Renegotiation and adaptation clauses in investment contracts, revisited.

AuthorGotanda, John Y.
PositionResponse to article by Klaus Berger in this issue, p. 1347

TABLE OF CONTENTS I. INTRODUCTION II. RENEGOTIATION AND ADAPTATION CLAUSES III. THE POTENTIAL DRAWBACKS IV. BENEFITING FROM THE USE OF RENEGOTIATION AND ADAPTATION CLAUSES V. CONCLUSION I. INTRODUCTION

Professor Dr. Klaus Berger, in Renegotiation and Adaptation of International Investment Contracts: The Role of Contract Drafters and Arbitrators, proposes that international investment contracts include a clause allowing the parties to renegotiate the terms of their contract if certain events take place. (1) If they are unable to reach an agreement, Professor Berger advocates that the parties agree to permit an arbitral tribunal to modify the terms of the contract to restore the economic equilibrium assumed by the parties when they concluded the agreement. (2) Although commentators have often championed these clauses, private parties involved in international transactions have included them infrequently. (3) This hesitancy may stem from fears that these clauses will make the contractual relationship unpredictable, raise the overall costs of the transaction, and be unenforceable or, if a tribunal is called upon to adapt the terms of the contract, will result in an unenforceable decision, or in the tribunal modifying the contract in a way that neither party intended. Despite these concerns, I agree with Professor Berger that such clauses may be beneficial in international investment contracts, but in more limited circumstances than he posits. (4) Specifically, I argue that renegotiation clauses should not be included when one of the parties controls the event that triggers renegotiation and adaptation. The renegotiation and adaptation clause should provide a tribunal with criteria to guide any adaptation of the agreement.

  1. RENEGOTIATION AND ADAPTATION CLAUSES

    Renegotiation clauses are provisions in contracts that, upon the happening of a certain event or events, require all parties to return to the bargaining table and renegotiate the terms of their agreements. Professor Berger states that these clauses are particularly useful in international investment contracts between a private party and a government entity. (5) He argues that because these contracts typically are of long duration, the political, economic and social climate could change radically during this period and dramatically alter the economic benefits that the parties originally envisioned would flow from the agreement. (6) He also argues that a renegotiation clause may both protect a state's sovereign right to change laws that may affect the agreement and provide a measure of protection to the private investor. According to Professor Berger's argument, instead of mandating that a state not change its laws in a way that would disrupt the financial returns negotiated under the parties' agreement--as do many traditional stabilization clauses--the clause would allow the state unilaterally to take steps that would affect its contractual regime. (7) However, the investor would then have the right to renegotiate or adapt the contract with the aim of restoring the original equilibrium between the parties. (8) Professor Berger asserts that using a renegotiation and adaptation clause in this manner leaves a state's sovereignty intact and protects the investor against changes in the law governing the agreement. (9)

  2. THE POTENTIAL DRAWBACKS

    Renegotiation clauses are not a panacea; they have a number of drawbacks. Investors may refuse to include them in their contracts for five reasons. (10) First, such clauses may reduce contract stability. (11) Second, including renegotiation clauses may raise the overall costs of the transaction. (12) Third, if the parties are unable to agree as a result of renegotiations and third-party adaptation of the contract is sought, an arbitral tribunal may decline to exercise jurisdiction or the adaptation may be unenforceable because of a lack of a "dispute" between the parties. (13) Fourth, if the parties' original agreement fails to provide the tribunal with sufficient parameters to adapt the contract, the tribunal may rewrite the agreement in a way that neither party intended. (14) Fifth, the events that trigger renegotiation may be within the control of the host state, raising the possibility that the process could be used unfairly to alter the agreement. (15)

    The first potential downside is that a renegotiation clause may interject uncertainty into the contractual arrangement. (16) Businesses value certainty and predictability. (17) In fact, predictability has been identified as a key element to a favorable climate for foreign investment. (18) As one arbitral tribunal pointed out: "[O]ne of the primary goals of contracting is providing predictability and certainty for the parties. Only in highly exceptional circumstances is it permissible to deviate from these considerations, which apply in particular in the international context." (19)

    History verifies the significance of creating uncertainty. (20) In 1978, the International Chamber of Commerce (ICC) promulgated rules for the adaptation of contracts. (21) In 1994, however, the ICC withdrew these rules because they had never been used. (22) An ICC Report noted that practitioners viewed adaptation clauses with skepticism, preferring instead the principle of pacta sunt servanda. (23)

    U.S. businesses in particular may be reluctant to include compelled renegotiation and adaptation clauses both because of the legal system's reliance on the principle of pacta sunt servanda and because such clauses are not regularly used in common-law countries, as they are in civil-law countries, like Germany and the Netherlands. (24) One commentator noted that the "reason for the difference between the common-law approach and the modern civil-law approach is that the leading common-law countries have not suffered from the unmanageable inflation that has ravaged much of the civil-law world." (25) However, he adds that "U.S. law should realize that international trade is different from domestic trade, and the modern civil-law solution ... deserves respect." (26)

    The second potential drawback is that renegotiation clauses may come at a cost. (27) When confronted with uncertainty of economic return, an investor may abstain from entering into the investment agreement or "structure the investment in such a way as to increase returns to offset the risk created by the environment." (28) Accordingly, if a host state mandates such a clause in any foreign investment contract, the state may lose the foreign investment or have to pay more for the investment of capital. In the latter case, in light of the increased uncertainty, the investor would seek a higher return on the investment than that investor would otherwise require, thus raising the overall transaction costs.

    The third downside is that, even if a renegotiation clause is included in an investment contract, in the event the parties are unable successfully to renegotiate the terms of their contract, it is unclear whether a "dispute" would exist between the parties. (29) Without a "dispute," the arbitral tribunal may not exercise jurisdiction and, even if it does, the tribunal may be unable to decree an enforceable award. (30)

    Some tribunals have concluded that when parties are unable to reach an agreement in...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT