BCDR-AAA/SCC JOINT CONFERENCE Salient Issues in Investment Arbitration The State’s Right to regulate v. the Protection of Foreign Investments 18 November 2018 – Manama, Bahrain Presented by Counselor/ Mahmoud El khrashy Legal Adviser Bahraini Ministry of Foreign Affairs (“MOFA”)

Police Powers and Regulatory Rights Doctrine of police powers II. Sources of the state’s police powers and regulatory rights III. The rise of competing concepts A. Legitimate expectations of the investor B. Stability of the legal framework of the investment C. The consequences of broadening the scope of such competing concepts IV. The balance between States’ regulatory powers and States’ obligations to protect foreign investment V. Conclusion

I. Doctrine of police powers The doctrine was articulated in the Third Restatement of the Foreign Relations Law of the United States of 1987 in the following terms: “A State is not responsible for loss of property or for other economic disadvantage resulting from bona fide general taxation, regulation, forfeiture for crime, or other action of the kind that is commonly accepted as within the police powers of states, if it is not discriminatory”.

II. Sources of State’s Police Powers and Regulatory Rights International Conventions & Treaties Customary International Law Case Law

II. Sources of State’s Police Powers and Regulatory Rights A. International Conventions & Treaties The 2004 and 2012 U.S. Model BITs provided that: “Except in rare circumstances, non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health, safeties, and the environment, do not constitute indirect expropriations”. Similar provisions were adopted by the 2004 and 2012 Canada Model BITs, Protocol 1 to the European Convention on Human Rights and EU-Canada Comprehensive Economic and Trade Agreement.

II. Sources of State’s Police Powers and Regulatory Rights B. Customary International Law According to the OECD, “[i]t is an accepted principle of customary international law that where economic injury results from a bona fide non-discriminatory regulation within the police power of the State, compensation is not required”. In Saluka v. Czech Republic & Sedco v. Nioc, the tribunal confirmed that such principle forms part of customary international law.

II. Sources of State’s Police Powers and Regulatory Rights C. Arbitral Decisions The Tribunal in Lauder v. Czech Republic adopted such principle stating that: “…. Parties to [the Bilateral] Treaty are not liable for economic injury that is the consequence of bona fide regulation within the accepted police powers of the State”. In Philip Morris v. Uruguay and Methanex v. USA, the Tribunals confirmed that such principle is “a matter of general international law”.

III. The Rise of Competing concepts under FET Standard The protection of legitimate expectations of the investor The Stability of the legal framework of the investment The consequences of broadening the scope of such competing concepts

III. The Rise of Competing Concepts under FET Standard A. The Legitimate Expectations of the Investor In his Separate Opinion in Thunderbird v. Mexico, Thomas Wälde noted that: “There had been a significant growth in the role and scope of the legitimate expectation principle, from an earlier function as a subsidiary interpretative principle… to its current role as a self- standing subcategory and independent basis for a claim under the “fair and equitable standard”.

III. The Rise of Competing Concepts under FET Standard A. The Legitimate Expectations of the Investor Some Investment Tribunals broadened the scope of such concept. In Tecmed v. Mexico, the tribunal went as far as to state that: “The foreign investor expects the host State to act in a consistent manner, free from ambiguity and totally transparently in its relations with the foreign investor, so that it may know beforehand any and all rules and regulations that will govern its investments, as well as the goals of the relevant policies and administrative practices or directives, […] The foreign investor also expects the host State to act consistently, i.e. without arbitrarily revoking any preexisting decisions or permits issued by the State that were relied upon by the investor…”.

III. The Rise of Competing Concepts under FET Standard B. The Stability of the Legal Framework of the Investment The tribunal in Occidental v. Ecuador confirmed that: “Stability of the legal and business framework is … an essential element of fair and equitable treatment” and “there is certainly an obligation not to alter the legal business environment in which the investment has been made”. In Duke Energy v. Ecuador, the tribunal emphasized that the stability of legitimate and trading space has been tied directly to the justifiable expectations of the investor.

III. The Rise of Competing Concepts under FET Standard C. The Consequences of Broadening the Scope of such Competing Concepts 1. Freezing governmental policy If the cost of adopting new policies is high, governments shall abstain from pursuing such policies. 2. Crippling the developing States’ ability to adopt legislative reforms In El Paso v. Argentina, the Tribunal observed: “… it is unthinkable that a State could make a general commitment to all foreign investors never to change its legislation whatever the circumstances, and it would be unreasonable for an investor to rely on such a freeze."

