IMPORTANCE OF UMBRELLA CLAUSE IN INTERNATIONAL INVESTMENT AGREEMENT.

AUTHORED BY:- Vijay Rai

Umbrella Clause

An umbrella clause is a provision in an international investment agreement (IIA) that requires a host State to observe all of its obligations to a foreign investor, regardless of whether they are contained in the IIA or domestic law. Umbrella clauses can be used to extend the scope of the application of an IIA and provide more protection to foreign investors.

Known variously as the mirror or parallel effect clause or pacta sunt servanda (i.e., the sanctity of contract clause), the umbrella clause is a treaty provision found in many BITs (Bilateral Investment Treaties) that requires each Contracting State to observe all investment obligations it has assumed concerning investors from the other Contracting State[1]. The general principle is indifference regarding the characterization of the behaviour of the State under its internal law for its international qualification: "The characterization of an act of a State as internationally wrongful is governed by international law. Such characterization is not affected by the characterization of the same act as lawful by internal law." [2]

The umbrella clause may also be written in broad terms. In other words, even a unilateral commitment made by a host state can be expressly incorporated. Regulatory or legislative acts may also fall under the scope of such a clause. Several Tribunals have affirmed the necessity of two primary conditions[3]:

(i)????????????The umbrella clause must be written in broad language so that it can encompass unilateral commitments made by the host State;

(ii)??????????the existence of a genuine unilateral commitment made by the host State to benefit the investor, culminating in a legislative or regulatory act.

Some evidence suggests that umbrella clauses can encourage a more favourable environment for FDI flows. For example, a study by the United Nations Conference on Trade and Development (UNCTAD) found that countries with umbrella clauses in their IIAs tend to attract more FDI than countries without umbrella clauses. However, it is essential to note that this is just one study, and more research is needed to confirm these findings.

There are also some potential drawbacks to umbrella clauses. For example, umbrella clauses can be used to challenge government measures that are designed to protect the public interest. In addition, umbrella clauses can be used to circumvent domestic legal protections for investors.

Overall, the veracity of the hypothesis that umbrella clauses encourage FDI flows is a matter of debate. There is some evidence to suggest that umbrella clauses can positively impact FDI flows, but there are also some potential drawbacks to consider. More research is needed to determine the true impact of umbrella clauses on FDI flows.

Arguments in favour of the hypothesis:

(i)????????????Umbrella clauses can provide foreign investors with greater certainty and predictability about the legal environment in which they operate. This can make investing in a country more attractive for foreign investors.

(ii)??????????Umbrella clauses can help to resolve disputes between foreign investors and host states more quickly and efficiently. This can help protect both parties' interests and encourage future investment.

(iii)????????Umbrella clauses can help to promote good governance and the rule of law in host states. This can create a more attractive investment environment for foreign investors.

Arguments against the hypothesis:

(i)????????????Umbrella clauses can be used to challenge government measures that are designed to protect the public interest. This can undermine the ability of governments to regulate in the public interest.

(ii)??????????Umbrella clauses can be used to circumvent domestic legal protections for investors. This can lead to unfair treatment of investors and undermine the rule of law.

(iii)????????Umbrella clauses can be used to create a "chill" effect[4] on government regulation. This can make it more difficult for governments to regulate in the public interest, even if they have legitimate reasons for doing so.

Ultimately, whether or not to include an umbrella clause in an IIA is a complex decision. There are both potential benefits and drawbacks to consider. The decision should be made on a case-by-case basis, considering all of the relevant factors.

Following are some examples of how umbrella clauses have been used to encourage FDI flows:

1. ??In 1994, the United States and Mexico signed the North American Free Trade Agreement (NAFTA). NAFTA includes an umbrella clause that requires both countries to observe all of their obligations to investors, regardless of whether those obligations are contained in NAFTA or domestic law. This has been credited with helping to attract billions of dollars in FDI to Mexico.
2. In 2002, China signed the Bilateral Investment Treaty (BIT) with the United States. The BIT includes an umbrella clause that foreign investors have used to challenge several Chinese government measures. Some of these challenges have been successful, leading to changes in Chinese law and policy.

