the standard for damages should be. In both CMS v.Argentina and
36
In Venezuela, the state not only imposed heavy retroactive and future taxes, but also forced a conversion of
the crude oil operating companies into mixed companies, with required state-majority ownership. See Venezuela
Approves Increase of Oil Taxes to 50%, El Cronista Comercial,August 30, 2006.A similar policy was later followed
in Bolivia, where the state declared invalid the contracts under which the foreign companies had invested in the
hydrocarbons sector after the 1996 privatization and forced them to sign new contracts with a 51 percent participation
of the Bolivian state-owned companyYPFB. See Hydrocarbons Law 3058/2005, of May 2005, Decree 28.701
and The 44 Oil Contracts were Ratified by Parliament, Diario El Mundo, December 4, 2006. Recently, in Algeria, the
Parliament, among other measures, has agreed to levy a windfall tax on the profits of oil companies, that is, to tax
“excess” profits when oil prices average more than U.S.$30; this is yet to be implemented as a law as of the time of
writing. See Algeria Agrees OilWindfallTax, BBC News, October 15, 2006.
37
When Argentina carried out the liberalization and privatization process of hydrocarbons in the early 1990s,
it made a commitment not to impose any fees, duties, rights or withholdings on exports. See Decree 1589/1989, art.
3. In early 2002, however, Law 25,561 authorized the government to impose export withholdings on hydrocarbons.
Argentina initially set the withholding tax for crude oil exports at 20 percent. See Decree 310/2002 of March 1,
2002, art. 1.The withholding tax rate was subsequently increased up to 45 percent on August 4, 2004. See Ministry
of Economics Resolution 532/2004.
38
Bauxite mining began in Jamaica in 1952. By 1957, Jamaica was the largest bauxite producer in the world,
accounting for 23 percent of world output. In 1974, following dramatic oil price rises, the government increased
bauxite taxes by a Production Levy.The levy, in effect, indexed the price of bauxite to the price at which the aluminum
companies sold aluminum ingots. See Ian Boyne, Jamaica Bauxite Institute Playing Critical Role, Jamaica Information
Service (2006). This levy led to the presentation of a claim at the International Center for Investment
Disputes (ICSID) by the U.S. companies dedicated to bauxite production in Jamaica. See Alcoa Minerals of Jamaica,
Inc. v. Jamaica (Case ARB/74/2), Kaiser Bauxite Co. v. Jamaica (Case ARB/74/3), and Reynolds Jamaica Mines Ltd
& Reynolds Metals Co. v. Jamaica (Case ARB/74/4).
CHORZÓW’S standard rejuvenated 113
Azurix v. Argentina, different panels established that for damage valuation purposes, the
unjust treatment compensation should be rooted in the fair market value principle.39
Unlike outright expropriation, the fair market value principle must be applied to
both the value of the investment in the absence of the measures and its post-measures
value, or what we call residual investment value.We next turn to the importance of ex
post information in determining this residual value.
1. Ex Post Information and Assessing the Residual InvestmentValue
Since typically BIT arbitrations last several years from the initial date of the measures
to the date of the award,the post-measures observable information will be substantial and
may reflect several sources of changes in company or asset value that can be categorized
and summarized into the following four main factors:
(i) subsequent measures by state affecting value;
(ii) damage mitigation actions by the investor;
(iii) actions within the control of the investor that are unrelated to the measures and
that result in an ex post reduction or increase in the value of the investment;
(iv) exogenous economic factors (i.e., change in business conditions) that are both
outside the control of the investor and unrelated to actions (or inactions) by the
state.
Experts, and panels, then, as a practical matter have to determine what part to use
of all the observable information about the performance of the company from the
moment it was affected by the measures until the valuation exercise date.
Subsequent measures by the state must be considered in assessing residual valuation,
as otherwise we would be valuing the residual value above its true fair market value.Thus,
a valuation as of the date of expropriation cannot be implemented without considering
future, ex post information.
Similarly, mitigating actions taken by the investor ought to be considered, as otherwise
the residual value would be underestimated.40
Such actions may involve cost or
investment reductions that have first order impact on valuation. Neither factor, though,
39
See CMS v.Argentina, supra note 30, para. 410;Azurix Corp. v.Argentina, ICSID Case ARB/01/12,Award,
July 14, 2006, para. 420.
