The State of Commercial Laws Interpretation of Umbrella Clauses in International Investment Arbitration

White Industries Australia Limited v. Republic of India (“White Industries”) has opened a pandoras box in India and India is today set for the “Investment Arbitration revolution”- a revolution which caught the western world by storm in the 1990’s and 2000’s. White Industries appears to be especially worrying because a foreign investor succeeded against the Indian Government before an international forum in a case where an effective remedy before an Indian Court was not available. Taking into account the number of foreign investors who do not obtain speedy justice in India, White Industries has set a dangerous precedent for foreign investors to follow. While Vodafone has already served the Indian Government a notice for investment treaty arbitration, parties such as Children Investment Fund also seem to be contemplating such action..by Anirudh Krishnan.White Industries Australia Limited v. Republic of India (“White Industries”) has opened a pandoras box in India and India is today set for the “Investment Arbitration revolution”- a revolution which caught the western world by storm in the 1990’s and 2000’s. White Industries appears to be especially worrying because a foreign investor succeeded against the Indian Government before an international forum in a case where an effective remedy before an Indian Court was not available. Taking into account the number of foreign investors who do not obtain speedy justice in India, White Industries has set a dangerous precedent for foreign investors to follow. While Vodafone has already served the Indian Government a notice for investment treaty arbitration, parties such as Children Investment Fund also seem to be contemplating such action..Much has been written analyzing White Industries as well as the issues likely to arise in Vodafone. However, a clause that forms an integral part of most Bilateral Investment Treaties(“BITs”) and which is arguably that clause of a BIT that provides the widest remedy for a foreign investor is the “umbrella clause”. .Umbrella Clause- Content and Origin.A typical umbrella clause reads as follows- “Each party shall observe any obligations it may have assumed with regard to investments”..Initially, umbrella clauses though present in many international treaties, were rarely invoked. This is due to the principle of diplomatic protection, pursuant to which any breach of the umbrella clause would have to be taken up by the State on behalf of its national and this rarely happened for diplomatic reasons. However, with the emergence of individual- State arbitrations, especially in the context of investment arbitration both under the ICSID Convention and BITs, umbrella clauses have gained prominence. Under individual-State arbitrations, an individual/ company can directly proceed against the host State before an international tribunal without having to rely on its home State to take up its cause..Construction of an umbrella clause.In this investor- State arbitration era, umbrella clauses provide useful tools for investors to use. The primary controversy surrounding umbrella clauses has been- how widely should an umbrella clause be construed? Should it be construed wide enough to include within its ambit purely contractual claims? If so, since the umbrella clause mandates that every host State “shall observe any obligations it may have assumed with regard to investments”, a breach of contract would amount to the State not observing its obligations with regard to the investments by the investor and consequently a claim under the BIT would also follow..There have been awards on either side of the spectrum. On one hand you have cases such as SGS v. Pakistan, where the ICSID Tribunal held that in light of the exclusive jurisdiction clause in the contract between the foreign investor and the State that granted domestic courts exclusive jurisdiction, the ICSID Tribunal would have no jurisdiction. Hence the umbrella clause was construed narrowly. It was held that the wording of the umbrella clause- “disputes relating to investments” pertained only to a “factual description of the subject matter” and what was relevant was “whether the cause of action arose out of the contract or BIT”. The tribunal went on to hold that the objective of the umbrella clause could not have been to include within its ambit all contractual claims..On the other hand you have cases such as SGS v. Philippines where contractual breaches were held to fall within the purview of umbrella clauses. The arguments to reach such a conclusion are many-fold and are set out later in this article..At the outset, it is apposite to set out the distinction between claims arising from breach of contract and from breach of BITs. The latter is a breach of a State’s obligations under international law whereas the former is purely contractual in nature. As elucidated by the Ad Hoc Committee in the Vivendi annulment case the former must be tested with reference to international law whereas a contractual breach is determined with reference to the proper law of contract. However, overlaps are often inevitable- often an obligation to comply with a contract forms part of the BIT and in such situations the breach of the contract may also give rise to a breach of an international obligation. In such a scenario, the interpretation of the contract as per the municipal law will be