The Only Thing We Have to Fear About Judicial Expropriation is the Fear of It

[Martin Jarrett is a Senior Research Fellow at the Max Planck Institute for Comparative Public Law and International Law.]

In a recently published arbitral award coming from an investor-state arbitration, the arbitral tribunal made a rare confession: it was uncomfortable with its decision finding that the state was not internationally responsible for its conduct.

The case was Krederi v. Ukraine. Although the statement of facts is heavily redacted, it is clear enough that the investor purchased blocks of land from Kiev City Council. These transactions were subsequently unwound by the Ukrainian courts. The reason for this unwinding was that there were deficiencies in the process followed by Kiev City Council in selling the land. But this unwinding was only partial. While title to the blocks of land was returned to Kiev City Council, the purchase prices were not refunded to the investor.

It looked like a textbook case of expropriation: the investor had assets, the state took them, and the investor was left with nothing. This explains the arbitral tribunal’s discomfort. To expunge itself from blame for its decision, it invoked a coercion-like defense to the effect that the existing jurisprudence tied its hands; in other words, this decision was a logical consequence of applying this jurisprudence.  It also sought to alleviate its discomfort by noting that there was some chance that the Ukrainian courts would order a refund to the investor in the future. For an investor who had already turned to the process of investor-state arbitration to obtain a refund, this optimism would have, at best, offered a little comfort or, at worst, left it infuriated.

Considering the expense of pursuing investor-state arbitration, the latter feeling was probably the predominant one. And the investor was right to feel this way. It must have asked itself: how can an arbitral tribunal, which is applying a body of rules dedicated to ensuring good governance practices in respect of investments, condone the taking of an investment without compensation?

Here is the answer: there is a phobia of judicial expropriation within the ranks of arbitrators. And by framing Ukraine’s conduct as a potential case of judicial expropriation, counsel for Ukraine presumably played on this phobia to deliver an, in the words of the arbitral tribunal, ‘unsatisfactory’ decision. Until this phobia is cured, it should be expected that such unsatisfactory decisions will continue to be handed down. This blogpost seeks to start the discussion on finding a cure. The first step in that process is the diagnosis of the illness.

I: The Diagnosis

A phobia consists of two elements: one, an irrational and persistent fear of a particular thing and, two, the performance of irrational acts to avoid that thing. For present purposes, the thing is making findings of judicial expropriation. And the act of choice for avoiding that thing is requiring that the court not only take an investment, but also requiring that that process of taking involve a serious procedural illegality. Because a serious procedural illegality was lacking in Krederi v. Ukraine, this entailed the rejection of the investor’s expropriation claim.

What makes this additional requirement irrational is that it has no doctrinal legs to stand on. Looking at the clause embodied in the expropriation standard in the applicable investment treaty, there is nothing to the effect that the taking process must be tainted by a serious procedural illegality. In fact, a search for similar language in any investment treaty would be futile. That is not to say that arbitral tribunals cannot read in additional elements, but this practice must be consistent with the nature of the rule question. In respect of the standard on expropriation, reading in a requirement for a serious procedural illegality is not consistent. A good indicator of the truth of this premise is that there is no similar requirement for expropriations carried out by the executive or legislative arms. The basic rule is: if executive or legislative conduct causes a loss of title over or the complete or substantial devaluation of an investment, then it is an expropriatory act. The state can plead a host of defenses to justify its expropriatory conduct, thereby avoiding international responsibility for it, but the basic point remains that merely causing one of these consequences is prima facie wrongful. The jurisprudence on executive expropriation and legislative expropriation recognizes this point. But the jurisprudence on judicial expropriation defies it by asking for ‘more wrongfulness’ in the form of a requirement for a serious procedure illegality. 

The proponents of this jurisprudence would justify this defiance on two grounds, which in turn serve as the reasons for the general fear of judicial expropriation. As demonstrated below, neither reason is valid.

