Investor State Contracts and Contractual Mechanisms
Introduction
Investor State Contracts in such areas as mining and exploration of natural resources and hydrocarbon exploration are unique for other forms of trade agreement that a state might enter into with foreign investors. This is because such international investment agreements are characterised by considerable impacts on national security and national income, and entail comparatively highly speculative, albeit significant, financial commitment from the parties to the contracts namely, the foreign investors and the host states. For this reason, there is a need for a high level of collaboration between investors and host states, in order to overcome delays that could prove costly to the project, or other hindrances that could hinder a smooth execution of the contract.
Foreign investors in such projects require regulatory stability in a bid to promote their investment. This is because such infrastructure projects tend to be capital intensive, are long-term, and are extremely reliant on the government's regulatory powers. The investor thus needs an assurance that they will have enough time to recoup their investment by attaining the projected cash flows, even as they remain prone to the actions of the host state that might undermine such projected financial viability. Foreign investors rely on various contractual devices in a bid to safeguard their investment from the actions or activities of the host state. This essay will explore three such contractual devices in detail. They are: Stabilisation clauses, choice of law; and arbitration provisions.
Overview of Relevant Clauses in investor-state Contracts
Stabilization clauses
The main objective of stabilisation clauses is to ‘stabilise’ the terms of conditions that define a certain investment project in a bid to manage non-commercial risk. Stabilisation clauses entail the host government committing itself to not change the existing regulatory framework upon which the project is based, either via legislations or other means, unless there has been contact with and consent has been given by the other contracting party, there is compensation involved, on the restoration of economic equilibrium.
Forms of Stabilisation Clauses
Economic equilibrium clauses
This type of stabilisation clause associates changes in the terms of the contract in a bid to facilitate its renegotiation and facilitate payment of compensation for the restoration of economic equilibrium. A good example of an investor state contract in which economic equilibrium clauses are featured is the Kashagan PSA (Production-Sharing Agreement) of 1997, and the contractual arrangements for the WAGP (West African Gas Pipeline).
The economic equilibrium has gained popularity in recent years, relative to the other forms of stabilisation clauses like the freezing clauses. This is largely the case owing to they are more versatile and flexible.
There are two main categories of economic equilibrium clauses. Full economic equilibrium clauses seek to protect parties to the contract against the potential financial effects of changes in legislation. A full economic equilibrium clause affords foreign investors protection against the economic effects of various laws. Conversely, a limited economic equilibrium clause could protect foreign investors against certain regulations or laws (for instance, discriminatory laws to foreign investors) or against expenses or costs over a given limit. The implication made by the economic equilibrium clauses is that, while new legislation will apply to the project, the investor stands to be compensated by virtue of the fact that they have complied with them. Such compensation could be in the form of extended concession, adjusted tariffs, monetary compensation, or tax reduction, among others. Having in place an economic equilibrium clause would mean that in the event of a contractual breach, it may be necessary for the parties to the contract to renegotiate the terms of the contract in a bid to bring back economic equilibrium to the project.
Freezing clauses
Freezing clauses entail freezing or fixing of the legislation applicable to the contract starting from the day the contract becomes functional and is applicable as long as the contract remains valid. Full freezing clauses seek to freeze all legislation, often over the duration of the contract or project. On the other hand, the aim of limited freezing clauses is to give protection to the investor against a restricted set of legislative actions.
Hybrid clauses
These integrate the characteristics of both the economic equilibrium and freezing clauses. The aim of the hybrid clauses is for the state to reinstate the investor a position similar to the other they had occupied before changes in legislation.
Efficacy of clauses in investor-state contracts
Although stabilisation clauses have come under constant attack regarding their efficacy and validity, they have traditionally been endorsed in various arbitral awards. For instance, in Texaco v. Libya, the arbitrators held that the availability of a stabilisation clause upgraded the contract between the parties into an international one. The arbitrator maintained that 'the right to nationalise is unquestionable today’ and is a key component of state sovereignty. The arbitrator further noted that failure to nationalise owing to contractual commitments is an indication of an exercise and manifestation of sovereignty, as opposed to its elimination. What this means is that an internationalised contract of which stabilisation clauses are part of are not restricted by nationalisation.
