EFFICIENCY OF INVESTOR-STATE CONTRACT CLAUSES
The modern contractual practice between foreign investors and host states often resorts to clauses aimed at limiting the risks of the investor associated with the unexpected exercise of sovereign legislative or administrative prerogatives. At the same time, investor state contracts are linked to international law and the regime of investment protection under bilateral and multilateral investment treaties.
After providing an overview of the most relevant clauses used in investor-state contracts, critically review their efficacy in terms of foreign investment protection as well as their relationship with international law.
1. Demonstrate an advanced and detailed knowledge and
understanding of the law relating to trans-national
2. Demonstrate an advanced knowledge and understanding of the scope and use of trans-national standard form contracts;
3. Work individually to clarify objectives and construct cogent and persuasive arguments in response to the issues and problems posed;
4. Locate and synthesise information from a range of published literature and electronic sources and present this effectively in oral, written and other media.
EFFICIENCY OF INVESTOR-STATE CONTRACT CLAUSES
Efficiency of Investor-State Contract Clauses
Table of Contents
Investor-state contracts form part of the common entry methods into foreign direct investment. State contracts play a major role in achieving foreign direct investment for both developing countries and long term contractors who depend on the exploitation of natural resources to stabilize their economies. This implies that, there must be a unifying law that will enable the parties involved in these contracts to agree on the terms of contract without considering the domestic law. State contracts and their relation to international law and international investment agreements combines a number of issues. The extension of protection provided for in the state contract depends on the definition of the investment clauses, the exclusion of certain definitions made in domestic laws, and the dispute resolution mechanism defined and applied to the state contract.
In the late 1980s towards early 1990s, there emerged a robust debate about the mixture of private and public law that came along with the proliferation of bilateral treaties of investment. As a result, there was need to have clauses that give special attention to issues surrounding the contracts. One of the methods used was the issuance of the arbitral award or judgment to the foreign investor. This has been realized by the use of clauses that are formulated differently to suit the type of contract and conserve the interests of the investor as well as the host nation. The general understanding and application of the investor-state contract clauses provide some contentious questions concerning investment arbitration. On the other hand, it is within the provisions of bilateral investment treaties that, host states guarantee all respect to the agreed obligations as assumed in the investment. However, the wordings used in the clauses has brought forth varied interpretation of the clauses worldwide.
Within the provisions of general international law, it is accepted that any breach by the state to a contract it had made with a private investor is not a violation unless the act involves an additional element that amounts to a breach of treaty, denial of justice, and expropriation. As a way of mitigating this hindrance and protect the interests of the private investor while holding the state responsible for any contractual breaches, a dispute resolution tribunal may use some of the articles in the international law to limit the implementation of state sovereignty. Therefore, to free investor-state contracts from undesired complications of domestic law, the relationship between the host state and the private investors has to be internationalized through a tribunal. For instance, the Texaco tribunal explained that, “a contract between a State and an alien private person could be ‘internationalized’ in the sense of being subjected to the only other legal order known to us, namely public international law”. This shows that investor-state contracts should not be considered as pertinent governed by the public international law the way inter-state transactions are, but parties my make public international law an object of reference or choice where applicable in the legal system. Tribunals formulate clauses that are used in the arbitration of disputes. Efficient internationalization can only be achieved by combining both the concepts of umbrella, stabilization, choice-of-law, and arbitration clauses. This ensures that the contracts are governed by international principles that cannot be affected or influenced by the unilateral interference of domestic rule making processes. This ensures that the disputes are resolved using a neutral judicial forum that impartially applies the relevant principles of the international law.
In a theoretical perspective, internationalization alone cannot ensure that contracts are validated. Internationalization elevates the existing domestic contracts to commitments of the state by devising clauses as objects under the international law. This leads to the formation of doctrines such as the doctrine of permanent sovereignty of state over the natural resources and the doctrine of economic rights over duties of the state. Any act that may in any way cause a breach to the doctrines or the clauses created, is considered a breach to the international law. Although, the concept has raised several views and arguments across the global legal framework. For instance, it is viewed that any breach of the clauses is considered as a breach of the international law regardless of whether any other customary norm was impaired. However, the arbitral tribunal formed may award full compensation over specific performance.
