International Investment Law

Critically appraise the legal nature of state contracts

Introduction

The internationalisation of state contracts raises some difficult questions relating to both public and private international law. The theory posits that regardless of the choice of the parties to such a contract of the proper law of the contract, international law supercedes their choice and becomes automatically applicable prevailing over governing law. Thus where municipal law applies as the sole applicable law either by virtue of the parties' express choice or by the conflict of laws rules, the theory of internationalisation initiates relating to what should be the proper law of a state contract in private international law. Besides theoretical implications, the issue has great practical significance in so far as it relates to foreign investment dispute settlement. In this essay, I attempt to critically analyze the legal nature of state contracts by focusing on the contract itself, the parties to the contract and the practice of international tribunals.

The nature of a state contract: Focusing on the contract

In the context of a state contract, monists give little weight to the proper law or applicable law of the contract especially when the parties' choice happens to be the municipal law of the host state. This is because monists aver that international law is supreme over municipal law. Consequently, although state contracts are designated by the parties to be governed by municipal law, they are no less than an internationalized contract because of the overarching applicability of international law for various considerations. This position creates disagreement in international investment law relating to the choice of law issues in the context of state contracts. This has led Jennings to observe that 'the particular topic of state contracts impinges upon some of the hardest questions of international law'.

The dicta of Judge Lauterpacht in the Norwegian Loans case encapsulates the essence of the monist argument very well:

It may be admitted...that an 'international' contract must be subject to some national law: this was the view of the Permanent Court of International Justice in the case of the Serbian and Brazilian Loans. However, this does not mean that that national law is a matter which is wholly outside the orbit of international law. National legislation...may be contrary, in its intention or efforts, to the international obligations of the State. The question of conformity of national legislation with international law is a matter of international law. The notion that if a matter is governed by national law it is for that reason at the same time outside the sphere of international law is both novel and, if accepted, subversive of international law. It is not enough for a State to bring a matter under the protective umbrella of its legislation, possibly of a predatory character, in order to shelter it effectively from any control by international law.
Thus according to Judge Lauterpacht, international law stands as a superior legal order with municipal law subordinate to it. However, such a doctrine is antagonistic to the legal implications of the attributes of state sovereignty, and reduces municipal law to the status of butler of international law. Lawyers who argue that a state contract will always be subject to international law despite any municipal law being chosen by the contracting parties as the sole proper law of the contract may be doing so without considering the context of the dicta by Judge Lauterpacht. It has to be borne in mind that he made this observation in the context of a decision of the International Court of Justice, a public international organ and especially in relation to a jurisdictional issue. However, the adherents of this view have the tendency to generalize it irrespective of the nature of the international tribunal dealing with the matter concerned. In this regard, the caveat issued by Judge Fitzmaurice is instructive:

[I]n view of his finding on the jurisdictional aspects of the Norwegian Loans case, Lauterpacht was not called upon to go into the substantive question of whether the alleged breach of contract would in fact have involved a violation of international law. Therefore it would be wrong to attribute to him the view that if there is in fact a breach by a State of a contract between itself and a foreign national or corporate entity, a breach of international law is thereby ipso facto constituted, even in the absence of any denial of justice such as would result if, for instance, a right of action were not afforded to the foreigner in the local courts, or if, such a right being afforded, the decision were given against him on manifestly dishonest grounds.
It is noteworthy that even Schwebel, an ardent follower of Judge Lauterpacht's view, had to concede, albeit with certain reluctance, the correctness of Judge Fitzmaurice's caveat. He wrote:
While still other States and scholars have not accepted the position which [Judge Fitzmaurice] sets forth, and while State practice is unquestionably uneven, it is believed that the weight of such international judgments as have been brought to bear on the question supports his view.
Thus Judge Lauterpacht's opinion in the Norwegian Loans case cannot be the authority for internationalisation of a state contract since such a contract on its own does not create an international obligation even though international law is designated by the contracting parties to be the governing law of the contract. This is especially true in the context of any international commercial arbitration which is almost without doubt of private international character or rather 'quasi-international'. The view expressed by Judge Fitzmaurice's caveat reflects the international practice and the relationship between municipal law and international law in reality.

