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Energy Law Exchange

November 6, 2017

Choice of Law in Host Government Agreements

Choice of law stands as the second “pillar” of contract stabilization, together with stabilization clauses and international arbitration.  In fact, choice of law provisions sometimes consist of stabilization clauses in the form of “freezing” by incorporation and inopposability provisions.  Brown emphasizes the importance of choice of law for contract stability:

 [The anxieties of the foreign investor] are more likely to focus on the possibility that the contractual obligations of the government may be discharged or modified by an exercise of the legislative competence of the State.  If such an event occurs the contract as originally agreed between the parties no longer exists, and remedies for breach of it may not be strictly in point.  It follows that in a situation in which the dominant concern of the foreign investor is with the legislative competence of the State, attention, in the first instance, at least, must focus on questions concerned with the proper law of the Contract.[1]

 When negotiating choice of law with a host government, the investor normally wants to “internationalize” the applicable law, so that changes in the national law of the host country do not apply to the investment contract, while the host government, as Sovereign, naturally wants its law to apply. 

Unless the host country agrees to application of the law of the investor’s home country or of a third country or of international law, without application of its own law – an unusual but not entirely unheard of occurrence[2] – the investor can proceed down two paths in negotiations with the host government over the applicable law.  Those two paths, by the way, can intersect.  The investor can seek to expand application of the host government’s laws to include extra-State laws and norms and/or the investor can seek to limit application to the contract of future changes to the host government’s laws.  Governments agree to go down either or both of these paths for basically the same reason they agree to include stabilization and international arbitration provisions in their investment contracts – the desire to attract foreign investment. 

No doubt exists that governments and investors can negotiate and enter into agreements that depart to greater or lesser extent from the law of the host countries.  “[I]t is an accepted universal principle of both domestic and international laws that the parties to a mixed public and private contract are free to select in their contract the law to govern their contractual relationship.”[3]  If the parties fail to specify the applicable law in their investment contract, an arbitral tribunal asked to choose the applicable law may conclude that that failure indicates the parties prefer another set of laws to govern their relationship.[4]  Possible sources of an expanded law include: (1) principles of law common to the home countries of the host government and the investors; (2) law of a third country; (3) and international law, including general principles of law.

A 1985 Syrian EDPP Contract offers a glaring example of what NOT to agree with respect to choice of law with multiple parties, each from a different country.

Taking into account their different nationalities, this Contract shall for the purpose of arbitration be given effect and be interpreted and applied in conformity with principles of law common to the SYRIAN ARAB REPUBLIC, the UNITED STATES OF AMERICA, THE NETHERLANDS and the UNITED KINGDOM, and the FEDERAL REPUBLIC OF GERMANY, and in the absence of such common principles, then in conformity with principle of law normally recognized by civilized nations in general, including those which have been applied by International Tribunals.”[5]

This approach promises months if not years of testimony and deliberations by the tribunal on the applicable law, with recourse eventually to international law. 

While recourse to the law of a third country might be theoretically possible, the likelihood of a host government’s agreeing that its investment contract would be governed by the law of another country seems extremely unlikely.  One notorious example of such an agreement can be found in the Karabakh PSC, where the applicable law clause provides in part: “This Agreement shall be governed and interpreted in accordance with principles of law common to the law of the Azerbaijan Republic and English law, and to the extent that no common principles exist in relation to any matter then in accordance with the principles of the common law of Alberta, Canada (except for laws regarding conflicts of laws).”[6]  The Kurdistan model contract governing law provision also chooses the law of a third country, calling for English law, “together with any relevant rules, customs and practices of international law, as well as by principles and practice generally accepted in petroleum producing countries and in the international petroleum industry.”[7]

The famous choice of law provision in the 1955 Libyan model Deed of Concession seems to present a shorter path than the one laid out in the Azerbaijan and Kurdistan contracts; it provides for application of the host country’s law plus international law.  “This Concession shall be governed by, and interpreted in accordance with, the principles of law of Libya common to the principles of International Law and in the absence of such common principles then by and in accordance with the general principles of law, including such of those principles as may have been applied by International Tribunals.”[8]  The Turkmenistan 1997 Model Production Sharing Agreement seems to take choice of the host country’s law, plus international law, to the next level.  It states: “This Agreement shall be governed by, interpreted and construed in accordance with the Law of Turkmenistan and as applicable, the principles of international law and the decisions of international tribunals and international treaties to which Turkmenistan is a party.”[9]  The last phrase brings into the model contract Turkmenistan’s investment treaty obligations.

When an investor and host government agree on application of international law, what does that mean?  Article 38(1) of the Statute of the International Court of Justice defines International Law as:

  • International conventions establishing rules expressly recognized by the contesting States
  •  International custom, as evidence of a general practice accepted as law
  • The general principles of law recognized by civilized nations
  • Judicial decisions and writings of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law.