First, in the absence of this requirement, state responsibility for judicial conduct would be indeterminate. Specifically, whenever a court orders that an investor turnover assets to another person, the investor could seek compensation in investor-state arbitration using the standard on expropriation, regardless of the merit of the decision under domestic law. But this line of thinking suffers from a fundamental flaw: it misunderstands the concept of cause. For when a court applies existing law in a legal dispute and that application results in an order requiring that an investor transfer its title over certain assets to another person, it seemingly causes that consequence. But this judicial conduct is not causal conduct. Causal conduct is voluntary conduct. In law, if a person’s conduct is directly controlled by another person, it is not voluntary. This judicial conduct is not voluntary because it is directly controlled by another arm of government, presumably the legislature. That arm of government makes the law and that law directs courts on how to resolve legal disputes falling within its scope. Then the courts have the duty to faithfully apply it, as per the core tenet of the rule of law for congruence between official action and declared rule.

Although this theory quells the protest about indeterminate state responsibility, it is briefly worth asking: does that mean the original making of the law, which is being applied by the courts, by the legislature is expropriatory? Potentially. But, in most cases, no. The doctrine on adverse possession from Anglo-American property law can illustrate this point. The core of this doctrine holds that if a person, other than the owner, continually possesses land for a substantial period of time with the owner’s knowledge and without his or her consent, then that person can apply for title to be transferred over to him or her. If the owner loses his or her land after a court approves such an application, he or she cannot point to the operation of the doctrine as the cause. Causal responsibility rather falls on his or her shoulders because he or she failed to comply with the rule, which could easily have been achieved by ordering that the adverse possessor vacate the land. What this example illustrates is a more general principle that if an investor loses an investment by application of the law and it could have complied with that law, then causal responsibility for that loss falls on it. Applying all of this theory, the process of courts applying the law is not potentially expropriatory and nor, in most cases, is the act of making the same law. Accordingly, the fear of indeterminate state responsibility is an illusory one.

But there is another justification for avoiding findings of judicial expropriation. And it is more formidable than the first justification, namely that making findings of judicial expropriation looks like international appellate review of domestic decisions. It is a cliché line, but it is a particularly apt reply to this objection: appearances can be deceiving.

The core of appellant review is error correction. Appellate courts examine decisions of inferior courts to determine whether those decisions are entailed by the applicable substantive law, properly applied and interpreted. 

The focus of the application of the concept of judicial expropriation is different. As explained above, the standard on expropriation is concerned with state conduct causing a transfer of title over or the complete or substantial devaluation of an investment, meaning that the question when applying judicial expropriation is: has the court caused one of these consequences? Answering that question does not involve error correction. Remembering that making law is potentially expropriatory because it is causal conduct, the focus when applying judicial expropriation is squarely on whether the court changed existing law. Just as when the legislature changes existing law and it causes one of these consequences, because the investor cannot comply with the law, the judicial arm should be held accountable for its changes to the law. 

II: The Cure

If this principle is not insisted on and the judicial arm is viewed as a sacred cow, states will milk it for all it is worth by channeling potentially expropriatory actions over to it. Whether by design or otherwise, this is what happened in Krederi v. Ukraine; in other words, the situation was characterised as one where the author of the investment loss was the Ukrainian courts. 

The outcome in this case should have been that there was a legislative expropriation and the Ukrainian courts’ role was that they put this expropriatory process into effect. The court applied statutory law and that application entailed that the transations for purchasing the land had to be unwound. That outcome owed nothing to non-compliance with the law by the investor, but it was rather on account of conduct of Kiev City Council because it failed to follow the correct procedures when making these transactions. Given this conclusion, the real question in this case asked: was the expropriation lawful? Without a full account of the facts, this question is difficult to answer. One comment, however, is that if Ukrainian law required the refunding of the purchase price, which the arbitral award hints at, the answer must be ‘no’ because the expropriation would not have been carried out in accordance with due process. Rather than being a case of no expropriation, Krederi v. Ukraine seemingly involved an unlawful expropriation.

To avoid future similar injustices, a cure to the phobia of judicial expropriation must be found. Like all phobias, one effective medicine is talking about the problem, and this blog entry hopes to start the conversation. Once the problem is aired and understood, it should be seen that the only thing we have to fear about judicial expropriation is the fear of it.