In another context, the applicable laws of contracting can be frozen in the event of doubtful concerns are raised. This shows that even though a state can bind itself to an investment contract, the clauses constitute a legal ground to terminate the contracts without paying any compensation. Another view establishes that, the validity of clauses has limited protection and tribunals should not always make decisions based on the vacuum within the relationship between the clause and the international law, but rather device and follow a case by case approach. This will enable the tribunal to give due consideration to the doctrines mentioned and come up with a well informed decision on the economic realities.
Umbrella clauses are developed based on a general provision that some international investment agreements protect the obligations that are undertaken towards the private nationals of the second parties in the contract. A good example of such clause is the 1983 Bilateral International Treaty, Article 2(2) between the United Kingdom and Saint Lucia which provided that,
“each contracting party shall observe any obligations it may have entered into with regard to investments of nationals or companies of the other contracting party”
A shallow interpretation of this clause would assert that the provisions within the clause protects the contractual rights of the investor against interferences that are likely to be caused by a simple breach of contract, legislative amendments, and administrative actions. Apparently, there are numerous uncertainties in the nature and effect of the clause. From the clause, it remains unclear whether all obligations created between the contracting parties can be enforced by the foreign investor alone or whether they can be enforced by the host nation alone.
Umbrella clauses have continued to bring controversies on the best ways of solving disputes. In another arbitral decision no successful solution was reached to clarify the extent unto which an investor can make a claim against the host country when a breach of contract has been made under the bilateral international treaties. The arbitral tribunal in the SGS v. Philippines interpreted a clause in the 1995 Bilateral international treaty article 11between Switzerland and the republic of Pakistan. The clause read,
“Either Contracting Party shall constantly guarantee the observance of the commitments it has entered into with respect to the investments of the investors of the other Contracting Party”
The clause is not clear and can easily lead to a divergent conclusion. This made the tribunal to change the approach to the case and draw a different approach based on the effects that the clause could be causing to the contract. this enabled the ratification of the clause to read,
“each Contracting Party shall observe any obligation it has assumed with regard to specific investments in its territory by investors of the other Contracting Party”
Even though the clause was less confusing compared to the initial clause, its implementation was left to the jurisdiction of the Philippines domestic courts.
Umbrella clauses lead to divergent jurisprudence that can be characterized to have a narrow and wide approach. The narrow approach favors and emphasizes the need to have a closer look at the scope of the treaty based on the existing clauses similar to and which can be implemented in the treaty. This easily puts the host nation into a state of no reassurance besides making it hard to resolve public-private disputes. The best way to deal with such disputes is by observing jurisprudence, exerting restraint, and carefully balancing the clauses based on the statutes of international law. Application or reference to other clauses should be done in a more precise manner. For instance, the application of the most favored nation clause may complicate the dispute resolution process. The most favored nation clause works on an observation over the number of contracts a foreign investor has had jurisdiction and the contractual breaches made. In such a case, the clause may acquit the party in breach when the state is making a claim. In the same view, a claim may be deemed viable when in reality the private investor was not in breach of any contract.
The stabilization clause seeks to preserve the host country’s laws as they apply during the time the contract is made and bars any application of changes made to the laws in the contract until its completion. A good example of such clause is within the Italian bilateral international treaty which states that,
“After the date when the investment has been made, any substantial modification in the legislation of the Contracting Party regulating directly or indirectly the investment shall not be applied retroactively and the investments made under this Agreement shall therefore be protected”
Although the clause does not amount to a full stabilization clause, the clause does allow for the formation of changes to the laws governing the contract but limits the applicability of the same laws to the contract. As such, the contract remains unaffected by the changes made to the laws.
