Contract claims covered by umbrella clause (ICSID)

Practical Law UK Legal Update Case Report 8-518-5344 (Approx. 7 pages)

Contract claims covered by umbrella clause (ICSID)

by PLC Arbitration

Background

The Agreement on the Promotion and Reciprocal Protection of Investments between Switzerland and Paraguay entered into force on 28 September 1992. Article 11 provides:

"[e]ither Contracting Party shall constantly guarantee the observance of the commitments it has entered into with respect to the investments of the other investors of the Contracting Party."

Article 11 is a so-called "umbrella clause". There is considerable debate regarding the meaning of umbrella clauses, which investors use to try to bring contractual claims within the ambit of a bilateral investment treaty (BIT), and two distinct approaches have emerged in the cases.

In SGS v Islamic Republic of Pakistan (ICSID Case No ARB/01/13), the tribunal took a narrow approach and found that an umbrella clause could only elevate a claim for breach of contract to the level of a treaty claim in exceptional circumstances.
By contrast, in SGS v Philippines (ICSID Case No ARB/02/6), the tribunal held that the umbrella clause gave the tribunal jurisdiction based on a broad interpretation of the mandatory language of the clause in that case.

Subsequent cases have tended to adopt one or other of those approaches. For detailed discussion about umbrella clauses, see Practice note, Umbrella clauses.

The Vienna Convention on the Law of Treaties 1969 (the Vienna Convention) sets out the principles governing the construction and interpretation of treaties. Article 31(1) of the Vienna Convention provides that:

"A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose."

Facts

In 1996, the claimant (SGS), a Swiss company, entered into a contract with the Ministry of Finance of Paraguay, to perform pre-shipment inspection and certification services for cargo destined for Paraguay. The contract was to remain in place for 15 years, but was terminated by mutual agreement after three years.

The contract contained a forum selection clause providing that any conflict, controversy or claim deriving from or in connection with the contract, its breach, termination or validity, should be submitted to the courts of Asunción under the law of Paraguay.

During the term of the contract, SGS issued 35 monthly invoices, of which the Ministry paid ten. The 25 unpaid invoices amounted to more than US$39 million. SGS pressed for payment and there were negotiations between the parties, both before and after termination of the contract. After a change of government in 2003, there began an ongoing process to investigate whether payments should be made to SGS. In June 2007, the President issued a decree directing the Attorney General to determine the existence and legal enforceability of SGS' claims, by first verifying that SGS actually performed the services. SGS commenced ICSID arbitration in October 2007, relying on the arbitration agreement in the Switzerland/Paraguay BIT.

SGS alleged that Paraguay breached its obligations under the umbrella clause in the BIT to observe commitments it entered into with SGS. Specifically, it claimed that:

Paraguay breached the contract with SGS by failing to meet its payment obligations.
Paraguay made, and broke, additional promises to pay SGS' invoices through various oral and written representations during and after the term of the contract.

(SGS also alleged that Paraguay took discriminatory measures against it and denied it fair and equitable treatment, in breach of the BIT. This update focuses on the claim under the umbrella clause.)

Paraguay objected to the tribunal's jurisdiction over the claim on various grounds, including the following:

A mere breach of contract could not rise to the level of a breach of the umbrella clause unless coupled with additional "sovereign" action.
The forum selection clause in the contract deprived the tribunal of jurisdiction to hear SGS' claims under the umbrella clause, or made the claims inadmissible to the extent that they were based on a theory that Paraguay breached the contract.

Decision on jurisdiction

In February 2010, the tribunal gave its decision on jurisdiction. It accepted jurisdiction over SGS' claims, finding that:

On its ordinary meaning, Paraguay was obliged under the umbrella clause in the BIT to guarantee the observance of its commitments (which included its obligations under the contract with SGS). It was unnecessary to show an abuse of sovereign authority.
As the tribunal had concluded that it had jurisdiction over the claims, it was compelled to decide them. To decline to do so, on the ground that the claims should be submitted to the Asunción courts, would put the tribunal at risk of failing to carry out is mandate under the BIT and the ICSID Convention. In the absence of an express waiver, a contractual forum selection clause should not be permitted to override the jurisdiction to hear treaty claims of a tribunal constituted under that treaty.
The conclusion that the tribunal had jurisdiction over claims for Paraguay's alleged failure to observe its contractual commitments under the umbrella clause was consistent with the intentions of Switzerland and Paraguay when negotiating the BIT. The state parties to the BIT intended to provide treaty protection in addition to whatever rights the investor could negotiate for itself in a contract and they gave the investor the option to enforce it, including through investor-state arbitration.

Arguments on the merits

The main issue in the merits phase of the arbitration was whether Paraguay failed to guarantee the observance of its contractual commitments, in breach of the umbrella clause. Paraguay argued that:

The alleged breach of contractual commitments did not involve the abuse of Paraguay's sovereign powers.
The forum selection clause in the contract precluded a finding of liability.
SGS itself breached the contract and that breach relieved Paraguay of its contractual obligations.

