Comparative Analysis of the Classical and Modern Stabilization Clauses in International Investment Agreements in Terms of the Protection of Foreign Investor

Milletlerarası Yatırım Sözleşmelerinde Yer Verilen Klasik ve Modern İstikrar Hükümlerinin Yabancı Yatırımcının Korunması Bakımından Karşılaştırılması

Aslıhan GÜLCAN

The long-term characteristic of the international investment agreements leads foreign investors to seek protection during the term of the agreement. Stabilization clauses are one of the contractual mechanisms to protect the foreign investor in international investment agreements. It is possible to divide the stabilization clauses into two main categories as classical and modern stabilization clauses. This article will examine the classical and modern stabilization clauses by making a comparison between them. Our aim is to clarify which type of clause is more effective in terms of the protection of the foreign investors’ contractual rights. In this regard, we will explain the general features of classical and modern stabilization clauses. Then, we will discuss important issues related to stabilization clauses, such as applicable law, validity and efficacy of stabilization clauses. Afterwards, reasons for the increasing tendency to modern stabilization clauses and significant issues related to them will be analyzed. Finally, we will examine the interpretation of stabilization clauses in international arbitration practice by giving specific references to some key arbitral awards.

Stabilization Clauses, Renegotiation, International Arbitration, International Investment Law.

Milletlerarası yatırım sözleşmelerinin uzun vadeli özelliği, yabancı yatırımcıları sözleşme süresince bir takım koruma mekanizmaları aramaya yöneltmektedir. İstikrar hükümleri de milletlerarası yatırım sözleşmelerinde yabancı yatırımcıyı korumaya yönelik sözleşme mekanizmalarından birisidir. İstikrar hükümlerini klasik ve modern istikrar hükümleri olmak üzere ikili bir ayırıma tabi tutmak mümkündür. Bu makalede amacımız, yabancı yatırımcıların sözleşmeden doğan haklarının korunması açısından hangi tür hükmün daha etkili olduğuna açıklık getirmektir. Bu kapsamda, klasik ve modern istikrar hükümlerini karşılaştırmalı olarak inceleyeceğiz: Bu bağlamda ilk olarak klasik ve modern istikrar hükümlerinin genel özelliklerini açıklayacağız. Ardından, uygulanacak hukuk, istikrar hükümlerinin geçerliliği ve etkinliği gibi önemli konuları tartışacağız. Daha sonra modern istikrar hükümlerine yönelik artan eğilimin nedenleri ve bunlarla ilgili önemli birtakım hususları değerlendireceğiz. Son olarak, konuya ilişkin önemli hakem kararlarına atıfta bulunarak, milletlerarası tahkim uygulaması kapsamında istikrar hükümlerinin ne şekilde ele alındığını inceleyeceğiz.

İstikrar Hükümleri, Yeniden Müzakere, Milletlerarası Tahkim, Milletlerarası Yatırım Hukuku.

INTRODUCTION

International investment agreements have a long-term characteristic and they include capital intensive projects with high costs. Besides, there is a significant time lag between the signing of the agreement and the production stage. Therefore, the process includes many risks such as commercial, geological and political. These risks can be unforeseeable at the beginning of the agreement and investors bear all of these risks with the expectation of high-profit return. Considering all of the aforementioned factors it is natural that investors seek protection. Therefore, several mechanisms have been developed and applied in international investment agreements. Contractual clauses are one of the mechanisms developed in this context. Stabilization, force majeure, hardship, and price review clauses can be shown as an example of these clauses.

In our article, we will focus on stabilization clauses: The stability of an international investment agreement is essential because without it the effectiveness of the agreement will be restricted. Stabilization clauses are one of the mechanisms to ensure the stability. Accordingly, stabilization clauses can be divided into two main categories: The first one is the classical stabilization clause in other words “freezing clauses”. The second type is economic (modern) stabilization clauses which become more common after the development of contract drafting methods.

This article will examine the classical and modern stabilization clauses by making a comparison between them. First, we will explain general features of classical stabilization clauses. Then, we will consider important issues related to classical stabilization clauses, such as applicable law, validity and efficacy of stabilization clauses. Secondly, we will explain modern stabilization clauses; in this context, reasons for the increasing tendency to modern stabilization clauses will be analyzed by giving specific references to remedies that are available under these clauses. After, we will seek to clarify which type of clause is more effective in terms of the protection of foreign investors’ contractual rights. Third, we will examine the interpretation of stabilization clauses by arbitrators and the function of these clauses within international arbitration. Finally, we will make some concluding remarks.