III. The Rise of Competing Concepts under FET Standard C. The Consequences of Broadening the Scope of such Competing Concepts 3. Preventing host States from fulfilling their international obligations If the challenged measures adopted by the host state are in compliance with their obligations under international law (whether environmental, health, labor or any other obligations), such measures cannot be considered expropriatory or in breach of international law.

IV. The Interaction between States’ Regulatory Powers and States’ Obligations to protect and promote Foreign Investment within their Territory Police Powers and Indirect Expropriation Police Powers and FET

IV. The Interaction between States’ Regulatory Powers and States’ Obligations to protect and promote Foreign Investment within their Territory B. Police Powers and FET To what extent the foreign investor is entitled to expect that national law is not going to change after it has performed its investment? First Approach: expectations are based solely on the existence of a particular legal framework at the time of investment. Second Approach: more restrictive, expectations require a specific representation to have been made by the host state. Third Approach: Expectations must take into account all circumstances and specifities of the case.

B. Police Powers and FET First Approach: expectations are solely based on the existence of a particular legal framework per se at the time of investment. The tribunal in Occidental v. Ecuador confirmed that: “Stability of the legal and business framework is … an essential element of fair and equitable treatment” and “there is certainly an obligation not to alter the legal business environment in which the investment has been made”. If the legal framework governing the investment changes in a way that was not anticipated or foreseen by the investor at the time of making the investment, then the investor should be compensated for the cost of complying with those changes (Early Argentine cases of CMS v. Argentina, LG&E v. Argentina & Ernon v. Argentina)

B. Police Powers and FET Second Approach: expectations of stable legal framework require a specific representation to have been made by the host state. In parkerings v. Lithuania, the Tribunal confirmed that: “It is each state’s undeniable right and privilege to exercise its sovereign legislative power. A state has the right to enact, modify or cancel a law at its own discretion. Save for the existence of an agreement, in the form of a stabilization clause or otherwise, there is nothing objectionable about the amendment brought to the regulatory framework existing at the time an investor made its investment.”

B. Police Powers and FET Second Approach: expectations of stable legal framework require a specific representation to have been made by the host state. The Tribunal in EDF v. Romania has stated in this regard: “Except where specific promises or representation are made by the State to the investor, the latter may not rely on a bilateral investment treaty as a kind of insurance policy against the risk of any changes in the host State’s legal and economic framework. Such expectation would be neither legitimate nor reasonable”. This approach was pursued in Slauka v. Czech Republic, and the later Argentine cases of Continental & Total.

B. Police Powers and FET Third Approach: expectations of stable legal framework are subject to further qualifying requirements. 1-Degree of change of law (drastic or severe). In El Paso case, the Tribunal stated that: “There can be no legitimate expectation for anyone that the legal framework will remain unchanged in the face of an extremely severe economic crisis. No reasonable investor can have such an expectation unless very specific commitments have been made towards it or unless the alteration of the legal framework is total.” 2- Level of development of the host state. In Parkerings case, the Tribunal stated that : “no expectation that the laws would remain unchanged was legitimate” especially if “the country was one in transition at the time of the investment”.

B. Police Powers and FET Third Approach: Expectations must take into account all circumstances and specificities of the case. 3-Whether the change in law was discriminatory or not. In Parkerings case, the Tribunal stated that: “The record does not show that the State acted unfairly, unreasonably or inequitably in the exercise of its legislative power. The Claimant has failed to demonstrate that the modifications of laws were made specifically to prejudice its investment.” 4- Whether the change in law was reasonable or not. In Impergilo v. Argentina, the Tribunal stated that: “The legitimate expectations of foreign investors cannot be that the State will never modify the legal framework, especially in times of crisis, but certainly investors must be protected from unreasonable modifications of that legal framework.”

Conclusion Policy makers should emphasize the State’s Regulatory rights and define the exact content FET provisions when negotiating IIAs and FTAs. Arbitral Tribunals should adopt more balanced approach which does not encroach on the State’s regulatory rights, such as the approach adopted by the Tribunal in Parkerings v. Lithuania: “no expectation that the laws would remain unchanged was legitimate”.

BCDR-AAA/SCC JOINT CONFERENCE Salient Issues in Investment Arbitration The State’s Right to regulate v. the Protection of Foreign Investments 18 November 2018 – Manama, Bahrain Presented by Counselor/ Mahmoud El Khrashy Legal Adviser Bahraini Ministry of Foreign Affairs (“MOFA”)