Decision

The tribunal held that Paraguay had breached its contractual commitments and, therefore, breached the umbrella clause in the BIT. It did not need to consider the claims of discriminatory measures and denial of fair and equitable treatment. Its award incorporated its earlier decision on jurisdiction.

SGS had met its initial burden of proving that Paraguay failed to guarantee the observance of its contractual commitments. It was not disputed that Paraguay had failed to pay 25 invoices, totalling over US$39 million. It was also undisputed that the invoices were issued under the contract and failure to pay properly issued invoices constituted a breach of Paraguay's contractual commitments. Therefore, it was for Paraguay to prove a defence, by establishing that non-payment was justified.

Abuse of sovereign authority unnecessary to establish breach of umbrella clause

The tribunal considered that there was "no meaningful distinction" between the argument raised by Paraguay on this issue in the merits phase and that raised (and rejected by the tribunal) in the jurisdictional phase of the arbitration. Therefore, it rejected Paraguay's argument that an abuse of sovereign authority was necessary to prove a violation of the umbrella clause.

The umbrella clause required the contracting parties to the BIT to observe commitments entered into regarding the investments of investors of the other contracting party. As a matter of the ordinary meaning, a contractual obligation was a legally binding "commitment". Therefore, applying Article 31(1) of the Vienna Convention, a contractual obligation was a "commitment" within the meaning of the umbrella clause.

Furthermore, there was nothing in Article 11 that stated or implied that a government would only fail to observe its commitments if it abused its sovereign authority. Therefore, applying standard principles of treaty interpretation, a breach of contract by Paraguay with respect to an investment of a Swiss investor would be a breach of the umbrella clause.

Forum selection clause in contract did not preclude finding of liability

The tribunal rejected Paraguay's argument that, under Paraguayan law and the terms of the contract, any determination of whether Paraguay breached the contract must be submitted to the local courts. The law applicable to SGS' claim was the BIT, including the umbrella clause and the investor-state dispute settlement provisions in Article 9. The tribunal disagreed with Paraguay's argument that the "commitment" made by Paraguay (for the purposes of the umbrella clause) was a single contractual obligation to pay SGS or resolve disputes about payment in the local courts.

In the absence of any legal authority to the contrary, it was clear that the payment and dispute resolution provisions in the contract were not alternative options, but two discrete obligations. It could not be correct that Paraguay had the option of either paying its invoices or submitting the dispute to the local courts.

The tribunal found that Paraguay's argument was an attempt to re-package the arguments it raised at the jurisdictional stage. The tribunal had rejected the argument at that stage and had not changed its conclusion.

Paraguay's breach of contractual commitments breached umbrella clause

The evidence did not establish that SGS had breached its contractual obligations as alleged. Therefore, Paraguay failed to satisfy the tribunal that its non-payment was justified. Accordingly, the tribunal concluded that:

Paraguay had failed to meet its contractual commitments.
That failure violated its obligations under the umbrella clause in the BIT.

Damages, interest and costs

The tribunal held that SGS was entitled to damages equal to the amount of the unpaid invoices, plus interest accruing from July 1999, being the first month after the contract was terminated. This was consistent with Article 38(2) of the International Law Commission's Articles on State Responsibility, which state that interest runs from the date when the principal sum should have been paid until the date the obligation to pay is fulfilled. It was also a "virtually universal principle" of international law and international arbitration practice to apply interest as of the date payment because due, in the case of delayed payment of monetary obligations.

Regarding the rate of interest, the contract did not make any provision. Further, although SGS had informed the Ministry of Finance in 1999 that it would charge interest on the outstanding invoices at the rate of LIBOR plus two percentage points, that was merely a unilateral statement of intent, which was neither accepted nor apparently even acknowledged by Paraguay. It was not binding on Paraguay or the tribunal.

Taking into account all the circumstances, the tribunal's that a rate of LIBOR plus one percentage point would be appropriate.

Apart from ordering Paraguay to pay its share of the costs of the arbitration, the tribunal made no award as to costs.

Comment

The award and the decision on jurisdiction that it incorporates add to the line of cases adopting a broad approach to the interpretation of umbrella clauses. Notably, in finding that the umbrella clause obliged the parties to the BIT to observe contractual obligations with investors, the tribunal acknowledged that it was departing from the decision in SGS v Pakistan, in which there was an identical umbrella clause. It agreed with the tribunal in cases like SGS v Philippines that this interpretation was necessary to give the umbrella clause purpose and effect.

Perhaps more significantly, the tribunal's conclusion on the effect of the contractual forum selection clause contrasts with the tribunal's decision in SGS v Philippines. The approach to this issue in SGS v Philippines has been followed in subsequent cases (for example, Bureau Veritas, Inspection, Valuation, Assessment and Control, BIVAC BV v The Republic of Paraguay (ICSID Case No ARB/07/9)). Therefore, the more liberal approach taken by the tribunal here would appear to buck the trend. It will be interesting to see if the tribunal's reasoning will be followed in future decisions on this issue.

Case

SGS Société Générale de Surveillance SA v Republic of Paraguay (ICSID Case No ARB/07/29), 10 February 2012.

Contract claims covered by umbrella clause (ICSID) | Practical Law