Legitimate expectations and state assurances: a look at the protection of predictability and stability of the legal framework for international construction projects

Indira GomesTuesday 7 December 2021

Credit: stsdiiozean/Shutterstock

This article analyses the problem of legitimate expectations in the context of the fair and equitable treatment standard. The arbitral cases reflect the importance of commitments made by states to investors, which affect their reliance on the stability of the projects’ legal framework. There is a balancing exercise that needs to be conducted by arbitral tribunals that requires a review of all the relevant aspects of the case. Arbitral awards have not been consistent in their assessment of the protection of legitimate expectations. Investors should therefore be cautious in their approach to possible claims, anticipating the uncertainties of such disputes.

Introduction

As with most business projects in foreign territories, major international construction projects have their daily activities exposed to the host state’s local laws, policies and public opinions.[1] However, should abrupt changes to the host state’s laws and regulations which alter the feasibility and the profitability of projects be considered part of the investors’ business risk? Should investors bear the risk of non-transparent or inconsistent regulatory requirements?

Considering the risk of instability and unpredictability of the legal and regulatory framework affecting international construction projects, this article analyses the extent to which contractors, as investors, can rely on the fair and equitable treatment (FET) protection deriving from investment treaties. In cases where the host state has made specific commitments, how should investors’ legitimate expectations be protected?

Changes to the regulatory and legal framework may result in delays, loss of profit and partial or total impossibility of the project

Contracts between participants in international construction projects and states typically cover complex infrastructures such as roads, bridges, airports and energy facilities. These projects are often maintained by long-term agreements, where the stability of the framework is essential for the feasibility of the project. Changes to the regulatory and legal framework may result in delays, loss of profit and partial or total impossibility of the project. Some changes in the regulatory framework could require additional works (eg, to meet new environmental and safety standards), increase the cost of resources or require the payment of additional taxes. In these circumstances the investor might not have a contractual claim against a contracting state party but might be protected under the relevant investment treaty.[2]

Although the risks of unpredictability and changes in the laws are perceived primarily as a concern in emerging countries, recent awards in the renewable energy field in Europe demonstrate that the problem can also arise in developed countries, which are often deemed to have a more stable and predictable regulatory framework.[3] For instance, the 2016 referendum in the United Kingdom, in which the country voted to leave the European Union, has urged a debate regarding the possibility of claims of violation of foreign investors’ legitimate expectations by the UK.[4]

This article aims to examine how investors in the construction industry could benefit from the protection of legitimate expectations. This is achieved mainly by assessing how arbitral awards have decided previous cases, so as to define patterns that could assist industry stakeholders in structuring claims in investment treaty law.

These claims are not only relevant to contractors. Other industry stakeholders, such as suppliers, developers and funders, may also benefit from understanding the limits and boundaries of treaty claims under the protection of legitimate expectations.

Legitimate expectations as an element of Fair and Equitable Treatment

In most cases, the protection of legitimate expectations is not explicitly mentioned in treaties. Investors rely on the open nature of FET as a standard capable of substantive protection that covers multiple situations. For example, an alleged breach of FET could relate to: a lack of procedural fairness and transparency in the access to justice;[5] legitimate expectations that the host state would comply with provisions of the concession contract;[6] changes in the tax and duties law which affected the project’s economic environment;[7] rejection of payment of invoices due to the investors’ non-compliance with an atypical local procedure;[8] and lack of transparency for the denial of construction permits.[9]

In the absence of uniformity in the domestic law systems of a doctrine of legitimate expectations, tribunals refrain from transposing the doctrine as a principle of international law.[10] The favoured approach of tribunals in assessing the protection of legitimate expectations is by considering the relevant circumstances of an alleged breach of FET.[11] The liability threshold for failure to accord FET is therefore assessed by considering the applicable rules of interpretation of the treaty and the circumstances of the case. The following situations can be used to introduce this concept.

A developer made several visits to a foreign country to construct a city in an area designated for agricultural use.[12] The developer acquired the land and signed an investment contract with the nation’s foreign investment committee. However, after the investor initiated its investment, the project was refused due to its failure to comply with the country’s urban development policy.

In another situation, a developer signed an urbanistic agreement with the state related to the requalification of land, in which the former would invest to build a residential complex.[13] After signing the agreement, the developer bought the land with the expectation of specifying it for residential use. However, the project was subsequently cancelled because the government did not conduct the required revision of the urban planning.