Similar sentiments have also been echoed by the 1962 UN General Assembly Resolution 1803, which indicates that ‘‘[f]oreign investment agreements freely entered into by [. . .] sovereign States shall be observed in good faith’’ (art 8). In Kuwait v Aminoil the perspective that stabilisation clauses are both legally binding and lawful was also applied, with the arbitrator arguing that host states have a right to enter types of contractual commitments. However, the arbitrators caution that such contractual commitments require being “...expressly stipulated for... within the regulations governing the conclusion of State contracts... and … cover a relatively limited period'’ on grounds that they greatly hinder a host state's ability to exercise its sovereign powers. Other cases in which the binding nature and legality of stabilisation clauses have found application include Revere Copper v OPIC, AGIP v Congo, and Methanex v US where they were upheld implicitly.
A state has the freedom to make a decision regarding if it wishes to enter into a stabilisation clause. In case of violation of a stabilisation clause, the parties involved are bound by law to ensure that negotiations happen in good faith as a means of reinstating the economic equilibrium.
Relationships of investor-state contractual clauses with international law
The controversy that surrounds the validity and legal effect of stabilisation clauses is largely attributed to their connection with the applicable clauses of the contract. In this case, the legal impact of a stabilisation clause is for the most part determined by whether the legislation that applies to the contract between investor and state also happens to be the domestic law that governs the state party. There are three likely situations that could emerge from this situation. To begin with, the national law that governs the host state could also govern the contract. This appears to be the norm and is usually preferred by host states. Also, the contract could be solely regulated by general principles of law, international law, practice, and principles of law applicable to more than one state. Such a practice tends to be the norm, rather than the exception. Finally, domestic law could govern a contract, with the option for international or municipal laws, or both, where necessary, or principles of industry (for example, the petroleum industry) or decisions by an international tribunal. The application of the municipal law that governs the host state implies that alterations in such applicable law by the host state might also impact the contractual terms by changing contractual obligations. As such, in case the applicable law happens to be the same one that governs the host state, the implied legal implications of stabilisation clauses are likely to be invalidated in the event that a state decides to amend it as a means of exercising its sovereignty.
The application of certain stabilisation clauses could hinder a state's action to execute new environmental and social laws for long-term investments. The contents of many clauses find application in environmental and social law, thus enabling investors to pursue compensation or exemptions formally and informally. Accordingly, limited and full freezing clauses could therefore likely cushion investors against new environmental and social laws, since the contents of the contract underpin a logical interpretation that compliance is not mandatory. Elsewhere, hybrid clauses commonly give investors a chance to request changes to the contract, which might entail being absolved from the legislation, to compensate an investor. Conversely, economic equilibrium clauses enable the investor to ask for contractual changes to facilitate compensation. What this appears to suggest is that certain stabilisation clauses afford an investor room for informally negotiating a delay in the application of the new law to the project, limited compliance with the new legislation, to compensation for consent. Investors can also rely on hybrid, economic equilibrium, and freezing clauses as formal tools or their protection in agreement with a claim of breach of contract in case there is no compensation or immunity forthcoming from the host state.
Choice of Law
Most investments entail an agreement between the foreign investor and the host state. Such investment contracts differ considerably in terms of form, contents, and designation. Examples of investment contracts entail BOT (build, operate, and transfer) contracts, as well as BOO (build, operate, and own) contracts. One of the main elements of investment contracts involves a choice of law provision. Usually, the host State desires its own legal system as this will act in its favour. On the other hand, the investor prefers a system of law that guarantees them security and stability from unilateral variations in the laws of the host State. From a practical context, the choice of law provisions differs "from a reference to the law of the host State to an exclusive choice of the rules of international law".
One of the key elements of the choice-of-law clause is to apply the principle of party autonomy as a means of seeing to it that the agreement between the host State and the foreign investor is not subject to the domestic laws of the host country. This is because there is the risk that the host State could exercise its sovereignty and change its domestic laws at will. A key assumption with regard to international contracts is that the parties to such contracts enjoy the autonomy to opt for the legislation that applies to the contract they have entered into. Going by the rule of party autonomy, foreign investors shall opt for a system of law besides the domestic law of a host nation. While it is still possible to choose the domestic law of another state, this is likely to come across as offensive behaviour in the eyes of the host State.
