The draft investment text in the Trans-Pacific Partnership (TPP) negotiations, which was leaked yesterday (June 13) by a U.S. civil society group, reveals that TPP countries are offering up radically different visions when it comes defining when a specific government action constitutes "indirect expropriation" of a company's property.

This is a key issue in the investment negotiations because companies will be able to launch legal challenges under the investor-state dispute settlement provisions of a final TPP deal if they believe a government action amounts to a direct or indirect expropriation of a covered investment.

Therefore, the exact definition of "indirect expropriation" is critical to defining the breadth of challenges that companies will be able to launch against government actions. The concept of direct expropriation, such as outright seizure of property, is more straightforward and less controversial.

According to the leaked text, countries have agreed to include the concept of indirect expropriation in a TPP deal. General provisions in Article 12.12 of the leaked investment text prohibit any signatory from expropriating or nationalizing a covered investment either "directly or indirectly."

But TPP countries have tabled competing proposals for an annex designed to describe in further detail what constitutes "indirect expropriation."

The first proposal, contained in Annex 12-C of the leaked text, generally reflects the language included in the new U.S. model bilateral investment treaty (BIT) as well as previous U.S. FTAs. It would provide the most protection for investors from potential government regulatory actions that could be challenged as indirect expropriation. One U.S. business source argued that this language, which also partly follows U.S. jurisprudence on the issue of indirect expropriation, is the option that should be included in a final deal.

The second proposal, contained in Annex 12-D, follows the text of China's free trade agreements with Peru and New Zealand and allows governments more flexibility to regulate. Critics argue that indirect expropriation provisions in past U.S. trade deals open up governments to challenges of regulatory actions designed to protect public welfare objectives.

Under the U.S.-backed proposal, whether an indirect expropriation has occurred must be determined on a case-by-case basis by examining several factors, including the economic impact of the government action, the extent to which the action interferes with reasonable expectations of the investor, and the "character" of the government action.

This first proposal in its final sentence clarifies that non-discriminatory regulatory actions designed and applied to protect "legitimate public welfare objectives, such as public health, safety and the environment," do not constitute indirect expropriations "except in rare circumstances."

By holding open the possibility that such regulatory actions can be challenged in “rare circumstances,” this proposal provides greater protections for investors. It also puts the burden of proof on a government by requiring it to show that, in the event of such a challenge, its actions were "designed and applied" to protect public welfare objectives.

By contrast, the competing proposal on indirect expropriation in Annex 12-D, would make it harder for an investor to prevail in an investor-state case, sources said.

For instance, in order to constitute indirect expropriation, this proposal states that a government's deprivation of the investor's property must be either "severe" or for an "indefinite period," and must be "disproportionate to the public purpose." One U.S. business source argued that it may be difficult for companies to prove that an indirect expropriation is "severe," for instance, especially as the meaning of that term in this context is somewhat ambiguous.

But one legal expert said this alternative definition could also offer advantages to investors over U.S. domestic law. This is because it would allow investors to argue a government action that was severe but only for a limited period of time amounted to indirect expropriation, while under U.S. domestic law a government action with a temporary effect does not amount to a “regulatory taking,” a term roughly equivalent to indirect expropriation.

This second proposal also does more to limit the ability of investors to sue governments over actions related to protection of public welfare objectives.

While the second proposal, much like the U.S.-backed one, provides that such actions could constitute indirect expropriation "in rare circumstances," it states that regulatory actions that "may be reasonably justified in the protection of the public welfare" do not amount to indirect expropriation. This is an easier threshold for a government to meet than the threshold in the U.S.-backed proposal, sources said.

This is because a government would not have to prove that a measure was "designed and applied" to protect the public welfare, but only that it may be "reasonably justified" as furthering that purpose, one source said.

In a memo released on June 13 that analyzes the draft text, Public Citizen, a civil society group critical of U.S. investment policy in trade agreements, argued that the alternative language contained in Annex 12-D is an “improvement” on the U.S. model language, but is still problematic.

Public Citizen pointed out that there is a third proposal for the final sentence of the expropriation annex that by far gives governments the most leeway to regulate without fear of being taken to arbitration for alleged indirect expropriation.

This third alternative, included in brackets at the end of the proposed Annex 12-D, provides greater certainty to governments by removing the reference to “in rare circumstances.” Instead, it states more categorically that “[n]on-discriminatory regulatory actions by a Party that are designed and applied to achieve legitimate public welfare objectives, such as the protection of public health, safety, and the environment do not constitute indirect expropriation.”

One business source rejected this formulation because it would completely bar investors from challenging a government regulatory action as indirect expropriation in key sectors such as renewable energy.

According to the Public Citizen memo, this third option has been proposed by just one TPP country, and the U.S. does not appear to support it. However, support for this third option could be broader, since it is identical to language included in the New Zealand-Malaysia FTA, the ASEAN-Australia-New Zealand FTA, and the intra-ASEAN investment agreement.

In its memo, Public Citizen also blasted the omission of a footnote that was included in the U.S.-Korea free trade agreement's annex on indirect expropriation. The footnote, which is not part of other U.S. trade pacts or the 2012 U.S. model BIT, essentially made it more difficult for investors to charge that a government regulatory action constituted an indirect expropriation based on the argument that the action interfered with the investor's reasonable expectations.

Specifically, that footnote clarified that “investor's expectations that regulations will not change are less likely to be reasonable in a heavily regulated sector than in a less heavily regulated sector.”

Civil society sources noted that the mining sector is one that is considered heavily regulated, and that the inclusion of such a footnote could help head off challenges in this sector such as the one brought by the Pacific Rim mining company against El Salvador under the Central American Free Trade Agreement. In that case, the company argued it had been subjected to new regulatory hurdles that went against its expectations, sources said.

The text was leaked on June 13 by the civil society group Citizens Trade Campaign, which like Public Citizen is critical of investment provisions in past U.S. trade agreements. The Office of the U.S. Trade Representative, when asked to confirm the authenticity of the TPP investment chapter, said it does not comment on the authenticity of alleged leaked texts.

Source: World Trade Online

 

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