Umbrella Clauses in Investment Treaty Arbitration

What is an umbrella clause?

An umbrella clause, also known as an umbrella agreement or observance of undertakings clause, is a provision found in a bilateral investment treaty (“BIT”) under which a State agrees to comply with all of the obligations it owes to foreign investors. Such a clause provides rights to foreign investors to arbitrate contractual disputes with sovereign entities, bringing commitments made by States and State entities under the protective umbrella of the BIT.

BITs sit alongside other State obligations under international law. An umbrella clause may take a number of forms and have bespoke wording, but all umbrella clauses have common features. They usually require State entities to abide by obligations flowing from specified investment commitments. If an arbitral tribunal finds that a State entity has breached such a commitment with a foreign party covered by the BIT, the breach becomes actionable under the BIT if the umbrella clause is triggered.

Why are umbrella clauses important?

The scope of an umbrella clause is important for foreign investors and State entities alike given the consequences for both parties if any dispute falls within the clause. If a dispute falls within the scope of an umbrella clause, it raises the dispute from being merely a private law contractual or non-treaty claim into a BIT breach. Typically, a breach of a provision of a BIT will result in a finding that the State in breach must pay compensation to the claimant investor. Less frequently, tribunals may grant non-pecuniary relief such as specific performance or an injunction.  

Where did they come from?

Umbrella clauses were first added to model investment treaties in the late 1950s in response to several international commercial disputes like the nationalisation of the Suez Canal and the Anglo-Iranian Oil Company’s dispute with Iran following the termination of a pipeline concession. BIT-originated disputes are a powerful tool because they provide an internationally-recognised form of redress which does not depend on a State respondent’s domestic courts. BITs are therefore popular today with international investors and States seeking to attract foreign direct investment.

What do umbrella clauses look like?

An early umbrella clause provided that “Either party shall observe any other obligation it may have entered into with regard to investments by nationals or companies of the other party” (found in the West Germany – Pakistan BIT, 1959). Umbrella clauses are usually drafted in broad terms to encompass every possible obligation of the State parties.

What issues arise in the interpretation of an umbrella clause?

The question of whether the alleged contractual breach falls within the scope of the BIT or whether it remains a non-treaty claim is vexed.

This issue was first considered by a tribunal constituted under the International Centre for Settlement of Investment Disputes (“ICSID”) Convention in SGS v Pakistan (2003) in a preliminary dispute on jurisdiction. The tribunal applied a restrictive or narrow interpretation of the material umbrella clause in the Switzerland-Pakistan BIT that required the State to “constantly guarantee the observance of the commitments it has entered into with respect to the investments of the investors of the other Contracting Party”.

In contrast, the tribunal in the subsequent case of SGS v The Philippines (2006) adopted a ‘plain meaning’ or wider interpretation of the material umbrella clauses in the Switzerland-Philippines BIT, which included the obligation at Article X(2) that “Each Contracting Party shall observe any obligation it has assumed with regard to specific investments in its territory by investors of the other Contracting Party”.

Two lines of cases have followed these cases; one of tribunals adopting a narrow approach that is seen as ‘pro-State’, and one of tribunals adopting a broader approach seen as ‘pro-investors’ rights’. As a result, tribunals subsequent to the SGS cases have acknowledged the jurisprudential dilemma, the split in expert legal opinion and commentary, and the effects of these arguments on the practical interpretation of the wording and context of each specific umbrella clause.

What other issues arise?

Since the SGS cases, the debate over umbrella clauses has developed into other areas where distinct, opposing and mutually exclusive decisions have been rendered by investment treaty arbitral tribunals:

• Disputes over whether regulatory and statutory obligations fall within the scope of an umbrella clause. In several cases, arbitration tribunals have considered whether, in addition to contractual obligations, obligations incumbent on a State entity as a matter of law or regulation fall within the scope of an umbrella clause, and so would be suitable subject matter for investment treaty arbitration. As with the scope of umbrella clauses, reported decisions tend go both ways, finding that umbrella clauses do and do not encompass regulatory or statutory obligations.
• The effect of an umbrella clause on choice of exclusive jurisdiction. From one perspective, umbrella clauses change the nature of a contractual dispute by allowing access to investment treaty arbitration, which implicitly overrides any express agreement to resolve disputes by other means (e.g. in favour of local courts). This position was rejected by the tribunal in SGS v Philippines, a decision followed in some, but not all, subsequent tribunal decisions. 
• The relationship between privity of contract and the claims under an umbrella clause. Tribunals have not been uniform in their treatment of claims by claimants in investment treaty arbitrations against State entities where the claimants were not party to the underlying contract alleged to have been breached, or where the State is the defendant to the claim but not itself a party to the contract. For instance, in Noble Ventures Inc v Romania (2005), the tribunal found that contractual breaches were attributable to the State, notwithstanding that the relevant contract was with a separate State entity.  In contrast, in Impregilo SpA v Islamic Republic of Pakistan (2005), the tribunal maintained the distinction between private contractual claims on the one hand and BIT claims on the other.
• Whether a State can counterclaim under a BIT depends on the wording of the treaty. For example, a treaty may refer solely to the State’s obligations and may not be wide enough to cover counterclaims founded on alleged breaches of the underlying contract
• (Mis)interpretation of the umbrella clause as a ground for annulment.  In part, this depends on the legislation and attitude of the court of the seat of the arbitration, as well as the reasoning of the award.

What other matters should potential investment treaty claimants consider?

Parties contemplating whether to bring a claim under an investment treaty for breach of contract should consider the following:

• Whether there is an underlying contractual claim, particularly if fraud or dishonesty are alleged (which may render the contract void under the applicable governing law).
• Whether the contractual dispute resolution clause contains any exclusive jurisdiction or other mandatory terms, such as obligations to negotiate in good faith before bringing a claim.
• Whether to sue under the contractually-agreed dispute resolution mechanism and/or bring a claim under an appropriate BIT.
• Any domestic barriers to a claim, such as limitation periods.
• The selection of appropriate counsel for the investment treaty arbitration.
• Obtaining sufficient funding for the dispute. 

What does the future hold for umbrella clauses in BITs?

BITs have recently lost popularity amongst some States, and some have removed umbrella clauses from their BITs, preferring instead narrower investor protections. Some commentators have proposed a sharper distinction between the State (which, as the sovereign, is party to the BIT) and State entities which enter into private law contracts that may not be captured by the umbrella clause, and a clearer understanding of which obligations fall within and without the scope of the clause.

Conclusion

Claimants in ostensibly private law contractual disputes with State entities should always consider whether they can bring claims  under a BIT or other foreign investor protections. The route is not always easy, but if the claim falls within the scope of an umbrella clause, claimants may have access to international dispute resolution mechanisms beyond the scope of domestic courts or forms of arbitration thereby taking the dispute outside of the national courts of the respondent State and entrusting the resolution of the dispute to an independent panel of experts. 

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