Shaishir Divatia

International Investment Law Project

214077 – Winter Semester 2017-18

Shaishir Divatia
3-5-2018
Shaishir Divatia ID - 214077

Application of Pacta Sunt Servanda in

International Investment Law
Introduction
‘Pacta Sunt Servanda’ is perhaps one of the most important and oldest principles in
international law, which states that ‘an agreement must be complied with’. This is derived
from the longer latin maxim pacta convent quae neque contra leges neque dolo mal inita
sunt oemnimodo observanda sunt (Agreements which are neither contrary to the laws nor
entered into fraudulently should be observed in every manner). 1 This principle forms the
basis of almost all international law, for without it, no international treaty would be binding
on any of its signatories. The only limitations to this principle therefore, in international law,
are found in jus cogens norms, that are essentially fundamental preemptory norms from
which it has been agreed there shall be no derogation.

Pacta sunt servanda was initially in force as an uncodified custom, without any treaty or
legislative backing. However, beginning in the 19th century, it was codified (without naming
it as such) into several multilateral declarations 2 and mentioned in the rulings of international
tribunals, eventually even being adopted into both, the Covenant of the League of Nations,
and later the United Nations Charter. 3 It was finally the Vienna Convention on the Law of
Treaties of 1969, that first explicitly incorporated the principle of pacta sunt servanda, in its
Preamble, as well as Article 26 of the Convention, that states “every treaty in force is binding
upon the parties to it and must be performed by them in good faith”. This aforementioned
principle of ‘good faith’ compels states to take all steps required to fulfil the conditions of
treaties, and not shirk obligations based on restrictions borne out of domestic municipal law.

Development of Pacta Sunt Servanda in International Investment Law

In the field of international investment law, the principle of pacta sunt servanda was first
applied in relation to foreign direct investment contracts, such as public-private law
concession agreements, in the 1950s.4 In the intervening period between the wars, and even
1
OpenJurist,org, Pacta Sunt Servanda, available at https://openjurist.org/law-dictionary/pacta-conventa-quae-
neque-contra-leges-neque-dolo-malo-inita-sunt-omni-modo-observanda-sunt last seen on 05/03/2018.
2
Like the Declaration of London, 1871.
3
Alina Kaczorowska, Public International Law, (3rd ed, 2002).
4
Thomas W. Walde, The Umbrella (or Sanctity of Contract/Pacta Sunt Servanda) Clause in Investment
Arbitration, available at http://www.biicl.org/files/946_thomas_walde_presentation.pdf, last seen on

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extending to the period following the Second World War, there was widespread nationalist
seizure of property and rescission of long-term investment agreements. In an attempt to push
back such challenges, lawyers sought to apply this principle so as to give protections to
investment treaties under international law. Owing to ambiguity and divergence in norms of
customary international law, the lawyers preferred protection to be bestowed by treaties,
particularly for proprietary rights against uncompensated expropriation, which they
considered a superset of long term investment contracts. There was clarity on the need of
such protection as being integral to attaining prosperity in international trade and economic
integration. This is evidence of the significant influence that the Havana Charter’s investment
chapter, whose mandate highlighted the need to improve the pillars of trade and finance of
Bretton Woods, played. The attempts to foster the growth of a global economy through good
governance, particularly for post-colonial emerging economies, motivated the strategy of
protecting investment treaties from uncompensated expropriation. Through these efforts,
clearer international norms and procedures came to be established, and accordingly the usage
of the umbrella clause emerged.

