DCF Valuation – The Thin Line Between Use and Abuse in Investor – State Disputes: An Analysis of Devas v. India

3/Jun/2021, 7:47 AM, Authored by Hiroo Advani, Tariq Khan & Muskaan Gopal

If you thought the concept of Fair and Equitable treatment is susceptible to abuse, you haven’t seen anything until you’ve seen what an imaginative claimant supported by its expert can come up with in quantum using DCF.

– George Cahill III

The Discounted Cash Flow (‘DCF’) valuation method was first introduced by Economist Myron J. Gordon in 1962[1] in an attempt to combine imprecise financial practices with economic theory to calculate the values of enterprises. This valuation method was later adopted by arbitral tribunals with an aim to calculate damages to be awarded.

Since the DCF method is used to estimate the value of an investment based on its expected future cash flows, there is no certainty regarding the final calculations. Various jurists have also pointed out that the calculations in the DCF valuation method contain so much conjecture that they appear to those uninitiated in accounting science hardly less speculative and just as obscure as the prophecies of Nostradamus.[2] Due to this, the tribunals were wary of applying this method to value assets unless the businesses fell under the definition of ‘going concern’[3] as per the World Bank Guidelines on the Treatment of Foreign Direct Investment.

Even while issuing its 1992 Guidelines on the Treatment of Foreign Direct Investment, the World Bank had highlighted that “particular caution should be observed in applying DCF, as experience shows that investors tend to greatly exaggerate their claims of compensation for lost future profits.[4] The guidelines also stressed the fact that DCF should not be applied to cases where the business was not a going concern with a proven record of profitability.’

The recent Award on Quantum i.e., the majority award in the case of Devas v. India (PCA Case No. 2013-09) has raised several questions on the validity of using the DCF valuation method in cases where the business is not going concern. The Tribunal’s decision in this majority award incorrectly goes to show that future profits necessarily exist and should be awarded regardless of the absence of a history of profits.

In the dissenting opinion of the majority award in Devas v. India, Justice Anil Dev Singh has clearly stated that: “Assumptions beyond tolerable level of speculation are antithetic to the DCF valuation.” This article, therefore, highlights the drawbacks of the DCF valuation method and proposes alternative measures to calculate damages in Investor-State disputes.

Summary of Devas v. India

The dispute concerns the annulment of a contract, entitled ‘Agreement for the Lease of Space Segment Capacity on ISRO/ANTRIX S-Band Spacecraft’ (‘Devas Agreement’) following a policy decision taken by the Government of India to reserve a part of the electromagnetic spectrum, known as the S-band, “for national needs, including for the needs of defence, para-military forces, railways and other public utility services as well as for societal needs, and having regard to the needs of the country’s strategic requirements.”

Devas (‘Claimant’) maintained that this policy decision taken by the Government of India amounted to an expropriation of the Claimants’ investments in India and was not accompanied by payment of fair and equitable compensation, in breach of the India – Mauritius Bilateral Investment Treaty (‘BIT’). However, India (‘Respondent’) argued that its policy decision was intended to satisfy the national security needs of the nation and that Devas had no right to proceed with the Devas Agreement uninterrupted by any governmental action.

While the Claimants requested damages amounting to 580 million USD based on the DCF method, the Respondent rejected the reliability of the DCF method by stating “it is highly suspect in the circumstances of this case, which involves a start-up company with no track record in a highly regulated industry with significant risks and uncertainties.” The Tribunal stated that since Devas was ‘likely to yield economic benefits, the DCF method could be considered appropriate and awarded compensation amounting to 111.30 million USD.

However, Justice Anil Dev Singh, in his dissenting opinion reasoned that since Devas had not generated any revenue, it was difficult to formulate a credible DCF valuation for Devas. Further, he elaborated on his stance by clearly showcasing that (a) Devas had no past records showing profitability; (b) It was not a going concern; (c) It lacked a customer base whereby its cost levels were untested, and (d) It lacked the Wireless Planning and Coordination (‘WPC’) license whose issuance was doubtful. Future profits require a degree of certainty which is lacking in this case especially since Multimedia Broadcasting Service markets can be highly volatile which can even make profitable businesses obsolete.

Conflicting views surrounding DCF valuation method in Investor-State disputes

The use of the DCF valuation method to calculate costs is a very recent development in International Investment Tribunals. It began with the dissenting opinion of Justice Bower regarding the majority award in Amoco International Finance Corporation v. Iran (IUSCT Case No. 56) decision. While the majority cast doubts on the validity of the DCF method, Justice Bower stated that the determination of the magnitude of damages should follow business practices i.e., the usage of DCF valuation, even if the process is speculative. Taking inspiration from Justice Bower’s opinion, the Tribunal in the case of Phillips Petroleum Company Iran v. The Islamic Republic of Iran (IUSCT Case No. 39) opined that the DCF method was justified since an investor would have relied on the same to determine the purchase price.

