The logic of contract in the world of investment treaties.

Author:Arato, Julian
Position:Abstract through II. The Treaty/Contract Question in Investor-State Jurisprudence C. Damages, p. 351-392


Investment treaties protect foreign investors who contract with sovereign states. It remains unclear, however, whether parties are free to contract around these treaty rules, or whether treaty provisions should be understood as mandatory terms that constrain party choice. While investment treaties clearly apply to contracts in some way, they are silent as to how these instruments ultimately interact. Moreover, arbitral jurisprudence has varied wildly on this point, creating significant problems of certainty, efficiency, and fairness--for states and foreign investors alike.

This Article reappraises the treaty/contract issue from the ex ante perspective of contracting states and foreign investors. I advance three main claims: one conceptual, one descriptive, and one normative. First, I argue that investment treaties must be understood as having generated a rudimentary, yet broad, law of contracts--governing agreements between states and foreign investors on pivotal issues, from substantive rights and duties, to damages and forum selection. Second, I argue that this emerging international law of contracts has developed sporadically, irregularly, and inconsistently, due in part to a tendency among tribunals to confuse the logics of contract and property. As a result, it remains undecided whether contracting parties should understand background treaty norms as defaults, sticky defaults, or mandatory terms--leaving the meaning of their contracts under a cloud of doubt. Third, I argue that the best way to resolve this problem for both states and investors, ex ante, is generally to privilege their contractual arrangements over background treaty rules. Even when these parties have different interests and values at stake, the treaty/contract problem is not zero-sum. Both sides usually stand to benefit from the freedom to negotiate around treaty rules as mere defaults--though I explore certain cases where treaty norms might justifiably exert a greater pull. In general, prioritizing party choice is not only optimal from the economic standpoint--it also provides states with the tools to secure their future capacities to regulate in the public interest.

Table of Contents Introduction I. Regulation and Choice in Transnational Contract Law A. Party Choice and Background Rules: Defaults, Sticky Defaults, and Mandatory Terms B. Contract Versus Property in International Investment Law C. How Might Treaty and Contract Relate? II. The Treaty/Contract Question in Investor-State Jurisprudence A. Forum Selection B. Legitimate Expectations and Stabilization C. Damages D. Jurisprudential Uncertainty III. Efficiency, Autonomy, and the Function of Choice A. The Function of Choice in the Logic of Contract B. Valuing of Choice in the Law and Policy of Foreign Direct Investment C. Justifying Constraints on Choice Conclusion: Toward Reforming the International Law of Investment Contracts Introduction

A traditional maxim of international law holds that all contracts are purely instruments of some domestic legal order. (1) Until very recently a contract between a private party and a foreign state, like any contract between private parties, would create rights and obligations under only the domestic law chosen by the parties. Today, however, this maxim is no longer correct. (2) Most clearly in the realm of sales, the 1980 Convention on the International Sale of Goods (CISG) has established a robust regime governing transnational contracts for the sale of goods, supplementing such instruments with a host of default and mandatory terms. (3) More recently, and far more quietly, a regime of international contract law has emerged in the field of foreign direct investment (FDI). A great deal of international contracting takes place under a manifold of treaties for the protection of foreign investments, which augment contracts between states and foreign investors--in whole or in part--with international legal rules. The advent of this world of investment treaties has subtly brought into being a rudimentary law of contracts--a broad complex of default and mandatory rules that alter contracts between states and foreign investors in relation to all kinds of questions, from the conditions of breach and defenses, to damages and forum selection. However, unlike the CISG, this emerging law of contracts has developed only sporadically, inconsistently, and irregularly. Contracts between states and foreign investors are no longer purely instruments of national law. But a better international law of contracts is essential if we are to remain sensitive to both the needs of foreign capital and the vitality of local and global public values.

The root of the problem is that investment treaties tend to say nothing, or only very little, about how they relate to contracts. (4) They often clearly apply to contracts between states and covered foreign investors (state contracts), either explicitly or by evident implication. (5) Some treaties even incorporate provisions that equate breach of a state contract with breach of the treaty (the "umbrella clause"). (6) But for the most part, investment treaties do not spell out the consequences of their application to contracts--for questions of breach, defenses, forum selection, calculating damages, or the whole host of terms articulating the life of any contractual agreement. (7) From the perspective of contract theory, crucial questions remain totally unaddressed: Are treaty rules on such matters defaults that the contracting parties can simply negotiate around, or are they mandatory rules that take precedence over conflicting contractual provisions? If mere defaults, how difficult is it for the parties to opt-out? What level of clarity or specificity is required, and why? Are the answers the same for all kinds of treaty provisions, or are some mandatory and some merely default? Are some defaults "stickier" than others? And what about the parties' contractual choice of law--what is the proper relationship between the demands of the treaty and the whole host of rules selected by the parties by implication, through their choice of law clause?

The broad problem can be illustrated through a simplified hypothetical. Assume that two countries, Acadia and Ruritania, have established a bilateral investment treaty (BIT) to promote and protect the flow of investment across their territories. The treaty lists contracts as covered investments, along with real property, intellectual property, and so on. It further guarantees foreign investors against expropriation, requiring that an expropriating state compensate the investor for the "fair market value" of her loss. As will be discussed below, in contract cases this standard of damages is generally taken to mean expectation damages, (8) By contrast, assume that the Ruritanian law of public contracts guarantees investors only reasonable reliance damages when the state breaches--so as not to bind the government's hands if future regulatory exigencies arise. (9) An Acadian investor contracts with the government of Ruritania to operate a dolomite quarry for twenty years. The contract comes under Ruritanian law and makes no express mention of damages. Ten years into the deal, Ruritania cancels the contract, citing newly discovered environmental concerns about dolomite mining. Assuming an expropriation occurred, which standard of damages controls? The domestic standard (reliance damages) or the treaty standard (expectation damages)? And what if the parties had included a provision in their contract expressly limiting damages (liquidated damages)? Surprisingly, international investment law does not adequately resolve these questions.

This Article grapples with the treaty/contract problem systematically as a question of contract theory. I argue that privileging party-choice in the context of transnational investment contracts is the best way to protect both the private law values of fairness and efficiency and the state's capacity to govern in the public interest.

From the ex ante perspective of contracting states and foreign investors, the ultimate relationship between treaty and contract will be of fundamental importance. As a purely commercial matter, the relative rigidity or flexibility of the treaty regime will bear strongly on the parties' ability to negotiate efficiently. At the same time, as a political matter, these questions will determine whether and how a state desiring FDI might effectively work protections for its future capacity to regulate into its contractual arrangements with foreign investors. Thus it is unsettling that the treaty/contract relationship remains generally undecided and, moreover, that it is so often decided the wrong way.

Uncertainty is the more glaring problem. It is clearly undesirable for all parties if, ex ante, they cannot predict whether tribunals will give effect to their contractual efforts to opt out of treaty rules ex post. Yet, in the face of treaty silence on the treaty/contract issue, arbitral jurisprudence has been highly uneven and irregular--often resolving these questions merely on the level of assumptions. (10) As a result, the meaning of state contracts in the world of investment treaties remains under a cloud of doubt.

But the deeper problem is that tribunals too often slip into an overly rigid and formalistic approach, prioritizing treaty provisions over negotiated contractual bargains. (11) This tendency is usually bad policy, with negative implications for both states and investors. It undercuts the autonomy of the parties, thereby undermining their capacity to allocate risk as they see fit. For the investor, this means risks associated with the viability and profitability of the project. States share those commercial concerns but also bear responsibility for the full range of noncommercial values of import in their respective societies. States negotiating investment contracts thus have to seriously manage the risk...

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