The use of umbrella clauses is likely to continue to grow in the future as countries seek to attract more foreign investment. However, it is important to be aware of the potential drawbacks of umbrella clauses, and to carefully consider the risks and benefits before including them in an IIA.

The Singapore–Czech Republic BIT (1995) provisions are a good example of an umbrella clause. The BIT includes an umbrella clause requiring each Contracting Party to observe all of its commitments to investors, regardless of whether those commitments are contained in the BIT or domestic law. This means that the BIT can be used to enforce obligations not explicitly mentioned in the BIT, such as commitments made in investment contracts or national law[5].

It also provides more protection to foreign investors by prohibiting the host State from interfering with any commitments that nationals or companies make with the nationals or companies of the other Contracting Party. This means that the host State cannot interfere with contracts between investors, even if those contracts are not explicitly mentioned in the BIT[6].

The Kyrgyz Republic–Kuwait BIT (2015) includes a provision that allows for more favourable treatment to be given to investments by investors of the other Contracting Party, even if that treatment is not explicitly mentioned in the BIT. This provision is known as a "most favoured nation" (MFN) clause[7].

The MFN clause in the Kyrgyz Republic–Kuwait BIT is a broad provision. It does not specify what types of treatment are covered or how the MFN standard should be interpreted. This means that the interpretation of the MFN clause is likely to be determined on a case-by-case basis by the courts or arbitral tribunals that are called upon to apply it.

The MFN clause in the Kyrgyz Republic–Kuwait BIT can be expected to impact FDI flows between the two countries positively. By ensuring that investors are treated fairly and equally, the MFN clause can help to create a more attractive investment environment. This can make investors more likely to choose to invest in the Kyrgyz Republic or Kuwait.

However, it is essential to note that the MFN clause can also have potential drawbacks. For example, the MFN clause could be used to challenge government measures that are designed to protect the public interest. In addition, the MFN clause could circumvent domestic legal protections for investors.

Ultimately, whether or not to include an MFN clause in an IIA is a complex one that should be made on a case-by-case basis, taking into account all of the relevant factors. Including an umbrella clause in an IIA can encourage a more favourable environment for FDI flows. This is because umbrella clauses give foreign investors greater certainty and predictability about the legal environment in which they operate. This can make investing in a country more attractive for foreign investors. Their absence encourages a less favourable environment for FDI flows. This is because foreign investors may only be willing to invest in a country if they are sure that their investments will be protected.

Conclusion

Umbrella clauses can be a valuable tool for encouraging FDI flows. They can provide foreign investors with greater certainty and predictability about the legal environment in which they are operating, and they can help to protect their investments from host state interference. However, it is important to note that umbrella clauses also have some potential drawbacks, such as the ability of foreign investors to challenge government measures that are designed to protect the public interest. Ultimately, the decision of whether or not to include an umbrella clause in an IIA is a complex one that should be made on a case-by-case basis, taking into account all of the relevant factors.

[1] Judith Gill et al., Contractual Claims and Bilateral Investment Treaties: A Comparative Review of the SGS Cases, 21 J. INT'L. ARB. 397, 403 n.31 (2004)

[2] International Law Commission, Responsibility of States for Internationally Wrongful Acts, 2001, Article 3.

[3] SGS Société Générale de Surveillance S.A. v. Islamic Republic of Pakistan, ICSID Case No. ARB/01/13, Decision of the Tribunal on Objections to Jurisdiction, 6 August 2003; see also, Noble Ventures Inc. v. Romania, ICSID Case No. ARB/01/11, Award, 12 October 2005.

[4] a chilling effect is the inhibition or discouragement of the legitimate exercise of natural and legal rights by the threat of legal sanction.

[5] Article 15. Other Obligations, https://edit.wti.org/document/show/8d400fa9-92f9-42a5-a156-9e4aa2a95639

[6] Article 3. Promotion and Protection of Investments, https://edit.wti.org/document/show/8d400fa9-92f9-42a5-a156-9e4aa2a95639

[7] Article 5 Most - Favoured - Nation Treatment, https://jusmundi.com/en/document/treaty/en-kuwait-kyrgyzstan-bit-2015-kuwait-kyrgyzstan-bit-2015-sunday-13th-december-2015