A somewhat different approach is suggested by Professor Jennings. His emphasis is first on the connection that may be established between the contract itself and the international law. He stated his argument as follows:

The first step then...is to establish a legal bridge between the contract and international law. An effective link must be forged between the principles of international law and the relevant municipal law, so that these two systems interact. We may find ourselves, for example, wishing to say that, even in the cases in which the contract is governed by the local municipal law as its proper law, certain overriding principles of international law impinge upon the contractual relationship itself. We can imagine a situation in which the principles of pacta sunt servanda or the notion of acquired rights or something of that sort operates so as to invalidate an apparent dissolution of the contract by municipal law. The relationship between international law and municipal law must be regarded as a monist system and no longer can be explained on the basis of a dualist theory that international law and municipal law operate on different planes and never the twain shall meet.
Jennings' view is based upon the monist concept of law comprising both municipal and international law and in which international law assumes primacy over municipal law. In his approach he seemed to have elevated the individual to becoming a subject of international law. It appears clear from Jennings' view that, whether the contract is governed by municipal or international law, any simple breach of contract would be a breach of international law and would thereby engage state responsibility vis-a-vis the alien. In this regard, he argued that: 'there is at any rate nothing inherent in the structure of international law, and in the relationship between international law and municipal law, that inhibits the sanctioning of contractual obligations by international law.' However, this opinion begs the question about the sanctioning of contractual obligations by international law since this body of law contains no rules relevant to a breach of contract as such. Despite this unexplained loophole, Professor Jennings also maintained that 'if there is any point of direct contact between international law and the state contract, the theory that the only remedy for the alien contractor is for a distinct tort entirely independent of the contract is no longer tenable.'
In order to establish a link between the contract and international law, Jennings suggested different contractual elements by virtue of which the parties' intention to internationalize the contract may be presumed. These elements include the nature and the terms of the contract, a provision for arbitration, a stabilization clause, and a choice-of-law clause. Irrespective of the proper law of the contract, these contractual elements are said to forge a point of direct contact between international law and the contract. It is doubtful, however, whether the parties' true intention to internationalize the contract can be presumed by such elements. Furthermore, whatever weight was once attributed to these principles as the protective shields for foreign investors' interests in the host state seems to have lost their appeal to some extent in the face of the well-recognized principle of permanent sovereignty of states over natural resources. In addition, it is doubtful whether a breach by a State of its contractual obligations with aliens constitutes per se a breach of an international obligation, unless there is some such additional element as denial of justice, or expropriation, or breach of treaty, in which case it is that additional element which will constitute the basis for the State's international responsibility.
It is clear, therefore, that focusing on the contract to determine the legal nature of a state contract leads to somewhat unsatisfactory results. Perhaps the focus should be on the status of the parties in the eyes of international law.

The nature of a state contract: Focusing on the parties

It cannot be denied that one of the parties to a state contract, the state, is a subject of international law, and that that law governs its conduct by providing certain international minimum standards with respect to the treatment of aliens. And no matter what the choice of law of the contract is, whether municipal or otherwise, since one of the parties to such a contract is a sovereign state the international minimum standards of state conduct must apply to it. If the host state's law is the only designated proper law of the contract, it must conform to the requirements laid down by international law governing the conduct of states. From this perspective, international law is to that extent supreme over municipal law as an objective standard. Most legal systems do in fact conform to such international law requirements of a lawful exercise of a state's prerogative rights vis-a-vis aliens. In this regard, Professor Bowett has observed that:

