Kevin Smith

Law & Valuation

Professor Palmiter

Spring 2001



Expropriation is the action of a foreign state in taking the property rights of an individual in the exercise of its sovereignty. Most international laws allow expropriation with a limitation that the expropriated company must be compensated. How this compensation is achieved is debated. The United States’ view is that "prompt, adequate, and effective" compensation be paid, however, customary international law appears to favor a standard of "full" compensation.

If "full" compensation is to be paid, tribunals now must apply a method of valuation to achieve this standard. The most widespread applications involve book value and discounted cash flow. A discounted cash flow analysis accounts for company intangibles and future profits that will be lost, while book value does not. In most situations a discounted cash flow is the best method for valuating an expropriated company giving it "full" compensation. However, practical considerations often hinder the proper application of both compensation and valuation techniques.




Webster’s Dictionary defines expropriation as "the action of the state in taking or modifying the property rights of an individual in the exercise of its sovereignty, as where property is sold under eminent domain." This act is often referred to as nationalization, although the terms are more or less synonymous. The expropriation of the United States companies has occurred often throughout the last half-century, most notably involving Cuba in the late 1950s and Iran in the late 1970s. Although not as well documented, nationalization has also been promulgated by the governments of Libya, Indonesia, Vietnam, Egypt, Mexico, and various Latin American countries.

The prevailing view is that a country is allowed to nationalize or expropriate property or a company from within its boarders. However, there are certain restrictions placed on this international form of eminent domain. Specifically, definitions of expropriation often include legal criteria that (1) there must be a public purpose for the taking, (2) it is not to be discriminatory, and (3) compensation must be paid. In practice it has been expropriations without satisfactory compensation which have caused international problems.

The variety of domestic and international agreements reached during the post WWII period makes it hard to speak of any specific uniform practice of determining proper compensation. "It is difficult . . . to state in black or even gray letter what is the international law now as regards compensation for expropriated alien properties." Because of this unrest of international laws, courts and commentators alike have found it difficult to find a common ground in determining the proper law to administer, in addition to the appropriate way to value the company once it has been expropriated. This paper will focus first on the debate as to the suitable standard of compensation and secondly, the methods of valuation used to effectuate this compensation standard.



The United States has consistently acknowledged the right of a sovereign nation to expropriate foreign-owned property, so long as the taking conformed to the standards of international law; that is, that it was for a public purpose, not discriminatory against US citizens, and accompanied by just compensation. While most states recognize that some form of compensation is due, it is the formulation of the compensation that is at issue.

"The view long held by the United States is that an alien whose property is expropriated is entitled to ‘prompt, adequate, and effective’ compensation." This is commonly referred to as the Hull doctrine named after the United States Sectary of State Cordell Hull. Hull accurately presented the then current position in international law in 1938 when he wrote his famous letter to the Mexican Government asking Mexico for "prompt, adequate and effective" compensation for the expropriated land of US nationals. The US government has since maintained this standard through numerous statements and congressional enactments as a requirement of international law.

However, support for this position outside the US is sparse and even within the US, the courts are somewhat reluctant to apply this standard. The International Restatement, the United Nations, and International Dispute Settlement forums (not to mention host country law) have all applied a different standard than that of the United States.

The US courts themselves are often bound to follow this band of generally accepted international law principles and thus, US courts will not even apply the US view. For example, in Banco Nacional De Cuba v. Chase Manhattan Bank, the US Court of Appeals for the Second Circuit applied principles of international law because there was not a sufficient number of States asserting the US standard to "constitute a norm of customary international law." The court found that the expropriated Chase banks were only entitled to "appropriate" or "full" compensation.

Commentators have agreed. "It is nothing short of absurd to pretend that the protestation of the rule of full, prompt, and adequate compensation . . . in all circumstances is representative of contemporary international law." The US pro-capitalist approach, which generally favors higher compensation, is thus displaced by generally accepted international law principles. These principles, often advocated by developing countries, dictate different compensation standards such as "just", "appropriate" or "full" compensation. Moreover, some countries argue that an expropriating nation need pay the foreign company no compensation whatsoever. For example, on occasion "some Latin American states have insisted specifically that international law imposes no duty to pay compensation when property is taken pursuant to a general program of social or economic reform."



In 1928, the Chorzow Case, one of the earliest and regularly cited expropriation cases, held that expropriation required only "the just price of what was expropriated," measured by "the value of the undertaking at the moment of dispossession, plus interest to the day of payment." Between the Chorzow Case and World War II, international courts and tribunals reviewed the issue, none holding that the appropriate measure of compensation was less than the "full value" of the property taken. Although international law has since varied, it is unlikely that "full value" meets the US standard of prompt, adequate, and effective.

