Galo Márquez*

The saga of Spanish investment arbitrations born out of Spain’s decision to disapply incentives in the renewable sector in the face of a financial crisis continues to generate awards on quantum and liability. The recent decision in Eiser v. Spain is one of many that has contributed to a pool of inconsistent arbitral awards. Given the increasing number of decisions, it is not surprising that arbitral tribunals have reached divergent decisions as to the wrongfulness of Spain’s measures. In his Dissent on Liability and Quantum, Prof. Philippe Sands affirms that “[n]o doubt, reasonable folk will question the wisdom of creating a system that allowed so many competing and contradictory awards to flower, and introduce the changes that seem so necessary” (¶ 1). This article addresses some of the inconsistencies arising from how arbitral tribunals have recognized that a state may make regulatory changes. Still, this recognition has not meaningfully impacted the damages awarded to investors.

Nor have the competing views of arbitral tribunals resulted in a uniform application of the law of damages in international arbitration. Typically, when tribunals determine that a state’s measure violates an investment treaty, they award damages for injury attributable to any part of the measure. By reviewing the decision in Eiser v. Spain, this article suggests a different approach. It argues that states should only be liable for the portion of damages attributable to the difference between the injury caused by the measure actually imposed, and the hypothetical injury that would have been caused by a lawful alternative measure. I will refer to this concept as the “Margin of Wrongfulness.”

It must be mentioned that this article builds upon the work of the Academic Forum on Investor-State Dispute Settlement (“ISDS”) before the United Nations Commission on International Trade Law Working Group III (“UNCITRAL”) on matters related to damages. The author is an appointed Member of the Academic Forum on ISDS and a representative observer before Working Group II on Arbitration and Dispute Resolution. However, the views expressed here are mine alone. The benefit of this article is twofold. First, it demonstrates an inconsistency in the way that arbitral tribunals have awarded damages, which the ISDS community has sparingly addressed. Second, by reviewing over a few dozen awards, the article identifies that the concept of ‘legitimate expectations’ in international investment law cannot continue developing as it has in the last few decades without a shift in how damages are awarded.

I. Introduction to the Spanish financial crisis

The Eiser v. Spain case is an old tale with a new twist. Like many other countries, Spain introduced at the end of the 90s a package of regulatory amendments and financial incentives to promote renewable energy in the country. Spain sought to promote a specific type of solar power through state subsidies. The new regulatory regime was an attempt to realize the spirit of the 1992 Framework Convention on Climate Change, the 1994 Energy Charter Treaty, and the 1997 Kyoto Protocol, as well as the 2001 European Union policy for reducing greenhouse gasses by means of developing renewable energy in the region.

Starting in 1998, Spain issued a series of decrees to promote renewable energy by means of a guarantee for long-term supply of energy (Eiser, ¶¶ 105-107). In the long term, however, these incentives were not sustainable. Spain was not left alone in the crusade to advance renewable energy throughout the 90s. In the first weeks of 1991, the Committee on Science and Technology of the European Parliament made an aggressive call to move towards renewable energy on the basis of the results of the Brundtland report—document recounting the world’s critical environmental problems. In the Committee’s view, “[e]very effort should be made to develop the potential for renewable energy which could form the foundation of the global energy structure during the 21st century” (p. 2, ¶ 5).

Answering this call, Spain issued Royal Decree 661/2007. The International Energy Agency viewed the Decree as seeking “[t]o contribute to Spain’s efforts to achieve its 2010 national target for the promotion of electricity from renewable energy under EC Directive 2001/77/CE.” More than an effort, several investors—including Eiser (¶¶ 357-35)—argued that Decree 661/2007 was a public policy creating an attractive environment for investment (Charanne v. Spain, ¶ 515).

This Decree was later retracted by Spain, causing significant harm to energy projects. The rationale behind a state’s incapacity to unreasonably and unfairly backtrack from a commitment is quite logical. In the same way that a person would not purchase a car for a price other than the one advertised, investors expect to receive the benefit of protective guarantees or commitments that the government has made to them. UNCTAD estimates that the Spanish Decree has been at the heart of over 40 investment arbitrations. This  number keeps growing as investors submit new ISDS cases arising from Spain’s retreat from its regulatory commitments to the energy sector (See, WOC v. Spain).