40
See Felix Prandl, Measure of Damages in International Commercial Arbitration, 23 Stanford J. Int’l L. 263, 297
(1987):“National laws and international conventions generally provide that a party may not recover damages that it
can reasonably avoid.” See also Thomas W.Wälde & Borzu Sabahi, Compensation, Damages and Valuation in
International Investment Law 28 (International Law Association, Committee on International Law of Foreign
Investment, 2004):“On the other hand, under the principles of contributory negligence and damage mitigation
tribunals have felt entitled to substantially reduce compensation if they considered that the investor contributed
substantially to risk or damage and did not apply professional due diligence.” International arbitration panels have, in
fact, recognized the claimant’s duty to mitigate damages. See Middle East Cement Shipping v. Arab Republic of
Egypt, ICSID Case ARB/99/6, Award, April 12, 2002, para. 167: “The duty to mitigate damages is not expressly
mentioned in the BIT. However, this duty can be considered to be part of the General Principles of Law which, in
turn, are part of the rules of international law which are applicable in this dispute according to Art. 42 of the ICSID
Convention.”
114 journal of international arbitration
ought to be used to compute pre-measures valuations. Obviously, subsequent measures
should not affect the value prior to the initial measures, and similarly, damage mitigation
actions should not affect the pre-measures value, as these actions would not have been
taken in the absence of the initial state measures. Damages, then, will be overstated if mitigation
events are ignored and will be underestimated if subsequent measures by the state
are not factored in the computation of the residual value of investment.
On the other hand, actions under the control of the investor that are unrelated to
the measures and that may impact on the valuation should be considered symmetrically in
both the pre-measures and post-measures valuations (i.e.,included or excluded from both
valuations).Thus, states must neither be responsible (i.e., compensate) for reductions41
nor
benefit (i.e., reduce compensation) from increases in value42
related to the own decisions
of the investor that are unrelated to state measures.43
Finally, the role of exogenous economic factors (i.e., change in business conditions)
that are both outside the control of the investor and unrelated to actions (or inactions) by
the state is the most controversial and least understood factor.44
Should changes in business
conditions since the date of the initial measures be taken into consideration? If business
conditions have improved, should this higher than anticipated residual value be considered?
If not considered, would this not allow the state to get away with lower damages? On the
other hand, if business conditions worsened, and are taken into account, is it not the case
that a lower residual value of the investment ends up in compensation for events related
to business risk rather than state actions? In addition, should these changed business conditions
also be used to compute pre-measures valuations?We deal with these questions in
the next section, and we also relate it to Chorzów’s compensation standard.
a. Case for considering improved business conditions
Consider, as an example, a claim of indirect expropriation or unjust treatment
involving a crude oil field, say circa 2004. Assume that the state, having promised the
investor a tax holiday, slaps a 50 percent production tax on oil revenues. The oil field
remains under the control and ownership of the investor, but the investor now cannot
enjoy the full potential of the crude oil field as it originally expected. Assume, further,
that at the time of the measure, crude oil prices were at U.S.$35/barrel. However, right
after the imposition of the production tax, crude oil prices doubled to U.S.$70/barrel.
The investor post-measures sells oil at U.S.$70/barrel, pays U.S.$35 per barrel produced
41
The most common example is when the loss in investment value is due to misjudgments by the foreign
investor. See Reisman & Sloane, supra note 1, at 130.
42
Such could be the case if the investor develops an unrelated line of business that increases the post-measures
value of the business.As long as this line of business would have been profitable in the absence of the measures, it is
reasonable to assume that it would be undertaken also, and thus, should not be counted to mitigate damages.
43
In some cases it may be difficult to determine to what extent a decision by the investor that affects the value
of its investment may or may not be related to the state measures.
44
Reisman & Sloane, supra note 1, at 130, argue that exogenous economic factors unrelated to state measures
prompt no rights of compensation to the foreign investor, following the decision in Oscar Chinn (Belg. v. U.K.),
1934 P.C.I.J. (Ser.A/B) No. 63 (December 12).
CHORZÓW’S standard rejuvenated 115
in taxes, and receives net of tax U.S.$35/barrel, exactly the same per barrel price as prior
to the imposition of the tax.