While there were scattered antecedents of pacta sunt servanda in bilateral treaties on state
contracts and in the US Ethiopia FCN (1949), it was first concretized in its present form
during the Abs-Shawcross model investment conventions towards the close of the 1950s. 5
The above-mentioned conventions attempted to internationalize contractual obligations that
prevented host states from unilaterally revoking contracts without ramifications on grounds
of the same being a domestic law question, as was the legal position at that time. The 1958
Abs-Doelle Draft, which was first proper instrument that encapsulated the umbrella clause
within investment protection, provided in its Article IV that “In so far as better treatment is
promised to non-nationals than to nationals either under inter-governmental or other
agreements… such promises shall prevail”37- and Art. IV also guarantees the freedom with
respect to acquisition, management and enjoyment of assets, rights and interests which can
not be limited, directly or indirectly, by statute regulation, administrative measure or
otherwise if such action would result in : (Art. 4, 3, d): a restriction or revocation of
concessions.6”

The Abs-Doelle Draft along with the Shawcross Model was largely responsible for the
formulisation of Article III of the Abs Shawcross Convention where it is established that

05/03/2018.
5
Rudolph Dolzer and Christoph Schreuer,Principles of International Investment Law (1st ed, 2008).
6
Article IV, The Abs-Doelle Draft, 1958.

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“Each Party shall at all times ensure the observance of any undertakings which it may have
given in relation to investments made by nationals of any other Party.” 7Similarly, the concept
also found mention in the first ever investment treated entered into by Germany and Pakistan.
Following this, the OECD Draft Convention, 1963 imbibed the concept in form of Article11
which enunciated that in the event of a contract with a foreign investor, a breach of set
obligation would result in the breach being qualified as an international tort. 8 It essentially
strengthened the concept of sacta sunt servanda within International Law.

However, there exists great criticism with respect to the fashion in which the Pacta sunt
servanda clause was elaborated upon in the aforementioned treaties. These were focused
largely on the protection for international investment contracts and envisaged a government
involvement at its essence. As a result, foreign investment through private persons was
largely neglected as these treaties since these treaties didn’t create a distinction between the
two. They were protective against the exploitation on the part of private entities and
consequently provided for arbitration, only on a state level, to their exclusion. The clause was
not constructed for the purpose of transactions entered into by private person without the
involvement of the government.

Since then, the pacta sunt servanda clause has been incorporated in several Bilateral
Investment Treaties. However, there are numerous trade agreements which fail to imbibe this
concept. An example is the North American Free Trade Agreement. the NAFTA emphasises
that protection of contracts must necessarily involve and consider the well explained
principles of Equity in Expropriation and legitimate investment backed expectations.9

In practice, pre SGS tribunals often preferred to decide cases on established grounds
(discrimination, fair and equitable, indirect expropriation) rather than rely on the umbrella
clause for reasons of judicial economy. One of the foremost examples of this approach is the
award rendered in the Energy Charter Treaty case in 2003. 10 In this case, the tribunal
preferred to reply on the much more judicially developed concept of discriminatory treatment
rather than on the basis of Article 10 of the Energy Charter Treaty which contained the pacta
sunt servanda clause.11

7
Article II, The Abs Shawcross Convention, 1959.
8
Article 11, The OECD Draft Convention, 1963.
9
Thomas W. Walde, The Umbrella (or Sanctity of Contract/Pacta Sunt Servanda) Clause in Investment
Arbitration, available at http://www.biicl.org/files/946_thomas_walde_presentation.pdf, last seen on 05/03/2018
10
Ibid.
11
Ibid.

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Modern approaches to Pacta Sunt Servanda in Internatonal

Investment Law
While the pacta sunt servanda clause has been subject to varying interpretations over recent
years, its jurisprudence has been relatively contemporary. The first of the cases discussing the
pacta sunt servanda clause was the case of Fedax NV v. Republic of Venezuela,12 which arose
out of a dispute between Venezuela and the Netherlands. The clause was applied in this case,
only in its ‘plain meaning’, that commitments should be observed under the BIT, to the
promissory note contractual document. While the tribunal in this case refrained from
interpreting the clause or its application in any depth, tribunals created after the culmination
of this case have expounded upon the scope of this clause, opting for either a narrow or an
expansive interpretation of the clause.