I. CLASSICAL STABILIZATION CLAUSES

Following the regulations of the host state regarding foreign investments, the second legal basis for foreign investments is the investment agreement concluded between the host state and the foreign investor¹ . The investment agreement is important in terms of forming the legal framework of the relationship between the host state and the foreign investor² . Besides, these agreements contain specific features: One of the most prominent features of these agreements is their long-term characteristic³ . Indeed, when we examine agreements like production-sharing agreements, concessions and oil and gas agreements we can see that the contractual relationship between the host state and the foreign investor take form in the long term. Another feature of these agreements is that they are capital intensive projects with high costs⁴ . Therefore, the long-term and capital-intensive characteristic of the investment agreements indicates the fragile position of the foreign investor against the host state. In addition, since the host state has sovereign power when it becomes the party the agreement that raises the risk of unilateral alteration of the agreement by virtue of the host state’s legislative power⁵ .

Another aspect of the issue is that at the beginning of the negotiation investor is more powerful than the host state: On the other hand, the host state’s negotiation power increases after the important progress on the project⁶ . Thus, the host state may oblige the investor to make amendments in the agreement which the investor wouldn’t accept in the beginning of the contract negotiations. In other words, the investor becomes a “prisoner” of the host state and the state can amend its legislature and make the agreement advantageous for itself⁷ . Therefore, it would be better for the investor to obtain favourable terms by minimising the risks at the beginning of the negotiations⁸ .

In other words, foreign investors are faced with commercial and non-commercial risks due to the activities they engage in the investment process⁹ . It is stated that the investor should bear the commercial risks, on the other hand, the investor cannot foresee the non-commercial risks and they are independent from the investment activity: Expropriation, war, non-transferability of profit and sales prices are included in this scope¹⁰ . On the other hand, the amendment of the current legislation by the host state against the investor due to various reasons is considered within the scope of political risks¹¹ . Regardless of the categorization of the risks, it is clear that foreign investors need protection during their investment process. Therefore, some mechanisms have developed to protect foreign investors against these risks. In this context, stabilization and arbitration clauses are very common in international investment agreements¹² .

Indeed, stabilisation clauses are one of the mechanisms developed in this context: The parties can adopt various techniques in order to stabilize their agreement by stabilisation clauses. Stabilisation clauses are subject to various distinctions in this context: According to this, it is stated that there are seven types of stabilisation clauses: The first type is aimed to freeze the law of the host state; the second type is regarding preventing the expropriation; the third type deals with financial matters, in particular the tax rate to be applied, export permits, etc.; the fourth type is related to the employment law; such as work permit¹³ . The fifth type of stabilization clause is dealing with the import-export regime and the sixth type of stabilization provisions relate to the free transfer of investment income; finally, the seventh type is related to assuring that the host state will not make amendments to the essential elements of the agreement¹⁴ .

In our opinion, it is possible to evaluate all of the above-mentioned stabilisation clauses within the scope of classical stabilisation clauses. As a matter of fact, although the regulation area is different, the aim is to prevent the host state from carrying out its administrative and legislative activities to the detriment of the investor. As will be explained in detail below, classical stabilization clauses prevent the implementation of future changes in the law of the host state or administrative activities to the investor, who is a party to the agreement in which the stabilization clause is included.

Within the scope of our article stabilization clauses will be examined under two main subtitles: Accordingly, the first type of stabilization clause is the classical stabilization clause in other words “freezing clauses”. Parties include these types of clauses in their agreements in order to guarantee that investors’ rights will be unaffected in the event of a change in the host state’s legislation¹⁵ . With these type of stabilization clauses included in the investment agreements, it is possible to freeze the legal regulation in force at the time the investment enters the host state: Thus, it is ensured that the legal amendments made by the host state are not applied to the investment agreement¹⁶ .

The second type is economic stabilization clauses; after the development of contract drafting methods, parties started to prefer modern/economic stabilization clauses for various reasons¹⁷ which will be examined in the second chapter of our article.

Usage of stabilization clauses started in the 1930s: First, it has started with the intent to limit the government’s power in the Middle East then it became popular in other parts of the world¹⁸ . After, they were considered as a defence against the expropriating¹⁹ . However, stabilisation clauses are improved with the development of contract drafting techniques. Today, stabilization clauses may cover any field of law which has an impact on the economic conditions of the agreement: The scope of stabilization clauses may contain: real estate; tax regime; employment law; exportation and importation provisions as well as the general legislative and contractual framework²⁰ .