The question, then, is the following: in computing either unjust treatment or indirect
expropriation damages, should damages be based on a price per barrel of U.S.$35,
U.S.$70, or some other combination of both?
As we discuss next, the answer to this question is that whichever price is used, it
ought to be used symmetrically in assessing both the pre- and post-measures value of the
asset.
b. Asymmetric treatment of ex post information generates absurd results
The “before vs. after” approach, in its simplest form, consists of using pre-measures
information to compute the value prior to the initial measures and using post-measures
information to compute the value after. Damages, then, would be the difference between
the two valuations. If such an approach is used for the crude oil example provided above,
the investor has no claim, as after the measures its net tax crude oil revenues are U.S.$35/
barrel, exactly the same as prior to the measures.The state, however, is able to freely violate
an explicit tax holiday commitment.
This result is not only unjust, as the investor is being denied, on an ongoing basis,
50 percent of the price of his now improved crude oil business, but would also be
inefficient from an economic perspective, as it would increase the cost of capital of subsequent
investments due to the higher risk of expropriation, thus contributing negatively
to higher social costs to the economy.45
The problem with this linear understanding of the “before vs. after” approach is
that it includes ex post information about changes in business conditions solely in the
“after” valuation. In other words, the approach uses ex post information on new business
conditions (that are certainly not triggered or controlled by the damaging party) in an
asymmetric fashion, affecting only one side of the damage equation—the “after” value.
This will result systematically in over- or under-compensation; that is, either attributing
damages for actions for which the state is not responsible (if business conditions worsened
independently of the measures) or, alternatively, depriving the investor of the adequate
compensation he is entitled to when business conditions improve.46
45
The state, however, is unjustly enriching itself. It now collects 50 percent of the new crude oil price, while
it does not have to compensate the investor. Should the state be allowed to keep this extra value that the investor
would have necessarily generated for itself in the absence of the measures? Furthermore, there are many cases of subsequent
measures in which the state amplifies the effects on investments precisely because business conditions turn
out to be better than they were when the first measures were taken. Under this perspective, the state eludes compensation
payments.
46
The potential for error is biased towards under-compensation. Indeed, since panels would be reluctant to
award higher damages simply because business conditions worsened, the asymmetric approach to damage computation
actually may foster expropriatory or opportunistic behavior by states, with the consequent negative implications
for foreign direct investment.
116 journal of international arbitration
Thus, to avoid this flaw of a simplistic interpretation of the “before vs. after”
approach, and thus to avoid over- or under-compensation, changed business conditions
ought to be considered symmetrically, in both the pre- and post-measures valuations.47
c. Symmetric treatment of ex post information
In the “but-for vs. actual” approach, changes in business conditions since the initial
date of measures are to be accounted for in both scenarios, and thus, damages (computed
as the difference between “but-for” and “actual”) will reflect differences attributable to
the measures only.
Let us return to the crude oil example of the introduction. Recall that pre-measures
crude oil prices were at U.S.$35/barrel.With a 50 percent tax on crude oil revenues, and
assuming that crude oil prices would have stayed the same at U.S.$ 35 per barrel, and that
the crude oil field was expected to be operated the same way with the tax or without it,
damages should be equivalent to U.S.$17.5 per barrel assuming that no damage mitigation
actions exist either from the state or the investor itself.
Consider now the doubling of crude oil prices mentioned in the example. The
increase in crude oil prices makes the residual value of the company, after the imposition
of the production tax, exactly equal to its pre-measures value. How should this ex post
change be taken into account?
As discussed, applying the ex post information asymmetrically generates an absurd
result (no compensation in this case). The issue is, then, how do damage results vary
between applying, symmetrically, the changed business conditions and not applying them
at all? Returning to the crude oil example, we have two possibilities: using the premeasures
prices in both the “but-for” and “actual” scenarios, which would result in
damages of U.S.$17.5 per barrel, or using the post-measures prices, which would result
in damages of U.S.$35 per barrel.
2. Damages Ignoring Ex Post Information
Using the pre-measures oil prices has some credibility in this case, as crude oil, being
a widely traded commodity, has well developed forward markets, which, as of the date
prior to the measures would have forecasted future prices at around U.S.$35 per barrel.
Thus, we can compute both scenarios with some reliable estimates of what the parties
expected would be crude oil free market prices.