A. The United Nations

Because international treaties and agreements often require the parties to follow the generally accepted principles of international law, much has been made of the United Nations’ view of compensation for expropriated companies. In 1962, the United Nations General Assembly declared that in cases of expropriation "the owner shall be paid appropriate compensation, in accordance with the rules in force in the State taking such measures in the exercise of its sovereignty and in accordance with international law."

This standard takes into account both the host country’s laws as well as general international laws, however the UN has since changed its stance. While still adhering to the "appropriate compensation" standard, a subsequent resolution in 1974 states that the expropriating State itself is to settle the dispute and should take into account "its relevant laws and regulations and all circumstances that the State considers pertinent."

The United States actually approved of this formulation of "appropriate" compensation. The US representative to the UN explained his vote in favor of the resolution stating that he was confident that the agreement reflected the US view of the Hull doctrine of "prompt, adequate and effective compensation." Although courts and commentators do not agree on exactly what standard "appropriate" suggests, most would agree that it does not reflect the Hull doctrine.

Although the UN has continued to promote the idea of "appropriate compensation", questions of "appropriateness" were now referred to the nationalizing state’s law and tribunals. The role of the prevailing international law was not mentioned, and thus what is customary in international law is not relevant. This standard now creates even more uncertainty as different host nations may have different – even conflicting – expropriation laws. This raises the issues of whether the resort to specific State law is meant to be exclusive and, if not, must it first be exhausted. In reviewing UN law, the second circuit in Banco Nacional De Cuba v. Chase Manhattan Bank held that international laws may be applied, but the national jurisdiction of the State taking the expropriation measures must be first exhausted.

The UN standard, termed "appropriate," is blurred because it now hinges on specific state interpretation. There is also not a stated valuation method that approximates "appropriate" compensation. "The actions of the General Assembly presents, at best, a confusing picture as to what the consensus may be as to the responsibilities of an expropriating nation to pay appropriate compensation." "The positions taken are varied, diverse, and not easily reconciled."

B. The U.S.- Iran Claims Tribunal

Many United States companies were expropriated from Iran in the late 1970s and the Iran - U.S. Claims Tribunal met throughout the 1980s to resolve the issues of compensation due these companies. This tribunal was not shackled with the US or UN standard of compensation, but the claims were governed instead by a separate treaty – the U.S.-Iran Treaty of Amity.

The treaty established that property shall not be taken "without the prompt payment of just compensation." It also provided that "[s]uch compensation . . . shall represent the full equivalent of the property taken." This standard did not espouse the US view and the Hull formula, although payment of "just compensation" for the "full value" did appear to effectuate it. In fact, all of the majority opinions did require that the payment be full compensation.

One case decided by the tribunal, Partial Award In Amoco International Finance Corporation v. Islamic Republic Of Iran, found that despite the UN General Assembly resolution in 1974, the prompt payment of just compensation is an obligation which is accepted as a general rule of customary international law. Thus the tribunal is looking to the standards of international law. The tribunal stated that this rule reflected the practice of states, was relayed in numerous expropriation conventions, and that the U.S.-Iran Treaty was just another example of such a practice.

The language of the U.S.-Iran Claims Tribunal suggests that just compensation is due, however, the outcomes include the standard of full compensation as well. Moreover, the standard stated in the treaty as discussed by the tribunal, still does not relay the appropriate valuation method to use. The Amoco decision stated, the wording of the treaty "does not solve the problem of the method to be used in order to determine the value of the property or interest in property which was expropriated."

  1. The International Restatement
  2. The Restatement of the Foreign Relations Law of the United States has also weighed in.

    A state is responsible under international law for injury resulting from a taking by the state of the property of a national of another state that (a) is not for a public purpose, or (b) is discriminatory, or (c) is not accompanied by provision for just compensation

    This does not reflect the Hull doctrine of "prompt, adequate and effective" compensation. The Restatement concludes that just compensation will only require "an amount equivalent to the value of the property taken." Thus, neither is there a mention made of the UN’s "appropriate" standard of compensation. The comments explain the reasoning for not accepting the Hull doctrine. "The United States Government has consistently taken the position . . . that under international law compensation must be prompt, adequate and effective," but this formulation has "not made its way into multilateral agreements or declarations or been universally utilized by international tribunals."
    The Restatement comments have reasoned that "just" compensation is inclusive of "full" compensation and encompasses some of the leading methods of valuation. Compensation to the expropriated company usually requires "fair market value" and this value "should take into account going concern value, if any, and other generally recognized principles of valuation." When compensating a company, the Restatement also takes into account the situation and circumstances surrounding the expropriation through the eyes of a hypothetical purchaser. Although the language of the Restatement is simple, the comments give it the force as one of the more in depth views for compensating an expropriated company.
  3. NAFTA

The Hull formulation has met strong resistance from developing states and has not made its way into multilateral agreements or declarations or been universally utilized by international tribunals, but it has been incorporated into a number of bilateral agreements negotiated by the United States. The conclusion of bilateral treaties has been one of the chief methods by which the United States has attempted to prevent problems from arising out of expropriations.

