Brexit and the investment arbitration puzzle: the risk of foreign investors’ legitimate expectations

This article was written by Marlen Estévez Sanz and Roberto Muñoz Rojo

After approximately 40 years of being part of the European Union (EU), the United Kingdom has recently decided, in a controversial referendum that took place on 23 June 2016, to leave the EU (popularly known as 'Brexit').  

In an unprecedented decision (the United Kingdom will be the first Member State to withdraw from the EU. On 29 March 2017 the United Kingdom formally communicated its intention to leaveto the EU, triggering the procedure set forth in Article 50 of the Treaty on European Union (TEU). Further, there have been official statements suggesting a hard Brexit, which would imply an abrupt detachment from the EU.

Among the many legal uncertainties that the Brexit poses, it is being discussed whether it could imply a sharp repeal of EU law and domestic legislation giving effect to the latter. If so, it would entail that the United Kingdom could no longer benefit from the EU single market. Consequently, transactions would not be subject to the EU harmonised regulation and standards, and UK-based companies may not take advantage of EU benefits deriving from the free movement of capital, workers and goods, as well as from the freedom of establishment.

Potential impact on companies operating in the United Kingdom

Any of the above drastic changes would have a severe impact on many companies that operate in different sectors in the United Kingdom (financial, healthcare, car and manufacturing industries are just some clear examples). These eventual harmful repercussions have created a state of uncertainty as to Brexit's real and final consequences, which has also generated a high degree of concern among foreign countries and businesses, as well as among practitioners.

An illustrative example is the proposal sent by the Law Society of Scotland to the UK Government, which highlighted that one of the most significant public interest issues will be «ensuring stability in the law[1]». In similar terms, the official communication sent by Japan to the EU and UK, stressing the importance of avoiding any major disruptions in the post-Brexit landscape and listing the requests of Japanese businesses operating in both markets[2]. In essence, both statements made clear the willingness to preserve most of the UK business-friendly status quo maintained thanks to the EU membership.

Yet foreign investors' concerns could swiftly turn against the United Kingdom. This could be the case depending on whether major adverse changes are finally introduced and disappointed investors are capable of evidencing that they relied ―when making their investments― on the stability of a legal system that, nevertheless, is radically altered, being unable to prevent or anticipate it. In such a scenario, these investors might bring claims against the United Kingdom, invoking treaty protection and seeking liability for the costs of adaptation to comply with the new regulatory framework, based on a breach of their legitimate expectations.

Legitimate expectations

It is widely accepted that the international law obligation of «fair and equitable treatment» (FET) also includes the protection of foreign investors' legitimate expectations by the host state that induced their investments[3] (given the broad wording of the investment treaties signed until the moment, as opposed to the current trend shown during the Comprehensive Economic and Trade Agreement (CETA) and the Transatlantic Trade and Investment Partnership (TTIP) negotiations).  

Both the United Kingdom and the EU are bound by obligations of FET, which are generally recognised in investment treaties, such as the 12 Bilateral Investment Treaties (BITs) that are currently in force between the United Kingdom and another EU Member States[4], as well in those over 80 BITs with non-EU Member States (all of which will remain in force after Brexit, if they are not terminated before).

Legitimate expectations, in its turn, can be generated either by (a) specific commitments addressed to particular investors or by (b) rules that, although not specifically addressed to certain investors, are aimed at enhancing foreign investments and upon which foreign investors rely when making their investments[5].Thus, apart from contractual arrangements (i.e. stabilization clauses) and other statements or declarations (representations, promises, etc.) made by host States to encourage investments, regulatory frameworks can also create legitimate expectations.

This can be seen from arbitral awards that have already assessed the possibility of bringing investment arbitral claims based on breaches of legitimate expectations due to regulatory changes.

For instance, the significance of legal stability was highlighted in Tecmed v. Mexico, where emphasis was placed on the importance for foreign investors of knowing beforehand the legal regime that will govern their investments, in order to plan and also to comply with such regulations[6]. Subsequent decisions, in Occidental v. Ecuador[7] and PSEG v. Turkey[8], have also emphasised the importance of ensuring the predictability and stability of the legal environment.

