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Executive Summary

This chapter reviews some of the most important clauses that appear in major international investment contracts, namely the choice of forum, international arbitration, stabilisation and related risk allocation clauses, and waiver of sovereign immunity clauses. It provides a practical overview of these clauses, together with examples of model clauses and the related jurisprudence, in order to help understand the implications of each clause. Each of those clauses is of critical importance and should be drafted carefully and tailored to the needs of the parties, while taking into account the particular features of the investment, all for the purposes of minimising the risk of disruption.

1.0 Introduction

International investment contracts are international commercial contracts between an individual foreign investor and a state or state-owned entity. They differ from international commercial transactions between two corporate entities since disputes relating to investment contracts necessarily involve sovereignty issues and the state party’s public policy objectives.¹ They are also to be distinguished from international investment treaties which are interstate bilateral or multilateral agreements entered into between the investor’s country of origin and the host state. Such agreements afford investors with standardised rights and duties vis-a-vis the state and as such provide an extra layer of protection against the host state.

Investors should bear in mind that in the negotiation of investment contracts with private parties, governments will want to maintain a certain level of control and stability in key sectors, such as oil and gas, telecommunications, infrastructure, public health and safety, and environment. In these sensitive areas, where a government is likely to have a high level of public accountability, a government is more likely to aim for a long-term partnership with an investor than a highly lucrative, or speculative short-term venture, and the terms of the underlying contracts are likely to reflect this fact.

An example of a long-term investment contract, where a partnership (or win-win) structure is promoted, is a Production Sharing Agreement (PSA) in extractive industries which can last for up to 30–40 years.² In such a long-term contract, an investor will want to protect its agreement from changes in a state’s legislation that may negatively affect its investment. What is more, an investor will often want to circumvent national courts — which may be perceived to be biased — and resolve any disputes that might arise before a neutral forum outside the host state’s jurisdiction. States, on the other hand, will often be reluctant to submit to the jurisdiction of a foreign nation, and often domestic laws will prohibit a state-owned entity from agreeing to be subject to a foreign jurisdiction.³

These are just a few of the issues that inevitably crop up when a commercial party and a state (or a state-owned entity) enter into an investment contract. The following

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sections discuss the negotiation of clauses that may be impacted by the sovereign nature of the state party.⁴ An investor must bear these issues in mind when negotiating the provisions discussed in this chapter with sovereign states.

2.0 Choice of Forum

Corporate entities who enter into international commercial transactions will typically agree to have their disputes settled either in a particular domestic court of a particular state, or through arbitration. This is usually achieved by including a forum selection clause, which is an agreement that either permits or requires the parties to bring their dispute to a designated national court or jurisdiction, or to arbitration.⁵

A forum selection clause may either be “exclusive”, or “non-exclusive”. An exclusive forum selection clause requires that disputes be resolved solely in the specified forum. It precludes litigation in other courts that would otherwise have jurisdiction. A nonexclusive forum selection clause allows parties to litigate their dispute in the specified forum, but unlike an exclusive clause, it is not mandatory, but permits litigation to be pursued in other courts that may have jurisdiction.⁶

Parties to international transactions should specify that their chosen jurisdiction is intended to be the exclusive jurisdiction. This ensures that other courts that might otherwise have jurisdiction are precluded from exercising it, and thus saves time and expense responding to, and litigating parallel proceedings.

While an investor may agree, and may have little choice but to agree to have the investment contract governed by the law of the state in which it is investing, few investors will submit to the exclusive jurisdiction of the state unless they have confidence in the state’s court system. In light of this fact, it has become common practice for investors that have doubts about the neutrality of the state’s court system to insist on an arbitration clause to secure a neutral forum.⁷

To avoid preliminary disputes relating to the agreed dispute resolution mechanism, the parties should opt for either a choice of forum clause, or an arbitration clause, but not both.⁸

3.0 International Arbitration Clause

International arbitration is founded on the principle that parties can, by consensus, determine to a great extent the way in which the arbitral proceedings will be conducted. Further, an international arbitration has the following distinctive characteristics:

• Arbitration seeks to provide a neutral dispute resolution mechanism and usually takes place outside either party’s home jurisdiction;⁹
• Arbitrations are typically decided by a tribunal composed of private persons selected by the parties, or by an institution;
• Arbitration produces a binding award that is generally capable of enforcement in national courts;¹⁰
• Arbitration allows for substantial procedural flexibility;¹¹ and
• An arbitration clause or the agreement to arbitrate is usually contained in a contract. The normal practice is for the parties to adopt a short model clause, recommended by an arbitral institution.¹²

By way of example, the London Court of International Arbitration (LCIA) recommends the following clause:

Any dispute arising out of or in connection with this contract, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration under the LCIA Rules, which Rules are deemed to be incorporated by reference into this clause.¹³

