Conflict of Treaty and Contract Forum in Investment Arbitration: The Umbrella Effect

 

Kunwar Aditya Singh*

 

5^th Year Student, Hidayatullah National Law University, Raipur (C.G)

 

 

ABSTRACT:

 

I. INTRODUCTION

The lifeblood of the global economy is foreign direct investment. Globalization has seen phenomenal increase inflows of foreign direct investment and also stimulated the development of legal mechanisms to protect foreign direct investment, and particularly investment treaties. A network of over two thousand Bilateral Investment Treaties has been created to define and protect the rights of foreign investors, supplemented by some ambitious multilateral instruments such as NAFTA and the Energy Charter Treaty.¹

 

A Bilateral Investment Treaty (BIT) is a treaty between two States establishing a legal framework for the treatment of investment flows between the two nations. It creates rights for investors of both States, called treaty rights, while legal proceedings arising from these rights can be called treaty claims and which in case of dispute are resolved in a forum mentioned in BIT called as treaty forum. The parties to a treaty claim are an investor of one State Party (known as the investors Home State) and the State where the particular investment was made (known as the Host State).

 

 

Foreign investment also usually involves contracts between the investor and entities within the Host State. These contracts might take the form of a concession contract with the State itself, or a State-owned entity, or might involve contracts with various state agencies. These contracts will also create rights (and obligations) for investors, which can be called contract rights (which give rise to legal proceedings called contract claims). Whenever, there is a dispute pertaining to contract, the parties to contract resort to dispute resolution forum provided in the contract (called as contractual forum) as agreed between two parties that can be either municipal court or arbitral tribunal which may or may not be similar to treaty forum.

 

The choice of forum for the investor in an investment arbitration is confusing one as many times arbitral tribunals have decided that the forum adjudicating upon treaty claims can club the contract claims of the Claimant (who is foreign investor and whose Home State has BIT with the Host State) by virtue of umbrella clause present in the BIT.

 

II. Understanding the Controversial: The Umbrella Clause

An umbrella clause is a provision in an investment protection treaty that guarantees the observation of obligations assumed by the host state vis-à-vis the investor. The most contentious issue in relation to clauses of this kind is whether and under what circumstances, investment agreements i.e. contracts between host state and investor, can be clubbed with the treaty claims in the BIT forum despite the fact that the forum consented by the foreign investor in the investment agreement is different.-

The scholars of international investment law comment on this controversial concept in the following words:

 

§  Dolzer and Stevens along the same lines state that - these provisions seek to ensure that each Party to the treaty will respect specific undertakings towards nationals of the other Party. The provision is of particular importance because it protects the investors contractual rights against any interference which might be caused by either a simple breach of contract or by administrative or legislative acts and because it is not entirely clear under general international law whether such measures constitute breaches of an international obligation.²

 

§  E. Gaillard notes that an historical examination of the origins of observance of undertakings clauses –“clauses with a mirror effect” – shows in the clearest manner that the intention of States negotiating and drafting such clauses is to permit a breach of contract to be effectively characterized as the breach of an international treaty obligation by the host state. The effect of the clause is to reflect at the level of international law what is analyzed at the level of applicable private law as simple contractual violation.³

 

§  C. Schreuer states that umbrella clauses have been added to some BITs to provide additional protection to investors beyond the traditional international standards. They are often referred to as umbrella clauses because they put contractual commitments under the BIT‗s protective umbrella. They add the compliance with investment contracts, or other undertakings of the host State, to the BIT‗s substantive standards. In this way, a violation of such a contract becomes a violation of the BIT.⁴

 

But the main ground of criticism of wider interpretation of umbrella clause at the international community is that a breach of contractual obligation with a foreign company by Host State may always become a breach of a BIT thereby attracting the protection available under international foreign investment law. This blurs the distinction between private law disputes and public law disputes.⁵

 

III. Treaty and Contractual Claims: Differentiated

The choice of rights by the investor will determine the course of the investment dispute. There are five criteria that serve to distinguish a treaty claim based on treaty rights, from a contract claim arising in the context of the dispute based on set of same facts.