Observe, however, that if the investor wanted to sell its oil field post-measures, it
would get a value commensurate with an after-tax price of U.S.$35 per barrel.Thus,adding
47
For support of the use of information in a symmetric fashion, see Pratt, Reilly, & Schweihs, supra note 27, at
869:“Ideally, operations before and after the damage period will show similar trends, thereby enabling the expert to
estimate the subject property’s performance during the damage period using either pre- or post-damage operations
as a performance standard with comparable damage amounts resulting. In many cases, only the ‘before’ period or the
‘after’ period is available to use to predict the ‘but-for’ performance during the damage period.”
CHORZÓW’S standard rejuvenated 117
just a U.S.$17.5 per barrel compensation under the BIT, the investor is worse off ex post
with the measures since without them it would have received a U.S.$70 per barrel price.
In other words, the investor has not been adequately compensated. It prefers not to have
the tax enacted rather than having the tax enacted and being compensated as per the
value at the time of expropriation.The state, however, benefited from the measures, as it
would compensate at U.S.$17.5 per barrel but collect taxes at U.S.$35 per barrel.
3. Damages Using Ex post Information
Consider now using ex post information to compute damages. Using ex post information
means that “but for” the measures the investor would be collecting U.S.$70 per
barrel, whereas he is actually receiving U.S.$35 per barrel.Thus, a compensation based
on a fair market valuation at the most recent date (plus the actual losses since the date of
introduction of the tax) would exactly leave the investor indifferent between the state
introducing the measures or not, which is in essence what the Chorzów principle of restoration
aims to achieve.Thus, ex post business conditions information, when introduced
symmetrically in the “but-for vs. actual” or the “before vs. after” analysis would provide
for adequate compensation to the investor in cases of indirect expropriation or unjust and
inequitable treatment.
The use of ex post information regarding business conditions has also additional positive
features because it provides the panel with a reality check as to what are the actual
damages suffered historically since the date of the initial measures, given the fact that
actual business conditions are used, as opposed to engaging in a theoretical exercise as to
what the value of the actual investment is worth, assuming no changes in business conditions
since the date of initial measures.
In our experience, panels consider this observable evidence as very valuable. In addition,
in complex damages cases it is often too difficult to construct a theoretical residual
value based purely on ex ante information. In particular, a potential mistake is to try to
assess the residual value at the day immediately after the measures and compare it with the
stock market quotes just prior to the measures. This may not shed any light as to the
extent of damages, as it is usually the case that such date is too premature to fully understand
the effects and subsequent implementation of the state measures in place. Indeed,
in indirect expropriation and unjust treatment it is not uncommon to observe that some
of the measures may be removed afterwards,or their impact may be eroded through time,
having an impact on damages that cannot be ignored.48
48
Some measures, although of a permanent nature, may not last forever and thus the impact on the business or
affected asset, although significant, may be restricted to a limited period of time. For instance, the CMS v.Argentina
panel which determined that Argentina had failed to provide just and equitable treatment, considered that the
“actual” scenario would be more favorable in the future than estimated by the claimant.The claimant estimated that
revenues in the “actual” scenario would not increase at all throughout a 26-year period, whereas the panel considered
that periodical increases might take place.This change resulted in mitigated damages to the claimant. See CMS v.
Argentina, supra note 30, para. 457.
118 journal of international arbitration
Another advantage of using ex post information is that post-measure events provide
essential information as to what extent the investor has been able to mitigate damages, by
adapting the performance of the affected company to the new circumstances. Ignoring
such business adaptation will be equivalent to ignoring an element of damage mitigation
that might be quite relevant.
Thus, choosing the proper valuation date for damages requires the selection of a
time when the measures and its implications are already well understood by the market
and fully implemented.This may be several months or years after the initial measures have
started.The safest and most accurate method is to use all the most recent and available
information (i.e., as of the date of the award), as one of Chorzów’s valuation options
wisely recommends.
B. How to consider worsened business conditions in indirect
expropriation and unjust treatment cases
Consider now in our simple example a fall in crude oil prices, which is equivalent
to worsened business conditions for reasons unrelated to state measures.Assume the price
of oil drops from U.S.$35 to U.S.$20 per barrel. Due to the tax, compensation as of the
most recent date would now be equivalent to U.S.$10 per barrel (50 percent of current oil
prices), whereas as of the date of the measures it would be higher, at U.S.$17.5 per barrel.