A few years into the application of Decree 661/2007, the Tribunal in Eiser recounts that Spain became concerned due to a “tariff deficit.” The tariff deficit is generally understood as “[t]he financial gap between the costs of subsidies paid to renewable energy producers and revenues derived from energy sales to consumers” (¶ 124). To combat this deficit, in December 2012, the Spanish Parliament imposed a 7% tax on the total value of the energy fed into the national grid. This tax eliminated the subsidies for renewable energy. This mechanism was followed by several other decrees that blunted the financial incentives and subsidies for foreign investors. In June 2014, the government dealt the final blow to Decree RD 661/2007 through a ‘ministerial order’ setting up a whole new regime for existing power plants (the “Disputed Measure”).

The Eiser case arose from a so-called ‘failed’ investment in the solar power sector in Spain (¶¶ 94-95). During the arbitration, Eiser valued its investment through the Discounted Cash Flow (“DCF”) method at €124.3 million (¶ 136). The relevance of damages in investment arbitration is a growing concern in the field. Certain circles claim that arbitral tribunals are awarding increasingly larger claims in favor of the investor. On this, the International Institute for Sustainable Development mentions that its “[r]esearch has found over 50 known cases in which an investor–state tribunal has awarded a foreign investor over USD 100 million in compensation. In at least eight claims, the award reached over USD 1 billion” (¶ 14).

The energy generation mechanism promoted under Decree 661/2007 was allegedly categorized as a renewable source. The new policies materialized in Decree RD 661/2007. The Arbitral Tribunal considered that the Decree contained a myriad of key elements, including: (i) a guaranteed “priority of dispatch” into Spain’s grid subject to certain conditions; and (ii) it allowed energy producers to adopt different tariffs for production in accordance with the specific characteristics of each project (¶ 112).

Eiser brought an investment arbitration under the Energy Charter Treaty as the general partner of a limited partnership, claiming that it invested in reliance on Royal Decree 661/2007 and its stabilization clause¾which restricted Spain from amending its regulatory framework (¶¶ 357-358). Eiser’s business model depends on identifying low-risk investments in public infrastructure.

The State’s decision to retract Decree 661/2007 had a devastating effect on several companies. Although many foreign investors had access to bilateral investment treaties or the Energy Charter Treaty, locals recount that Spain’s decision to retroactively backtrack from the Decree 661/2007 (the Disputed Measures) “[l]ed to […] the total ruin of 62 000 families […] and that their opportunities to file claims before the Spanish Government have been restricted, given that they did not have access to more impartial, international courts.” This was not the case for Eiser, which enjoyed its position as a United Kingdom incorporated company with the capacity to bring an investment arbitration against Spain.

II. The Tribunal’s Award

Against this backdrop, the Eiser Tribunal was tasked with reviewing if the Disputed Measures breached the fair and equitable treatment (“FET”) standard. Embarking on this task, the Arbitral Tribunal had to address the State’s capacity to regulate¾a heavily disputed point in international investment law (Isolux v. Spain, ¶¶ 409-426; Novenergia II v. Spain, ¶ 542-697). Although the nuances to identify a breach of legitimate expectations may be contested, arbitral tribunals have generally considered the following points (¶¶ 369-372):

  • Whether the investor’s expectations were legitimate, reasonable or fair, and not based on subjective considerations.
  • The reliance of the investor on such expectations when making its an investment.
  • The State’s unilateral conduct to the detriment of the legitimate expectation.
  • The existence of a damage to the investor.

Following the steps of Parkerings v. Lithuania, the Tribunal in Eiser departed from the premise that “[a]bsent explicit undertakings directly extended to investors and guaranteeing that States will not change their laws or regulations, investment treaties do not eliminate States’ right to modify their regulatory regimes to meet evolving circumstances and public needs” (¶ 369). Accordingly, FET itself does not paralyze the regulatory powers of the governments.