The International Centre for Settlement of Investment Disputes (ICSID), provides the following model clause:

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The [Government]/[name of constituent subdivision or agency] of name of Contracting State (hereinafter the “Host State”) and name of investor (hereinafter the “Investor”) hereby consent to submit to the International Centre for Settlement of Investment Disputes (hereinafter the “Centre”) any dispute arising out of or relating to this agreement for settlement by [conciliation]/ [arbitration]/[conciliation followed, if the dispute remains unresolved within time limit of the communication of the report of the Conciliation Commission to the parties, by arbitration] pursuant to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (hereinafter the “Convention”).¹⁴

When parties agree to resolve disputes by arbitration, they intend that arbitration be an obligation for resolving all disputes between them.

The safest way for an investor to select an arbitration clause is to choose a model clause recommended by a prominent arbitration institution. Model arbitration clauses share certain basic features: consent to arbitration, identification of the institution administering the dispute, and a general description of the type of claims that may be submitted to arbitration. However, model clauses tend to be very basic and may not address all issues that are important to the parties. The key consideration should be the language containing the consent to arbitration; it must be unambiguous. Additionally, the parties should address all important considerations, such as the seat of the arbitration,¹⁵ the applicable law, the language of the proceedings, the number and mode of selection of arbitrators, including a default means of selection in the event a party does not participate in the process, and the finality of an award rendered by a tribunal (i.e., no appeal).

4.0 Stabilisation Clauses

Stabilisation clauses seek to negate the impact that future legislative changes may have on an investment.¹⁶ The objective is to “freeze” the applicable law, the fiscal regime, and other essential conditions affecting the investment to a certain point in time.¹⁷ However, due to concerns about the validity of such clauses, recent agreements often contain provisions requiring renegotiation of the agreement when a change in law or regulations materially affects the investor’s benefits.

4.1 “Freezing” Clauses

Freezing clauses were introduced in the 1960s and 1970s as a reaction to a wave of nationalisations of foreign investment projects in the oil industry.¹⁸ A freezing provision has been described as: “[L]anguage which freezes the provisions of a national system of law chosen as the law of the contract as to the date of the contract in order to prevent the application to the contract of any future alterations of this system.”¹⁹

The enforceability of freezing clauses has always been a key concern for investors. Many commentators are of the view that: (i) domestic courts cannot apply a “stabilised” or “frozen” national law, ignoring the subsequent enactment of mandatory rules, unless expressly authorised by the competent organ under the constitution (for example the legislative power), and that (ii) the source of such authority cannot be represented by a commercial contract.²⁰

With respect to international law, some commentators maintain that stabilisation clauses are incompatible with the principle of a state’s permanent sovereignty over its natural resources and are therefore invalid under international law.²¹ Other commentators²² and arbitral tribunals have held that stabilisation clauses are valid, because, among other things, they represent an expression of the exercise of that state’s sovereignty. Generally, though, a government cannot prevent a subsequent government from modifying prior commitments through legislation. In any event, although their validity is not disputed, the legal effect and the scope of freezing clauses have been repeatedly called into question and the matter is far from settled.²³

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4.2 Re-balancing Provisions

Re-balancing provisions seek to protect the economic position of investors when future legislative and/or regulatory changes negatively impact their original investment.²⁶ These include various forms of economic equilibrium clauses or renegotiation clauses. These are the modern form of stabilisation provisions that are present in long-term contracts. Their goal is to create the stabilisation effect without restricting the state’s legislative powers.²⁷ Economic equilibrium/re-balancing clauses typically require the parties to enter into negotiations, following a change in law, to restore the contract’s original economic equilibrium. The obligation to renegotiate is often subject to a materiality test, i.e., a change in the terms of the contract is only called for when there is a “material adverse effect”.²⁸

The following is an example of a re-balancing clause from a Nigerian contract:

Should the income of the state or the Contractor be materially altered as a result of new laws, orders or regulations then, in such an event, the Parties shall agree to make the necessary adjustments to the relevant provisions of this Contract, observing the principle that the affected Party shall be restored to substantially the same economic condition as it would have been in had such change in laws or regulations not occurred. The cost of such restoration to the other Party may not exceed the benefit received by such other Party as a result of such change.²⁹

Attempts to achieve re-balancing take many forms and several methods have been used together.³⁰ An example of the mixed use of stability mechanisms can be seen in the 1996 Azerbaijan Shah Deniz Production Sharing Contract³¹ which combines an intangibility/freezing mechanism, a balancing mechanism, and an allocation mechanism.³² In essence, this agreement included a general prohibition of adversely affecting the contractor’s rights without prior consent, but it also provided that if the state alters the terms of the contract an overall economic equilibrium should be maintained. What is more, compensation should be provided if the contractor’s position is by any means worsened. As such, this is an example of a combined clause with multiple layers of protection.

