Legal Analysis of Indirect Expropriation Claim Under Korea-Us FTA

INTRODUCTION

On June 30, 2007, the United States and the Republic of Korea signed the U.S.-Korea Free Trade Agreement (“KOR-US FTA”). After 4 years of a long delay caused by political oppositions against the ratification, Congress finally approved the agreement on October 12, 2011, and Korea’s National Assembly subsequently approved it on November 22, 2011. The United States and Korea completed their review of the measures both sides had taken to implement the FTA and exchanged diplomatic notes on February 21 agreeing to bring the agreement into force on March 15, 2012.

Like other FTAs that the United State has already concluded, KOR-US FTA covers a wide range of subjects that have plagued the trading relationship for decades and these subjects are reflected in the final text of the agreement. With respect to the subject of investment, the KOR-US FTA Chapter 11 governs the admission and protection of foreign investments in host countries. Specifically, this Chapter provides several provisions prescribing the government from expropriating foreign investments directly or indirectly without awarding foreign investors “prompt, adequate, and effective” compensation.

However, there is growing concern in both countries that considerable ambiguity over the standard for determining an indirect expropriation may make legitimate governmental regulations susceptible to foreign investors’ relentless legal challenges. A series of controversial NAFTA Tribunal decisions have also heightened such a concern. Furthermore, the incorporation of the investor-state dispute (ISD) mechanism in KOR-US FTA opened the door for foreign investors to bring an expropriation claim without procedural difficulty against the host country’s regulatory measures that may affect their investments, because the ISD procedure effectively 2

eliminated complicated procedural hurdles that foreign investors would have to overcome if they filed the claim in international or domestic courts.

To mitigate difficulty caused by blurred distinctions between an indirect expropriation and a government action that does not trigger a compensation obligation, this Article will attempt to shed light on the interpretation of indirect expropriation in the context of KOR-US FTA. At the beginning chapter, for purposes of providing background knowledge, the Article will provide a brief history of bilateral investment treaty (BIT) and trace the origins of the expropriation provisions found in KOR-US FTA. In the next chapter, the Article will evaluate the influence of the NAFTA Chapter 11 on the expropriation provisions of KOR-US FTA, and attempt to discover discrepancies between the NAFTA Chapter 11 jurisprudence and the U.S. Taking Clause jurisprudence. Particularly, this chapter’s analysis will offer a helpful insight on understanding of the textual improvement made in KOR-US FTA because the investment provisions of KOR-US FTA are basically modeled on the NAFTA Chapter 11. Finally, the Article will explore the concrete standard for determining an indirect expropriation articulated in KOR-US FTA, and analyze each considerable factor under customary international law.

HISTORY OF INVESTMENT TREATIES AND EXPROPRIATION

Industrialized countries have long made efforts to achieve a global consensus about the principle that foreign investments cannot be nationalized without appropriate compensation. Particularly, the United State has strongly endorsed the “Hull Formula,” which requires a state to provide “prompt, adequate, and effective” compensation for the expropriation of foreign investments. 1However, continuous attempts to incorporate the Hull Formula into multilateral 1  treaty were frustrated because the “Calvo Doctrine” gained widespread acceptance among developing countries.2 This doctrine emphasized a sovereign state’s freedom from interference by other states, thereby providing developing countries with legal justification for noncompensable expropriation of foreign investments.

Failures to establish the multilateral treaty for protection of foreign investments led industrialized countries to consider protection of their investments through an alternative measure – BIT. Beginning in 1959, several European countries led by Germany began to negotiate BITs that incorporated protections against expropriation of foreign investments.4 In the 1970s, the United States also adopted such an approach and launched its own BIT program aimed at protecting the foreign investments of United States corporations. 5 BITs have more proliferated since the collapse of the Soviet Union, and there are currently more than1500 BITs in force, involving 160 countries. 6 Virtually all of these agreements contain expropriation provisions, although only about half of them directly incorporate the language of the Hull Formula.

See Manuel R. G. Mora, The Calvo Clause in Latin American Constitutions and International Law, 206-07 (1950). The Mexican Constitution’s Calvo Clause provides: “The State may grant the same right to foreigners [to acquire ownership of lands and other property], provided they agree…to consider themselves as nationals in respect to such property, and bind themselves not to invoke the protection of their governments in matters relating thereto under penalty, in case of noncompliance with the agreement, of forefeiture of the property acquired to the Nation.” Constitucion Politica de los Estados Mexicanos (1917), ch. I, art. 27. 4