III. Overlapping principles for determining the margin of wrongfulness

An award on quantum must flow from a prior determination of liability, granted through the same award or in a prior stage. Arbitrators sometimes split their decisions on liability and quantum into different awards, but these components may very well be included in the same award. Several breaches have been claimed in the Spanish arbitrations, but a notable one is the myriad of claims concerning the FET provision. Tribunals have considered that FET may spin off in several protections, including a violation of legitimate expectations, lack of transparency, lack of due process, and arbitrariness (Electrabel v. Hungary I, ¶ 7.74.; PV Investors v. Spain II, ¶ 565; RREEF v. Spain II, ¶ 260; Operafund v. Spain, ¶ 524).

EDF v. Romania, an important case on the analysis of a claimant’s legitimate expectations, explained that a mere regulatory instability does not amount to a breach of a FET provision (¶ 217):

The idea that legitimate expectations, and therefore FET, imply the stability of the legal and business framework, may not be correct if stated in an overly-broad and unqualified formulation. The FET might then mean the virtual freezing of the legal regulation of economic activities, in contrast with the State’s normal regulatory power and the evolutionary character of economic life.

The Eiser Tribunal considered that Spain’s withdrawal of Decree 661/2007 amounted to a breach of the FET standard and the investor’s legitimate expectations. The Tribunal notably awarded full compensation for all losses to the project attributable to Spain’s retraction of Decree 661/2007. By applying a Margin of Wrongfulness, the Tribunal should have discounted from the award losses attributable to the portion of Spain’s measure that would not have amounted to an arbitrary abrogation of Decree 661/2007. In other words, if not all amendments to the regulatory framework are abusive, then the financial gap between the measure that Spain could have taken without breaching FET and the measure that, if applied, would be illegal constitutes the Margin of Wrongfulness.

Reduction of damages in findings where a government disregards an investor’s legitimate expectations is not uncommon. In MTD v. Chile, the Arbitral Tribunal found a breach to the FET standard by considering that Chile had induced a legitimate expectation that a real estate project would be feasible, even when the acquired land could not be developed for commercial purposes (¶ 217). In what has been called a Solomonic decision (Potestà, pp. 38-39), the Tribunal reduced by 50% the damages awarded to the investor due to its failure to conduct an independent assessment of the land.

As such, not all damages need to be compensated. The Margin of Wrongfulness would imply the existence of an ‘unjustified damage’ standard (Muhammad, p. 108) and not a mere reduction in the value of the investor’s investment (Wöss, ¶ 9-10). The Eiser Tribunal unfortunately missed this aspect. Incoherently, it considered that states are not confined to a straitjacket when amending prior legislation, without analyzing the resulting effect on damage quantum. The Eiser Tribunal is not alone in this omission. In the Renergy case, the Tribunal, by majority, invoked “[w]ell-established arbitral case-law” holding “that even in the absence of any specific commitment, Article 10(1) ECT does protect investors against legislative changes that exceed a (wide) acceptable margin” (¶ 642). The recognition of an exceeding acceptable margin might justify the existence of a Margin of Wrongfulness.

The Eiser case is also enlightening as to the impact that a fact witness might have on damages. In most awards, the decision on quantum is driven by the technical viewpoints of experts. In Eiser, the Tribunal reflected that during the arbitration hearing, representatives of the investor opined on the weight that the Disputed Measure had on the investment:

In response to the Tribunal’s question at the Hearing, Mr. Meissner, a founding partner of Eiser, drew a distinction between the changes in Spain’s regulatory regime and other regulatory situations where regulators might “tinker a little bit with the returns.” In contrast, he deposed that “here we had a complete value destruction. We lost all value in this particular project.”

The factual witness’ statement suggests that “tinker[ing] a little bit with the returns”—i.e., the Margin of Wrongfulness—would be acceptable. This implies an additional layer of analysis that exceeds the scope of this article, where the Margin of Wrongfulness might also be justified since an investor is expected to value its investment considering the risks of the project. This is relevant, because under several methods to quantify damages in arbitration a discount rate needs to be applied to the future cash flows that an investor might expect. The ICCA Task Force on Damages considers than an investor’s “[u]nbiased cash flows are expected (average) cash flows—not the cash flows that investors may hope for if everything goes well”.