 

3.1 Source of Rights

The most fundamental distinction between a treaty claim and a contract claim is the source of the right on which the claim is based. The basis of a treaty claim is a right established and defined in an investment treaty, while the basis of a contract claim is some right created and defined in a contract. The source of the right is the unique distinguishing feature of a treaty claim without any possible overlap with a contract claim. A treaty right can never arise from a contract.⁶

 

The conventional position in international law is that treaties do not create direct rights and obligations for private individuals.⁷ Nevertheless, public international law has increasingly recognised that the State Parties to some treaties-particularly treaties dealing with human rights or investment protection-intend to create rights for private parties against States, and effect has been given to this intention by recognising the procedural capacity‘ of individuals to enforce these rights by means of treaty claims against States.⁸

 

3.2 The Content of the Rights

The content of treaty rights is normally quite distinct from that of contract rights. The content and definition of treaty rights depend on the terms of the particular BIT that creates the rights. The form of BITs varies widely, reflecting the different priorities, approaches and bargaining positions of states. However, BITs are intended to facilitate investment, and therefore address issues of laws, policies or official action that might impede or endanger investment flows.⁹

 

There are, however, a core of generic treaty rights, well established and defined in international law, that in practice have formed the basis of treaty claims by investors against Host States. There is a rapidly growing arbitral jurisprudence relating to these treaty rights¹⁰. Therefore, the most familiar treaty rights that are defined by international law are as follows:

 

3.2.1 Right to National Treatment

The objective of national treatment principle is to address discrimination on the basis of nationality of ownership of an investment. In order to ascertain what discrimination is, it is necessary to compare the treatment of foreign investor to the treatment accorded to a domestic investor in similar circumstances. The meaning of the principle of national treatment under foreign investment law can be understood from UNCTAD Report on national treatment: “the national treatment standard is perhaps the single most important standard of treatment enshrined in international investment agreements. At the same time, it is perhaps the most difficult standard to achieve as it touches upon economically sensitive issues.”¹¹

 

3.2.2 Right to Most Favoured Nation Treatment

Most favoured nation (MFN) treatment is one of the oldest and most important principles of both foreign investment law and the law of international trade. The MFN Clause seems to have found its expression in a treaty concluded as early as 1417 by King Henry IV of England with Duke John of Burgundy granting English vessels right to use the harbours of Flanders in the same way as French, Dutch and Scottish.¹²

 

The Draft Articles on MFN prepared by International Law Commission (ILC) in 1978 provides that the a MFN clause is a treaty provision whereby a State undertakes an obligation towards another State to accord most-favoured-nation treatment in an agreed sphere of relations.¹³ Further, as defined in UNCTAD report, MFN treatment in the context of foreign investment means that a host country treats the investors from one foreign country no less favourably than investors from any other foreign country.¹⁴

The reason why investors seek protection under MFN principle is to avoid any discrimination against them which would put them at a competitive disadvantage compared to other investors from third countries. The idea of MFN is to ensure equality of competitive opportunities between investors from different foreign countries.

 

3.2.3 Right to Compensation for Expropriation

1. An expropriation must be for public purpose

2. It should be non-discriminatory

3. It is taken in accordance with applicable laws and due process

4. Full, prompt, adequate and effective compensation needs to be paid.

 

1. Direct Expropriation

2. Indirect Expropriation

3. Creeping Expropriation

3.2.4 Right to Fair and Equitable Treatment (FET)

 

The concept of fair and equitable treatment if not the major principle of investment law but is deeply rooted in customary international law. Violation of fair and equitable treatment by the host state is the most common allegation made by the foreign investors before the international investment tribunals.

 

The precise meaning of the term fair and equitable treatment has been subject of interest both in literature and case laws dealing with the treatment of foreign investment. For instance, ICSID tribunal in Noble Ventures v. Romania¹⁵ held that this standard of protection was “general standard which find its specification in inter alia the duty to provide full protection and security, prohibition of arbitrary and discriminatory measure and obligation to observe contractual obligations towards the investor.”

