What Really Happens on the Choice-Of-Law Clause on International Investment Contracts and How China Deals With This Matter?

Often parties seek to avoid the law of the host-state in international investment contracts. They choose any body of law or legal principles they wish, so long as it is not solely the law of the host state. Some clauses mentioned below are presented as a typical example. The traditional view used to be that such contracts are subject to the domestic law of the host state. Certain problems did arise due to the underdeveloped legal systems. The investors have sought to find ways which provide a higher standard and better promote their interests. The terms of an umbrella clause or a stabilization clause give the solution by providing protection. It used to be that when an investment dispute arose, the host state court had the jurisdiction to settle it.  Now, it allows foreign investors and host states to settle the dispute without based exclusively on the national law of the host state. China has shown a great importance on settling disputes as the Chinese Belt and Road project grows fast.

Below, a short approach is introduced on how the parties, investor and state, seek to avoid the laws of the host state, the reason behind which they choose any body of laws or legal principles, how international law principles are applied to such contracts and possible solutions and how China is dealing with this matter.

  1. Introduction

The question dealing with the controversy as to whether the contracts signed by an investor and a host state should be governed by the domestic law of the host state or public international law, i.e. customary international law and the treaty law are considered significant. The traditional view used to be that such contracts are subject to the domestic law of the host state. However, despite the fact that this view may have some merit, certain problems did arise in the past due to the underdeveloped legal systems of the great majority of developing countries.

  1. The domestic law as a traditional approach

In particular, the domestic law of the host state was not guaranteeing a stable legal environment or the procedure in the national courts was quite slow and unpredictable. For example, it was quite often for the legal framework to be amended after the conclusion of the contract and even worse that the host state would proceed to the expropriation of the investment, as defined at the Article 25 ICSID[1].

  1. The “internationalization process”

This problematic situation made foreign investors to search for new ways of protection in order to secure their investment capitals and be reassured that the system of the country which hosts their investment would remain stable, at least with respect to their investment.

Around the 1950s, a tendency emerged for these contracts to be seen as “internationalized”, mainly for reasons associated with the aforementioned protection of the investors. It seems that the internationalization process promotes better the investors’ interests because international law provides higher standards in comparison with the unstable procedure provided by domestic law (e.g. non- discrimination, national treatment, just compensation in case of expropriation). This is mainly the reason why, up to nowadays, the parties, in investor – state contracts define international law as the applicable law in their relations. Of course, no interpretative issue arises in case the parties have already defined the applicable law.

From my point of view, this change came naturally. The domestic law does not always guarantee a stable platform, whereas the international law does as it is explained. In the unfortunate case that the parties have not determined the applicable law, it is submitted, in light of the above, that international law should govern their relations. International investment law is a distinct body of law that has been formatted particularly for the objective of these contracts

This opinion has been confirmed time and again by international tribunals. For instance, the Tribunal in Texaco v. Libya[2] internationalized the relevant contract, meaning that it applied international law and not strictly the municipal law of the Host State. As the tribunal in Texaco v. Libya mentioned, if the concession-related disputes were only governed by national law, the binding nature of the Contract could have been endangered by the laws of Libya. In other words, it is undeniable that the Host State has the inherent power to change and adjust its laws freely in a manner that it considers appropriate. Consequently, a foreign investment would run the risk of being treated unfairly (e.g. nationalization) under the arbitrary regulations of the Host State at any time. Hence, in order for the foreign investor to be protected, the applicable law should offer the standards provided by international law. On the other hand, this does not seem so fair for the host country, as the investment takes place in its territory. For this reason, it is better that the parties agree the applicable law beforehand.

  1. The bilateral and Multilateral investment treaties give the solution

The applicable law problem was solved mainly in two ways: By the bilateral or multilateral investment treaties (BITs/MITs) that the countries sign among them or by introducing stabilization clauses into the contract between the investor and the state.

It is also significant that major developing states delay concluding BITs. China, for example, concluded its first BIT in 1982.[3] However, China has signed a significant number of BITs the last years. Since 1998, the priority for the Chinese BIT policy was to protect the Chinese overseas Foreign Direct Investment. Importantly, beginning with Barbados-China (1998), China changed its practice of limiting investor-state arbitration to disputes concerning the amount of compensation resulting from expropriation and consented generally to the arbitration of disputes unlike early Chinese BITs, which provided for significant limitations in substantive and procedural protections, China’s most recent BITs provide.[4]

BITs are international treaties concerning how the countries deal with investment transactions. They are essentially a set of rules with the intention of both parties of a project to be regulated by this. The parties usually put also an umbrella clause in their contracts so as to ensure that any claim arising out of their agreement will be elevated to international law status and so the investment will acquire international protection.

