Relationship between contract and treaty claims

Practical Law UK Legal Update Case Report 2-500-2069 (Approx. 7 pages)

Relationship between contract and treaty claims

by PLC Arbitration

Background

Turkey-Pakistan BIT

The Turkey-Pakistan bilateral investment treaty of 1995 (the BIT) protects the investments of foreign investors against various types of wrongdoing by the host State.

The preamble provides, in part:

"Agreeing that fair and equitable treatment of investment is desirable in order to maintain a stable framework for investment and maximum effective utilization of economic resources …"

Article II(2) provides:

"Each Party shall accord to … investments, once established, treatment no less favourable than that accorded in similar situations to investments of its investors or to investments of investors of any third country, whichever is the most favourable."

Article III prohibits unlawful expropriation.

ILC Articles on State Responsibility

The ILC Articles on State Responsibility (ILC Articles) contain a statement of customary international law on the question of attribution for purposes of asserting the responsibility of a State towards another State, which is applicable by analogy to the responsibility of States towards private parties.

Articles 4, 5 and 8 of the ILC Articles provide as follows:

Article 4

Conduct of organs of a State

"1. The conduct of any State organ shall be considered an act of that State under international law, whether the organ exercises legislative, executive, judicial or any other functions, whatever position it holds in the organization of the State, and whatever its character as an organ of the central government or of a territorial unit of the State.

2. An organ includes any person or entity which has that status in accordance with the internal law of the State."

Article 5

Conduct of persons or entities exercising elements of governmental authority

"The conduct of a person or entity which is not an organ of the State under article 4 but which is empowered by the law of that State to exercise elements of the governmental authority shall be considered an act of the State under international law, provided the person or entity is acting in that capacity in the particular instance..."

Article 8

Conduct directed or controlled by a State

"The conduct of a person or group of persons shall be considered an act of a State under international law if the person or group of persons is in fact acting on the instructions of, or under the direction or control of, that State in carrying out the conduct."

Facts

In 1993 the claimant, a Turkish company, contracted with Pakistan's NHA to build the Pakistan Islamabad-Peshawar Motorway (the M-1 Project). NHA was a public corporation with separate legal personality, controlled by the Government of Pakistan. Disputes under the 1993 contract were settled by the parties entering into a new contract (the contract) in 1997. NHA advanced to the claimant a percentage of the contract price and the claimant provided NHA with bank guarantees for that same amount (the Mobilisation Advance Guarantees).

Between 1999 and 2001, the claimant requested extensions of time for completion of various works under the contract, some of which extensions were granted. The parties agreed that work had fallen behind schedule, but disagreed about whose fault that was.

During that period the contract parties corresponded and held meetings relating to the delays. In 2001, NHA served a notice of termination requiring the claimant to vacate the work site. The civil engineering section of the Pakistan army then secured the site and the claimant's employees were evacuated. NHA also sought payment under the Mobilisation Advance Guarantees from the guarantor banks.

The claimant commenced ICSID arbitration in April 2002.

In December 2002 NHA contracted with a Pakistani entity for completion of the M-1 Project.

Claimant's allegations

The claimant alleged that Pakistan, through the actions of NHA, had breached the BIT by expelling the claimant, by acting improperly following the expulsion, and by attempting to enforce the Mobilisation Advance Guarantees.

The claimant alleged that Pakistan:

Breached its obligation to accord the claimant fair and equitable treatment (which obligation was incorporated into the BIT through the most favoured nation (MFN) clause).
Breached the MFN and national treatment standards by favouring Pakistani and foreign contractors over the claimant.
Was guilty of illegal expropriation of the claimant's contractual rights, plant and equipment and Mobilisation Advance Guarantees.

The claimant claimed US$494.6 million in compensation, plus interest.

Pakistan's position

In an earlier phase of the arbitration, Pakistan had unsuccessfully challenged the tribunal's jurisdiction over the treaty claims set out above (see Bayindir Insaat Turizm Ticaret VE Sanayi AS v Islamic Republic of Pakistan, Decision on Jurisdiction, ICSID Case No ARB/03/29, 14 November 2005).