In today’s scenario, it has now become a given that investors are entitled to compensation. PwC in its research on the usage of the DCF method stated that “It was accepted in 9 out of the 11 cases in which it was proposed. This is a lower rejection rate (18%) compared to the historical average shown in the 2015 research (37%).[5]

However, attempting to calculate the damages in terms of real-market methods places a heavy burden on the State’s finances especially since slight miscalculations can change the value by millions of dollars, which in turn leads to heavily inflated awards. This is supported by the 2001 Articles on State Responsibility by the International Law Commission (ILC), which stated that “The use of DCF models is only appropriate in a narrow range of circumstances, such as when an investor has a contractual entitlement to a defined income stream.[6]  Moreover, in cases where the damages are calculated using the DCF method, the experts appointed end up giving credibility to calculations that are not based upon real numbers. This leads to highly – inflated awards, especially when the tribunal relies solely on the DCF method.

The Tribunals fail to enquire whether there indeed is legality to such entitlement and instead merely concentrate on whether such an investment could have been profitable. Due to this, they end up giving awards with highly inflated damages that bear little to no resemblance to the actual amount invested by the investor. In the case of Mohamed Abdulmohsen Al-Kharafi & Sons Co. v. Libya and others, the Tribunal awarded $1 billion in damages for a ‘theoretical’ project where the investor had initially claimed a settlement of $5 million. A court in Cairo has recently set aside the award on the grounds that the valuation awarded was vastly distinct from the reality. Even in the case of Tethyan Copper Company Pty Limited v. Islamic Republic of Pakistan (ICSID Case No. ARB/12/1), the Tribunal employed the DCF method for a project which had not yet started production. The Tribunal ended up awarding damages, which with interest amounted to over $6 billion. On top of this, the Tribunal ordered Pakistan to pay the Claimant’s costs which amounted to $60 million. These cases go to show that Tribunals need to be extremely careful when it comes to reliance on the DCF valuation method. Even the slightest of errors in the discount rate can lead to an astronomical amount in damages which burdens the States unfairly.

It is to be noted that where the State’s breach has led to the loss of an investment opportunity, but the actual right to the contract or the necessary licenses were missing, it is wrong to award compensation to the Investor. This has been reiterated by the tribunal in the case of Bear Creek Mining Corporation v. Republic of Peru (ICSID Case No. ARB/14/21). The tribunal refused to employ the DCF valuation method as the investor had failed to acquire the necessary regulatory approvals to proceed with the project. This created a doubt as to whether the investments could have been profitable. In these circumstances, the tribunal held that the actual amounts invested provided the best evidence of the project’s value.

Even in the Devas case, the Tribunal via the Award on Quantum i.e., the Majority Award, incorrectly ended up giving the award in favour of the Claimant by using the DCF valuation method even when the all-important WPC License had not been given to the Claimants. By such an award, the Tribunal is simply propagating the idea that future profits necessarily exist without showcasing any certifiable history to prove the same.

It has also been highlighted by multiple tribunals that DCF valuation is not appropriate, and tribunals should refer to cost-valuation methods for calculation damages. In Vivendi v. Argentina II (ICSID Case No. ARB/97/3), the tribunal stated that “the net present value provided by a DCF analysis is not always appropriate and becomes less so as the assumptions and projections become increasingly speculative. And, as Respondent points out, many international tribunals have stated that an award based on future profits is not appropriate unless the relevant enterprise is profitable and has operated for a sufficient period to establish its performance record.” Even in Caratube International Oil Company and Devincci Salah Hourani v. Kazakistan (ICSID case no. ARB/13/13), the tribunal rejected the DCF approach to compute Fair Market Value (‘FMV’), stating that the Claimant was not a going concern and had no historical records of profitability as per the World Bank Guidelines.

It is, therefore, essential to ensure that where the investors’ future profits are legally protected, the tribunal award the investors reasonable profits only. Thus, it is pertinent to come up with other valuation methods apart from the DCF valuation method to ensure reasonable monetary awards.

Alternatives to inaccurate usage of the DCF method

Due to multiple tribunals using the DCF method inappropriately to value early-stage businesses, a few treaties are coming up with clauses that prevent the same. An example of that is the Colombia Model BIT (2017), wherein it is stated that:

“In its final assessment of monetary damages, the Tribunal shall take into account:

  1. A comparison of multiple valuation methods; and
  2. The monetary values that the claimant reported in Economic Declarations, required by the Host Party for the making and operation of the Covered Investment.”[7]

This is an attempt to prevent tribunals from using the DCF valuation method without considering other calculation methods which will oftentimes give lower valuations.