the argument that the State's conduct is governed by international law adds very little to the substantive requirements except in the extreme situation of a State claiming, by virtue of its own municipal law, prerogatives not generally recognized to the State under most systems of law, such as the right to discriminate against aliens or the right to refuse all compensation.
By saying that the specific municipal law as the sole proper law of the contract must conform to the requirements laid down by international law governing the conduct of states is not to suggest that international law supplants the proper law as the system in which the contract has its being. Thus, international law is relevant only to the extent that it constitutes the international minimum standard and not principal law of the state contract. It is expected that an international arbitral tribunal will have a sympathetic ear to the pleading of international law by a foreign investor, but it cannot be guaranteed except in the limited sense when the municipal law of the host country is the sole and exclusive choice of law. Professor Higgins also holds this opinion and suggests that:
Of course, the best way to avoid sole reliance on domestic law is, one has to say, by having a governing law clause that introduces international law. If, in the bargaining process, the private party has been unable to accomplish this, it seems doubtful that international arbitrators should remedy that which one of the negotiating parties was unable to achieve.
The above analysis still begs the question, what do tribunals do when they are faced with these questions. In the next section we survey the practice of some tribunals.

The nature of a state contract: Focusing on the activities of tribunals

The jurisprudence of tribunals that have dealt with state contracts provide a lot of insight into the nature of state contracts because their decisions are very much connected to the status of international and domestic law with regards to the obligations between the parties. In this regard, it is worth noting that in the Pyramids case, the ICC tribunal accepted that Egyptian law was the proper law of the contract. However, the tribunal took the view that international law could be deemed as part of Egyptian law and therefore concluded that:
We find that reference to Egyptian law must be construed so as to include such principles of international law as may be applicable and that national laws of Egypt can be relied upon only in as much as they do not contravene said principles.
The tribunal's conclusion, that principles of international law override internal legislation in the event of inconsistency attributes supremacy to international law over municipal law, is generally an expression of the monist doctrine. However, the authoritative value, in view of the position of the applicable law, of such a formulation is in doubt because it is contrary to the practice of most states. Moreover, such a proposition would negate the parties' right to chose the proper law of the contract and relegate municipal law, clearly chosen to be the applicable law, to the status of second hand rules.
Another instructive case is the Aminoil case wherein the tribunal applied primarily the law of Kuwait which had, in the tribunal's view, international law as an integral part of it. However, the tribunal was not faced with a conflict between a principle of international law which it considered applicable and a rule of Kuwait law. As the tribunal said: 'the different legal elements do not always and everywhere blend as successfully as in the present case.' Since no conflict arose between the two laws, the issue of the primacy of the one over the other did not need to be dealt with in practice. Had there been any conflict as such, it might be that the tribunal would have attached supremacy to international law or perhaps it might have shown deference to the municipal law.
A monist rendering of state contracts, as was the case with the ICC tribunal in the Pyramids case, would uphold the supremacy of international law. However, such a position is challenged by a dualist account of the relationship between international law and municipal law in so far as state contracts are concerned. In this regard, dualist theory posits that though the two systems are distinct, the application of international law by way of incorporation or transformation in the municipal law is only possible because the municipal law conditions its validity and operation within the municipal sphere, and thus the municipal law assumes primacy over international law. Perhaps this would be the case in most municipal courts where priority will be given to an inconsistent rule of municipal law over international law in case any conflict arises between the two. As to whether an international arbitration tribunal in an arbitration between a state and a foreign private party would do follow this course in similar circumstances, the opinion of some distinguished scholars is negative. A great number of jurists tend to entrust any kind of international arbitral tribunal, irrespective of its standing or status in international law, with the authority to rule on the relationship between international law and municipal law. As Judge Schwebel observed: 'it appears to be assumed that international arbitral tribunals, including those sitting between states and aliens, are "monist" rather than "dualist" in the place they accord to international law.'
Judge Schwebel's remarks are borne out by the arbitral award in the Texaco/Calasiatic case, rendered by Professor Rene-Jean Dupuy. The arbitration concerned the nationalization by Libya of several petroleum concessions held by two American companies. The arbitral panel held that international law governs the arbitration's procedure, and that the deeds of concession involved are contracts 'within the domain of international law.' It was further held that the entire contractual relationship is 'internationalized' and further that the nationalization was a breach of the contracts. This holding by the tribunal was supported by its findings that the contracts were not administrative contracts and that the nationalization measures, notwithstanding the fact that they were sovereign acts, could not nullify contracts whose operative law was international law.
Thus, it is clear that a good number of international tribunals ascribe primacy status to international law even when the contract in question determined that the proper law of the contract should be the municipal law. However, it seems correct to argue that the freedom of choice of the parties should be respected. According to Bowett in a commentary on the Pyramids case:
Whenever there is a contractual choice of a specific municipal legal system as the proper law, the choice is to that legal system per se. There is no renvoi to international law and thereby to other municipal systems generally, via the concept of 'general principles of law' as a part of international law.
In other words an express choice of municipal law should not be subverted by the insertion of public international law through crafty legal engineering since, in my view; this undermines the whole purpose of agreeing on the proper law of the contract.