See Jeswald W. Salacuse, BIT by BIT: The Growth of Bilateral Investment Treaties and Their Impact on Foreign Investment in Developing Countries, 655-57 (1990).
5
See Kenneth J. Vandevelde, The Bilateral Investment Treaty Program of the United States, 21 Cornell Int’l L.J. 201 (1998); see also M.S. Bergman, Bilateral Investment Protection Treaties: An Examination of the Evolution and Significance of the U. S. Prototype Treaty, 16 N.Y.U. J. Int’l Law & Pol’y 1 (1983). 6

See United Nations Conference on Trade and Development (UNCTAD), Bilateral Investment Treaties in the Mid1990s, at 8-10, U.N. Doc. UNCTAD/ITE/IIT/7, U.N. Sales No. E98.II.D.8 (1998). For an updated list of texts of bilateral
treaties to which the United States is a party; see also U.S. Bilateral Investment Treaty Program, List of U.S. Bilateral Investment Treaties, http://www.state.gov/www/issues/economic/7treaty.html. 7

See Mohamed I. Khalil, Treatment of Foreign Investment in Bilateral Investment Treaties, ICSID Rev.–Foreign Inv. L.J., 374-75 (1992).
3

4

The expropriation provisions in the recent BITs went much further beyond protection guaranteed under Hull Formula. Most of the current BITs require compensation not only for direct expropriation of property, but also for “indirect expropriation” – accomplished indirectly through measures equivalent to expropriation or nationalization.8 Also, many of the recent BITs provide with foreign investors a separate dispute settlement measure through the World Bank’s International Centre for the Settlement of Investment Disputes (ICSID). This settlement procedure has significantly relaxed procedural requirements that foreign investors have to comply with when they bring a claim in international or domestic courts.

Like other BITs, the expropriation provisions of KOR-US FTA should be interpreted in accordance with customary international law. There are myriad of international arbitration or court judgments on indirect expropriation claims arising from thousands of BITs, each of which can be a source of customary international law. However, such cases should be carefully used for interpretation purposes, because each BIT has its own distinct language as well as negotiating history and such differences may have affected the outcome of alleged indirect expropriation claims.

III

COMPARISON: NAFTA AND U.S. TAKING JURISPRUDENCE

The NAFTA Chapter 11 jurisprudence will shed light on the determination of
indirect expropriation claims arising from the investment provisions of KOR-US FTA. Despite some distinctions between the texts of these treaties, the investment provisions of KOR-US FTA are basically modeled on the text of the NAFTA Chapter 11. Also, a series of recent NAFTA Tribunal decisions have reflected well the modern approach to afford foreign investors a broad 8

See UNCTAD, supra note 6, at 33-34.

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protection. Consequently, the NAFTA Chapter 11 jurisprudence will serve as one of the most reliable international law sources in future litigation arising from the investment provisions of KOR-US FTA.

There is no serious doubt that United States jurisprudence under the Takings Clause of the Fifth Amendment has been one of the most influential sources in interpreting indirect expropriation claims arising from myriad of international investment treaties. However, contrary to the widespread belief that the NAFTA Tribunal has simply emulated the U.S. Taking Clause jurisprudence, the Tribunal decisions and dicta goes well beyond protections guaranteed under the Takings Clause in several respects.

First, the nascent interpretation of the recent NAFTA tribunal decisions suggests that the scope of property right to which the right of compensation applies under the NAFTA Chapter 11 is broader than that under the Taking Clause. The Takings Clause generally applies only to regulations of specific interests in property rights. In College Savings Bank v. Florida Prepaid Postsecondary Education Expense Board, the Supreme Court rejected the idea that business opportunity can be recognized as property interest for purposes of the Taking Clause analysis, noting that “business in the sense of the activity of doing business, or the activity of making a profit is not property” and therefore is not entitled to the same constitutional protection. 9 Challenges to regulations of economic activity that do not affect a specific property interest, but instead only reduce the profitability of an economic enterprise, are entitled to review, if at all,

9

See College Savings Bank v. Florida Prepaid Postsecondary Education Expense Board, 527 U.S. 666 (1999).

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only under the highly deferential standard applied to substantive due process challenges to economic regulations.10

Under the NAFTA Chapter 11, on the other hand, the definition of “investment” encompasses not only specific interests in property rights, but also more generalized economic interests. In Metalclad v. United Mexican States, the NAFTA Tribunal stated that the claimant’s broader interest in operating a particular type of business — the hazardous waste facility — fell within the scope of “investment” for the purposes of expropriation claims.11 In addition to the right to operate a particular type of business, the NAFTA expropriation provisions also apply to regulatory actions affecting the ability to sell products in a particular market. Indeed, in Pope & Talbot v. Canada, the Tribunal agreed with the claimant’s assertion that “access to the U.S. market” constituted a form of “investment” in the context of the NAFTA expropriation provisions.12 S.D. Myers v. Canada is another case in which the Tribunal found the opportunity to sell one’s products in a particular market to qualify as investment for purposes of indirect expropriation claims, although the Tribunal expressed skepticism over whether such form of investment could be expropriated through a regulatory action.13

