Missing the forest for the trees: creeping FET violations in investment arbitration

Written by Juan Pablo Hernández Páez
The Treaty Examiner, vol. 2, issue 1
4 May 2021

I recently had the opportunity to examine the El Paso Energy v. Argentina case, where the arbitral tribunal famously recognized (or, in Argentina’s opinion, “created”) the concept of “creeping” violations of the fair and equitable treatment (FET) standard. The notion of a succession of acts or omissions that are individually lawful but collectively unlawful is no stranger to international law – but it may have unintended consequences when it comes to the FET standard. This blog post addresses whether it is possible to speak of “creeping” FET violations and, if so, how investment tribunals should go about the subject.

Composite acts under international law

A discussion of “creeping” FET violations has to begin with Article 15(1) of the ILC Articles on State Responsibility (ARSIWA), which provides as follows:

The breach of an international obligation by a State through a series of actions or omissions defined in aggregate as wrongful occurs when the action or omission occurs which, taken with the other actions or omissions, is sufficient to constitute the wrongful act.

It appears from this definition that not every international obligation can be breached through a composite act. It is only when a conduct is “defined in aggregate as wrongful” that State responsibility is entailed. In other words, it is not the obligation that needs to be thus defined; rather, the norm in question must establish a prohibited conduct and describe it as the accretion of acts and omissions.

The ILC exemplifies the application of Article 15 of the ARSIWA by reference to crimes against humanity and genocide (Art. 15, ¶¶2, 3), where the repetition of conduct is of central importance. For instance, an act of murder is generally a matter of national law, but it becomes a crime against humanity, in breach of international law, when it is committed as part of a “a widespread or systematic attack directed against any civilian population” (Article 7(1)(a) of the Rome Statute and Article 2(1)(a) of the ILC Articles on Crimes Against Humanity). The same occurs with genocide. Socioeconomic policies, individually, may prima facie comply with international law; but when taken in aggregate, they may constitute the infliction of “conditions of life calculated to bring about [the] physical destruction [of the protected group] in whole or in part”, committed with the specific intent “to destroy [that group] as such” (Article II(c) of the Genocide Convention). In most cases, it is only when looking at the bigger picture that the international illegality can be identified.

Although it is unclear to what extent Article 15(1) of the ARSIWA reflects or codifies customary international law, it is submitted that the same result as the one outlined above is achieved under the general definition of an internationally wrongful act. Customary law requires the State conduct to constitute “a breach of an international obligation” (see ICJ, Tehran Hostages, 1980, para. 56 and Article 2(a) of the ARSIWA). If international law defines the prohibited conduct in aggregate, a breach of the underlying obligation will necessarily take the form of a composite act as understood by the ILC. In that sense, Article 15 is a derivation of Article 2 of the ARSIWA.

On that note, I turn to the FET standard.

Creeping FET violations

Those familiar with investment arbitration are aware of the concept of “creeping” expropriations. This concept refers to “indirect expropriation that occurs as a result of a series of measures taken over time that cumulatively have an expropriatory effect, rather than a single measure or group of measures that occur at one time” (Newcombe/Paradell, 2009, p. 343). The policy concern behind creeping expropriation is that such an internationally wrongful act can only be discovered in retrospect, since there is no specific act which substantially deprives the investment of value.

Can the same reasoning be applied to the FET standard? Here we go back to the El Paso Energy case. The arbitral tribunal in that case recognized expressly the concept of “creeping violations of the FET standard” in the 2011 arbitral award, by drawing an analogy to creeping expropriations (¶¶518, 519):

The Tribunal considers that, in the same way as one can speak of creeping expropriation, there can also be creeping violations of the FET standard. According to the case-law, a creeping expropriation is a process extending over time and composed of a succession or accumulation of measures which, taken separately, would not have the effect of dispossessing the investor but, when viewed as a whole, do lead to that result. A creeping violation of the FET standard could thus be described as a process extending over time and comprising a succession or an accumulation of measures which, taken separately, would not breach that standard but, when taken together, do lead to such a result.