In the two cases described above, the investors initiated a dispute against the state for an alleged breach of FET through the frustration of legitimate expectations. The first investor was partially successful in its claim. The tribunal held that the state breached its obligation to accord FET by approving an investment for a project contrary to the government’s urban policy.[14] The second case was dismissed because the sole arbitrator considered that the commitment made by the state was a mere possibility and not sufficiently clear to generate legitimate expectations.[15] As will be seen, not all commitments create the protection of legitimate expectations, and the particular circumstances of each case also have a significant role in the decisions.

The protection of legitimate expectations where the host state made specific commitments

The state’s sovereign right to amend its laws and regulations is not unrestricted. Arbitral tribunals generally accept that when the state has made specific commitments to the investor, the latter may have legitimate expectations that the legal framework will not change.[16] For example, some tribunals consider that specific commitments can be found in general laws and regulations.[17] The problem is that tribunals are not always consistent in their assessment of what constitutes a specific commitment for the purposes of determining a reasonable reliance.[18]

One of the aspects discussed by arbitral tribunals to assess if the protection of legitimate expectations exists is the level of formality of the state’s representations. The Tribunal in White Industries v India held that statements by government officials regarding India’s legal system ‘do not come close to meeting the standard required’.[19] A similar assessment was made in Charanne v Spain, where the majority of the tribunal rejected that general documents, press releases, presentations and reports distributed to attract potential investors could generate legitimate expectations.[20] Conversely, the Continental v Argentina tribunal concluded that political statements ‘have the least legal value’.[21]

In Crystallex v Venezuela, the tribunal analysed the value of different types of representations made in various forms and contexts.[22] In this case, the investor faced difficulties obtaining an environmental permit and relied on assurances made by high-level government officials. The permit was ultimately denied, and the investor claimed a breach of legitimate expectations. The tribunal assessed two types of representations: general statements made by politicians and a letter sent by the relevant ministry. The tribunal concluded that the politicians’ general promises that the project would be successful could not generate legitimate expectations.[23] On the other hand, a letter sent by the relevant ministry, clearly making reference to an evaluation process having been carried out, and stating that ‘once the Bond has been posted […] the permit will be handed over’ was the determinant to the finding of infringement of legitimate expectations.[24]

Not all commitments create the protection of legitimate expectations

These cases seem to infer that it is unreasonable for investors to rely on representations made in a political context, as it’s not uncommon for politicians to break promises. On the other hand, a formal document signed by a government representative could be sufficient to generate some protection, depending on how explicit and unambiguous its terms are.

Investors should not rely on implicit terms. For example, in Toto v Lebanon,[25] the contractor signed a contract with the state in a road construction project. The contractor claimed, among other things, that the state changed the project regulatory framework, in particular, that the Lebanese custom duties on cement, building materials, diesel and steel unreasonably increased. Toto based its argument on the fact that the government agency, through the tender documents, required the contractor to examine all Lebanese laws and argued that it was implied that the project would be subject to the Lebanese tax legislation at the time the contract was signed.[26] The tribunal denied the existence of a specific commitment in the case, and the contractor failed to establish that the state acted in a drastic and discriminatory manner.[27]

Tribunals have been adopting a cautious approach when the state’s right to regulate is in question. To generate a protection of legitimate expectations a statement must purposely and specifically induce the investment.[28] It is common in international projects for government agencies to require the bidding companies to examine local laws before submitting a proposal. Although the investor might expect and desire that the laws remain unchanged, a protection of legitimate expectations will rarely materialise without a specific commitment or some sort of stabilisation clause in the contract.[29] The critical aspect is not so much that the assurance exists in a legally binding document but that it contains a clear commitment directly made to induce the investor.[30] This is particularly relevant for the construction industry, where participants often rely on verbal representations. In El Paso v Argentina, the tribunal confirmed that the investor could rely on different forms of commitments, such as a letter of intent or a promise made in a face-to-face business meeting.[31]

In very specific circumstances, tribunals have found that general laws could generate legitimate expectations. The recent case Masdar v Spain[32] concerned the change of legislation specifically enacted to encourage investments in Spain’s renewable energy sector. Through these laws, Spain guaranteed the stability of benefits if the investors registered the investment with the relevant authority and complied with the required conditions over a particular time period. The Masdar tribunal decided that Spain breached its FET obligations since the claimant had registered the investment and complied with all the conditions regarding the plant’s construction.[33] In this case, it was determinant that the investor sought and received specific confirmation from the state that the project would benefit from the laws which were later modified.[34]

However, similar facts were assessed by the Charanne v Spain tribunal, which considered the registration to be a mere administrative requirement and rejected the claim.[35] This demonstrates how unpredictable the outcome of claims can become without a doctrine of precedent in arbitral jurisprudence. The two cases were related to the same country, and their source was the Energy Charter Treaty. Investors should take into account the possibility of such contradictions before pursuing a claim.