Although not specifically stated, the US view of "prompt, adequate and effective" has finally made its way into international law by way of the North American Free Trade Agreement. Art. 1110(2) of NAFTA on expropriation and compensation provides:

Compensation shall be equivalent to the fair market value of the expropriated investment immediately before the expropriation took place ("date of expropriation"), and shall not reflect any change in value occurring because the intended expropriation had become known earlier. Valuation criteria shall include going concern value, asset value including declared tax value of tangible property, and other criteria, as appropriate, to determine fair market value

  Courts and dispute resolution decisions have treated NAFTA as promising the expropriated company the complete value using contemporary valuation techniques. In a recent settlement dispute, the International Centre for Settlement of Investment Disputes determined the appropriate valuation technique under NAFTA’s compensation standard of "fair market value". In Metalclad v. United Mexican States, the tribunal held that, "[n]ormally, the fair market value of a going concern which has a history of profitable operation may be based on an estimate of future profits subject to a discounted cash flow analysis." In this instance, the tribunal held that the expropriated company was only entitled to the value of their investment because the company had yet to operate for a sufficient amount of time to establish a performance record.

Thus, the best way the US can ensure that its higher standards of compensation will be used is to draft them into international agreements. Even thought the Hull formula is not specifically stated, the US has enough language as to the specific valuation techniques in the NAFTA agreement to completely and wholly award its expropriated companies their absolute value.



What can be stated with some semblance of agreement is that some form of compensation is due to an expropriated company. However, the multiple international laws determining that compensation is in fact due, all set forth different standards. Obviously when a specific treaty is signed between two countries, that treaty will govern any compensation issues. However, when there is no treaty in place and general international laws must be examined, the issue for courts and tribunals becomes much more difficult.
The only standard that comes close to international agreement is that of "full" compensation. The US - Iran settlement tribunal declared that full compensation would be used to compensate the US companies and the International Restatement, in a round-about way, seems to take this approach as well. More recently, NAFTA has approved many of today’s current valuation techniques which would, on their face, seem to lead to "full" compensation. However, squaring these American views with the United Nations criterion is difficult.
The UN has last held that the state expropriating foreign property is entitled to determine the compensation and also that the state use its own national legislation to resolve any disputes which might arise. Commentators have viewed this as "evidence that international law no longer required full compensation for the expropriation of foreign property." However, recent international tribunals have taken a different approach. Surprisingly, they have often held that general principles of international law requires "full" compensation.
Thus the UN’s ambiguous designation of "appropriate" compensation to be only interpreted by the expropriating state’s tribunals may be replaced by the courts themselves looking to common international standards. This affirmation of a full compensation standard is explained by the both a widespread recognition that it fosters foreign investment vital to economic development and it is based on the legitimacy and integrity of judicial and arbitral precedents as sources of international law.

Still, there is no definition of "full" compensation. "Trends in world markets, political relations between the states involved, economic restructurings in the expropriating state – all play a role, directly or indirectly, in determining how much compensation is "full". Customary international law is beginning to adhere to a settled form of compensation for expropriated companies, but international laws are far from static. "Until the synthesis of the developing world and the developed world’s views, ad hoc arrangements will continue to resolve most of the conflicts."



Matching an appropriate valuation method such as going concern or discounted cash flow with terms such as "full", "just" or "appropriate" may be impossible. While most tribunals espouse their method of valuation, very few decisions are bold enough to break down their award. Applying an incorrect method of valuation can completely destroy the compensation standard a court or tribunal has tried so desperately to state. However, the method of valuation cuts both ways as it also gives the court a chance for judicial activism, allowing them to make the award fit the circumstances.
There are many different compensation standards set forth by different international laws and treaties. As stated above, the closest resolution that can be generated out of customary international law is that of "full" compensation. "The other standards proffered for compensation are wholly indeterminate. To tell an arbitrator to decide which value is ‘just,’ ‘adequate’ or ‘appropriate under all the circumstances’ is to tell the arbitrator nothing." The question still remains, what does full compensation mean? What valuation techniques does this term require and how is this desired level of compensation best achieved?
A. Book Value

"One can argue about how to arrive at full value, but the intent is clear: the investor should receive the value the market would give." But who is the market? There is no market for an expropriated company because the expropriating government will not allow any buyers. Developing countries have often argued that because there is no market to value the company, expropriated companies’ compensation should be limited to the book value.