While host government contracts have rarely expressly incorporated Article 38(1) by reference, at least one concession did so in 1933, requiring that the arbitral “award shall be based on juridical principles contained in Article 38 of the Statutes [sic] of the Permanent Court of International Justice.  There shall be no appeal against the award.”[10]

Customary international law requires two key elements: (1) a relatively uniform and consistent state practice regarding a particular matter; and (2) a belief among states that such practice is legally compelled.[11]  Under customary international law a State is responsible for economic injury to nationals of other States resulting from a taking by the State of the property of the national of another State that is not for a public purpose, or is discriminatory, or is not accompanied by provision for just compensation.[12]  A State may also be responsible under customary international law for injury resulting from a repudiation or breach by the State of a contract with a national of another State where the repudiation is discriminatory or motivated by non-commercial considerations, and compensatory damages are not paid, or for injury from other arbitrary or discriminatory acts or omissions by the State that impair property or other economic interests of a national of another State.[13] 

General principles of law recognized by civilized nations constitute the third category of international law under Article 38(1) of the ICJ Statute.  They include principles that exist in national laws of States worldwide, general principles of law derived from the specific nature of the international community, principles intrinsic to the idea of law, and general principles of law that appear to arise from notions of natural law or natural justice.[14]  These principles include: duty of good faith; pacta sunt servanda (contract should be honored); doctrine of unjust enrichment; estoppel and acquiescence; respect for acquired rights; rights must not be abused; obligation to repair a wrong; principle of res judicata (a final judgment on merits is conclusive between parties); passage of time as a defense to a claim; no one may be judge in his own case; non-aggravation of dispute before tribunal.  The AIPN 2017 Model Dispute Resolution Agreement states in part: “The substantive law of ____ [designate state/country], to the extent consistent with international law, as defined in Article 38 of the Statute of the International Court of Justice . . . shall apply to the determination of [disputes, claims, or controversies of any nature arising out of or relating to this Agreement . . . . To the extent the laws of ____ [designate state/country] are not consistent with international law, then general principles of international law shall prevail.”[15]

While the host country’s law may already recognize most or all of the legal principles mentioned above, expanding the applicable law to encompass both the host country’s law and international law, or general principles of international law, provides protection for investments based on application of international principles and doctrines (such as good faith, unjust enrichment, estoppel, and respect for acquired rights) as interpreted and applied by international tribunals. International law becomes especially useful in circumstances in which it may be deemed to prevail over contrary national laws promulgated by the host government after the parties entered into their contract.

As noted, in addition to or in the alternative to expanding the host country’s law to include principles of international law, the investor can negotiate to limit or reduce application of that law by insisting on one or more of the stabilization devices discussed above when confronted by the host government’s demand that its law govern their contractual relationship.  In this way, the investor can accede to the government’s demand, but subject to inclusion of provisions in the contract that: (1) “freeze” the law by incorporation of a specific set of law; (2) require the host government’s law to be consistent with the terms of the investment contract; (3) require mutual written agreement to amend the contract; (4) “contractualize” key provisions of the law; (5) allocate risk as the government or NOC’s area of responsibility constituting a lex specialis; (6) limit the effect of changes in the law by requiring renegotiation to restore the original value of the contractual relationship; or (7) require enactment of the contract into law.

[1] Roland Brown, Choice of Law Provisions in Concession and Related Contracts, 39 Modern L. Rev. 625, 632-33 (1976).

[2] See Kurdistan Regional Government of Iraq Model Production Sharing Contract art. 43.1 (2012).

[3] LIAMCO v. Libya, Award (April 12, 1977), VI Year Book Com. Arb. 89, 92 (1981).

[4] Cf. Saudi Arabia v. Arabian American Oil Co., Award (August 23, 1958), in 27 Int’l Law Rep. 117, 156 (1963) (“The Arbitration Tribunal holds, therefore, that it has to ascertain the law to be applied to the merits according to the indications given by the Parties and, failing adequate indications of the Parties, to determine this law taking all the circumstances of the case into consideration.”).

[5] Syrian Arab Republic Contract for the Exploration, Development and Production of Petroleum (August 21, 1985), 26 I.L.M. 1186, 1213 (1987).

[6] Agreement on the Exploration, Development and Production Sharing for the Karabakh Prospective Struture and Area Adjacent in the Azerbaijan Sector of the Caspian Sea art. 22.1 (10th Nov. 1995).

[7] See Kurdistan Regional Government of Iraq Model Production Sharing Contract art. 43.1 (2012).

[8] Libya Model Deed of Concession cl. 28(7) (attached as Schedule 2 to Libya Petroleum Law No. 25 of 1955).

[9] Model Production Sharing Agreement for Petroleum Exploration and Production in Turkmenistan (Part 1) art. 29.1 (March 20, 1997).

[10] Concession granted by Persian Government to Anglo-Persian Oil Company art. 22(F) (29 April 1933).  The AIPN Model Dispute Resolution Agreement ¶ 1(B), at 4 (2017), provides in part: “The substantive law of ____ [designate state/country], to the extent consistent with international law, as defined in Article 38 of the Statute of the International Court of Justice . . . shall apply to the determination of [disputes, claims, or controversies of any nature arising out of or relating to this Agreement . . . .”

[11] See Sean D. Murphy, Principles of International Law 78 (2006).

[12] See Restatement of the Law (Third) of the Foreign Relations Laws of the United States § 712 (1987).

[13] See id.

[14] See Sean D. Murphy, Principles of International Law 86-88 (2006).

[15] AIPN Model Dispute Resolution Agreement ¶ 1(B), at 4 (2017).