The Interpretation of Umbrella Clause in Investment Treaties - Case Study Example

Introduction Since 1945 the growth of international foreign investment has been improved slightly until it reached a peak in the 1990s. This development of international foreign investment was tied with a number of bilateral investment treaties (BITs), which grew from 500 in 1999 to 2000 in the year 2000.1 In addition, some multilateral investment treaties (MITs) were created in order to introduce flow to the international economy, such as the Energy Charter Treaty (ECT) in 1994 and the North American Free Trade Agreement (NAFTA) in 1994.2 It seems clear that the purpose of investment treaties is to address the typical risks of a long-term investment, for example, commercial risks and political risks in order to obtain protection for investment.3 In fact, there are different standards of protection which BITs usually include some of them, as in the case of fair and equitable treatment, full protection and security, most favoured nation treatment and umbrella clause. However, umbrella clause has been widely debated in academic discussions and arbitral practices during the recent years4. Commentators have illustrated the argument in terms of interpretation the umbrella clause in investment treaties that derived from different tribunals in order to know whether breaching contractual obligations amount to violating treaty obligations. Within the context of this argument, tribunals will be able to know if they have the jurisdiction to hear claims arising from an alleged investment contract breach. This essay aims to analyse the interpretation of umbrella clause in investment treaties. In the subsequent part of this paper first, the definition of umbrella clause has been provided according to some commentators, and different formulations of the umbrella terms have also been included in the part. Subsequent to that, the background of umbrella clause is accounted for. In this part, the initial appearance and use for umbrella clause in the light of international investment treaties have been included with reference to the BIT models, which are related to some developed countries. Finally, the critical analysis part of interpretation the umbrella clause and jurisdiction over contract claims have also been introduced with examples related to recent investment treaties and arbitration decisions. 1. Definition of Umbrella Clause Some authors and commentators tried during the last decade to explain the meaning of umbrella clause. Dolzer and Schreuer represented it as “a provision in an investment protection treaty that guarantees the observation of obligations assumed by the host state vis-à-vis the investor”.5 Moreover, Gallagher and Shan introduced the umbrella clause by revealing that the clause is taken its name from its main objective namely in order to “oblige the host state to observe any commitments it has entered into with regard to foreign investors”.6 Some also assume that the umbrella clause could be extended to beyond what it created for, as F.A. Mann stated that the umbrella clause “is a provision of particular importance in that it protects the investor against any interference with his contractual rights, whether it results from a mere breach of contract or legislative or administrative act”.7 As a matter of fact, umbrella clause is also known as ‘mirror effect’, ‘pacta sunt servanda clause’, ‘parallel effect’, ‘elevator’, ‘respect clause’ and ‘sanctity of contract’. Yet, the limit of subject matter rationale materiae jurisdiction does not remain uniform under the BITs.8 Some BITs encompass disputes pertaining to an ‘obligation under the agreement’ only for claims of violations of BIT. Other BITs extend the jurisdiction to ‘any dispute relating to investments’. Some others construct an international law obligation that a host state shall, for instance, ‘constantly guarantee the observance of the commitments it has entered to’; ‘observe any obligation it has assumed’, in respect to investments.9 Thus, a breach of such an obligation may consist of violation of a Contracting Party’s obligation under provisions of a BIT. 2. Background and Evolution of Umbrella Clause Before the introduction of the umbrella clauses into the international investment law, the investors relied on the limited use of diplomatic protection in order to be well protected from illegitimate acts of the host state. As a customary international law, a state can only avail and exercise its right of diplomatic protection if its citizen has been injured by the way of a breach of the provisions of the international law. Generally, a state does not carry out its international responsibility if it violates a contract that has signed and entered into with a national or company of another state, unless the contract covers a violation of rule of customary international law especially in the unfair state acts, such as expropriation without compensation.10 As a result, the umbrella clause was constructed and introduced into the international investment law for making diplomatic protection available not only for such visible violations of international investment law but also for simple breaches by a state of contracts and that is the aim of umbrella clause.11 The first appeared of umbrella clause was by Sir Elihu Lauterpacht when he advised the Anglo-Iranian Oil Company to guarantee that the host state would observe its commitments towards foreign investors under particular investment contract in the Anglo-Iranian Consortium Agreement of 1954, due to the fact that the new government sought to bring all oil