Book value is an assets method of valuation that is often referred to as net asset value. This valuation represents the net worth of the company (assets minus liabilities) as seen on the balance sheet. Book value is often cited as an improper valuation method for valuating companies because it does not take into account the company’s goodwill, trademark rights, or earnings potential – the company’s going concern. Net book value also omits valuation intangibles such as contractual rights and commercial prospects.

In Banco Nacional De Cuba v. Chase Manhattan Bank, the court awarded Chase only the net asset value (book value) of its bank branches that were expropriated and did not take into account a going concern premium. The second circuit reasoned that an award of "lost" future earnings would not be proper because of the state of the Cuban economy at the time. The court stated that no potential buyer would have paid Chase a premium in anticipation of its future Cuban earnings after the revolution.

Chase is not being compensated for its goodwill or future earnings and the Cuban government is thus paying less compensation. This decision is flawed because it does not realize that Cuba is paying less because of their own actions. The Cuban government is devaluating the Chase branches itself by creating an economic and political crisis, thus not allowing any possible buyers to pay for the expropriated companies. It also ignores the ongoing value of Chase’s banking business which could become even more valuable than it would have if Chase had remained in control. Thus, in cases where a company has possible goodwill or the potential for future earnings, a book value valuation does not properly reflect "full" compensation.

B. Going Concern Value

"The term ‘going concern value’ generally refers to the proposition that the prospective buyer of a business will be willing to pay a premium over the book value of the assets in the expectation that the earnings of the business will continue and that the new owner will receive that stream of earnings." A going concern method is based on the projected earnings or cash flow of a company. This method will also take into account the goodwill of the company which includes its brand names, reputation and customer loyalty. This is the value that a hypothetical buyer would pay for the company when dealing at arms length.

The Iran-United States Claims Tribunals recognized that "a general principle of public international law" was that foreign nationals are entitled to "the value of the property taken," which included "the going concern or fair market value" of the property. Commentators have agreed. In a case of lawful nationalization, the owner of the nationalized property is entitled to compensation and the appropriate method is to value the company as a going concern including compensation not only for physical assets, but also for goodwill and lost future profits.

Going concern is the proper valuation method to apply "when the expropriated rights involve an ongoing business activity with demonstrable future earning power." However, a discounted cash flow method is arguably appropriate in order to permit a "discount" from the fair market value standard by taking into account such factors as the financial burden on the expropriating state's economy. The United Nations has stated that going concern is often done "by reference to the market value of similar properties." "[But] where such market value cannot be ascertained, the economic or current value of that asset can be ascertained by the discounted cash flow (DCF) method."

C. Discounted Cash Flow

The discounted cash flow (DCF) method of valuation is often considered the most appropriate. Because a company can be expected to grow at a constant or continuous rate, the value of an asset today can be assessed by taking the projected cash flows at a certain growth rate for the period of the investment and then discounting them back to a present value. The United Nations arrives at a DCF valuation by "calculat[ing] the value at one specified time of cash flows that are to be received at a different time by discounting the yearly net cash flows to present value, with the discount rate including cost of capital and risk components."

In reviewing the decision of Phillips Petroleum Co. Iran v. Islamic Republic of Iran, commentators have stated:

In justifying the use of the DCF method in this claim, as opposed to the net book value, . . . the Tribunal stressed that the purpose of estimating the future profitability of an income-producing enterprise is not to award anticipated profits lost through breach of contract but to determine the value of the property interests at the time of taking, which necessarily includes their income-producing prospects as they would have been perceived at that time by a prospective buyer.

The Iran - U.S. Tribunal, however, was quick to point out that while a DCF analysis can, and often should, be an essential component of a valuation analysis, it must not exclude "other relevant considerations" revealed by the evidence of the case. Specifically, in Amoco International Finance, the tribunal found that customary international law required the minimum standard of compensation to be the "full value," but flatly rejected the DCF method. The tribunal separated the assets of the company’s going concern, including goodwill and commercial prospects, from financial capitalization of anticipated future revenues. The company could not be compensated for lost future earnings because the expropriation was a lawful one, and loss of future earnings is the correct standard of compensation only for unlawful expropriations.

