Mahmoud Abdel Aziz | Business Law |

Investment
Contracts
Investment Contracts:
An investment agreement states the rights and responsibilities of
the related parties and establishes the terms of the investment. It sets
out the nature, structure and pattern of investment. The quantum of
funds that has to be invested for procuring the good or services are
defined in the investment contract. Investments are made either in the
form of equity or debt. Equity investments like equity and preference
shares allow the investors voting rights in the management of the
investor company whereas the holders of debt instruments like
debentures, deposits, etc. are entitled only to repayment of principal
amount and interest.
The parties to an investment contract can be individuals,
partnership firms, companies, government or the general public.
Similar to any other contract, an investment contract also states the
name and addresses of the parties to the contract who are accepting
to make investments in the business venture. It also specifies the
amount of investment and the manner and form of such investment.
The consideration for investments would generally be a share of profits
or in the case of public limited companies dividend returns.
Investments could be made for a definite time or perpetually. In case of
limited time investments, the time frame within which the investment
has to be returned and the method of repayment would also be agreed
upon in the contract.

TYPES OF INVESTMENT CONTRACTS:

State-investor contracts
Large-scale investments may last for decades. They involve
interests of the investor, as well as the public interests of the host
state. General legislation of the host country may not sufficiently
address the nature of the project and the kind of interests concerned.
The legal setting of each investment needs to be adjusted to the
specifics and the complexity of each investment. The investment
contract will also reflect the bargaining power of both sides under the
circumstances of the individual project. Therefore, investors and host
states often negotiate investment agreements. Not surprisingly, no
general pattern applicable to all situations has emerged in practice.
Even within individual sectors of the economy, the typical agreements
have evolved significantly in the past decades.

In practice, especially the legal regime of oil and gas projects by

multinational companies has been determined in large part by
investment agreements' in the decades before 1945, these

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agreements (concessions) typically covered large areas of land,
transferred title of the oil reserves to the investor, and did not contain
an obligation of the investor to explore or produce oil. Under these
agreements the host country would receive a bonus for the concession
as such and royalties for barrels actually produced.

A second generation of agreements emerged in the 1960s and

1970s. These reflected the new power of oil -producing countries, their
desire to control their resources, and their aspiration to develop the
necessary skills and technologies within their own borders. Often,
state-owned companies were set up for the purpose of concluding and
supervising the agreements with the foreign investor. Areas with
potential reserves were more restricted and closely defined, and the
title to oil and gas remained with the host country. The risks inherent in
a failure to find suitable oil or gas were shifted to the foreign investor
who was, however, allowed to recover exploration costs in case
commercially usable reserves were found. Once oil or gas was
produced, the product was divided between the two parties to the
investment agreement under a negotiated formula, often subject to a
gradual decrease of the rights of the investor. These arrangements
were set out in so-called production-sharing or profit-sharing
agreements. Increasingly, host countries tended to restrict the role of
the foreign investor to the provision of technical expertise and
services. Remarkably, however, exploration remained in the hands of
the investor at its own risk. While this type of agreement seems
preferable at first sight for the host country, especially if non-
exporting, it also places the burden of financing on the host country
and therefore has not been relied upon by all countries.

Beyond the area of energy exploration and production, projects

creating utilities and infrastructure have blossomed, especially in the
early 1990s, in the period of privatization. Typical arrangements often
relied on the concept of 'build, operate, and own' (BOO), placing all
major benefits and risks on the investor. Sometimes, the entire project
was to be transferred to the host country after a certain period (build,
operate, transfer, 'BOT'). Joint venture arrangements with companies of
the host state have their own advantages for the foreign investor, but
they have sometimes also led to disappointments. Projects for
construction alone usually follow a special pattern.

Beyond the allocation of rights, tasks, risks, and responsibilities,

investment contracts had to lay down the ground rules on which the
parties agreed. These rules included, in particular, the law applicable
to the project and the choice of a forum for dispute resolution. Specific
provisions were often included concerning force majeure, good faith
and changed circumstances. From a legal perspective, the most

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complex and difficult questions often concerned the inclusion of
clauses regulating the conduct of the parties in case of political
changes in the host country and in case of changes in the economic
equilibrium between the host state and the investor.

2. APPLICABLE LAW
For both the state and the investor, the determination of the law
applicable to the contract and the agreement on dispute resolution are
often considered the most sensitive legal issues. The host state will
view both areas from the vantage point of protecting its national
sovereignty. The investor's priority will be the choice of a legal order
that provides a stable and predictable legal environment and of a
forum for dispute resolution that will preclude bias or political influence
against the investor. Depending upon the bargaining power and the
negotiating skill of the parties, a number of possible choices have
emerged for the applicable law. These range from a mere reference to
the law of the host state to an exclusive choice of the rules of
international law.