a question of fact for determining whether the State has complied with its obligations under the BIT. Despite this possibility of overlap, it is imperative to note that the two causes of action are different and whether each of these causes of actions results in any liability must be tested based on the law governing such a cause of action..The narrow construction approach.The broad arguments in favour of construing the umbrella clause narrowly are:.Since the general rule in international law is that a breach of a contract cannot result in a violation of international law and a construction where contractual breaches do amount to a breach of an international treaty is an exception to the rule, the burden is on the party endeavoring to invoke the exception to establish that the unambiguous intention of the parties to the BIT was that the umbrella clause should be construed so as to include contractual claims.[1]An expansive construction of the umbrella clause would render all other standards prescribed in the BIT redundant as a broadly construed umbrella clause would also protect an investor against statutory and regulatory breaches and it would be sufficient to merely have an umbrella clause and the dispute resolution clause.[2]A broad interpretation would render redundant the negotiations between the investor and the State and the freely negotiated dispute settlement clause will be rendered redundant.[3]There would exist the possibility of two conflicting decisions- the local arbitrator may hold that there is no breach of contract but the international tribunal may hold otherwise.If not interpreted narrowly, an umbrella clause is capable of being expanded indefinitely.[4].The broad construction approach.The broad arguments against construing the umbrella clause narrowly are- .The narrow interpretation as the one provided in SGS v. Pakistan goes against the principle that treaty provisions must be given their ordinary meaning (as mandated by Vienna Convention on the Law of Treaties- Article 31(1)).[5] Moreover, the literary meaning is in consonance with the object of the Treaty which is to afford maximum protection to investors.If an umbrella clause is widely interpreted, it does not render the other clauses of the BIT redundant as protections such as Most Favoured Nation Treatment, Fair and Equitable Treatment are not guaranteed by the contract. While certain constitutional frameworks would guarantee these protections, many Constitutions restrict applicability of such rights to citizens.If contractual disputes are not covered by an umbrella clause, the umbrella clause is rendered ineffective. A wide interpretation gives it sufficient meaning. Pursuant to the doctrine of effect utile, the words of the treaty must be given some rather than no effect. [6]The argument that a broad interpretation would render redundant the negotiations between the investor and the State fails to take into consideration the fact that in many cases the dispute settlement clause of the contract is freely negotiated keeping in mind the already existing BIT. In numerous cases, it is the BIT that comes first and the contract entered into at the domestic level follows.The argument that there exists the possibility of two conflicting decisions is valid. It is true that there is a fair chance that the local arbitrator, appointed pursuant to the domestic contract may decide one way and the international tribunal, appointed pursuant to the BIT would decide otherwise. However, such a problem occurs in numerous situations under domestic law and has been tackled successfully by staying one of the proceedings pending the other. Similar principles can be developed in the context of international investment arbitration as well..Conclusion .Though both arguments have their merits, I personally find the broader construction more convincing. However, it is imperative to note that the following factors greatly influence construction of umbrella clauses:.Placement of the clause- In SGS v. Pakistan, the umbrella clause was placed towards the end of the contract and not with the substantive rights. Hence the presumption was that the umbrella clause was not the source of any substantive rights.Wording of the clause- As Mann points out what is crucial is the wording of the clause. The clause may refer to “general commitments” or “commitments specific to the investment” and these influence the interpretation. The former would be interpreted more widely than the latter. .There is the view that a broad construction of umbrella clauses might open the floodgates. However, it is imperative to note that invoking arbitration under a BIT is a highly expensive process and costs are rarely awarded by investment arbitration tribunals. In such a scenario, it is only those parties who genuinely believe that they have a strong case, which are likely to invoke this mechanism and it is only just that these parties be given a right to protect their investments..Anirudh Krishnan is a graduate of NALSAR and completed his BCL at the University of Oxford. He is a qualified solicitor, England and Wales and is currently an advocate in the Madras High Court. He is also Chief Editor,Justice R.S. Bachawat’s Law of Arbitration and Conciliation. He can be contacted at mail [dot] anirudhkrishnan [at] gmail [dot] com..[1] SGS v. Pakistan.[2] SGS v. Pakistan, El Paso v. Argentina.[3] SGS v. Pakistan.[4] SGS v. Pakistan.[5] Eureka v. Poland.[6] Eureka v. Poland