It is not always easy to determine which commitment weighted more in the tribunal’s decision. This is due to the lack of step-by-step reasoning from most tribunals in assessing the value of representations.[36] Nonetheless, a review of the cases provides some indication of what type of characteristics a representation should have to be reasonably relied on by investors. The most important point to retain is that not every contractual commitment, representation or assurance can generate legitimate expectations. Arbitral tribunals tend to dismiss representations made in a political context, especially when they are made to induce an indeterminate number of possible investors. The level of inducement is connected to the specificity of the commitment made by the host state. Tribunals generally consider that such commitments should be unambiguous and addressed to the specific investor.

Assumption of risk under host state circumstances

In some cases, arbitral tribunals have regarded the host state’s economic, social and political circumstances as an essential part of their assessment of legitimate expectations.[37] In this sense, tribunals will consider the circumstances when the investment was made, what information the investor had or should have reasonably had and if the investors acted diligently.[38] In undertaking such an exercise, tribunals generally consider the information and conditions available to the investors when they decided to invest and refrain from assessing the protection of legitimate expectations with the use of hindsight.[39]

For example, the Genin v Estonia tribunal stated that it would consider the fact that the investor knowingly decided to invest in a ‘renascent independent state, coming rapidly to grips with the reality of modern financial, commercial and banking practices’.[40] The assessment of whether an investor could have objectively relied on an existing legal framework should entail considerations of what the investor knew or ought to have known about the country’s situation.

In Bayindir v Pakistan a contractor signed a concession contract with a public authority to construct a road in Pakistan.[41] Disputes arose pertaining to claims for payment and extension of time. Some claims were settled between the parties, and an addendum to the contract was concluded. After the addendum, disputes continued, and the public authority decided to terminate the contract and expel the contractor. Concerning the violation of the FET standard, the investor alleged that the termination of the concession contract frustrated its legitimate expectations because the leader in power made several assurances that the government would continue to support the project.[42] The tribunal decided that the investor should not have ignored the ‘volatility of the political conditions’ existing in Pakistan when it agreed on the addendum to the contract and that the future of the project was connected to the changes affecting the state’s politics.[43]

In another case, a contractor signed a contract with a municipality to construct and operate a public car park system.[44] After the agreement had been signed, the state enacted several laws that changed the possibility of the investor to charge fees to the public, which would financially affect the project. The investor claimed that the changes in the laws frustrated its legitimate expectations. The investor’s allegations were dismissed as the tribunal specifically noted that the political and social circumstances in the country, which was transitioning to the EU, could not justify legitimate expectations concerning the stability of the investment.[45]

A review of the cases demonstrates that the context of the host state in which the investor decided to invest is deemed by arbitral tribunals as a fundamental aspect of the protection of legitimate expectations. The open nature of the FET standard supports this view in the sense that what would be unfair and inequitable in normal circumstances might not be the situation in economic or social crisis.

Another important aspect relating to the circumstances of the host state is the assessment of regulatory risk for the construction and operation of projects with high environmental impact. For example, in Methanex v USA, the tribunal held that the investor could not have expected that the state of California’s regulations would remain unchanged as the investor knew that there were environmental concerns.[46] In this case, the claimant, a Canadian producer of methanol, challenged Californian legislation that banned the production of petrol containing methanol-based additives on environmental grounds. The investor claimed a violation, inter alia, of NAFTA’s FET obligation, arguing that the ban was unjustified, destroyed its market and discriminated in favour of the United States’ domestic ethanol industry.[47] Similarly, in Glamis Gold v USA, the claim of infringement of legitimate expectations partly failed because the location where the claimant was operating was sensitive to the environmental consequences of mining operations.[48]

Arbitral tribunals presume that the ‘investor is an experienced and savvy businessman’ who normally carries out due diligence concerning the investment framework.[49] Risk is one of the elements that flow from the business and assist tribunals in identifying investments protected under the treaty.