Regardless of the method chosen to achieve re-balancing, all approaches have one important common feature in that they seek to respond to the economic impact of a change in law by the state rather than attempting to prevent an actual change in the law.³³

The parties should carefully consider what they mean by a “change in the law” and take steps to define the scope of such a provision. Some clauses, for example, have attempted to include shifts in government policy and adverse case law within the definition. A state may wish to exclude such shifts due to their broad reach, and may instead seek to limit the definition to legislative acts.

Investors may wish to include more comprehensive provisions that seek to restrict changes to a broad range of legislative areas. Investors should be aware that a state party may try to balance the preservation of its sovereign power against its desire to

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attract investors when negotiating stabilisation provisions. Investors should also be aware that a state may aim for limited stabilisation provisions, i.e., provisions that seek to restrict changes to specific legislative areas, such as tax or labour laws.

Both parties should always bear in mind that for a long-term partnership to succeed, there has to be an understanding of the tension between the legal validity of stabilisation provisions and the legal effect. The latter is restricted by public interest considerations, i.e, a state must reserve its legislative freedom in matters of public interest, such as taxation, protection of the environment and health.

5.0 Waiver of Sovereign Immunity

Since states are independent and legally equal, in principle, no state may exercise jurisdiction over another state without its consent. Originally, under customary international law, virtually all areas of state activity were immune from the jurisdiction of foreign courts with only very narrow exceptions. The increasing activity of states in economic affairs led most states to adopt a doctrine of restrictive immunity by which their immunity from suit has been curtailed given their involvement in acts of a commercial nature similar to those of private commercial actors.

This doctrine is reflected in international conventions such as the European Convention on State Immunity,³⁴ adopted by the Council of Europe in 1972. Similarly, with some variations, several countries have codified the doctrine of restrictive immunity in their national legislation. The UK State Immunity Act of 1978 and the US Foreign Sovereign Immunities Act of 1976 are examples.

There are two levels of state immunity: (i) immunity from jurisdiction, which is the immunity of a foreign state from the jurisdiction of municipal courts of another state to adjudicate a claim against it, arising, for example, from a contract; and (ii) immunity from execution, which constitutes the exemption of a foreign state from enforcement measures against its state property, for example by attaching a bank account of the state.

5.1 Immunity from Jurisdiction (Recognition and Enforcement)

A state is considered to have submitted to the jurisdiction of an arbitral tribunal upon entering into an arbitration agreement. However, consent to arbitration does not necessarily extend to the waiver of sovereign immunity in relation to execution of an award in national courts.³⁵ For example, UK legislation provides that an agreement to arbitrate constitutes a waiver of immunity in relation to the arbitral proceedings themselves and any ancillary proceedings in the national courts. It does not however extend to a waiver of immunity from execution.³⁶

A waiver of sovereign immunity must be given by the state itself and be in accordance with its domestic laws and regulations. Although divergent views have been expressed, state organs and state representatives are generally not empowered to waive state immunity, but this broadly depends on the nature of the agreement. Further, the expression of the waiver must be unequivocal and certain, and a waiver of immunity from execution of judgments or awards must be given separately from a waiver of immunity from jurisdiction. A state is only able to waive its procedural immunity insofar as its national laws allow the waiver.³⁷

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5.2 Immunity from Execution

It is generally well established that a separate waiver is required for immunity from execution. The UK SIA requires express written consent to waive immunity against execution on property of a foreign state, and US and Canadian statutes also require a separate waiver in respect of immunity from execution. However, US and Canadian statutes allow for a waiver to be either express or implicit. The US statute goes further by limiting such waiver only to immunity from execution against property in commercial use in the United States.⁴⁰ States are cautious when it comes to waiving part of their sovereignty and as a consequence it comes as no surprise that waiver of immunity from jurisdiction does not entail waiver of immunity from execution.

When states decide to waive their immunity from execution — and this is not done lightly — one of the clauses that has been recommended by ICSID reads as follows:

The Host State hereby waives any right of sovereign immunity as to it and its property in respect of the enforcement and execution of any award rendered by an Arbitral Tribunal constituted pursuant to this agreement.⁴¹

Finally, some commentators suggest that where a state has entered into an arbitration agreement, and committed itself to participate in arbitral proceedings under institutional rules,⁴² or is a party to the New York Convention, there is an even stronger indication of an implied waiver of immunity against execution on the basis that these instruments impose obligations on the party to honour any arbitral award rendered.⁴³ There is, however, a considerable diversity of views among both jurists and courts as to how far a state can be assumed to have given its consent and to have waived immunity from execution in such situations.⁴⁴

Notes

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