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Regulatory Expropriation and Legislative Change: Navigating the Boundaries of Sovereign Power 26 February 2026

This article is part of WFW’s mini-series on investment arbitration. Drawing on the experience and expertise of WFW partners and lawyers in commencing and defending investment treaty claims, the series provides practical guidance for both foreign investors and host States. In this second article, we explore the concept of regulatory expropriation, drawing the distinction between legitimate regulation and indirect expropriation and highlighting strategic considerations for both investors and States. Upcoming articles will explore key standards of protection including full protection and security, national treatment and MFN clauses, as well as analysing umbrella clauses and the role of contractual commitments in treaty disputes.

"When they substantially deprive investors of the economic use or value of their investments, such measures may amount to indirect or regulatory expropriation, even without the formal taking of the property in question."

Governments worldwide are under increasing pressure to adapt laws and regulations to meet urgent public needs: climate change, energy transition, tax fairness and public health. These reforms are essential for sustainable development and social welfare. Yet, under international investment law, such measures can sometimes cross a critical line. When they substantially deprive investors of the economic use or value of their investments, such measures may amount to indirect or regulatory expropriation, even without the formal taking of the property in question.

For States, the challenge lies in exercising sovereign powers responsibly while minimising treaty risk and maintaining investor confidence. For investors, it is imperative to anticipate regulatory changes and structure investments to mitigate exposure.

Understanding Regulatory Expropriation

Direct expropriation is relatively straightforward: it involves an overt act of taking, such as compulsory transfer of title or permanent seizure of an investment. Regulatory or indirect expropriation, however, is subtler. It occurs when State measures, such as environmental restrictions, tax reforms, or energy price controls, effectively neutralise or destroy the economic use and enjoyment of an investment without formally transferring ownership.

In determining if an expropriation has occurred, tribunals typically consider the following:

  • whether the measure has caused a substantial deprivation of the investment’s value or utility, and whether the interference is permanent or severe (effect-based approach);¹
  • whether the investor’s legitimate expectations have been frustrated:²
    • investors may rely on specific assurances, stable regulatory frameworks, or consistent administrative practice;
    • yet expectations must be reasonable and contextual. In dynamic sectors such as energy or environmental regulation, change is foreseeable;
    • tribunals recognise that States cannot freeze their regulatory powers indefinitely;
  • the absence of compensation and the manner in which the measure was implemented (transparent and non-discriminatory or arbitrary and targeted);³ and
  • the purpose of the measure and whether it is proportional to its objectives.⁴

Legitimate Regulation vs. Disguised Expropriation

International jurisprudence has drawn a delicate line between bona fide regulation and measures that go too far. Three landmark cases illustrate this tension.

Tecmed v. Mexico involved the non-renewal of a landfill permit on environmental grounds. The tribunal emphasised that while States have the right to regulate, they must balance public interest with investor rights. Even if consistent with domestic law, abrupt and disproportionate measures that undermine legitimate expectations may constitute expropriation. The tribunal specifically stated that “foreign investor expects the host State to act in a consistent manner, free from ambiguity and totally transparently in its relations with the foreign investor, so that it may know beforehand any and all rules and regulations that will govern its investments, as well as the goals of the relevant policies and administrative practices or directives, to be able to plan its investment and comply with such regulations.”⁵

The tribunal emphasised that in that case Mexico’s Environmental Protection Agency failed to “report, in clear and express terms … its position as to the effect of [Tecmed’s] infringements on the renewal of the Permit” which prevented the investor “from being able to express its position as to such issue” and to agree on the measures required to cure the defaults.⁶ The tribunal also questioned Mexico’s motives and found that “[t]he refusal to renew the Permit in this case was actually used to permanently close down a site whose operation had become a nuisance due to political reasons […] regardless of the company in charge of the operation and regardless of whether or not it was being properly operated.”⁷

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"The 'responsibility for public health measures rests with the government and investment tribunals should pay great deference to governmental judgments of national needs in matters such as the protection of public health'."

In Methanex v. USA the dispute concerned California’s ban of a gasoline additive called MTBE (methyl tert-butyl ether), citing pollution of surface water and groundwater. The tribunal rejected Methanex’s claims, affirming that non-discriminatory regulation enacted in good faith for public welfare falls within the State’s powers, even if it adversely affects foreign investors. The tribunal took into account the fact that California “ordered a careful assessment of the problem” and “responded reasonably to independent findings that large volumes of the state’s ground and surface water had become polluted […] and that preventative measures were called for”.⁸ The tribunal was satisfied that “California agencies acted with a view to protecting the environmental interests of the citizens of California, and not with the intent to harm foreign methanol producers.”⁹

In Philip Morris v. Uruguay, in a majority decision, the tribunal upheld tobacco control measures, recognising the State’s broad discretion to protect public health. The tribunal found the measures to be “a valid exercise of the State’s police powers”¹⁰ and explained that the “responsibility for public health measures rests with the government and investment tribunals should pay great deference to governmental judgments of national needs in matters such as the protection of public health.”¹¹ The tribunal specifically dismissed Philip Morris’s claim that the measures violated their legitimate expectations and noted that given the “widely accepted articulations of international concern for the harmful effect of tobacco, the expectation could only have been of progressively more stringent regulation of the sale and use of tobacco products”.¹²

These cases underscore a consistent principle: States enjoy significant regulatory latitude, but measures must be proportionate, transparent and non-discriminatory. Investors, in turn, cannot expect absolute regulatory stability, particularly in sectors where change is foreseeable.