In Maffezini v Spain, the investor claimed that a state entity responsible for offering information to investors provided an inaccurate feasibility study.[50] The investor also claimed that it was pressured by state officials to start investing in the project without having completed an Environmental Impact Assessment. The tribunal dismissed both claims, stating that treaties are not insurance policies against bad business decisions and that the deficiencies of the state’s actions could not be deemed to relieve the investor from risks inherent to the investment. The tribunal also held that ignorance of local laws should not be counted as a defence.[51]

The Masdar v Spain case, regarding the installation and operation of renewable energy plants, provided some guidance on what might be considered a good example of acceptable due diligence for the purposes of generating the protection of legitimate expectations.[52] In this case, the investor had: (1) commissioned external reports; (2) engaged in multiple discussions with the local partner, which had detailed knowledge of the regulatory framework; and (3) had extensive discussions with the local banks and law firms. The tribunal was satisfied that the investor had exercised the required due diligence and that its legitimate expectations were reasonable in light of the circumstances.[53]

Conclusion

The ambiguity and flexibility of the FET standard allows arbitral tribunals to assess the protection of legitimate expectations concerning a variety of state conduct. It may therefore seem attractive to investors to claim breach of legitimate expectations due to its comprehensive scope. However, the vagueness of the protection conferred by the standard creates uncertainties.

There are inconsistencies in arbitral awards regarding how the investor’s reliance should be assessed. For instance, there is still much debate regarding the formality, certainty and specificity of assurances required to induce the investor. The assessment of what the investor knew or should have known regarding the circumstances of the host state has also led to different results in the finding of liability. This lack of clarity contributes to the unpredictability of the outcome of claims based on alleged violations of the investor’s legitimate expectations.

The vagueness of the protection conferred by the standard creates uncertainties

Notwithstanding the above, some aspects have been consistently considered by arbitral tribunals, which may guide investors as to what to expect (or what not to expect) from the protection of legitimate expectations.

First, investors should not expect to be protected under the concept of legitimate expectations against damages arising from changes to the general legislation of the host state. Unless the state made specific assurances, investors should not rely on the existing legal framework. Likewise, general statements made by politicians or government officials may not be relied upon.

Second, the level of inducement is connected with the specificity of the commitment made by the host state. Participants may rely on verbal representations so long as the commitments are clear, unambiguous and addressed to the specific investor.

Third, arbitral awards generally presume that investors will assume a certain degree of risk associated with their investment. They are required to perform due diligence to assess the requirements of local laws and the country’s economic, political and social circumstances.

Overall, there is a balancing exercise that needs to be conducted by arbitral tribunals, which requires an assessment of all the relevant aspects of the case. Such an exercise will weigh the right of the state to adopt measures in the public interest against the expectations of the investor arising from representations made by the state. Ultimately, investors’ expectations will only be deemed reasonable if the liability threshold to accord FET has been reached. The overall expectations of investors regarding their protection from states’ assurances under FET should therefore be as strict as possible in order to anticipate the uncertainties of treaty claims. The high profile of investor–state disputes makes them costly and slow, and consequently, investors should adopt a conservative approach in their assessment of possible claims.

 

[1] Noah Rubins and N Stephan Kinsella, International Investment Political Risk and Dispute Resolution. A Practicioner’s Guide (Oceana Publications 2005), p 3.

[2] See, eg, MTD Equity Sdn Bhd and MTD Chile SA v Republic of Chile, ICSID case No ARB/01/7 Award (25 May 2004) and Walter Bau AG v Kingdom of Thailand, UNCITRAL, Award (1 July 2009).

[3] See, eg, Antin Infrastructure Services Luxembourg Sàrl. and Antin Energia Termosolar BV v Kingdom of Spain, ICSID case No ARB/13/31 (15 June 2018), Eiser Infrastructure Limited and Energía Solar Luxembourg Sàrl v Kingdom of Spain, ICSID case No ARB/13/36 (4 May 2017).

[4] Aymar de Fleurieu, ‘Brexit and Legitimate Expectations: A Case for Foreign Investors?’ in Jennifer Hillman and Gary Horlick (eds), Legal Aspects of Brexit. Implications of the United Kingdom’s Decision to Withdraw from the European Union, (Institute of International Economic Law 2017) p 287.

[5] ATA Construction, Industrial and Trading Company v The Hashemite Kingdom of Jordan, ICSID case No ARB/08/2 (7 March 2011).

[6] See Walter Bau v Thailand, Mondev v United States, ICSID case No ARB(AF)/99/2; Duke Energy Electroquil Partners & Electroquil SA v Ecuador, ICSID case No ARB/04/19, Award (18 August 2008); Waste Management v Mexico, ICSID case No ARB(AF)/00/3.

[7] See MTD v Chile and Biwater Gauff (Tanzania) Ltd v United Republic of Tanzania (ICSID case No ARB/05/ 22, Award of 24 July 2008).