operations under its supervision and control.12 After that, the clause was drafted in different international investment conventions from which some of them were never adopted. For instance, the Abs Draft International Convention for the Mutual Protection of Private Property Rights in Foreign Countries (1956) in Article 4 which represented the umbrella clause as an investment protection clause provided that “In so far as better treatment is promised to non-nationals than to nationals either under intergovernmental or other agreements or by administrative decrees of one of the High contracting Parties, including most-favoured nation clauses, such promises shall prevail”13. In effect, this approach was reformulated in the Abs-Shawcross Draft Convention on Investment Abroad (1959) in Article 2 which stipulated that “Each Party shall at all times ensure the observance of any undertakings, which it may have given in relation to investments made by nationals of any other Party”14. Furthermore, the Organization for Economic Co-operation and Development (OECD) Draft Conventions on the Protection of Foreign Property (1967) Article 2 stipulated that “Each Party shall at all times ensure the observance of undertakings given by it in relation to property of nationals of any other Party”15. In addition, the Draft MAI also included two formulations for a “respect clauses”. The first one was a standard clause provided that “Each Contracting Party shall observe any obligation it has entered into with regard to a specific investment of an investor of another Contracting Party”.16 The second one was substantive approach to the respect clause which provided that “Each contacting Party shall observe any other obligation in writing, it has assumed with regard to investments in its territory by investors of another Contracting Party. Disputes arising from such obligations shall only be settled under the terms of the contracts underlying the obligations”.17 On the other hand, some conventions were signed and entered into force. For example, the CET (1994) in Article 10(1) details minimum standards of investment protection and at the end emphasises the principle of pacta sunt servanda by making it an obligation of “Each Contracting Party shall observe any obligations it has entered into with an Investor or an Investment of an Investor of any other Contracting Party”.18 Even though NAFTA (1994) addresses both matters of trade and investment, and contains some standards of treatment and protection, it does not contain the umbrella clause.19 Because of the evolution of the international investment, a largr number of BITs have been created in order to improve the growth of foreign investment. Since 1959 more than 2,500 BITs have been adopted, but less than half of them contained the umbrella clause.20 The first modern BIT between Germany and Pakistan 1959 which entered in to force in 1962 contained an umbrella clause in Article 7 which stipulated that “Either Party shall observe any other obligation it may have entered into with regard to investments by nationals or companies of the other Party”21. However, with the recent change and development on the global economy in the early 1990s, the number of cases increased dramatically which palyed major role in improving the models of BIT in many countrise by adding many standers of protiction and treatment, such as umbrella clouse.22 For instance, The German Model BIT Article 8(2) provides that “Each Contracting State shall observe any other obligation it has assumed with regard to investments in its territory by investors of the other Contracting State”. In addition, the United Kingdom Model BIT Article 2(2) stipulates that “Each Contracting Party shall observe any obligation it may have entered into with regard to investments of nationals or companies of the other Contracting Party” and other countries, as in the case of Austria, Netherlands, Sweden and Switzerland. Although the United State and French mentioned to umbrella clause in some of their BITs, their Model BIT do not contain the clause.23 Sometimes the drafting of umbrella clause is not clear enough to rely on it. For example, the BIT between Belgium-Luxembourg Economic Union and the Republic of Colombia (2009) maintains to umbrella clause in Article III (3) which reads as follow: Each Contracting Party shall protect within its territory investments made in accordance with its law by investors of the other Contracting Party and shall not impair, either in law or in practice, by arbitrary or unjustified discriminatory measures the management, maintenance, use, enjoyment, extension, sale and liquidation of said investments. The umbrella clause in this Article is insufficient to determine the nature and extent of investment protection. Although the Contracting Parties have been enabled to avail the provisions of the international investment laws, yet they cannot include their subjective elaboration in the term ‘investment protection.’ They have to rely on the arbitrators’ subjective interpretation of the umbrella clause in the event of a dispute between or among the parties at a dispute. Therefore, the umbrella clause has been changed dramatically in its drafting which lead to a huge impact on its interpretation. This clause is classified as a bridge between contracting parties in the light of international law in order to observe the investor rights by the hose state. 