Apart from the income-based approach which uses the DCF method, there also exist the assets-based approach and the market-based approach to calculate the FMV of a business. The assets-based approach states that the value of a business is derived from the FMV of the assets (tangible and intangible) less the liabilities. On the other hand, in the market-based approach, the FMV of a business is derived by referencing a group of similar businesses.

Additionally, in recent times, multiple tribunals have referred to the rate of return method to calculate compensation instead of the DCF method. In the case of RREEF Infrastructure Ltd. v. Kingdom of Spain (ICSID Case No. ARB/13/30), the tribunal relied on the Internal Rates of Return specified by the parties to decide on the calculation of damages. Even in the case of Novenergia v. Spain (SCC Case No. 063/2015), the Tribunal stated that “the internal rates of return is a relevant measurement for what the Claimant was expecting to get from its investment in the Kingdom of Spain at the time of making the investment.

It is also essential to note that even when the Investor has a legitimate expectation of future profits, it is not ensured that they will be entitled to the entire value of profitability that was projected at the time of the breach by the State. The same has been highlighted in the RREEF Infrastructure Ltd. v. Kingdom of Spain (ICSID Case No. ARB/13/30), where the tribunal stated that its task is to reconcile the Investor’s claim with the State’s monetary position, especially in consideration of public interest.


The DCF valuation method, in the absence of any other reliable methods for calculating damages, has become a popular choice for parties in Investor-State disputes. It does have its advantages since it uses the same methodology as real-world business models to calculate the estimated profits. Parties rely heavily on this method to make humongous claims for ‘lost profits’ all the while inundating the Tribunal with expert reports and complex jargon. However, while it does link financial and economic theories in an attempt to give precise calculations for prospective damages, it cannot be considered accurate as no one has a perfect knowledge of the future. While the method for calculating adequate compensation remains unclear in international investment disputes, there is sufficient jurisprudence to show that for the damages being claimed by the parties, there needs to exist evidence backing those calculations.

It can be argued that the DCF valuation method has its benefits, since it helps calculate the ‘intrinsic values’ of a business and derives the inherent value of its future cash flow for the stakeholders. However, it is important to understand that the DCF method cannot be applied as a straight-jacketed formula in every Investor-State dispute. The DCF method is pyramided on the edifice of concrete evidence and usage of it in disputes without concrete evidence leads to its abuse. Even in Devas v. India, it appears that apart from the estimates provided by the Claimants, there were no other factors that could have assisted in a precise usage of the DCF method.

The DCF method has in certain cases led to the parties being overcompensated, as there is too much reliance on the expert reports. The extreme reliance on the expert reports leads to an inadvertent delegation of the decision-making power by the Tribunals. Therefore, the practice of having an expert on the panel of arbitrators must be encouraged to ensure that the Tribunals have the requisite experience to deal with these matters.

The Awards passed by the Tribunal must be based on concrete evidence and the Tribunals must be prudent while computing the damages. The parties will continue to make aggressive claims for damages, however, it is the responsibility of the Tribunals to carefully ascertain the damages in an already uncertain world. The damages claimed must also be restrictively interpreted, so as to not overburden the state and to not harm the promotion of economic cooperation and development between countries as after all such inflated damages might end up harming the public interest.

The addition of damages in the reform agenda of the UNCITRAL Working Group III and the changes to the Energy Charter Treaty (‘ECT’) showcase that the ease with which, such inflated awards have been given, have brought attention to the misuse of the DCF valuation method. The only hope now is that the Tribunals realize that the current system relies solely on myths and assumptions when quantifying damages and change their perceptions to truly justify the assessment of the claims.

[1] Myron J. Gordon, The Investment, Financing and Valuation of the Corporation, Homewood Ill: Irwin, 1962.

[2] Seidl-Hohenveldern Ignaz, The Assessment of Damages in Transnational Arbitrations, French Yearbook of International Law (1987), Volume 33, p. 7-31, Available at: https://www.persee.fr/doc/afdi_0066-3085_1987_num_33_1_2766 .

[3] Section (6) part (IV), World Bank Guidelines on the Treatment of Foreign Direct Investment.

[4] Legal Framework for the Treatment of Foreign Investment, Vol. II: Guidelines, (n. 42) pg. 26.

[5] PwC International Arbitration damages research 2017 update, Available at: https://www.pwc.co.uk/forensic-services/assets/pwc-international-arbitration-damages-research-2017.pdf.

[6] Yearbook of the International Law Commission, (2001), Volume II (Part Two), Responsibility of States for Internationally Wrongful Acts. UN Doc. A/56/10, Art. 36, Available at: https://legal.un.org/ilc/publications/yearbooks/english/ilc_2001_v2_p2.pdf

[7] Colombia Model BIT (2017), p.21.