Clarification of the legitimate expectations of investors in relation to the stability of regulatory frameworks
Scholz holding Gmbh c. Royaume du Maroc, award, ICSID n° ARB/19/2
In recent years, investors have frequently invoked the notion of legitimate expectations in alleging a breach of a state’s obligation to ensure fair and equitable treatment. Although the concept has become somewhat clearer, its scope nevertheless remains uncertain. This paper examines the tribunal’s legal interpretation in the Scholz Holding GmbH case, which is part of an ongoing development in case law. It concludes that in order to protect legitimate expectations based on the stability of the regulatory framework, any change to that framework must be both disproportionate and unjustified in order to frustrate those expectations.
On August 1, 2022, the arbitral tribunal formed for the case of Scholz Holding GmbH v. Kingdom of Morocco rendered its award, rejecting all allegations of breaches based on the BIT between the Kingdom of Morocco and Germany, including the frustration of legitimate expectations claimed by the investor, a company incorporated under German law. The general context of the dispute is straightforward: the investor claimed that it had invested in a steel business in Morocco and that, shortly after that investment, the Moroccan authorities took measures to prevent it from carrying out its activities properly by modifying the legal and regulatory framework on which it had relied. The investor considered those measures to be in breach of the BIT. More specifically, the investor argued that Morocco had breached several of its obligations under the BIT, such as the obligations to accord fair and equitable treatment, treatment no less favourable, full protection and security, and not to expropriate without compensation. These allegations stem largely from the change in the legal and regulatory environment applicable to the investor, marked by the abolition of a tax exemption and the imposition of restrictions on exports.
On the basis of fair and equitable treatment, the investor alleged that these measures frustrated its legitimate expectations. The respondent maintained that it had not been established that the preservation of the investor’s “legitimate expectations” was a component of this standard. The tribunal did not follow the respondent’s position. However, it held that in the absence of any commitment, promise, or declaration on the part of the state, the investor could not legitimately expect the state not to amend its laws and regulations in order to protect its national interests (paragraph 178 of the award). In this respect, the award is particularly interesting because the tribunal clarified the legal scope of this much-debated concept in the field of investment arbitration. A great deal has been written on the subject, but both this award and others in the Spanish renewables arbitration saga have contributed to the clarification of the legal scope of the concept.
Legitimate expectations as part of FET
Following in the wake of several previous rulings, the tribunal confirmed that legitimate expectations are a component of FET. Article 2(2) of the applicable BIT provides that “in each case, each Contracting State shall treat the investments of investors of the other Contracting State in a fair and equitable manner.” Without necessarily examining the content of this FET standard, which is also more complex, it suffices to note that the investor, referring to the cases Glencore International v. Colombia and CMS v. Argentina, argued that Morocco had breached FET by making unpredictable and unstable changes to the regulatory framework, thereby frustrating its legitimate expectations (paragraph 143).
The tribunal noted, first of all, that Article 2 of the BIT does not provide any definition of the content of the fair and equitable treatment standard. On the basis of Article 32 of the VCLT, the tribunal held that in the absence of special provisions, Article 2.2 of the BIT must be interpreted by reference to the standard established in international law (paragraph 243 of the award). Moreover, the tribunal based its decision on established case law, namely the award in Waste Management II v. Mexico, considering that this standard of treatment is not fixed in the definition given by the Claims Commission in the Neer case of 1927. In 2019, several arbitration awards focused on the issue of FET, in particular, the protection of the legitimate expectations of investors. It is now widely accepted that these expectations are protected as part of this treatment. The tribunal agreed with this established case law, which tends to set a precedent. The tribunal considered that
“the fact that the host State has breached or contradicted statements or representations on which the investor based legitimate expectations at the time of investing is relevant to an assessment of whether there has been a breach of the obligation to accord fair and equitable treatment. (paragraph 246)”
Furthermore, as will be noted, the awards are unanimous that the existence of these expectations arises from the combination of the undertakings given by the state and their interpretation by the investor. However, determining which state behaviours can give rise to such expectations is the subject of intense debate. This is particularly illustrated by the practice connected with the Spanish renewable energy arbitration saga. However, it is important to stress that not every violation of FET constitutes a frustration of legitimate expectations, and not every frustration of legitimate expectations constitutes an internationally wrongful act giving rise to state responsibility. Indeed, the tribunal concluded that no evidence had been provided of any conduct by the Moroccan authorities in breach of FET (paragraph 262).