In the case, Texaco v. Libya 1978, the government made an attempt to nationalize all the rights, interests and property of Texaco in Libya prompting Texaco to request for an arbitration. The arbitrator found Libya of breach to its obligations under the practice of concessions. According to the contract, Libya was bound to perform its obligations accruing to the original terms. Compared to the umbrella clause, stabilization clause is more direct and does not lead to any divergent decisions. It is clear from the case that whenever reference has been made to the principles of international law, any international arbitration is held sufficient for the contract. As a result, lack of adequate law in the statutes of the host state and the need to protect private investors from unilateral and abrupt changes to the domestic law are covered by the clause. Although general international law comprises of subjects from diversified backgrounds, the legal capacity drawn when creating the stabilization clauses does not only attribute to the state but also to the private investor. As such, a private investor unlike the state, has is limited to invoke the rights within the contract that are only applicable to him.
The application of Libyan law to the arbitration proceedings was the main conflict in the case. According to the Libyan domestic laws, the contract was in breach. But even if the contract was in breach of the Libyan laws, the tribunal noted that Libyan law under the stabilization clause does not prevent the application of general international law but provides a platform for the combination of the two for the Libyan laws to be considered in compliance with international laws. Stabilization clauses recognizes the right of the state to nationalize their laws just like the international laws recognizes the nationalization of domestic laws. But the rights are not sufficient justifications when contractual obligations are being made on the international front.
Arbitration clauses, also known as forum selection clauses, allow the private investor to submit disputes that arise under the contract to an arbiter tribunal that is constituted outside the host state. Every arbitration is initiated by an agreement between the parties on the criteria to use when solving disputes that arise within the legal relationship. The agreement is created as a clause in the and may be in writing within the contract or as a separate agreement. Where it is not made in writing, arbitration clause may be subject to the governing common law to the extent that both parties are residents of common law or practice their businesses within the confinements of common law. One of the key elements of arbitration clauses is consent which makes the clauses legal and binding else there can be no arbitration mechanisms to resolve any disputes arising.
In the case of Aminoil v. Kuwait 1982, Aminiol was granted 60-year concession to explore and exploit oil and gas in Kuwait. In the original contract, the price of the agreement was a down payment and a royalty for every ton of oil and a subsequent annual royalty that was fixed. In the contract, a stabilization clause was included barring the Kuwait government from altering the terms of the contract. There were numerous developments and after thirteen years of exploration, the parties agreed to make modifications to the concession where the fixed royalties were subject to a 50/50 principle royalty plan. After changes in the global oil market, final amendments to the contract was initiated and completed after 27 years of exploration to take into effect the global oil market changes. An effort by the Kuwait parliament to amend the contractual terms failed to be applied and it was followed by the Abu Dhabi Formula which was aimed at transferring power from oil exploring companies to the states. Aminoil and Kuwait failed to reach at a compromise to the issue and the Kuwait government applied the Decree law which stated that the contract be terminated. An ad hoc tribunal comprising of three members was formed and every party had to conclude a different arbitration agreement.
The tribunal applied the Kuwait law as the law directly involved in the emergence of the issues at leading to the disputes. Subsequently, the tribunal applied general international law because it was part of the constituents of internationalization of contracts and formed part of the Kuwait’s law. This was done on the basis of the arbitration agreement. As noted by the tribunal, the Kuwait law and the international law was not in contradiction hence there was no need to expand on their relationship. The agreements between the parties were binding and legal. As a result, Aminoil owed Kuwait everything due under the instruments of the contract just like Kuwait. Even though a stabilization clause was included in the contract agreement, it lacked the outright prohibition of nationalization since Kuwait was now an independent nation with special advantages that enabled it to enjoy contractual equilibrium. The tribunal in an aim to protect the interests of both parties applied the international law.
Arbitration clauses provide a framework in the determination of disputes arising out of legitimate augments of contractual equilibrium. As observed in Aminoil v. Kuwait 1982, the initial contract was made when the country of Kuwait had not received independence. A stabilization clause inserted to protect the interests of the private investor, Aminoil, from both the colonial governance and the Kuwait government. On the other hand, after attaining independence, Kuwait was entitled to contractual equilibrium yet the clause still formed part of the agreement. Arbitration clauses in the contract made it easy for the tribunal to resolve the stalemate using the international law fulfilling the interests of both parties.