3. Interpretation the Umbrella Clause Through the tribunals’ practices and decisions, there is no consistent jurisprudence with regard to their jurisdiction over contract claims.24 What is worse, since no unambiguous line of reasoning has so far been established, the arguments availed have risen considerable confusion regarding the role and function of the umbrella clause. Some commentators highlight three ways to interpret umbrella clauses according to tribunals’ awards, which may lead tribunal in the future to know whether it has jurisdiction to hear claims arising from an alleged contract breach. 3.1 Narrow Interpretation The first school of thought prefers a narrow interpretation of umbrella clause or intent theory. The meaning of this interpretation is that breaching contractual obligations cannot elevate to breach bilateral investment treaty, unless the Contracting States intend contractual claims to be covered by BIT.25 The proponents of this school support that an umbrella clause has the potential for opening floodgates of unrestricted actions. They observe that tribunals, which take place in ICSID, UNCITRAL, NAFTA and other places, need to interpret the clause in a very restrictive manner in order to avoid the unrestricted actions between international and municipal legal orders.26 Consequently, this narrow interpretation of the umbrella clause has been supported on some cases, for instance, Société Générale de Surveillance SA v. Islamic Republic of Pakistan27, Joy Mining Machinery Limited v The Arabic Republic of Egypt 28and El Paso Energy International Company v The Argentine Republic.29 3.1.1 Société Générale de Surveillance SA v. Islamic Republic of Pakistan The SGS a Swiss company had concluded a contract with Pakistan to provide pre-shipment inspection services, which had a forum selection clause for Pakistan’s court.30 When the dispute had risen, Pakistan terminated the contract and the claimant started in the ICSID between the company and Pakistan under Pakistan-Switzerland (1995) BIT which mentioned to umbrella clause in Article 11 that says “Either Contracting Party shall constantly guarantee the observance of commitments it has entered into with respect to the investments of the investors of the other Contracting Party.”31 The SGS claim was that “the umbrella clause has the effect of elevating a simple breach of contract claim to a treaty claim under international law”32. In contrast, the tribunal first observed that it was the first international arbitral tribunal to “examine the legal effect of a clause such as Article 11 of the BIT.”33 Then, it rejected the SGS’s claim that the meaning of the clause according to Article 11 was to elevate breaches contract to be equal to breaches of the BIT 34, due to the fact that the conventional understanding of the clause according to Article 31 of the Vienna Convention on the Law of Treaties would lead to a far-reaching impact on the sovereignty of the host state, as the tribunal affirmed: The legal consequences that the Claimant would have us attribute to Article 11 of the BIT are so far-reaching in scope, and so automatic and unqualified and sweeping in their operation, so burdensome in their potential impact upon a Contracting Party, we believe that clear and convincing evidence must be adduced by the Claimant.35 In my view, the tribunal was right about not elevating the contract claim to the BIT level owing to the scope of the clause is far too narrow to have any concrete effect. Moreover, the scope of the terms “commitments it has entered into” in Article 11 of the BIT can never be capable of indefinite explanation and the terms has to be understood only in the context of an investment contract or a particular investment.36 3.1.2 Joy Mining Machinery Limited v. The Arabic Republic of Egypt The Joy Mining an English company had concluded a contract with Egypt in order to provide specialized mining equipments to the Industrial and Mining of the Arab Republic of Egypt. The dispute appeared between the company and Egypt regarding to release certain guarantees supplied by the company.37 The case took place before the ICSID under the United Kingdom-Egypt (1997) BIT, which provides umbrella clause in Article 2(2) that reads “Each Contracting Party shall observe any obligation it may have entered into with regard to investments of nationals or companies of the other Contracting Party”.38 Even though the dispute in this case tended to be purely commercial rather than investment, Joy Mining alleged that the host state had violated the umbrella clause. Otherwise, the tribunal supported the narrow interpretation by holding that: In this context, it could not be held that an umbrella clause inserted in the Treaty, and not very prominently, could have the effect of transforming all contract disputes into investment disputes under the Treaty, unless of course there would be a clear violation of the Treaty rights and obligations or a violation of contract rights of such a magnitude as to trigger the Treaty protection, which is not the case. The connection between the Contract and the Treaty is the missing link that prevents any such effect. This might be perfectly different in other cases where that link is found to exist, but certainly it is not the case here.39 In my opinion, the tribunal was right to refuse the claimant, because the dispute in this case was purely commercial not investment disputes. In this context, the commercial disputes have to be settled through the mechanism set forth by the contract between the company and Egypt.40 Furthermore, the tribunal stated the circumstances that may allow elevating the contract disputes to the BIT level, in particular, when there is a clear violation of the treaty rights or “interference with the company’s contract right”41 by the host state. 