Second, the NAFTA Tribunal standard also departs from the U.S. Taking Clause jurisprudence in its approach to the degree of adverse effect that a regulatory measure must have on the relevant economic interest in order to require compensation. Under the Taking Clause jurisprudence, regulatory measures that destroy all economic value of a property are generally 10

See Concrete Pipe and Prods. of Cal. v. Constr. Laborers Pension Trust for S. Cal., 508 U.S. 602, 639 (1993) (“[U]nder the deferential standard of review applied in substantive due process challenges to economic legislation there is no need for mathematical precision in the fit between justification and means.”). 11

See Metalclad Corp. v. United Mexican States, ICSID Case No. ARB(AF)/97/1 (Arbitral Trib. 2000). 12
See Pope & Talbot Inc. v. Canada, Interim Award by the United Nations Commission on International Trade Law (UNCITRAL) (Arbitral Trib. 2000).
13
See S.D. Myers v. Canada, Partial Award by UNCITRAL (Arbitral Trib. 2000).

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considered to constitute per se takings.14 In addition to such per se takings, regulatory measures that do not completely eliminate the value of property may also constitute a taking under an ad hoc analysis, first announced by the Court in Penn Central Transportation Co. v. New York City.15 This analysis focuses on three factors: (1) the economic impact of the regulation, (2) the degree to which the regulation has interfered with the owner’s reasonable expectations concerning the property, and (3) the character of the regulatory action.16 In subsequent cases examined under the Penn Central analysis, the court observed that degree of adverse effect on the economic value must be “functionally equivalent to the classic taking in which government directly appropriates private property or ousts the owner from his domain” to constitute regulatory takings.17 In this respect, under the Penn Central analysis, a government may exercise its police powers to regulate property without compensating the owner, even if the regulation causes the property to lose most of its value.18

The NAFTA expropriation provisions, in contrast, appear to require a lower level of impairment of the value of investment in order for a foreign investor to be entitled to compensation. Metaclad tribunal have suggested that regulatory measures may constitute acts of expropriation even if they
only have a “substantial” or “significant” adverse impact on the value of an investment, observing that “expropriation under NAFTA includes ….. covert or incidental

14

See Lucas v. S.C. Coastal Council, 505 U.S. 1003, 1015 (1992). See Penn Central Transportation Co. v. New York City, 438 U.S. 104, 124-25 (1978). 16
Id, at 115.
17
See Lingle v. Chevron, 544 U.S. 528, 539 (2005).
18
See Lucas, 505 U.S. at 1023 (1992) (stating that governments “may consistent with the Takings Clause, affect property values by regulation without incurring an obligation to compensate—a reality [the Court] acknowledge[s] explicitly with respect to the full scope of the State’s police power”). 15

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interference with the use of property which has the effect of depriving the owner, in whole or in significant part……”19

Finally, the NAFTA Tribunal has taken a less stringent approach with respect to procedural requirements for expropriation claims. Under the strict ripeness rule of the Takings Clause jurisprudence, a court can adjudicates a regulatory takings claim on merit only when the challenged regulation “goes too far” and results in a taking under the Fifth Amendment. 20 Specifically, the claimant must demonstrate both that he has received a “final decision” regarding what level of development is permitted on the property and that he has exhausted available state procedures for seeking compensation.21

By contrast, none of the NAFTA Tribunal cases have imposed on claimants a strict procedural requirement comparable to the ripeness rule that must be met under the Takings Clause. Indeed, in Ethyl Corporation v. Canada in which the claimant challenged the legislation that had not even yet been
adopted, the Tribunal explicitly rejected the government’s ripeness objection against an indirect expropriation claim. 22 Consequently, NAFTA claimants, unlike property owners seeking compensation under the Takings Clause, need not obtain a final determination of permissible property uses, nor exhaust available domestic remedies.