 

In Genin v. Estonia¹⁶ the arbitral tribunal stated that a violation of the fair and equitable principle could be established by acts showing willful neglect of duty, an insufficiency of action falling below international standards or even subjective bad faith. According to a report prepared by UNCTAD this term carries two meanings:

 

 Firstly, beneficiaries are entitled to fairness and equity as these terms are understood in non-technical terms.

 

 Secondly, beneficiaries are assured treatment in keeping with the international minimum standard for the investors.

 

3.3 Parties to Claim

The parties to a treaty claim are always an investor of the Home State and the Host State. The State Party is the State itself, and not a Federal or regional unit, or any state entity or agency.¹⁷ This is so even though the investor has had no direct contact with the State at a national level and complains, for example, treatment by a provincial state agency. Accordingly, the doctrine of State responsibility might be attributed to the State for the actions of internal organs of the State as a matter of public international law and is often an important element in the determination of a treaty claim. The principles of State responsibility have been the subject of long examination by the International Law Commission.¹⁸

 

In contrast, the parties to a contract claim are the parties to the contract. If the foreign investor enters into a concession contract with the Host State, as in Lanco International Inc. v. The Argentine Republic¹⁹, the parties to a treaty claim will be identical to the parties to a contract claim. However, the investment might relate to the affairs of a region of a State, in which case the investors are likely to be dealing directly with regional authorities and might have a concession contract with these authorities.

 

3.4 Applicable Law

There is also difference between a treaty claim and a contract claim regarding the applicable law. The applicable law under a BIT normally includes the provisions of the BIT itself, the domestic law of the Host State and ―…the general principles of international law…²⁰ Whereas; concession contracts are normally governed by the domestic law of the Home State. In practical terms, a contract claim is likely to be determined according to the Host State's law relating to administrative contracts.

 

3.5 Liability of Host State

Finally, a successful treaty claim results in State responsibility in international law. A successful contract claim results in State responsibility under the rules of its domestic law.²¹ However, it is possible for the nature of State liability under treaty and a contract to overlap. State liability for breach of contract in domestic law might lead to international responsibility where it is compounded by an exhaustion of domestic remedies and a denial of justice.

 

The Vivendi arbitration²² and Vivendi Annulment Case²³ are excellent illustration of the possible complexities of the relationship between treaty claims and contract claims. A treaty claim- defined by its source, subject matter, parties‘ applicable law, and the nature of the Host State liability is conceptually separate from a contractual claim, and it is imperative that the parties involved in the arbitration of an investment dispute, and particularly the Arbitral Tribunal, maintain a clear focus on this concept throughout the arbitration.

 

IV. Arbitral Awards and Umbrella Clause

BITs establish a legal framework for the treatment and protection of foreign investment and investors and any claims arising therefrom. Similarly, foreign investment also involves contracts between the investor and the host state or entities of the host state, for example in the form of concession contracts. Although the rights of the investor under each instrument are different, sometimes they may overlap raising procedural complexities.

 

V. CONCLUSION:

Investment treaties have created a new source of rights directly enforceable by the investor, thereby increasing the security and encouraging flows of foreign direct investment. However, this new source of rights is generating novel jurisprudential questions, and in particular issues relating to the possible duplication of claims, proceedings and relief.

 

When a State-owned company breaches a contract concluded with a foreign investor or when the host state breaches the contractual commitments assumed with a company in which a foreign investor has a stake, investors may have both contract and treaty claims against the host state. This has an impact on determinations of jurisdiction of the tribunal.²⁴ In a case where the essential basis of a claim brought before an international tribunal is a breach of contract, the tribunal will give effect to any valid choice of forum clause in the contract. But where the fundamental basis of the Claim is a treaty laying down an independent standard by which the conduct of the parties is to be judged, the existence of an exclusive jurisdiction clause in a contract between the claimant and the respondent state or one of its subdivisions cannot operate as a bar to the application of the treaty standard. Besides, it must be understood that observance of undertaking provision should not be deemed to have mirror effect elevating contract claim to level of treaty claim.