3.1.3 El Paso v. The Argentine Republic On 6 June 2003 El Paso, an American company, submitted an arbitration request against Argentine in the ICSID.42 It relied on the US-Argentina BIT (1991) which contained umbrella clause in Article II(2)(c) that reads “Each Party shall observe any obligation it may have entered into with regard to investments”43 The tribunal in this case rejected the argument that the so called umbrella clause included in Article II(2)(c) could elevate any contract claim to the level of a treaty claim alleged by the El Paso. It concluded that “As a consequence, the question of their elevation to the level of a treaty claim does not arise”.44 3.2 Wide Interpretation The second school of thought supports a wide interpretation of umbrella clause. This interpretation means that umbrella clause transforms the contract claims into treaty claims elevating contract breaches to the breaches of BIT. The wide interpretation of the umbrella clause has been upheld on some cases, for instance, Société Générale de Surveillance SA v. Republic of the Philippines45, Eurko v. Republic of Poland46 and Noble Ventures, Inc. v. Romania .47 3.2.1 Société Générale de Surveillance SA v. Republic of the Philippines At the end of 1980s the SGS signed a contract with Philippines to offer import supervision services. The contract included a clause to settle all disputes between them in the court of Philippines and apply the Philippines Law.48 In 2000 a dispute had risen about submitting certain money claims to the Philippines and the SGS instituted proceeding before the ICSID under Switzerland-Philippines BIT which in Article X(2) stipulated that “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”.49 The tribunal in this case remarked the obligatory wording of Article X(2) and concluded that the object and purpose of the BIT “supported an effective interpretation” of this provision.50 Also, it rejected the interpretation of the umbrella clause in the SGS v. Pakistan decision and described it as “unconvincing”51 and “a highly restrictive”52. In addition, the tribunal concluded that: To summarise the Tribunal’s conclusions on this point, Article X(2) makes it a breach of the BIT for the host State to fail to observe binding commitments, including contractual commitments, which it has assumed with regard to specific investments. But it does not convert the issue of the extent of content of such obligations into an issue of international law.53 In this case I think the meaning of Article X(2) is to elevate contract claims to the BIT level because the terms “any obligation … specific investments” cover also the contractual breaches which might appear between the investor and the host state. 3.2.2 Eureko B.V. v. Republic of Poland The tribunal in this case adopted the wide interpretation. The Eureko, a Dutch company, instituted a claim before ICSID under the Netherlands-Poland BIT. Article 3.5 of the BIT contains the umbrella clause, which provided that each Contracting Party “shall observe any obligations it may have entered into with regard to investments of investors of the other Contracting Party.”54 The tribunal examined the meaning of the clause in Article 3.5 according with its ordinary meaning as stipulated in Article 31(1) of the Vienna Convention on the Law of Treaties (1969). It stated that: The plain meaning – the “ordinary meaning” – of a provision prescribing that a State “shall observe any obligations it may have entered into” with regard to certain foreign investments is not obscure. The phrase, “shall observe” is imperative and categorical. “Any” obligations is capacious; it means not only obligations of a certain type, but “any” – that is to say, all obligations entered into with regards to investments of investors of the other Contracting Party.55 3.2.3 Noble Ventures, Inc. v. Romania This case follows the same line of reasoning as Eureko case, in examining the meaning of umbrella clause which mentioned in Article II(2)(c) of the US-Romania BIT (1992) that provides that “Each Party shall observe any obligation it may have entered into with regard to investments.” The tribunal concluded that “an umbrella clause is usually seen as transforming municipal law obligations into obligations directly cognizable in international law”56. Moreover, it did not find it in necessary to restrict the exact scope of the clause and made no definitive conclusions on whether the clause “perfectly assimilates to breach of the BIT any breach by a host State of any contracts obligation”.57 3.3 Recent Interpretation The third school of thought adopts a recent jurisprudence or a balanced approach. The meaning of this approach is that to distinguish between the state as a merchant and as a sovereign. In other words, if the contract obligations were assumed by a State acting in its sovereign capacity they can elevate to a BIT claim, but if it was acting in the merchant capacity, such claims will not tantamount to BIT claims.58 This way of interpretation has been applied in many cases, such as CMS Gas Transmission Company v. The Argentine Republic,59 El Paso Energy International Company v. The Argentine Republic 60 and Pan American Energy LLC v. The Argentine Republic 61. 3.3.1 CMS Gas Transmission Company v. The Argentine Republic On July 26, 2001, the CMS, an American company, submitted a request to ICSID for arbitration against Argentina under the US-Argentina BIT (1991) that contained umbrella clause in Article II(2)(c) which reads “Each Party shall observe any obligation it may have entered into with regard to investments”.62 The tribunal in this case referred to the distinction between the “”governmental” and “commercial” as it said “Purely commercial aspects of a contract might not be protected by the treaty in some situations, but the protection is likely to be available when there is significant interference by governments or public agencies with the rights of the investor”63. 