The Tribunal, taking an all-encompassing view of consequences of the measures complained of by El Paso, including the contribution of these measures to its decision to sell its investments in Argentina, concludes that, by their cumulative effect, they amount to a breach of the fair and equitable treatment standard.

After the El Paso tribunal awarded the claimant approximately USD 43 million in damages, Argentina filed for annulment. In a unanimous decision, the ad hoc committee ruled that the tribunal’s finding of creeping FET violations was not a “judicial creation” in excess of its powers (as claimed by Argentina), as it was derived from previous jurisprudence and, in any event, the passage in question was better regarded as obiter in the tribunal’s decision on liability.

The issue of interest here is whether the El Paso arbitral tribunal erred when it found that the FET standard could be violated by a composite act. For starters, there is an issue of applicable law. The formulation of FET standards in investment treaties varies remarkably (Fair and Equitable Treatment, UNCTAD Series on Issues of International Investment Agreements II, pp. 17-35). While it is not my intent to revisit here the issue whether the FET standard reflects customary international law or is equal to the customary minimum standard, I point out that the exact content of the FET obligation appears to be context- and fact-sensitive. Whether the standard obligates the State actively to promote an investment-friendly regulatory environment (2004 MTD Equity Sdn Bhd and MTD Chile SA v. Chile, para. 113), or simply to avoid conduct that frustrates the legitimate expectations of investors (2003 Tecmed v. Mexico, para. 154) or something in between (2007 Parkering-Compagniet AS v. Lithuania, para. 332), depends on the formulation of the applicable treaty. Therefore, a tribunal must first look to the FET provision in the treaty, evaluating its language in its context and in light of the treaty’s object and purpose (Article 31 of the Vienna Convention on the Law of Treaties).

However, I do believe there is a general rule that FET violations can occur “in aggregate”. Although treaty practice varies, the term “fair and equitable treatment” is consistent (Fair and Equitable Treatment, UNCTAD Series on Issues of International Investment Agreements II, p. 63). What is prohibited by the clauses is unfair and inequitable treatment of the investment by the State. In its ordinary meaning, “treatment” refers to a manner of behaving towards someone or something, here the investment (x x x). Therefore, “treatment” does not necessarily imply a discrete act or omission but may consist in a pattern of conduct by the State. The object and purpose of investment treaties in general, and of FET clauses in particular, to protect the legitimate expectations of the investor and protect the investment against arbitrary action by the State, would support the interpretation that “treatment” encompasses composite acts. Otherwise, the State could frustrate the FET standard by fragmenting its arbitrary treatment of the investment into discrete acts or omissions that individually appear innocuous – and, consequently, it could make the investment tribunal “miss the forest for the trees”.

This consideration, however, needs to be calibrated with notions of regulatory policy. The FET standard should not punish “sheer bad governance” (to use the terms of Professors Newcombe and Paradell, supra, p. 279) on the part of the State. It should also not freeze the power of the State to regulate in accordance with public policy objectives. It is a fact of life that law naturally changes over time, and indeed it should. Investors should not be entitled to invoke any general and gradual regulatory change to claim compensation, since this would distort the FET standard. Therefore, the cumulative effect of the measures must be manifestly and clearly to produce a denial of justice or frustrate the legitimate expectations of the investor. In other words, and drawing a parallel to creeping expropriation, the combined effect of the measures must be tantamount to an abrupt and instant FET violation. The standard should be further raised when each of the measures composing the alleged violation is taken strictly in pursuance of a public policy objective, especially by States facing economic, social or similar problems.

PIE DE IMPRENTA: Juan Pablo Hernández (editor-in-chief), Guatemala, 4 May 2021.

Juan Pablo Hernández Páez
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Juan Pablo Hernández Páez
Editor-in-Chief at The Treaty Examiner | juanhernandez@ufm.edu | Website | + posts

Juan Pablo is an international law enthusiast from Guatemala. He is a Moot Coach at Universidad Francisco Marroquín and the founder of The Treaty Examiner.