Conclusion

It is obvious from the preceding analysis that characterizing the legal nature of a state contract is no easy matter. It seems that it is more appropriate to argue that the legal nature of a state contract is informed by a combination of municipal law and international law with international law only introducing standards which delimit the application of the municipal laws selected by the parties, but which cannot prevail over specific references to a particular legal system. This kind of proposition would result in more fairness between parties to a state contract rather than the wholesale introduction of a body of law that was not agreed.

Bibliography

Cases

American Independent Oil Company v Kuwait 21 ILM 976; 66 ILR 518.
Case of Certain Norwegian Loans ICJ Reports (1957) 9.
SPP (Middle East) Ltd and Southern Pacific Projects v. Egypt and EGOTH [1988] LAR 309.
Texaco Overseas Petroleum Company and California Asiatic Oil Company v The Government of the Libyan Arab Republic 17 ILM 1978.

Books

E Lauterpacht (ed) International Law, Being the Collected Papers of Hersch Lauterpacht, vol. 1 (Cambridge University Press London 1970), chapter 2, 216-230.
Higgins, R Problems and Process: International Law and How We Use It (Oxford University Press New York 1994).
Hossain, K and. Chowdhury, SR (eds) Permanent Sovereignty Over Natural Resources in International Law: Principle and Practice (St Martin's Press London 1984).
Jennings, RY Rules Governing Contracts Between States and Foreign Nationals (Cambridge University Press London 1965)
Jennings, Sir R and Watts, Sir A Oppenheim's International Law 9th ed vol. 1 (Longman London 1992).
Mayer, P (1986) 'La neutralisation du pouvoir normatif de l'Etat en matire de contrats d'Etat', 113 Journal du Droit International.
Schwebel, SM International Arbitration: Three Salient Problems (Grotius Publications Cambridge 1987).
Schwebel, SM Justice in International Law (Grotius Publications Cambridge New York 1994)
Sornarajah, M The International Law on Foreign Investment (Cambridge University Press Cambridge 1994).

Articles and book chapters

Bowett, D (1986) 'Claims Between States and Private Entities: The Twilight Zone of International Law', 35 Catholic University Law Review 929.
Fitzmaurice, Sir G (1961) 'Hersch Lauterpacht - The Scholar as Judge: Part I' 37 BYIL 1.
Gaja, G 'Positivism and Dualism in Dionisio Anzilotti' 3 EJIL (1992) 123.
Jennings, RY (1961) 'State Contracts in International Law' 37 BYIL 156.
Lalive, F 'Contracts Between a State or a State Agency and a Foreign Company, Theory and Practice: Choice of Law in a New Arbitration Case' 13 ICLQ (1964) 987.
Lillich, R 'The Law Governing Disputes under Economic Development Agreements: Re-examining the Concept of Internationalisation' in R Lillich and C Brower (eds) International Arbitration in the Twenty-First Century: Towards Judicialisation and Uniformity (Transnational Publishers Irvington New York 1993) 92.
Lipstein, K 'International Arbitration Between Individuals and Governments and the Conflict of Laws', in B Cheng and E Brown Contemporary Problems in International Law: Essays in Honour of Schwarzenberger (Stevens London 1988) 177.