Brexit And The High Cost Of Promises

The message for those thinking of pursuing claims against the British government in international tribunals for losses caused by a probable hard or no-deal Brexit is clear: Find out what Toyota and Nissan got and ask for the same. Evidence of government promises added to wholesale changes brought about by Brexit could lead to hefty compensation pay-outs. Brexit could spawn a legal morass and economic disaster in more ways than you think.
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Promises are always dangerous in politics, and in the context of Brexit easy promises could soon lead to unmanageable liabilities. This week the issue of government reassurances to foreign investors re-emerged as Toyota is rumoured to have received (similarly to Nissan) commitments aimed to entice it to maintain its manufacturing activity in the UK post-Brexit. While the content of these 'deals' remains undisclosed, they complicate the already dangerous legal waters that the government will need to navigate. If the UK makes giving assurances the main way to deal with the uncertainties of Brexit, it may soon be facing lawsuits. And, such lawsuits are likely to come from investors established in the City, rather than auto manufacturers. The following explains why.

A key question is whether a foreign investor feeling aggrieved by Britain's decision to leave the EU could bring a claim in an investor state dispute settlement (ISDS) tribunal. For example, foreign owned financial firms could seek legal redress arguing that changes brought about by Brexit (from the point of exit onwards) will violate legitimate expectations protected by Bilateral Investment Treaties (BIT) the UK has signed with their country of origin. How this could work is revealed by looking at Spain, the closest example of a western, developed economy having faced an avalanche of ISDS claims due to a significant change in regulatory conditions (in their case, involving legal frameworks for renewables).

In these Spanish cases investors claim that, amongst other violations, Spain did not afford them fair and equitable treatment as required to by its treaty obligations. In the first case to reach conclusion a Dutch solar energy investor (Charanne) argued that fair and equitable treatment demands the maintenance of a stable and predictable legal framework for investments. Spain, they claimed, had frustrated their legitimate expectations through wholesale changes to the regulation of solar energy generation. Spain countered that legislative changes introduced in the energy sector were an expression of its sovereign right to regulate. Meeting standards under its treaty obligations, in its view, did not mean freezing a legal framework in place, as would happen under a stabilization clause (an explicit commitment to maintain regulatory environments for the duration of the investment).

The Charanne tribunal agreed that in the absence of specific commitments adopted by Spain, the threshold for a finding of fair treatment violation was not reached. Specific commitments could have found expression by means of a declaration by Spain addressed to the investors, but this had not taken place. It is well established that a state is entitled to maintain a reasonable degree of regulatory flexibility to respond to changing circumstances in the public interest. Consequently, the requirement of fairness must not be understood as the immutability of the legal framework. So far so good, you may be thinking, but there is a catch. A state is deemed to be allowed to regulate so long as it does not fundamentally and abruptly alter the whole regulatory environment causing major losses to the investor. Spain won its first challenge, but celebrations did not last long.

The second important decision on these Spanish claims resulted in a win for the investor and goes to the core of what the protection of legitimate expectations is about. In a case brought by a British energy company (Eiser), the tribunal underlined that treaties protect investors from a fundamental regulatory change (total and unreasonable) in a manner that does not take into account the circumstances of existing investments made in reliance on the prior regime. Crucially, the tribunal recognized that the regulatory power of the state has a limit that is established by the commitments assumed under investment treaties that cannot be ignored. In summary, an investor can win a case if they come under the protection of a treaty and if the government has made an explicit commitment (that it then breaches) and/or if the change is radical enough to violate legitimate expectations.

How could a financial firm based in London, lucky to benefit from the protection of a BIT between its home country and the UK, use all this? Brexit will most likely result in London becoming a much different business proposition. London can no longer be the gateway to European finance, as it is projected to lose its place in the single market. London can no longer guarantee access to one of the world's biggest consumer markets. One could argue that leaving the single market, losing the financial passport, is an abrupt, wholesale upending of the entire regulatory background of an investment, rendering such investment practically worthless.

The message for those thinking of pursuing claims against the British government in international tribunals for losses caused by a probable hard or no-deal Brexit is clear: Find out what Toyota and Nissan got and ask for the same. Evidence of government promises added to wholesale changes brought about by Brexit could lead to hefty compensation pay-outs. Brexit could spawn a legal morass and economic disaster in more ways than you think.

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