In between these extremes, general principles of law, the usages

of the industry, and, more seldom, rules of natural justice or of equity
have been chosen. Often, a combination of national law and
international rules as applicable law has been negotiated as a
compromise. The matter will also be determined by the position of
international law within the domestic order of the host state. If
international law is applicable, on the basis of the constitution of the
host state or of legislative measures, the investor will obviously find it
less difficult to accept a reference to domestic law alone. However,
such rules in the constitution or legislative provisions are subject to
unilateral change on the part of the host country without a right to
object on the part of the investor. Choice of law clauses may be in need
of interpretation in various ways. The meaning of clauses referring to
general principles of law or to the usage of trade may not be self-
evident in the light of the circumstances of each case. The reference to
the rules or principles of international law itself may raise issues of
interpretation, any reference in a choice-of-law clause to two different
legal orders or principles will, in the case of collision or diversity among
them, pose the question of a hierarchy or of the selection of the legal
order for the individual issue concerned. And a simple reference to the
domestic law will in itself raise the question whether an international
tribunal will not, in view of its own legal basis, and in the light of the
rules of international law applicable to aliens and foreign companies,
invariably consider international rules relevant.? The Permanent Court
of International Justice, in the Serbian Loans Case, pointed to the
requirement that every contract must have a basis in a national legal

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order!' The tribunal had no reason, in the context of that statement, to
address the role of general rules of international law governing aliens.

3. Stabilization Clauses
A special variant of a choice-of-law clause in a contract is a so-
called stabilization clause, which may read: 'The laws of the [host
state] are applicable as in force of December 31, 1986.' Alternatively,
such a clause may provide that any future changes of the host state's
law, that work to the investor's disadvantage, will not be applied to it.
Such a clause is typically inserted at the request of the investor. Yet it
relies on domestic rather than international law. This is a compromise
between the preferences of the host state and of the
investor in long-term contracts. Clearly, the freezing of the legal
order of the host state for purposes of the contract implies a reduction
of the host state's sovereign power. Over the last decade, reliance on
such clauses has decreased in practice, mainly in deference to the
sovereignty of the host state. The precise legal meaning and effect of
stabilization clauses have never been fully clarified. One view is that
any change of the law applicable to the contract (as opposed to any
change of the domestic law) will be in violation of a stabilization
clause. An alternative view, that seeks to protect the sovereignty of the
host state, is that any change of the law is permitted but will be
accompanied by a duty to compensate the foreign company protected
by a stabilization clause.

The sanctity and stability of contractual relations has more

recently received renewed attention in customary law as applied to
foreign investment19 and even more so in the interpretation and
application of treaty-based clauses such as 'fair and equitable
treatment' and of the 'umbrella clause' Future jurisprudence will have
to determine whether and to what extent the legal significance of a
stabilization clause coincides with the understanding of these treaty-
based clauses.

4. Renegotiation/Adaptation
As an alternative concept to preserve the sanctity and stability
of a contract, the more recent trend has been to agree on a
renegotiation clause. Such a clause may focus on economic equilibrium
rather than on a legal stability. Difficulties will arise if the
circumstances triggering the right to renegotiate, usually on the part of

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the investor, are not described in sufficient detail in the investment
contract. Beyond the triggering clause, the parties have various
choices to structure the actual process of appropriate renegotiation.
Adaptation of a contract based on automatically applicable criteria is
rarely foreseen. Typically, renegotiation clauses rely on criteria that
leave space for negotiation. Sometimes no criteria for the process of
renegotiation are included. Generally, renegotiation clauses obviously
provide for more flexibility than a stabilization clause. But their
practicability and usefulness remain to be tested in practice.

The concept of an `economic equilibrium' remains to be defined

in legal terms. Moreover, a duty to renegotiate relies on the continued
good will of both parties during a dispute. Therefore, the clause may
not prove to be helpful in the context of a dispute. Thus, it is far from
clear whether a duty to renegotiate will serve the practical needs of a
long-term investment. If the clause should fail to produce useful
results, the search for effective mechanisms for stabilization will be
helpful in the context of a dispute. Thus, it is far from clear whether a
duty to renegotiate will serve the practical needs of a long-term
investment. If the clause should fail to produce useful results, the
search for effective mechanisms for stabilization will continue.

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