To the extent that the state measures did not prevent the investor from selling its
assets at a prior point in time when business conditions were better, panels would probably
be reluctant to grant compensation that exceeds current actual damages, at U.S.$10
per barrel.The reason is twofold. First, if the investor wants to sell now (with worsened
business conditions) it could obtain no more than U.S.$20 per barrel in the absence of the
measures. Secondly, forcing the state to compensate on the basis of U.S.$17.5 per barrel
today, when it is collecting only U.S.$10 per barrel, seems unfair—leaving aside punitive
considerations—as the state will be made worse off.
Thus, compensation at U.S.$10 per barrel would leave the investor in the position
as if the measures had not taken place,at least to the extent that the state is not responsible
for inhibiting the possibility of the investor selling its asset. Notice that this conclusion
differs from the Chorzów standard for full expropriation. Indeed, with outright (and fullfledged)
expropriation the investor was prevented by the state measures from exercising
the option of selling its business at arm’s length, and instead was forced to transfer it to
the state. In Chorzów, then, the use of the value as known as of the time of the expropriation
does not necessarily generate an unjust compensation to the investor,and the transfer
of the ex post business risk to the state does not imply any over-compensation.
On the other hand, to avoid the possibility of over-compensation the optional
element of Chorzów should not be used in indirect expropriation and unjust and
inequitable treatment. Rather, damages ought to be valued directly using the most recent
information (i.e., valued at the date of the award, or at a prior date but using all available
ex post information).
CHORZÓW’S standard rejuvenated 119
V. Conclusion
Unlike outright expropriation where the investor is forced to transfer the asset to the
state, unjust treatment and indirect expropriation have some distinctive economic features.
We have shown in this article that at least two of these distinctive features (accounting for a
residual value and changing business conditions), require the use of ex post information to
adequately value damages and to comply with the Chorzów’s principle of full restoration.
Changing business conditions is a relevant feature of ex post information that
deserves special consideration. We have demonstrated in this article that ex post
information on business conditions must not only be used to compute “full-restoration”
damages, but also has to be treated symmetrically in the “but-for vs. actual” damage
valuation approach.Asymmetric use of ex post information,which is similar to a simplistic
interpretation of the “before vs. after” approach to damages, on the contrary, will result
in inadequate compensation given the complexities in choosing proper dates of valuation
as well as improper (asymmetric) comparison of ex post facts that have altered the value of
the investment through time.
We find that the introduction of ex post information on business conditions is not
only reasonable but also often unavoidable, as the residual value of the investment is fully
contaminated by those changing business conditions.The real challenge for the damage
expert and panels alike is, then, how to separate out the observable ex post information so
as to:
(a) appropriately and accurately compute damages without taking into account
changes in value that may be unrelated to the actions by the state, without
ignoring the ex post consequences of damaging measures; and
(b) symmetrically account for ex post business conditions in modeling the “but-for”
and “actual” scenarios.
Chorzów’s compensation standard, by allowing as an option to compute damages as
the fair market value of the investment as of the date of the award (plus historical losses
since the date of the measure) fully captures our recommendations about the need for
including ex post information to properly value damages.This, because computing damages
à la Chorzów as of the date of the award also requires the full use of all the relevant
ex post information available. In addition, applying Chorzów’s standard preserves the deterrent
component of the compensation by not allowing states to capture profits from
improved business conditions since the date of the measures.The only caveat that prevents
us from fully advocating Chorzów’s dual compensation standard in indirect expropriation
and unjust treatment cases is that when business conditions deteriorate and are
unrelated to state measures, the option to assess damages as of the “date of the measures”
without considering any ex post information might well result in over-compensation, and
thus ought to be discarded as an option. Instead, a valuation as of the date of the award
must be used.
120 journal of international arbitration
Thus, our final recommendation is that in indirect expropriation and unjust and
inequitable treatment cases, panels should “rejuvenate” Chorzów’s compensation standards
and lean towards valuation exercises that compute damages as of the date of the award,
using all ex post information available, rather than trying to isolate, recreate and/or
second-guess valuation exercises that require investor expectations of the distant past,
ignoring actual events.
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www.kluwerlawonline.com/journalofinternationalarbitration
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