It is common place for a developing country to provide tempting privileges so that many investors from developed countries will be willing to set up their projects in their country. Both parties have advantages to gain; one can set up a company and take huge advantages regarding the flexible legal system and the other could easily diminish the employment problems. However, on a long-term basis, this could easily appear to be problematic because the developing country might not be able to afford it.

It is not uncommon that an investor from a developed country might take advantage of a developing country doing its business against the host country rights, as in the Kiobel [5]case. Another obstacle is the interpretation of a BIT treaty.  Since it is an international law treaty between two states, it is permeated by international law. When international law is mentioned it is questioned as to what exactly is the source of international law. What does this mean?

In accordance with the Article 38 of International Court of Justice (ICJ) the source of international law is:

  1. International conventions, whether general or particular, establishing rules expressly recognized by the contesting states,
  2. International custom, as evidence of a general practice accepted as a law,
  3. The general principles of law recognized by civilized nations,
  4. Subject to the provision of art. 59 judicial decisions and the teaching of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law.
  1. The interpretation of the international law

The cases of Libya are interpreted differently using a different source of the international law[6]. To be specific, as in the BP[7] case, the agreement is governed by the “general principles of law”, in the Texaco case by the “the principles of law of Libya common to the principles of international law” and in the LIAMCO[8] case by excluding any part of Libyan law which is in conflict with the principles of international law. In any case the Vienna Convention on the Law of Treaties on 1969 is a good tool for the interpretation of the international law.

Another effort made by the industrialized countries to restate the principles governing the protection of foreign investments was the United Nations General Assembly resolution 1803 (UNGA). However, the investment arbitration clause is based on a contract. So, under the Article 8 UNGA, it is stated that:

Foreign investment agreements freely entered into by or between sovereign states hall be observed in good faith, states and international organizations shall strictly and conscientiously respect the sovereignty of peoples and nationals over their natural wealth and resources in accordance with the charter and the principles set forth in the present resolution.

This means that the main idea is both parties must abide by the terms of their contract.

  1. How the stabilization clause works

Another method to ensure the stability of an agreement between the investor and the state is the stabilization clause, which should be respected by both parties. Hence, by including a stabilization clause in the Concession-Contract, the Concession would be governed by the already existing regulations of the Host State, regardless of any future changes. Thus, if a country decides in the future to change the current legal framework, it does not have any impact on the contract between them.

The majority of these contracts related to investment law include into their terms an umbrella clause or a stabilization clause. In case the state breaches this clause, the investor has the right to compensation or specific performance of the contract. Furthermore, the reasoning behind the inclusion of stabilization clauses in such contracts can be explained easily. According to the famous general principle of law pacta sunt servanda and the principle of the good faith, the binding nature of the contract does not allow one of the parties to supersede its obligations without repercussions.

Therefore, the contractual rights which are given by concession to the parties are not going to change unless the parties decide to.

However, no investor wishes to lose investment capitals by expropriation, which is the most severe form of a state to intervene taking the property of a party without any adequate compensation provided.

An example of a stabilization clause involved in the concession agreement in the case Texaco v. Libya arbitration reads as follows[9]:

The Government of Libya will take all step necessary to ensure the company enjoys all the rights conferred by the concession. The contractual rights expressly created by this concession shall not be altered except by the mutual consent of the parties.

The above is a form of indirect stabilization clause which implies that the future legislative changes would not be applied to their agreement. The foreign invest must give his consent in order these changes made impact on their agreement.

However, even if the country has a stability in governance, it is sometimes impossible to foresee the dynamic factors in the market. This is the reason the fiscal policies keep changing significantly from time to time and it seems impossible for the countries to respect their commitments.

Of course, the principle of the state territorial sovereignty is important. However, there is a limit on its rights by the time it voluntarily signs a concession contract with another party. In other words, the expropriation could take place if some requirements are fulfilled, namely the expropriation must serve the public purpose and an adequate compensation must be given[10].  At this point it is important to mention that when an investment dispute arises, the host states’ courts have the jurisdiction to settle it. On the one hand, conflict of law rules may be taken into consideration in the host state court proceeding, on the other hand dragging the country outside of the host state would be a barrier because of the state immunity.

  1. The new age of settling the disputes

So, in order the foreign investment disputes be solved efficiently, a new system of dispute settlement was developed during the second half of the 20th century. It allowed foreign investors and host States to settle the disputes that arose between them directly, without having to anticipate the exercise of diplomatic protection that relied upon the discretion of the investor’s state of nationality.

In this regard, in order for the weaker party, (i.e. the foreign investor) to be treated more equally, usually the law applicable to concession-related matters was not exclusively the national law of the Host State. This entailed that during investor-State arbitration the law governing the dispute was other than purely that of the Host State, while frequently public international law and its principles applied.