The discounted cash flow method has also been discarded in such cases where the future earnings are too speculative to give meaningful projections. The International Centre for Settlement of Investment Disputes (ICSID) has held so on more than one occasion. During the expropriation of a company form Egypt, the tribunal held that the DCF method is not appropriate for determining the fair compensation because the project was not in existence for a sufficient period of time to generate the data necessary for a meaningful DCF calculation. Here, the project was in its infancy and the revenue projections in the DCF calculations were too hypothetical.

More recently, in Metalclad, the ICSID held that, under NAFTA, where the enterprise has not operated for a sufficiently long enough time to establish a performance record or if it has failed to make profits, the expropriated company was only entitled to the value of their investment.

The discounted cash flow method is one of the best valuating tools because it takes into account more of the company’s intangibles and what it would sell for on a hypothetical market. Although it comes up with a better valuation, the DCF is not free form critics in expropriation cases. It is easy to see why the DCF should not be used in cases where the investment in the expropriating country has not established itself. Here, there is no valid way to project the potential earnings of something that has not yet realized any gains. The law will compensate the company only with the value of its investment, but this is fair because the company has not secured a valid growth rate and compensation cannot be based on speculative projections.

However, in the case of a well established company, the DCF method of valuation is the best tool available. The company is entitled to have its investment bought at the market price by a hypothetical buyer. Because the expropriating country is forcing the sale, it should be the hypothetical buyer. The price of such an investment will include a going concern of intangibles such as goodwill and future profits. The DCF method takes these into account and the expropriating country should be made to compensate for this value and not just the book value as stated on the company’s balance sheet.

D. Is There a "Correct" Valuation?

In some instances of expropriation, an abstract formula like "book value" is used to justify amounts of compensation that are in fact below the required levels of adequate compensation in the sense of market value. The discounted cash flow method is better suited to approximate "full" value in that it takes more company specifics into account when valuating. Of course, one size does not fit all and, because each expropriation needs to be compensated differently, one valuated method will not do. In the case of "just" or appropriate" compensation, often book value will serve as a correct valuation and it is also easier for the tribunal to grasp and apply.

When applied to the correct situation, the discounted cash flow method is the most principled, but in application, a different story is told. Often the stated method of valuation falls by the roadside as the tribunal takes on a role of judicial activism. "[V]aluation calculations are inevitably circumstantial, and it is difficult to distinguish a principled disagreement over the relevance of various categories of circumstances from the evidentiary assessments that attend any valuation process." Often tribunals are merely finding a valuation to apply as they see fit. "There are limitless opportunities for a tribunal to make factual findings or to employ valuation methods that substantially vitiate the impact of its legal rulings."

Because most tribunals will not divulge their valuation analysis in depth, this process offers the adjudicators the ability to declare a valuation that neither parties are happy with but one that both will accept. While, in theory, the DCF method ought to be applied, the application process can completely undermine the correct valuation.



Despite, most tribunals and commentators differing over the correct compensation terms and arguing over the different accepted approaches to valuation, US companies commonly take what they can get. Often the company is being expropriated from a country that is nationalizing the industry within their boarders – receiving payment at all is the first concern. This is why the focus has concentrated on the correct standards of compensation, rather than specific valuation techniques to achieve these standards. Arguing for "full" compensation over "appropriate" is the first step and this standard has still not been settled. In expropriation cases, determining the correct valuation method to use is only secondary.

Often, expropriated companies receive no monetary payment at all. After protracted negotiations, one United States company had to accept a compensatory arrangement with Peru in which a complex service agreement took the place of monetary compensation. During the Guatemalan expropriation of US nationals, Guatemala took the position that 3-percent government bonds maturing in 25 years would be effective as compensation. In addition, Libya has successfully offered a large amount of oil instead of money as compensation to expropriated American oil companies.




The varying methods of compensation reflect, in a greater sense, the complexity of international laws. The plethora of international laws including treaties, regional agreements such as NAFTA, special decisional tribunals, restatements of the law, and the home country’s own laws lead to no real agreement on the standard of compensation due to an expropriated company.  In some circles, the standard boils down to "full" compensation, but determining the correct valuation method to realize this standard is just as troublesome.

Tribunals often award either book value or discount the company’s future earnings using a discounted cash flow analysis. While, the DCF better accounts for the company’s expected profits from the investment, it is often discarded or manipulated. There is no true solution to the correct valuation method and overall, most cases will be determined on their facts. Taking into account the practical considerations, the compensation debate may be a largely academic one.