Choice-of-law clause refers to super national law system that has the general principle of law that when put in a contract eliminates the potential of the host country to interfere with the contract. it is one of the law systems that is used in the achievement of an efficient internationalization system. The basic approach of this clause ensures that the contract is governed within the principles of international law which falls beyond the interference of the unilateral domestic enforcement of the law. The arising disputes are resolved by a unilateral arbitral forum that applies the relevant principles adopted from international law.
In Sapphire v. NOIC 1963, Sapphire was contracted to expand the exploration and exploitation by Iran due to the technical and financial abilities the company had. The contract was valued at 8 million US dollars within a period of four years. The parties in the contract agreed and set up IRCAN, a joint venture to carry out the operations. The contract between Sapphire and IRCAN was distinguished into two periods where the first period dealt with the exploration while the second period dealt with the extraction of the oil. In the contract, Sapphire was expected to commence works in the first six months after signing the contract and drilling to years after singing the contract. the contract also had a clause stating that in the event Sapphire failed to commence works within the said periods, NOIC was obliged to terminate the contract six months after the expiry of the said dates and a payment of the liability from Sapphire. In the subsequent months, Sapphire started works and send two expenses reports to NOIC which NOIC rejected to acknowledge claiming that Sapphire failed to consult them before starting the work. Sapphire would later notify NOIC of an arbitration which was also rejected by NOIC. Besides Sapphire choosing a sole arbitrator, NOIC did not choose one forcing Sapphire to appoint the president of the Swiss federal court to arbitrate the dispute.
The choice of law clause allows the parties in the contract to choose a new legal framework to arbitrate over the disputes raised. In the case of Sapphire v. NOIC, the sole arbitrator used both procedural and substantive law to make an equitable decision. This enable the arbiter to use continental and Anglo-Saxon laws which were not explicit to the contract. the use of the new laws excluded the application of traditional rules as implemented in the private international law.
Clauses used in investor-state
contracts provide the parties with better mechanisms to solve disputes that
arise out of contracts. There are several clauses including; stabilization,
umbrella, choice-of-law, and arbitration, used in the contract agreements which
whenever the parties fail to agree, they are used to solve the disputes.
International law cannot be used fully whenever a breach of contract between the
private investor and the host nation occurs because international laws do not
hold states responsible for any breach of contract. To protect the interests of
the private investors, contract clauses are added to the contract or made as an
accompanying document to the contract. consent of both parties is mandatory for
the document to be considered as authentic. Contract clauses allow the
application of international law to the dispute resolution mechanism to reach a
satisfying solution that can be accommodated fully by both parties.
 Sam Halabi, ‘Efficient contracting between foreign investors and host states’. Northwestern Journal of International Law & Business (2011) vol. 31, 261.
 Lise Johnson, L. and Oleksandr Volkov. ‘Investor-state contracts, host-state “commitments” and the myth of stability in international law’ The American Review of International Arbitration, (2013) 24(3), 361.
 Lise Johnson, and Oleksandr Volkov, ‘Investor-state contracts, host-state “commitments” and the myth of stability in international law’  24 The American Review of International Arbitration, (3), 361
 Jarrod Wong, ‘Umbrella clauses in bilateral investment treaties: of breaches of contract, treaty violations, and the divide between developing and developed countries in foreign investment disputes’ (2006) www.georgemasonlawreview.org/wp-content/uploads/2014/03/14-1_Wong.pdf. accessed 14 May 2017.
 United Nations, ‘State contracts: UNCTAD Series on issues in international investment agreements.’ (2004) unctad.org/en/Docs/iteiit200411_en.pdf. accessed 14 May 2017.
 United Nations, ‘State contracts: UNCTAD Series on issues in international investment agreements.’ (2004) unctad.org/en/Docs/iteiit200411_en.pdf. accessed 14 May 2017.
 Texaco v. Libya  53 I.L.R. 389, 422.
 Aminoil v. Kuwait  21 ILM 976
 Sapphire v. NOIC  35 I.L.R. 136
 Sergey Ripinsky and Kevin Williams, Damages in international investment law (British Institute of International and Comparative Law, reprint edn, 2015)