This was the International Centre for Settlement of Investment Disputes (ICSID), the institution based on a Convention which provides support to deal with these issues by choosing arbitration and setting up an arbitration system which promotes the justice between the parties.

  1. How China deals with the matter of choice of law

When a party is characterized as dealing with foreign-related transaction, then it can freely make the choice of law. However, a wholly foreign owned enterprise (WFOE) and Sino-foreign joint venture are always considered domestic entities under PRC law. If the parties fail to agree on applicable law, the applicable law should be the one which predominantly exists in the contract. This means the law which seems to have a connection.

Article 128 of Contract Law provides that the parties have a valid arbitration clause on a foreign-related transaction agreement” “the parties on a foreign-related contract may apply a PRC arbitration institution or another arbitration institution for arbitration”.

In December 2017, the China International Economic and Trade Arbitration Commission (CIETAC)[11] created its Investment Arbitration Rules, as the first set of investment arbitration rules by a Chinese arbitral institution.

In January, the Shenzhen Court of International Arbitration (SCIA) came into force. It has since entered into cooperation arrangements with the ICC and ICSID, agreeing to share facilities and knowledge in administering international commercial disputes.[12]

China has updated its arbitration system and is promoting its arbitration centres. However, although China has invented arbitration centres for Chinese and foreign-related transactions, foreign investors seek to solve the dispute with Hong Kong International Arbitration Centre or International Chamber of Commerce in Paris, or other institutions which are the oldest and have shown to be impartial on settling disputes. 

  1. Conclusion

Last but not least, we may mention that as favorable as international investment law may be with regard to investors, the developing states that host such investments do not necessarily share that view. As an example of this negative opinion, we may refer to the withdrawal of many South American countries from the ICSID Convention (inter alia: Venezuela). A majority of developing states cannot follow the standards and the pace of international law, whereas the developed countries seem to take advantage of the developing countries. This is also obvious in another international law regime that of the World Trade Organization and its dispute settlement system.

To conclude, international investment law and international dispute settlement (e.g. international arbitration) are very useful tools for the protection of the parties in an investor-state contract. However, the system should not overlook or undermine the needs and the de facto weaknesses of the least developed states.

China seeks to protect its investment by establishing a strong arbitration system. Its effort to establish arbitration centres is a signal of China’s determination to internationalize the country’s dispute resolution platform.

*Special thanks to Ms. Eirini Fasia , LL.B, LL.M, MJur , MPhil Oxford , for her contribution.

[1] Definition of investment and foreign investor at the Article 25 International Centre for Settlement of Investment Disputes (ICSID) states: (1) The jurisdiction of the Centre shall extend to any legal dispute arising directly out of an investment, between a Contracting State (or any constituent subdivision or agency of a Contracting State designated to the Centre by that State) and a national of another Contracting State, which the parties to the dispute consent in writing to submit to the Centre. When the parties have given their consent, no party may withdraw its consent unilaterally. (b) any juridical person which had the nationality of a Contracting State other than the State party to the dispute on the date on which the parties consented to submit such dispute to conciliation or arbitration and any juridical person which had the nationality of the Contracting State party to the dispute on that date and which, because of foreign control, the parties have agreed should be treated as a national of another Contracting State for the purposes of this Convention.

[2] Texaco Overseas Petroleum Co. v. Libya, Int’l Arbitral Award, 104 J. Droit Int’l 350 (1977), translated in 17 I.L.M. 1 (1978).

 [3] China-Sweden (1982).

[4] Newcombe A, Paradell L, Law and Practice of Investment Treaties, Kluwer Law International (2008).

[5] Kiobel v. Royal Dutch Petroleum Co., United States Supreme Court 569 U.S. 12 (2013)ׄׄ

[6] Shalakany A., Arbitration and the Third World: A plea for Reassessing Bias Under the Specter of Neoliberalism, vol. 41, no. 2, Spring 2000, 448-457.

[7] BP Exploration company (Libya) Limited v. Government of the Libyan Arab Republic, 53 I.L.R. 297.

[8] Libyan American Oil Company (LIAMCO) V. the government of the Libyan Arab Republic, 20.I.L.M 1 (1997).

[9] Sornarajah M., The International Law on Foreign Investment, Public International Law, Cambridge University Press, second edition, 2004, 332.

[10] Dolzer R. & Schreuer C. - Principles of International Investment Law, Oxford University Press, Second Edition, 2012, 101-126.

[11] http://www.cietac.org/Uploads/201709/59c8d60367bb5.pdf

Support Lawyer at Linklaters- London, former Junior Legal Consultant at Wallem Group- Hong Kong. Greek Qualified Lawyer and Candidate Solicitor in England and Wales.