According to Born, "choice-of-law clauses can be drafted broadly enough to encompass the arbitration clause contained in the parties' contract, even though it is "separable". Viñuales is of the view that choice-of-law clauses offer a certain level of stability in situations where the legislation upon which the contract is based is different from the one governing the host State.
Foreign investors frequently resort to the elimination of their contractual relationship with the host State from the reach of the municipal laws that govern the host State. This is usually achieved by ensuring that the contractual agreement is subject to the principles of law as practiced by civilised nations or legislations that identify with the laws of the foreign investor's home country. By internationalising the agreement between the parties to the contract, it means that the contract is now subjected to international law, as opposed to municipal law.
Arbitration Provisions
The aforementioned choice of law by the foreign investors with the goal of internationalising the agreement with the host State is frequently the centre of controversy and hence disputes between the two parties to the contract. Accordingly, this underscores the significance of international arbitration in order to settle such disputes that may arise due to this form of agreement. An arbitration clause is a term used in reference to an agreement between the foreign investor and the host State, and it is usually based on the conventional technique of agreeing to commercial arbitration. Arbitration provisions of this kind that seek to ensure agreement between the various disputing parties act as the basis for various investment arbitrations (for example, Adriano Gardella v Ivory Coast; Amco v Indonesia; and Atlantic Triton v Guine, among others). The Sapphire case is also a good example that demonstrates the growing significance of subjecting international investment contracts to international law. This significance merged to form the decision that the arbitral Tribunal took. As the Tribunal lacks an elaborate choice of law provision, it sought to apply international law. The contract in question failed to offer an express choice of law although it did indicate that performance ought to be executed based on the principles of goodwill and good faith. The Tribunal, while taking into account the impact of the parties’ choice, ruled against the application of Swiss law based on the argument that the conflict of laws ought not to act as a binding factor to the international arbitral Tribunal. The parties to the contract had already concluded the agreement and it was due to be implemented in Iran. Nonetheless, the Tribunal noted that there was sufficient evidence in the contract to rule out its being subjected to Iranian law. Accordingly, the Tribunal indicated that the contract should be subjected to the laws of a civilised nation.
Conclusion
Investor State Contracts have found wide application, especially in the exploration of natural resources such as oil and minerals. They are meant to ensure a smooth implementation of the projects by facilitating collaboration between the host state and foreign investors. This is based on the understanding that both the host State and the international investor would wish for the contract to be guided by laws that are favourable to them. To avoid such controversies between parties to the agreement, various contractual devices have been developed to govern investor state contracts, including stabilisation clauses, choice of law, and arbitration clauses. Stabilisation clauses are among the most commonly applied clauses in investor-state contract and they are three main types: Economic equilibrium clauses that seek to restore economic equilibrium of the project; freezing clauses that seek to 'fix' the laws applicable to the contract; and hybrid clauses that integrate the characteristics of these other two forms of stabilisation clauses. In terms of efficacy, stabilisation clauses have found wide application in different arbitral awards and are also not limited by nationalisation. They also enjoy a close association with other applicable contractual law clauses.
The choice-of-law clause involves an internationalising of the agreement between the parties to the contract, implying that the contract is subject to international law, and not the municipal law of the host State. Conversely, the goal of arbitration clauses is to create room for agreement between disputing parties by involving an international arbitrator.
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[1] Sornarajah, M, Resistance and Change in the International Law on Foreign Investment (Cambridge University Press, 2015) 2.
[2] Lowenfeld, Andreas, International Economic Law (Oxford University Press, 2008) 488.
[3] Vickers, Alice,’ The Choice of Law Clause in Contracts between Parties of Developing and Developed Nations’ (1981) 11 Ga. J. Int’l & Comp. 617.
[4] Schrijver, Nico, Sovereignty Over Natural Resources: Balancing Rights and Duties (Cambridge University Press, 2008) 340.
[5] Methanex Corp v United States of America, Final Award, 3 August 2005.
[6] Adriano Gardella S.p.A. v. Côte d'Ivoire, ICSID Case No. ARB/74/1.