In the merits phase, Pakistan argued that NHA's actions were not attributable to Pakistan and that, in any event:

The fair and equitable treatment claim was not based on any specific fair and equitable treatment clause in another BIT; furthermore, the actions relied on by the claimant constituted a "legitimate exercise" of NHA's rights under the contract.
The MFN and national treatment claims must fail because Pakistan had not intended to favour local or foreign contractors as compared to the claimant.
The expropriation claim must fail because the claimant's investment was treated at all times in accordance with the contract.

Decision

The claimant failed to establish any of its allegations of breach of the BIT.

Attribution of NHA's acts to Pakistan

As a first step, the tribunal had to consider whether the relevant conduct of NHA was attributable to Pakistan under international law (as reflected in the ILC Articles).

The tribunal found that, because of its status as a separate legal entity, NHA was not an organ of the state for the purposes of Article 4 of the ILC Articles. Furthermore, NHA's actions were not attributable to Pakistan under Article 5 because, although NHA was "generally empowered to exercise elements of governmental authority", it was acting in commercial rather than sovereign capacity at the relevant time.

NHA's conduct was, however, attributable to Pakistan under Article 8 of the ILC Articles because "each specific act allegedly in breach of the [BIT] was a direct consequence of the decision of the NHA to terminate the [c]ontract, which decision received express clearance from the Pakistani Government". NHA was "acting on the instructions of, or under the direction or control of, [Pakistan] in carrying out the conduct".

The tribunal noted that the fact that conduct was attributable to Pakistan pursuant to Article 8 did not necessarily mean that the acts qualified as sovereign acts, as commercial acts could also be attributed under that Article.

Relevance of the contractual relationship between the claimant and NHA

The tribunal noted that its jurisdiction covered only treaty claims and not contract claims (the latter of which were subject to a different dispute resolution mechanism). It would take account of matters relating to the contract as facts, to the extent that they were relevant to the treaty claims.

The tribunal emphasised that the question of whether there had been a breach of the BIT did not require a determination of whether there had been a breach of contract. A BIT breach could exist in the absence of a breach of contract, and the existence of a breach of contract would not be sufficient to establish breach of the BIT.

Fair and equitable treatment

Incorporation of the obligation through the MFN clause

The tribunal held that the MFN clause in the BIT allowed the claimant to benefit from the fair and equitable treatment obligation contained in another treaty. However, the tribunal rejected the claimant's alternative argument that the reference to fair and equitable treatment in the preamble to the BIT could constitute a freestanding obligation.

The tribunal noted that the claimant had referred to many other BITs in arguing for the importation of a fair and equitable treatment obligation, and had "especially referred" to the Pakistan-UK BIT. Pakistan objected to reliance on the Pakistan-UK BIT on the grounds that it was concluded prior to the Turkey-Pakistan BIT and that, had they intended to include such a fair and equitable treatment clause, Turkey and Pakistan could have inserted it expressly in their own, later, treaty.

The tribunal did not need to rule on Pakistan's objection, because the claimant had also referred to the Pakistan-Switzerland BIT. That BIT was concluded after the Turkey-Pakistan BIT and contained a very similar fair and equitable treatment obligation to that in the Pakistan-UK BIT. Thus, the tribunal treated the Pakistan-Switzerland BIT as the source of the obligation.

Frustration of reasonable expectations

The claimant argued that it had had a reasonable expectation that "the legal framework affecting its investment would remain stable" and that Pakistan would "cooperate in resolving any issues that could arise under the [c]ontract". The claimant referred to "undertakings and representations made explicitly or implicitly by Pakistan" and argued that its expectations were frustrated by the changing political circumstances in Pakistan, in particular the coming to power of General Musharraf in October 1999.

The tribunal found that the claimant's reasonable expectations had not been frustrated. It focused on the claimant's expectations in 1997 when the contract was reactivated, rather than in 1993 when the parties had entered into the earlier version of the contract. This was when the relevant decision to invest had been made. The timing was important because between 1993 and 1997 the claimant had experienced various changes of policy as the political situation in Pakistan changed from time to time. In particular, Prime Minister Nawaz Sharif had been a supporter of the M-1 Project, but the project was opposed by the government that took over when he lost office in 1993. Upon Mr Sharif's return to power in 1997, the project was reactivated.