The Margin of Wrongfulness does put into question some of the premises on which the law of state reparation has been built. Through state responsibility doctrine, investors expect to receive compensation after a violation of international law, which “[s]hould reflect all financially assessable damages” (Marboe, ¶ 3.289). This principle is derived from the acclaimed Factory at Chorzów case, where the Permanent Court of International Justice settled that “[r]eparation must, as far as possible, wipe out all the consequences of the illegal act and reestablish the situation which would, in all probability, have existed if that act had not been committed” (Chorzów, PCIJ 1927, p. 47). The decision in Chorzów has become a cornerstone of the law on damages and is widely cited by tribunals, including in the Eiser case (Eiser, ¶ 421). The Margin of Wrongfulness brings to light some potential deficiencies in the development of damages in ISDS since the Chorzów case.

While the Margin of Wrongfulness questions the legality of the Disputed Measure, it could also be applied by questioning the legitimate expectation of the investor to receive damages. Reparation as understood in Chorzów is built on two premises: (i) the existence of an illegal act, and (ii) the reestablishment of the situation had the act never been committed (Amoco v. Iran, ¶ 191-195). The first premise is compatible with the Margin of Wrongfulness since it implicitly recognizes that damages cannot be awarded for a lawful act, subject to certain nuances on the type of breach committed (e.g., lawful expropriation still requires compensation). The second premise, however, is more questionable. Compensation should restore the injured party not to their pre-breach position, but to the position they would have arrived at had a ‘lawful’ measure been enacted. Restoring the injured party to the pre-breach position presumes that the State’s measure is unlawful in its entirety—but this may not necessarily be true. Arguably, the Tribunal’s recognition of the Margin of Wrongfulness and the Chorzów case invites discussion on how the premises of international damages should be reconsidered or disregarded by future arbitrators in cases such as Eiser v. Spain.

If the Margin of Wrongfulness is accepted as a legal premise then the arbitrators would need to identify the lawful-scenario of the State’s measure. This would require tribunals to heavily engage in hypothetical factual and financial situations, which ISDS tribunals are familiar with. Most investment arbitrations necessitate that arbitrators identify a “but-for” scenario, derived from the principle of causation in international damages. According to the Brattle Group, one of the most active quantum experts in ISDS cases, “[c]ausation requires the careful construction of a counterfactual or ‘but-for’ world that eliminates only the conduct at issue but retains all relevant features of the actual world. The construction of the but-for world is necessarily hypothetical and must remain internally consistent”.

Assessing the Margin of Wrongfulness by considering a potential hypothetical scenario is then inherent to the ordinary course of damages identification conducted by tribunals. This alternative factual situations are also grounded as a matter of law. In the 1987 Amoco decision before the Iran-US Claims Tribunal, Judge Bower separately opined that once liability is found with a degree of certainty, then quantification may be performed with “[t]he best available evidence, even though this process be inherently speculative” (n. 142, ¶ 26). An alternative evaluation of the Margin of Wrongfulness would then be compatible with the perspective taken by some stakeholders.

IV. Conclusion

Eiser v. Spain underscores the intricate nature of investment disputes and the importance of balancing a state’s regulatory authority with investor protections. Recognizing the Margin of Wrongfulness and considering how this concept impacts damages may contribute to a more nuanced approach in future arbitration cases, fostering a fair and equitable resolution for all parties involved. It would also incentivize uniformity in cases where a state, such as Spain, is faced with a wave of investment claims. Moreover, achieving certainty as to the standard on which an investment tribunal should award damages might also function as a prevent mechanism of control for States when enacting amendments to their international commitments.

*Galo Márquez is an Associate in the International Arbitration practice at Creel, García-Cuellar, Aiza y Enríquez, and a Member of the Academic Forum on ISDS before UNCITRAL. He is also a Business Law Professor at Tec de Monterrey.

Cover image credit