3.3.2 El Paso Energy International Company v. The Argentine Republic On June 6, 2003, El Paso, an American company, filed a request to ICSID for arbitration against Argentina under the US-Argentina BIT (1991) which contained umbrella clause in Article II(2)(c)64. The tribunal in this case made a distinction between the state as a merchant and as a sovereign and concluded that: Interpreted this way, the umbrella clause read in conjunction with Article VII, will not extend the Treaty protection to breaches of an ordinary commercial contract entered into by the State or a State-owned entity, but will cover additional investment protections contractually agreed by the State as a sovereign, such as stabilization clause inserted in an investment agreement.65 3.3.3 Pan American Energy LLC v. The Argentine Republic The tribunal in this case also does not restrict the scope of the umbrella clause as it done in the case between SGS v. Pakistan. It accepts that obligations in contract are covered by the umbrella clause to the extent that they bind the host state in its sovereign capacity.66 Conclusion Investment treaty arbitration is a peculiar form of settlement of disputes. The inconsistent interpretations of the umbrella clauses provided by the number of arbitration tribunals prove that the international investment law has yet to become mature and still is going through its young age. The umbrella clause cannot be interpreted with a uniform method but considerably relies on the subjective understanding and the interpretations of the international tribunals. The tribunals do not consider only the content and arguments of the parties at a dispute, but also they take into account the object, context and purpose. In addition to that, the tribunals are required to take into account the related precedents of different jurisprudence so that an appropriate ruling could be provided. However, foreign investment regime does not have a uniform system but they keep on changing and every treaty includes different types of umbrella clauses and their scope is only ascertainable by the international arbitration tribunals in the event of a dispute between the contracting parties. Furthermore, it can be said that the increase in the investment arbitration number experiences the tactical structuring of the international investments in a way to allow the investors to invent claims under the multiple investment treaties. In addition, such manoeuvring shares their part in the inconsistent decisions of the tribunals. Bibliography Books Dolzer R and Schreuer C, Principles of International Investment Law (OUP 2008). Dolzer R and Stevens M, Bilateral Investment Treaties (KLI 1995). Gallagher N and Shan W, Chinese Investment Treaties Policies and Practice (OUP 2009). McLachlan C and others, International Investment Arbitration, Substantive Principles (OUP 2007). Journal Articles Gautam P, ‘The Umbrella Clause: A search for greater legal certainty’ (Submitted in part fulfillment of the degree of LL.M. in the University of Glasgow, August 2008). Hober K, ‘Investment Arbitration and the Energy Charter Treaty’ [2010] JIDS. Mann F A, ‘British Treaties for the Promotion and Protection of Investments’ [2008] BYIL. Sinclair A C, ‘The Origins of the Umbrella Clause in the International Law of Investment Protection’ (2004) 20/4 AI. Weissenfels A, ‘Seminar on International Investment Protection: Umbrella Clause’ (2006/2007). Yannaca K, ‘Interpretation of the Umbrella Clause in Investment Agreements’ (2006) OECD Working Papers on International Investment Number 3/2006. Cases CMS Gas Transmission Company v. Argentina, ICSID Case No. ARB/01/8, Award on Jurisdiction, 12 May 2005. El Paso Energy International Company v. Argentina, ICSID Case No. ARB/03/15, Award on Jurisdiction,27 April 2006. El Paso Energy International Company v. Argentina, ICSID Case No. ARB/03/15, Award on Jurisdiction,31 October 2011 Eurko v. Republic of Poland, ICSID Reports 335, Partial Award, 19 August 2004. Joy Mining Machinery Limited v. The Arabic Republic of Egypt, ICSID Case No. ARB/03/11, Award on Jurisdiction, 6 August 2004. Noble Ventures, Inc. v. Romania, ICSID Case No. ARB/01/11, Award on Jurisdiction, 12 October 2005. Pan American Energy LLC v. Argentina, ICSID Case No. ARB/03/13, Award on Jurisdiction, 27 July 2006. Société Générale de Surveillance SA v. Islamic Republic of Pakistan, ICSID Case No. ARB/01/13, Award on Jurisdiction, 6 August 2003. Société Générale de Surveillance SA v. Republic of the Philippines, ICSID Case No. ARB/02/6, Award on Jurisdiction, 29 January 2004. Authorities Abs Draft International Convention for the Mutual Protection of Private Property Rights in Foreign Countries (1956). Abs-Shawcross Draft Convention on Investment Abroad (1959). Belgium Luxembourg-Colombia 2009 Energy Charter Treaty in 1994. German Model BIT 2005. Germany-Pakistan BIT 1959. Netherlands-Poland BIT. Pakistan-Switzerland BIT 1995. Organization for Economic Co-operation and Development Draft Conventions on the Protection of Foreign Property (1967). Switzerland-Philippines BIT. The Vienna Convention on the Law of Treaties 1969 (Vienna, 23 May 1969), Entered into force on 27 January 1980. US-Argentina BIT 1991. US-Romania BIT 1992. United Kingdom-Egypt BIT 1997. United Kingdom Model BIT 2005. Read More