Narrow Interpretation
One of the earliest cases that discussed the scope of a pacta sunt servanda umbrella clause
was concerned a dispute based on the Pakistan Switzerland BIT. 13 In this case, the contention
that the umbrella clause equated a contractual breach to a breach of a treaty was rejected by
the tribunal, who believed that the potential legal ramifications of such an automatic elevation
would be far too vast and onerous on the state, and thus found that the wording of the clause
did not warrant the same. Further, it was also stated that an expansive interpretation of the
clause could prove to be a slippery slope, as a vast number of state contracts, if now violated,
would qualify as a breach of treaty.

This narrow interpretation by the tribunal was met with severe criticism from the Swiss
Government, who disagreed with the interpretation on the grounds that it was antithetical to
the intentions of the parties while creating the BIT, as well as dissimilar to the meaning of
similar clauses in other contemporary BITs.

A similar interpretation was key to the decision was reached by the tribunal in the case of Joy
Mining Machinery Ltd v. Egypt,14 where it held that the release of bank guarantees (that
formed the subject of the dispute) was a commercial in nature, and that such contractual
disputes were to be settled as per the provisions of the contract. The umbrella clause did not

12
37 ILM 1391 (1998).
13
SGS Société Générale de Surveillance S.A. v. Pakistan, 18 ICSID F.I.L.J. 307 (2003).
14
Joy Mining Machinery Limited v. The Arabic Republic of Egypt, ICSID case No. ARB/03/11, 6 August 2004

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automatically elevate all contractual disputes to investment disputes, except in cases of a

violation of rights and obligations under the treaty, or a violation of contractual rights so
grave in nature that it attracted treaty protection.

Another important case espousing the narrow interpretation of the umbrella clause was the El
Paso15 case. The tribunal here ruled in contrary to the tribunal in the SGS v. Phillipines,16
which had sought to resolve any ambiguities in the contract in favour of the investors. In El
Paso, the tribunal sought instead to strike a balance between a state’s sovereignty and the
accompanying responsibility to maintain a regulatory mechanism for its economic
development, and the need to protect foreign investors in the country.

The tribunal dismissed the suggestion of an expansive interpretation of the clause, and opined
that a distinction needed to be drawn between the actions of a State or its instrumentalities in
its role as a merchant, and the role of a state carrying out sovereign functions. The Tribunal
further stated that the umbrella clause would not protect ordinary contractual reaches by the
state or entities owned by it, unless the relevant transactions were not entered into by the state
in its capacity of sovereign. It was also feared that a wide interpretation would upset the
national and international economic order- with investors ceasing to exercise ordinary
restraint in the face of receiving unexpected orders from the ICSID tribunal.

Another instance of the Tribunal interpreting such clauses restrictively is in CMS Gas
17
Transmission Company v Republic of Argentina, wherein it was held that the contracts
between the states and the investors were such that the state entered into them in a sovereign
capacity, thus ensuring that if the nature of the agreement is purely commercial, no treaty
protection would be enjoyed by the relevant investors.18

Broad Interpretation
Tribunals, however, have not always chosen to construe pacta sunt servanda clauses
19
restrictively. SGS v. Philippines was a seminal case where the tribunal found the rationale
behind the SGS v. Pakistan20 to be rather unpersuasive, and instead held that the very purpose
of the umbrella clause was to accord a contractual breach with the protection given to breach
15
El Paso Energy International Company v. The Argentine Republic, ICSID Case No. ARB/03/15, 27 April
2006.
16
SGS Société Générale de Surveillance SA v. the Republic of the Philippines, ICSID case No. ARB/02/6, , 29
January 2004.
17
CMS v. Republic of Argentina, ICSID case No. ARB/01/8, Award 12 May 2005.
18
CMS v. Republic of Argentina, ICSID case No. ARB/01/8, Award 12 May 2005.
19
SGS Société Générale de Surveillance SA v. the Republic of the Philippines, ICSID case No. ARB/02/6, , 29
January 2004.
20
SGS Société Générale de Surveillance S.A. v. Pakistan, 18 ICSID F.I.L.J. 307 (2003).