In the context of the Spanish arbitration, some of the awards handed down consider that Spain was not committed to maintaining the regime in force at the time of the investments. In this case, the state can escape liability unless the changes made are deemed unreasonable and disproportionate for investors. The tribunal in this case agreed with this reasoning, with a slight difference in terminology. Consequently, this decision does not constitute an innovation in the strict sense of the term but rather contributes to consolidating developing case law on the relationship between the stability of the regulatory framework and the protection of legitimate agreements.
Legitimate expectations are not systematically based on the stability of the regulatory framework
The central contention of the investor is essentially that an investor can derive legitimate expectations not only from statements and representations made to it directly by the host state but also from the general legislative and regulatory framework established by the state, on which it has relied with the expectation that it will not be disrupted. In the view of the tribunal, the existence of such a breach must be assessed in the light of the nature of those statements and that conduct, as well as the legitimate and proportionate nature of the measures taken by the state.
On the basis of prevailing case law and relying on a 2012 UNCTAD study, the state of the law in this area can be summarized in the following terms:
“Arbitral decisions suggest in this regard that an investor may derive legitimate expectations from either (a) specific commitments addressed to it personally, for example in the form of a stabilization clause, or (b) rules which are not specifically addressed to a particular investor but which are put in place for the specific purpose of encouraging foreign investment and on which the foreign investor has relied in making its investment.” (paragraph 278)
The tribunal considered that there was no stabilization clause nor any specific commitment by the state to the investor concerning the stability of the regulatory and legislative framework applicable to it. Therefore, it remained to be seen whether the sector-specific regulations in force in January 2008 were such as to have generated legitimate expectations.
In this respect, the tribunal, following part of the case law in the Spanish renewables saga, made some refinements by clarifying certain conditions. In order for the investor to be able to rely on legitimate expectations concerning the legislative and regulatory framework in existence at the time of its investment, the tribunal considered, on the one hand, that the framework must have been put in place with a view to attracting investment in the sector in question and, on the other, that the investor must establish that it determined its decision to invest. To this end, the tribunal held that
“the fact that this tax exemption was established in the 2007 Finance Act for a period of five years does not amount to an undertaking by the State, in the absence of any specific declaration to that effect and any tax stabilization clause, not to amend that regime before the expiry of that period. (§303)”
In addition to the two criteria mentioned above, the tribunal referred to two others that are found in certain Spanish renewables awards. Thus, it is not enough for the regulatory framework to exist and be decisive for the investor. According to the tribunal, in order to engage the international responsibility of the state, the changes made must be “disproportionate” in relation to the objective pursued and “unjustified” with regard to the legitimate public interest (paragraph 280). In the absence of disproportionate and unjustified character, even though the regulatory framework is changing and determining, the liability of the state cannot be established on the basis of legitimate expectations. However, these two criteria are intrinsic to the FET standard, making it redundant to invoke the protection of legitimate expectations in the absence of an undertaking or representation from the state. However, while the disproportion criterion is relatively easy to determine, the general interest criterion remains open to question. In addition, the awards handed down in the Spanish renewables cases place greater emphasis on the concepts of “unreasonable” and “disproportionate.” Does this suggest a difference in terminology rather than substance?
In any event, the tribunal in question considered that these conditions were not met in this specific case. In other words, the changes made to the Moroccan regulatory framework were neither disproportionate nor unjustified in terms of the general interest (paragraphs 280 to 300), and consequently, there were no reasonable legitimate expectations protected by the BIT. These two criteria, disproportionate and unjustified, are quite protective of the law-making power of states to take measures to protect the public interest, even if this may affect the expectations of investors.
Conclusion
Over a long period of time, tribunals have analyzed in depth the legal basis for legitimate expectations. The approach adopted by the Scholz tribunal is, therefore, interesting, as it determines the legal scope of legitimate expectations. And in so doing, it consolidates a certain practice of case law. Moreover, it weakens the historic position of the Tecmed tribunal, which is cited by investors and tribunals favourable to extending the protection of legitimate expectations to the stability of the regulatory or legislative framework. Moreover, one of the arbitrators on the tribunal in this case, Professor Zachary Douglas, supported such a position in a dissenting opinion in Mathias Kruck and others v. Kingdom of Spain.
In summary, this position adopted by the Scholz tribunal is confirmed by certain recent treaty clauses (e.g., here and here) intended to dispel any possible allegation of frustration of legitimate expectations.
Note
The tribunal was composed of Alexis Mourre (president, French national), Professor Nassib G. Ziadé (claimant’s appointee, Chilean and Lebanese national), and Professor Zachary Douglas KC (respondent’s appointee, Australian national)
Author
Issiaka Guindo is a doctoral student at the Sorbonne Doctoral School of Law.