Implications for investors

Investors should adopt a proactive approach to regulatory risk:

  • early policy analysis: understanding climate commitments, tax reforms, and energy transition strategies can inform investment decisions and financial modelling;
  • contractual protections: where possible, investors should seek contractual protections such as stabilisation clauses or economic equilibrium mechanisms;
  • assurances provided by State authorities should be carefully documented;
  • corporate structuring: aligning investment nationality and seat with favourable treaty protections can provide access to robust dispute resolution forums;
  • maintaining a clear evidentiary record of regulatory engagement and economic impact will strengthen any future claim or negotiation; and
  • constructive engagement with regulators can often prevent disputes. Participating in consultations, proposing alternatives and seeking phased compliance can preserve value and relationships.

Implications for States

For States, the priority is to design and implement reforms in a manner that minimises treaty exposure:

  • measures should be grounded in evidence, clearly articulated as serving legitimate public objectives and applied transparently;
  • due process (notice, consultation, and reasoned decision-making) must accompany any changes;
  • avoiding discriminatory or targeted measures is critical;
  • any measure must be proportionate to the stated goals;
  • phased implementation and transitional arrangements can mitigate investor impact; and
  • in sectors facing disruptive change, compensation schemes or contract rebalancing may be prudent to reduce litigation risk.

Sectoral Hotspots

Energy transition policies, such as coal plant retirements or renewable permitting reforms, pose significant challenges. Abrupt cancellations or discriminatory restrictions can trigger claims, while phased, evidence-based measures are more defensible. Environmental regulation, including chemicals bans or biodiversity offsets, is generally protected if non-discriminatory and scientifically justified. Tax reforms, particularly retroactive levies or windfall taxes, require careful calibration to avoid allegations of disguised expropriation. Public health measures, as seen in Philip Morris, attract strong deference when proportionate and transparent.

Conclusion

Regulatory expropriation is not about form but effect. Severe, lasting economic deprivation can be compensable even without formal nationalization. States retain broad regulatory powers, but proportionality, due process and non-discrimination remain essential. Investors cannot demand absolute stability, yet they can protect themselves through foresight, structuring and engagement.

"Investors cannot demand absolute stability, yet they can protect themselves through foresight, structuring and engagement."

How We Can Help

Our team advises both investors and States on managing regulatory change risk, structuring investments for treaty protection and resolving disputes under international law. We combine transactional insight with dispute resolution expertise to help clients navigate reform agendas without derailing commercial objectives.

If you would like to discuss risk mitigation strategies, review current exposures or explore recent arbitral trends, please contact us.

Footnotes

[1] See e.g., Metalclad Corporation v. The United Mexican States, ICSID Case No. ARB(AF)/97/1, Award, 30 August 2000, paras.103, 108, 111.
[2] See e.g., Azurix Corp. v. The Argentine Republic (I), ICSID Case No. ARB/01/12, Award, 14 July 2006, para.316.
[3] See e.g., Mobil Exploration and Development Inc. Suc. Argentina and Mobil Argentina S.A. v. Argentine Republic, ICSID Case No. ARB/04/16, Decision on Jurisdiction and Liability, 10 April 2013, para. 818.
[4] See e.g., LG&E Energy Corp., LG&E Capital Corp. and LG&E International Inc. v. Argentine Republic, ICSID Case No. ARB/02/1, Decision on Liability, 3 October 2006, para. 195.
[5] Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award, 29 May 2003, para. 154.
[6] Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award, 29 May 2003, para. 162.
[7] Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award, 29 May 2003, para. 164.
[8] Methanex Corporation v. United States of America, UNCITRAL, Final Award of the Tribunal on Jurisdiction and Merits, 3 August 2005, Part IV, para. 20.
[9] Methanex Corporation v. United States of America, UNCITRAL, Final Award of the Tribunal on Jurisdiction and Merits, 3 August 2005, Part IV, para. 20.
[10] Philip Morris Brands Sàrl, Philip Morris Products S.A. and Abal Hermanos S.A. v. Oriental Republic of Uruguay, ICSID Case No. ARB/10/7, Award, 8 July 2016, para. 287.
[11] Philip Morris Brands Sàrl, Philip Morris Products S.A. and Abal Hermanos S.A. v. Oriental Republic of Uruguay, ICSID Case No. ARB/10/7, Award, 8 July 2016, para. 399.
[12] Philip Morris Brands Sàrl, Philip Morris Products S.A. and Abal Hermanos S.A. v. Oriental Republic of Uruguay, ICSID Case No. ARB/10/7, Award, 8 July 2016, para. 430.

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