[8] Garanti Koza LLP v Turkmenistan, ICSID case No ARB/11/20 (19 December 2016).

[9] Tecnicas Medioambientales Tecmed SA v The United Mexican States, case No ARB (AF)/00/2, Award (29 May 2003).

[10] ICJ Judgment of 1 October 2018, paras 160–62.

[11] Crystallex International Corporation v Bolivarian Republic of Venezuela, ICSID case No ARB(AF)/11/2 (4 April 2016), para 546.

[12] See n 7 above.

[13] See Inversión y Gestión de Bienes, IGB, SL and IGB18 Las Rozas, SL v Kingdom of Spain, ICSID case No ARB/12/17 (14 August 2015).

[14] See n 7 above, at para 166.

[15] See n 13 above, at para 137.

[16] Masdar Solar & Wind Cooperatief UA v Kingdom of Spain, ICSID case No ARB/14/1, paras 489–91.

[17] See, eg, Suez, Sociedad General de Aguas de Barcelona SA, and InterAguas Servicios Integrales del Agua SA v The Argentine Republic, ICSID case No ARB/03/17 (30 July 2010), paras 222–23.

[18] See n 16 above, at paras 489–91.

[19] White Industries Australia Ltd v The Republic of India, Final Award (30 November 2011), para 5.2.6.

[20] Charanne and Construction Investments v Spain, SCC case No V 062/2012 (21 January 2016), paras 491–508.

[21] Continental Casualty Co v Argentina, ICSID case No ARB/03/9, Award (5 September 2008), para 261.

[22] Crystallex International Corporation v Bolivarian Republic of Venezuela, ICSID case No ARB(AF)/11/2 (4 April 2016), paras 487, 546–575.

[23] Ibid, para 553.

[24] See n 22 above, paras 562–64.

[25] Toto Costruzioni Generali SPA v Republic of Lebanon, ICSID case No ARB/07/12, Award (7 June 2012).

[26] Ibid, paras 239–46.

[27] Ibid.

[28] Glamis Gold, Ltd v The United States of America, UNCITRAL (8 June 2009), para 766.

[29] In this respect, see, eg, Katja Gehne and Romulo Brillo, ‘Stabilization Clauses in International Investment Law: Beyond Balancing and Fair and Equitable Treatment’, Working Paper No 2013/46, Swiss National Centre of Competence in Research, 2014, pp 28–29.

[30] El Paso Energy International Company v The Argentine Republic, ICSID case No ARB/03/15, Award (31 October 2011) para 376.

[31] Ibid.

[32] See n 16 above.

[33] See n 16 above, paras 511–22.

[34] Ibid.

[35] See n 20 above, paras 491–508.

[36] Yulia Levashova, The Right of States to Regulate in International Investment Law: The Search for Balance Between Public Interest and Fair and Equitable Treatment (Wolters Kluwer 2019), p 247.

[37] See, eg, Bayindir Insaat Turizm Ticaret Ve Sanayi AS v Islamic Republic of Pakistan, ICSID case No ARB/03/29, Decision on Jurisdiction (14 November 2005) and Parkerings-Compagniet AS v Republic of Lithuania, ICSID case No ARB/05/8, Award (11 September 2007).

[38] See n 3 above, Antin v Spain, at para 537.

[39] Ibid.

[40] Genin, Eastern Credit Ltd, Inc and AS Baltoil v The Republic of Estonia, ICSID case No ARB/99/2 (25 June 2001), para 348.

[41] See n 37 above, Bayindir v Pakistan, at paras 190-199.

[42] Ibid.

[43] Ibid.

[44] See n 37 above, Parkerings v Lithuania paras 87–9.3 and IGB v Spain, para 140.

[45] See n 37 above, Parkerings v Lithuania, para 335.

[46] Methanex Corporation v USA, UNCITRAL (3 August 2005), Chapter D, para 9.

[47] Ibid.

[48] Glamis Gold, Ltd v USA, UNCITRAL (8 June 2009), para 767.

[49] Saluka Investments BV v The Czech Republic, UNCITRAL, IIC 209 (17 March 2006), pp 79–80.

[50] Emilio Agustín Maffezini v The Kingdom of Spain, ICSID case No ARB/97/7 (13 November 2000), para 58.

[51] Ibid, paras 65–70.

[52] See n 16 above, Masdar v Spain, paras 497–99.

[53] Ibid.

Indira Gomes is a legal consultant for TIMOR GAP, EP. She can be contacted at gomes.indira@gmail.com

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