 

As rightly pointed out by the El Paso Tribunal²⁵, broad interpretation of the umbrella clause would have ―far reaching consequences, quite destructive for the distinction between national legal orders and the international legal order. In addition, it expressed its conviction that the investors will not use appropriate restraint if the Tribunals offer them unexpected remedies.”

Finally, a review of the relationship between treaty and contract claims in investment disputes, and the nature of choice of forum provisions, demonstrates the diversity and complexity of the procedural requirements of modern investment treaties. An investor requires a clear dispute resolution strategy for any investor-State dispute before initiating any proceedings or making any choice of forum.

 

REFRENCES:

1.       Bernardo M. Cremades and David J.A. Cairns, The Brave New World of Global Arbitration, Journal of World Investment, Vol. 3, 2002, p. 173-209

2.       Dolzer and Stevens, Bilateral Investment Treaties, Kluwer Law, 1995, pp. 81-82

3.       E. Gaillard, L. Arbitragesur le fondement des traités de protection des investissements,Eng. Edition,Revue de l‗Arbitrage p.868

4.       C. Schreuer, Travelling the BIT Route: of Waiting Periods, Umbrella clauses and Forks in The Road, Journal of World Investment, 2004, pp.231-256.

5.       Nolan and Baldwin, Treatment of Contract-Based Claim in Treaty-Based Arbitration, Mealey‗s Int ernational Arbitration Report, Vol. 21(6), 2006, p.115

6.       Stanimir A. Alexandrov, Breaches of Contract and Breaches of Treaty – The Jurisdiction of Treaty-based Arbitration Tribunals to Decide Breach of Contract Claims in SGS v. Pakistan and SGS v. Philippines, Journal of World Investment, Vol. 5 , 2004 ,p. 555

7.       James Crawford, The International Law Commission's Articles on State Responsibility: Introduction, Text and Commentaries, Cambridge University Press, 2002, p. 194

8.       Ian Brownlie Q.C., Principles of Public International Law, 5th Ed., Oxford University Press, pp. 553

9.       J. Vandevelde, U.S. Bilateral Investment Treaties: The Second Wave, Michigan Journal of International Law, Vol. 14, 1993, p. 621-704

10.     Charles N. Brower and Jeremy K. Sharpe, Multiple and Conflicting International Arbitral Awards, Journal of World Investment, Vol. 4, 2003, p. 211-222

11.     UNCTAD, National Treatment: UNCTAD Series on Issues in International Investment Agreements, New York and Geneva, 1999, p. 212SD Sutton,

12.     Maffezini v. Kingdom of Spain and ICSID Secretary General ‟s Screening Power, Arbitration International, Vol. 21 (1), 2005, p. 115

13.     Art. 4 of Draft Articles on MFN Clause in 30th Session of ILC in 1978

14.     UNCTAD, Most Favoured Nation Treatment, UNCTAD Series on International Investment Agreements, New York and Geneva, 1999, p. 5

15.     ICSID Case No. ARB/01/11 (2005)

16.     Alex Genin, Eastern Credit Limited, Inc., and A.S. Baltoil v. The Republic of Estonia, ICSID Case No. ARB/99/2 (2001)

17.     Christoph Schreuer, The ICSID Convention: A Commentary, Cambridge University Press, 2001, p. 168

18.     James Crawford, The International Law Commission's Articles on State Responsibility: Introduction, Text and Commentaries, Cambridge University Press, 2002, p. 602

19.     ICSID Case No. ARB/02/1 (2006)

20.     R. J. Jennings, State Contracts in International Law, British Yearbook , Vol. 37, 1961, p.156

21.     Ian Brownlie Q.C., Principles of Public International Law, 5th Ed., Oxford University Press, pp. 553

22.     ICSID Case No. ARB/97/3 (2001)

23.     ICSID Case No. ARB/97/3 (2002)

24.     Proceedings of Symposium co-organised by ICSID, OECD and UNCTAD, Improving Investor-State Dispute Settlement, December 12, 2005

25.     Supra Note 45