While the claimant argued that it relied on Mr Sharif's "repeated assurances of Pakistan's commitment to the project", the tribunal stated that the claimant "could not ignore the fact that the future of the Project was linked to the shifts then affecting Pakistan's politics as well as to the position of Mr Sharif".

Noting that the reasonableness of the claimant's expectations also had to be assessed in the light of its contractual relationship with NHA, the tribunal found that "there was no basis for the Claimant to expect that NHA would not avail itself of its contractual rights".

Expulsion for reasons unrelated to contractual performance

The claimant alleged that the decision to expel it was unrelated to its performance under the contract, and that it was the result of a conspiracy between the engineer, NHA and the Government of Pakistan. The tribunal found that the evidence was not sufficient to establish a conspiracy to expel the claimant.

Having rejected the existence of a conspiracy, the tribunal considered whether the claimant was nonetheless expelled for reasons unrelated to its contractual performance. The tribunal held that, on the facts, NHA had grounds to be concerned about the claimant's performance of the contract, with the result that it was entitled to consider termination. Thus, the decision to terminate the contract did not breach the fair and equitable treatment standard. Similarly, NHA's failure to pay certain amounts owing to the claimant under the contract, and its decision to call on the Mobilisation Advance Guarantees, were both based on an arguable interpretation of the contract and thus did not constitute a breach of the fair and equitable treatment standard.

Denial of due process

The claimant alleged that Pakistan had breached the fair and equitable treatment standard by denying the claimant due process, because decisions regarding its investment were taken "at the highest level without it being heard".

The tribunal observed that the decision-making in question was internal decision-making of NHA and the Government of Pakistan, and that "the decision of NHA, in consultation with the government, to resort to certain contractual remedies … [was] not as such subject to procedural requirements other than those contractually agreed." The tribunal found that, in any event, the claimant had been given the opportunity to present its case during the relevant period.

Most favoured nation and national treatment

The tribunal agreed with the claimant that the test is an objective one, not requiring a showing of discriminatory intent on the part of the respondent.

In the case of local investors, the tribunal found that the claimant had not established that its contractual situation was comparable to that of the contractors who took over the M-1 project after the claimant's expulsion. Thus, the requirement in Article II(2) of the BIT was not met and no further analysis was required.

As to MFN treatment, the tribunal was unable to make a meaningful comparison between the claimant's situation and that of other foreign investors because it did not have enough data on the contracts involved. The tribunal acknowledged that the claimant had requested the production of documents from Pakistan relating to the contracts of other foreign investors, that Pakistan had resisted those requests and that the tribunal had granted some and not others. Noting the difficulties faced by the claimant in establishing such a claim, the tribunal nevertheless held that the claimant had not substantiated its allegations to an extent that would justify a reversal of the burden of proof on this issue.

Expropriation

Because the claimant's contractual rights were, by definition, limited by the terms of the contract, only action clearly in breach of the contract could lead to a finding that those rights had been expropriated. While restating that it did not have jurisdiction to adjudge the question of breach of contract, the tribunal found that because there was "a reasonable interpretation of the [c]ontract according to which the mechanisms leading to [the] expulsion as well as those regarding measures subsequent to the expulsion" were acceptable under the contract, a finding of expropriation was not open.

Further, the claimant had not established that the acts relied upon were sovereign acts. Government action based on "legitimate contractual considerations" did not necessarily involve the exercise of sovereign powers.

Comment

The case is of interest because it deals with alleged treaty breaches in the context of a contractual relationship, where the tribunal has no jurisdiction over breaches of contract. The tribunal here was careful to emphasise that it lacked jurisdiction over contract claims, while nonetheless finding that, because Pakistan/NHA's actions were taken in accordance with a reasonable interpretation of the terms of the contract, they could not have breached the claimant's international law rights.

The case is a good example of an MFN clause being used to import treatment standards from other BITs. However, the award also illustrates the evidential difficulties of proving a breach of an MFN clause. It will usually be necessary to rely upon other "comparable" contracts entered into by the state party. In many such cases, the state party will resist disclosure of documents relating to such contracts, making it very difficult for the claimant to establish the necessary factual basis for its claim.

Case

Bayindir Insaat Turizm Ticaret VE Sanayi AS v Islamic Republic of Pakistan (ICSID Case No ARB/03/29)

Relationship between contract and treaty claims | Practical Law