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of treaties. Despite reading this umbrella clause broadly, the tribunal also stated here that in
such a case where the contract vested exclusive jurisdiction over contractual disputes to
another forum for dispute resolution, then that forum would have primary jurisdiction over an
international tribunal. Therefore, the tribunal declined to adjudicate upon the merits in the
case, referring the case back to the domestic court (the agreed forum for dispute resolution),
and only allowing the claimant to reappear before the tribunal in case of a defect in the
judgment of the domestic court.

A similar view was taken in Sempra Energy International v. Argentina,21 where the tribunal
observed that the umbrella clause in the treaty, which compelled the parties to observe
contractual terms, created a nexus between the contract and the investment treaty – thus
equating contractual claims to treaty claims.

In the case of Eureko B.V. v Poland,22 yet another important case that espoused a wider
interpretation of the umbrella clause, the tribunal referred to Article 31 of the Vienna
Convention,23 which requires treaties to be interpreted as per their “ordinary meaning”. Thus,
while adopting a literal reading of the umbrella clause, it was found that the provision
requiring states to observe all obligations entered into with regards to foreign investments
was categorical in nature, leaving no room for ambiguity or alternate interpretation. The
tribunal was therefore of the view that treaty protection would be accorded to all breaches of
contractual obligation.

The LG&E v Argentina24 case is a recent case that has favoured a wider interpretation of the
Pacta Sunt Servanda clause. The tribunal here observed that the umbrella clause required the
host state to meet its obligations towards foreign investors, extending treaty protection to
contractual obligations which flowed from a plain reading of the clause.

Conclusion
As evidenced in this paper, the pacta sunt servanda or umbrella clause has been incorporated
into treaties in various forms since the 1950s, and has now become a popular feature in
modern bilateral investment treaties. This clause was initially incorporated primarily to deter
unilateral termination of investment contracts and unfair expropriation by states, and its

21
Sempra Energy International v. Republic of Argentina, ICSID case No. ARB/02/16, , 11 May 2005.
22
Eureko B.V. v. Poland, Partial Award, 19 August 2005.
23
Article 31, the Vienna Convention on the Law of Treaties, 1969.
24
LG&E Energy Corp., LG&E Capital Corp., LG&E International Inc. v. the Argentine Republic, ICSID case
No. ARB/02/1, 3 October 2006.

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scholars only imagined the principle of pacta sunt servanda to be pertinent in investment law
in such scenarios where the state, in its sovereign capacity, entered into an agreement with
the private investor – not anticipating the possibility of granting contractual breaches with
treaty protection through this clause. This may be juxtaposed against an approach to umbrella
clauses that advocated a wider interpretation of the same – by equating even mere contractual
breaches to a breach of the treaty in which this clause was enshrined. This approach was
solely academic in nature, until the decisions of the tribunals in the two aforementioned SGS
cases,25 which, along with the other cases mentioned in the paper, helped flesh out the two
contrasting approaches to interpreting pacta sunt servanda clauses.

The author of this paper is more inclined towards the wider interpretation of this umbrella
clause, given the principle of pacta sunt servanda, as enshrined in Article 26 of the Vienna
Convention,26 is based on the good faith that compels states to perform all obligations
towards the foreign investors (including contractual ones), especially considering that the
investors had relied on them during the initial investment. Additionally, the very existence of
the pacta sunt servanda clause in bilateral investment treaties that requires states to ‘abide by
all obligations’ related to the investments, necessitates a broad reading of the clause – which
is the meaning gleaned when ‘ordinary meaning’ is accorded to its terms, as mandated by
Article 31 of the Vienna Convention. It is for these reasons that a wider interpretation of the
pacta sunt servanda clause has been favoured by many tribunals and jurists today, and it is
imperative, for the benefit of investor-state relations and minimisation of arbitrariness in the
state’s dealings with investors, that contractual obligations be accorded treaty protection, and
tribunals continue to adopt this approach more uniformly in the future.

25
Supra
26
Article 26, the Vienna Convention on the Law of Treaties, 1969.