IV

NEW TREATY TEXT: INDIRECT EXPROPRIATION UNDER KOR-US FTA
A. Textual improvements of KOR-US FTA indirect expropriation provisions

19

See Metalclad, supra note 11, para. 103.
See Suitum v. Tahoe Reg’l Planning Agency, 520 U.S. 725, 738 (1997). 21
See MacDonald, Sommer & Frates v. Yolo County, 477 U.S. 340, 348 (1986). 22
See Ethyl Corp. v. Canada, Award on Jurisdiction, 55-60 (June 24, 1998). .
20

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As discussed in the preceding chapter, the expansion of property rights protected under the NAFTA expropriation provisions, along with the relaxed procedural standard for filing an indirect expropriation claim, resulted in an unequal treatment between foreign investors and domestic property owners in U.S. Having realized this problem, Congress instructed the Office of the United States Trade Representative (USTR) to ensure that expropriation provisions in future trade agreements do not provide foreign investors with greater rights than those provided to property owners under United States law. 23 In response to Congress’ “no greater rights” mandate, USTR has made some refinements to the NAFTA model expropriation text, and reflected these modifications in recently signed free trade agreements with Chile, Singapore, and several Central American countries.24 As analyzed in detail below, KOR-US FTA has also fully reflected the recent approach that attempts to refine the NAFTA model expropriation provisions.

The KOR-US FTA Chapter 11 articulates the general principles of bilateral investment treaty as well as the relevant expropriation provisions. Article 11.6.1. provides that “neither [p]arty may expropriate or nationalize a covered investment either directly or indirectly through measures equivalent to expropriation… except: (a) for a public purpose;

(b) in a non-

discriminatory manner; (c) on payment of prompt, adequate, and effective compensation; and (d) in accordance with due process of law…”25

Ostensibly, the above textual language has little distinction from the Chapter 11 text of NAFTA. However, the KOR-US FTA Chapter 11 has not simply adopted the counterpart of

23

See Office of the U.S. Trade Representative, United States and Central American Nations Launch Free Trade Negotiations (Jan. 8, 2003).
24
See David A. Gantz, Contrasting Key Investment Provisions of the NAFTA with the United States-Chile FTA, in NAFTA INVESTMENT LAW AND ARBITRATION: PAST ISSUES, CURRENT PRACTICE, FUTURE PROSPECTS, 400 (2004).

25
KOR-US FTA Article 11.6.1.

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NAFTA, rather has made some improvement to resolve uncertainty presented by the NAFTA text.

First, this new treaty text has incorporated the term “equivalent to expropriation” rather than “tantamount to expropriation” employed in the
NAFTA Chapter 11. 26 In several earlier indirect expropriation claims that arose from the NAFTA Chapter 11, claimants often asserted based on the textual language “tantamount” that indirect expropriation can also occur through measures other than those expropriatory in nature or effect.27 Although the NAFTA Tribunal has explicitly rejected such broad interpretation28, considerable ambiguity of the term “tantamount” leaves open the possibility that the NAFTA Tribunal might interpret the definition of indirect expropriation liberally in future litigation. Reflecting such a concern, KOR-US FTA has opted for the term “equivalent” – more clear and accurate language – rather than “tantamount,” and thereby effectively foreclosed the possibility that the KOR-US FTA Tribunal might expand the definition of indirect expropriation based on the ambiguous textual language.

Furthermore, the KOR-US FTA Chapter 11 provides a detailed guidance as to the scope of investment that can be subject to an indirect expropriation. Article 11.28 has defined “investment” as “every asset that an investor owns or controls, directly or indirectly, [and] that has the characteristics of an investment, including such characteristics as the commitment of capital or other resources, the expectation of gain or profit, or the assumption of risk.”29 Also, the Article has enumerated various forms of investment including an enterprise, stocks, bonds, debentures, options, intellectual property rights, licenses, lease, authorizations, other tangible or

26

Id.
KOR-US FTA Article 11.6.1.
28
See S.D. Myers, supra note 13, at 45.
29
See Metalclad, supra note 11, at 100.
27

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intangible, movable or immovable property, and related property rights.30 In effect, almost all conceivable forms of tangible or intangible property rights would fall within the category of investment for purposes of indirect expropriation claims.

In addition to the textual changes, KOR-US FTA attaches an annex further clarifying the appropriate test for determining an “indirect expropriation.” The annex 11-B mandates that all determinations of indirect expropriation “require a case-by-case, fact-based inquiry that considers all relevant factors.” 31 Also, this provision codifies three key factors that must be considered: (1) the economic impact of the government action; (2) the extent to which the government action interferes with distinct, reasonable investment-backed expectations; and (3) the character of the government action.32 Although these factors are not stated to be exclusive, they will play a significant role in determining whether a government action constitutes an indirect expropriation. In fact, these factors have been frequently analyzed in many earlier expropriation cases.

The annex also makes clear that nondiscriminatory regulatory actions for legitimate public welfare objectives generally do not constitute an indirect expropriation.33 It also provides specific examples of what might be considered “legitimate public welfare objectives,” mentioning “public health, safety, the environment, and real estate price stabilization.”34 This provision aims to curb a foreign investor’s interference in the state affairs involving public welfare purposes, thereby safeguarding the state’s right to exercise its regulatory power.