Accordingly, at least in principle, severe changes in the UK legal regime could trigger claims by foreign investors affected by such changes, invoking principles such as the protection of their legitimate expectations. However, arbitral decisions have limited the scenarios in which these claims might be upheld.

UK safe harbour

Arbitral awards have held that, despite legitimate expectations that may exist, investors do not have the right of benefiting from a sort of legal immutability[9].    

Thus, as established in Saluka v. The Czech Republic, investors cannot reasonably expect that the circumstances at the time the investment is made remain "totally unchanged[10]". Similarly, as stated in Electrabel v. Hungary, host States have a "reasonable degree of regulatory flexibility to respond to changing circumstances in the public interest[11]". Indeed, in Total v. Argentina, it was concluded that States have the responsibility to «amend their legislation in order to adapt it to change and the emerging needs and requests of their people in the normal exercise of their prerogatives and duties[12]». 

A similar approach was also taken in the recent case of Charanne v. Spain, under the Energy Charter Treaty. The dispute concerned changes in the Spanish electricity regime that implied a considerable reduction of foreign investors' profitability. The tribunal concluded that, in the absence of a particular commitment given by the host state, an investor cannot have the legitimate expectation that a regulation will not be modified. This was all the more so in that case, since – in the tribunal's view – the investors could have certainly foreseen the changes that caused the dispute, given that they were expressly allowed by domestic legislation[13].  

As a result, if the time comes when a claim is made against the United Kingdom in relation to Brexit, the United Kingdom could counter-argue that its legal system did not constitute any specific commitment towards investors (which should be evidenced by investors, despite the hurdles that may exist in this case) and that, in any event, the United Kingdom had a sovereign right to make changes to the regulatory environment as a result of the requests of UK citizens made through the referendum. The United Kingdom could also argue that Brexit could have been foreseen since the option to withdraw from the EU was expressly regulated in the TEU (Article 50).

Possible risks

Nevertheless, the (succinct) dissenting opinion of Mr Guido Santiago Tawil in Charanne v. Spain might open the possibility of an alternative outcome. In his opinion, the Spanish regulatory framework in place at the time was indeed crucial for inducing a particular group of investors to make certain investments. In the arbitrator's view, investments had been made based on the objective belief that the specific regulatory regime was not expected to change. Therefore, the regulatory changes amounted to a violation of legitimate expectations and, consequently, the host State should have faced legal consequences[14]

Further, liabilities may arise if an arbitral tribunal finds that the changes brought about by Brexit are of sufficient magnitude to consider them as a total change of the regulatory legislation. Thus, in El Paso v. Argentine it was stated that, despite the fact that no reasonable investor can have the legitimate expectation to freeze a legal system, the latter would be unless "the alteration of the legal framework is total[15]".   

Likewise, in determining the investor's legitimate expectations and in assessing any eventual liability, it has been clarified that the arbitral tribunal should also have to consider all the particular circumstances surrounding the case[16], including the economic, political, socioeconomic, cultural and historical status of the host State, in order to assess the reasonableness of the foreign investor's legitimate expectations[17].   

Based on the foregoing, the particularities of the UK situation could tilt the balance in favour of foreign investors' claims and to the detriment of the host State's right to amend the regulatory framework.  

In particular, it could be argued that foreign businesses indeed preferred the United Kingdom as their gateway to the EU ― primarily ― in light of the legal system that is currently in place. Additionally, in a Brexit scenario the regulatory changes could affect the whole legal environment (i.e. not only a sector or industry), amounting therefore to a total change of the system. Lastly, it could be contended that no realistic businessmen could ever have predicted Brexit, based on the UK background (openness to foreign companies under the EU umbrella), history (over 40 years of EU membership), and economic situation (it is not a developing or unstable jurisdiction), as well as on the lack of any precedent or even given the United Kingdom's pre-Brexit active involvement in EU future perspectives (e.g. the Europe 2020 strategy of which the United Kingdom was a part of).