The purpose of classical stabilization clauses is the protect investors by limiting the legislative or administrative power of the host state. Thus, the host state will be retained from altering the terms of the contract by new legislations²¹ . There are different ways to provide this outcome: Firstly, parties can agree on that any modifications in the agreement will be made by mutual consent of the parties or they can decide that the applicable law of the contract will be the law of the host state that they agreed on when they were concluding the contract²² . The clauses used to provide the second method called as “freezing clauses”. While explaining the general nature of classic stabilization clauses we will focus on freezing clauses in this article.

Freezing clauses also defined by some jurists as “stabilization clause stricto sensu” ensure that applicable law to the agreement between the foreign investor and the host state will be the law of the state at the time that the agreement was concluded²³ . Since freezing clauses have the power to freeze the host state’s legislative ability to change the agreement, they are more preferable for investors compared to the state.

In this context, there are some criticisms about this traditional form of stabilization clauses: Firstly, these clauses are inconsistent with the host state’s sovereign authority because they restrain the host state’s autonomy. Secondly, stabilization clauses limit the power of the host state to dispose of its natural resources which is one of the inalienable powers of the state²⁴ .

In our opinion, these criticisms are valid and cause legitimate questions about the validity and efficiency of freezing clauses. As we will explain in detail below; is it possible to argue that freezing clauses are fully effective or do they become completely ineffective against the principle of sovereign authority? To answer this question, it is necessary to consider the issue from different angles. In this context, first of all, the relationship between the applicable law to the contract and the freezing clauses should be examined. Indeed, the applicable law will directly affect the validity and bindingness of the freezing clauses. Therefore, it is an important issue that needs to be addressed. Afterwards, we will discuss the validity and efficacy of freezing clauses and we will try to answer whether freezing clauses have a functional value.

For both the host state and the investor, the determination of the law applicable to the agreement is often regarded as one of the most significant legal issues²⁵ . The matter of applicable law has special importance in terms of stabilisation clauses: Because both the legal effect of the stabilisation clause and the interpretation of it will depend on the applicable law to the agreement²⁶ .

The first issue that should be emphasized regarding the applicable law and stabilization clauses is; whether the inclusion of these clauses in the agreement would mean a choice of law. As it is accurately stated in the doctrine; although stabilization clauses freeze the provisions of a certain national law for a specific time these should not mean that the parties have made a choice of law²⁷ . If the law of a state is chosen, the rules to be applied to the agreement will also change when there is an amendment in the chosen legal system²⁸ . As a matter of fact, due to the freezing effect of the stabilization clauses, these provisions have become an independent body of rules by separating from the positive law of a state which is living and developing²⁹ . Therefore, we also agree that in an agreement where a stabilization clause is included, certain legal rules are chosen rather than the choice of law. Therefore, just because a stabilization clause is included in the agreement that does not mean that the law of the host state is the applicable law of the agreement. Thus, the parties need to state separately the law applicable to the investment agreement.

Secondly, it is stated that the stabilization clauses will be effective in cases where the law of the host state is applied to the investment agreement. On the other hand, in cases where the law of another country or international law will be applied to the agreement, there will be no need for stabilization clauses since the host state will not interfere with the agreement with a legislative amendment³⁰ . However, it should be borne in mind that even if parties refer to the international law or foreign law as applicable law, this will not be enough to provide contractual stability; because the host state’s legislative authority and its right to nationalise is recognized by the international law³¹ . Besides, even if the agreement is governed by international law, it is subject to overriding mandatory public law rules and the state will be able to interfere with the agreement in cases like public interest³² . Therefore, in our opinion even if the host state’s law is not the applicable law to the agreement, stabilization clauses are needed to provide stability to the agreement. On the other hand, it is possible to say that the effectiveness of stabilization clauses will be more where a law other than the host state’s is the applicable law.

From the perspective of the investor; the investor will tend to choose a law that provides stability and predictability for him. It is also important for the investor to choose a forum for dispute resolution which will prevent prejudice or political influence against him³³ . On the other hand, the host state will tend to choose a legal order that will protect its sovereign authority³⁴ . As we briefly stated above, there is a variety of choices regarding the applicable law; in this context, the bargaining power of the parties will be determinative: First, parties can decide the law applicable to the agreement will be the law of the host state which is generally preferred by host states; second, the agreement may be governed by international law; third, the agreement may be governed by the combination of domestic law and international law³⁵ . It is stated that most of the time parties agree on a combination of national law and international rules as applicable law³⁶ . In addition, parties also can choose the law of a third country that has a well-developed legal system regarding the dispute resolution of related transactions³⁷ .