Concluding remarks

British citizens have legitimately decided in a referendum to exit the EU. This verdict has, however, brought numerous legal challenges and uncertainties. Among them, stakeholders and observers have already highlighted the importance of avoiding any major disruptions to the UK regulatory framework.

Otherwise, if the legal regime changes abruptly or radically, there could be room for foreign investors' claims against the United Kingdom, invoking a violation of their legitimate expectations recognised in their respective investment treaties. Such a possibility, although limited by arbitral awards, seems real and therefore should be taken into consideration by the United Kingdom when negotiating the new regulatory framework and the eventual transitional regime.

This article was first published in the Arbitration Committee newsletter, Vol 22 No 1, June 2017, and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.

[1] Law Society of Scotland. Proposal-UK Government. Negotiation Priorites on leaving the EU: Proposals by the Law Society of Scotland, November 2016. 

[2] Japan's Message to the United Kingdom and the European Union

[3] Suez, Sociedad General de Aguas de Barcelona S.A., and Vivendi Universal S.A. v. The Argentine Republic, ICSID Case No. ARB/03/19, Decision on Liability, 30 July 2010, para. 248; International Thunderbird Gaming Corporation v. The United Mexican States, NAFTA/UNCITRAL, Separate Opinion of Professor Thomas W. Wälde, December 2005, para. 1.

[4] UNCTAD, Investment Dispute Settlement Navigator.

[5] United Nations Conference on Trade and Development, "Fair and Equitable Treatment, UNCTAD Series on Issues in International Investment Agreements II", 2012, p. 69. Also, CMS Gas Transmission Company v. The Argentine Republic, ICSID Case No. ARB/01/8, Award, 12 May 2005, para 274.

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

[7] Occidental Exploration and Production Company v. the Republic of Ecuador, UNCITRAL rules, Administered Case No. UN 3467, Award, 1 July 2004, para. 183.

[8] PSEG Global INC. and Konya Ilgin Elektrik Üretim Ve Ticaret Limited Sirketi v. the Republic of Turkey, ICSID Case No. ARB/02/5, Award, 19 January 2007, para. 240.

[9] Loan Micula, Viorel Micula, SC European Food SA, SC Starmill SRL and SC Multipack SRL v. Romania, ICSID Case No. ARB/05/20, Award, 11 December 2013, para. 673.

[10] Saluka Investments BV (The Netherlands) v. The Czech Republic, UNCITRAL-PCA, Partial Award, 17 March 2006, para. 305.

[11] Electrabel SA v. Hungary, ICSID Case No. ARB/07/19, Award, 25 November 2015, para. 7.77.

[12] Total SA v. Argentine Republic, ICSID Case No. ARB/04/1, Decision on Liability, 27 December 2010, para. 115.

[13] Charanne BV and Construction Investments SARL v. the Kingdom of Spain, SCC Case No. 062/2012, Award, 21 January 2016, paras. 493, 505 to 508.

[14] Ibid., Dissenting opinion of Mr Guido Santiago Tawil, 21 December 2015, paras. 5 and 12.

[15] El Paso Energy International company v. Argentine Republic, ICSID Case No. ARB/03/15, Award, 31 October 2011, para. 374.

[16] Noble Ventures, Inc. v. Romania, ICSID Case No. ARB/01/11), Award, 12 October 2005, para. 181.

[17] Generation Ukraine Inc. v. Ukraine, ICSID Case No ARB/00/9, Award, 16 September 2003, para. 20.37; Parkerings-Compagniet AS v. Republic of Lithuania, ICSID Case No. ARB/05/8, Award, 11 September 2007, para. 335; Duke Energy Electroquil Partners and Electroquil SA v. Ecuador, ICSID Case No. ARB/04/19, Award, 12 August 2008, para. 340; EDF International SA, SAUR International SA and León Participaciones Argentinas SA v. Argentine Republic, ICSID Case No. ARB/03/23, Award, 11 June 2012, para. 1004.

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