The content of the domestic law of the host state is also important at the stage of determining the applicable law to the agreement: If the constitution of the host state allows the application of international law, the foreign investor will be more likely to accept the domestic law of the host state as the applicable law³⁸ . However, if the constitution contains provisions that allow the host state to change the law unilaterally without the right of objection of the investor; the investor will not be willing to choose the law of the host state as the applicable law to the agreement³⁹ . This issue is particularly significant if the agreement contains a freezing clause. In case of the applicable law to the agreement is the domestic law of the host state that allows to the state to change to law unilaterally, this will adversely affect the legal enforcement and efficacy of the freezing clause in case of conflict between the parties: In this scenario, it would be possible for the host state to apply any change to the agreement based on different kinds of reasons such as public interest or public order⁴⁰ .

Another argument is that by including stabilization clauses, the agreement is internationalized: However, the definition of “internalization” is not clear⁴¹ . Actually, the scope of the term is examined and determined by tribunals within the framework of arbitration proceedings. For instance, in Texaco and AGIP v. Congo awards the tribunal emphasized the subject and defined the term⁴² . In addition, it is stated that the internationalization of the agreement is a separate method from the stabilization clauses within the scope of investor protection⁴³ . It is also argued that internationalization of the agreement is the appearance of the “lex mercatoria” concept in foreign investment disputes⁴⁴ . Since in the modern international economy, the distinction between investment disputes and commercial disputes has disappeared so it is possible to use the term “lex mercatoria” in investment disputes in which the state is a party⁴⁵ . Also, this issue has been addressed in various ICSID awards⁴⁶ : It has been stated that investment agreements allow the application of international law and the tribunal applied the international law as “lex specialis”.

In addition, harmony should be ensured between the chosen law and the dispute resolution method to be applied in case of conflict⁴⁷ . This issue is especially important in cases where “lex mercatoria” is chosen as the applicable law: If “lex mercatoria” is chosen as the applicable law, but international arbitration is not referred to as a dispute resolution method; domestic courts will not apply the non-national “lex mercatoria” and will refer to objective connecting factors to determine the applicable law⁴⁸ . On the other hand, arbitral tribunals have the power to decide on the basis of fairness and equity: In such a case, the arbitral tribunals will apply the “lex mercatoria” in the context of equity and fairness⁴⁹ . Therefore, in order for the applicable law to function effectively, it is important to include international arbitration as a dispute resolution method in investment agreements alongside the applicable law.

On the other hand, some authors aptly argue that although the agreement is governed by international law, mandatory public law rules, such as the protection of public interest, will always prevail⁵⁰ . Indeed, whether international law, the domestic law of the host state, or the law of a third country applies to the contract; the exercise of sovereign authority of the host state on public interest grounds cannot be overridden by stabilization clauses⁵¹ . Also, it is stated that applicability and impact of international law rules are different in each legal system: In some legal systems, international agreements are self-executing, while in others they are non-executing. Therefore, in some cases, the rule of domestic law and the rule of international law may conflict with each other. Thus, relying on the provision of international law can be complex and contradictory⁵² . However, it is not possible to completely exclude international law: Even if the parties do not refer to the general principles of international law in the agreement, the international tribunal will take into account the general principles of international law such as the international minimum standard for the protection of foreign investors or obligation to act in good faith⁵³ .

In the light of the above information, it is clear that the investor should consider the governing law issue to obtain maximum protection from stabilization clauses. If the agreement is governed by the host state’s law, this might be disadvantageous for the investor. In this case, the host state will be able to reduce the effect of the stabilization clause or even make it completely invalid by amending its legislation⁵⁴ . Therefore, we suggest that the applicable law of the agreement should be international law which is more advantageous for foreign investors. However, it also depends on the bargaining power of the foreign investor. If the host state cannot be persuaded that international law will be the applicable law, at least a combination of national and international law should be applied to the agreement. Another alternative would be the application of a foreign law that has a well-developed legal system regarding the dispute resolution of related transactions. Since the applicable law of the agreement will be a law other than the host state’s law itself, the state will not be able to change this law unilaterally and the stabilization clause will provide more protection to the investor. However, it should always be taken into account that regardless of which law applies to the agreement, the host state’s exercise of sovereign immunity cannot be prevented.

Therefore, the issue of stabilization clauses and the applicable law is important in cases where there is no application of sovereign right by the host state. In addition, even though there are some arbitral awards and scholarly opinions suggest that where there is no direct reference to international law as the applicable law in the agreement but still general principles of international law will be applied; we suggest that parties should refer to the international law as the applicable law in the agreement to guarantee the application of international law rules.