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*Columbia FDI Perspectives*
Perspectives on topical foreign direct investment issues
No. 298 February 22, 2021
Editor-in-Chief: Karl P. Sauvant ([log in to unmask])
Managing Editor: Riccardo Loschi ([log in to unmask])
*Obsolescence of the obsolescing bargain: *
*Why governments must get investor-state contracts right*
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* <#m_-7539441282534079566__edn1>
by
Karl P. Sauvant and Louis T. Wells** <#m_-7539441282534079566__edn2>
In 1975, one of us co-authored a book on mineral agreements subtitled
“Promises as Prologue.”[1] <#m_-7539441282534079566__edn3> The premise was
that agreements that purported to be binding for 25-30 years would be
frequently renegotiated to adjust the allocation of benefits among the
parties.
The “obsolescing bargain” concept[2] <#m_-7539441282534079566__edn4>
contended that international investors hold most of the cards when
contracts are initially negotiated because host countries are so eager to
attract them. Once investments are made, especially in natural resources
and infrastructure, tables are turned and host countries hold the cards.
The original bargain would become obsolete: having sunk money into a
project, investors had little power to object to renegotiation, unless they
controlled downstream markets or held special technologies.
Governments have sought larger benefits through renegotiations triggered by
unanticipated windfalls to investors, from mineral prices or unexpectedly
rich discoveries—or, simply, because they received less revenue than they
anticipated. Also, new governments could blame predecessors for “giving
away the store.” Another side to broken promises arose when prices were
falling: investors would ask governments for more favorable terms,
threatening mine closure, unemployment and loss of export revenues if they
had to abide by contracts.
Thus, for example, when mineral prices rose and governments that had failed
to build automatic adjustments into their agreements sought to revise them
as in the past, investors turned to international arbitration to insist
that promises were promises: *pacta sunt servanda*. Venezuela, for
instance, had agreed terms for its Orinoco Belt heavy crude in the
mid-1990s, when prices of a barrel of oil hovered around US$20 and lower;
by mid-2005, oil prices were above US$60. The new Venezuelan government
(from 1998) did not see sufficient benefits accruing to the country and
insisted on revisions to provide the state with significant ownership.
ExxonMobil and ConocoPhillips refused, and their facilities in Venezuela
were nationalized. Both companies filed claims under bilateral investment
treaties—for US$15 billion and US$30 billion, respectively.[3]
<#m_-7539441282534079566__edn5>
As the number of arbitrations and size of awards grew under the IIAs,
investors discovered their power. ICSID alone had registered 745 cases by
the end of 2019, with 59% of them registered during the 2010s. Nearly a
quarter arose in oil, gas and mining, and about half in infrastructure.[4]
<#m_-7539441282534079566__edn6> The still-contested ConocoPhillips ICSID
award exceeded US$8 billion.
Certainly, not every investor has refused to renegotiate. In Venezuela,
Chevron renegotiated and continued to operate. In Liberia in 2006, after
briefly protesting that it had an enforceable agreement, Mittal accepted
changes in its only recently concluded iron-ore contract when the new
government of President Sirleaf took over. Yet, the government was
constrained in what it could obtain because the investor held the option of
international arbitration.
One lesson for governments is clear: mistakes, vague terms and failures to
account for future conditions and concerns can no longer easily be
corrected later. Governments must get contracts right from the beginning.
Resource contracts need mechanisms to cover the prospects of future
windfalls: progressive royalties or income taxes, or production-sharing
formulas that adjust government take. They also need working provisions, so
investors lose mining rights for failure to meet deadlines for production
and target production rates. Agreements should anticipate potential
problems with transfer pricing, debt financing, etc. The scope and duration
of any stability clauses must be limited, anticipating that taxes and
environmental and social concerns might be subjects of future legislation.
Ideally, contract terms should be subject to occasional review.
Negotiating truly binding promises in complex agreements requires
government expertise that matches that of international investors. This
includes that of lawyers; financial analysts; industry, market and
environmental experts; and sometimes others. Most governments cannot afford
to build all the needed expertise in-house. Just as companies bring in
outside legal help, investment bankers and consultants, governments can
seek negotiation expertise from such organizations as the African Legal
Support Facility
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the CONNEX Support Unit
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and the International Senior Lawyers Project
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Final decisions, however, always rest with government officials, who are
sensitive to local political economy concerns—but they must know that
promises are no longer prologues: bargains they strike now will no longer
be easily changed later.
------------------------------
* <#m_-7539441282534079566__ednref1> *The Columbia FDI Perspectives are a
forum for public debate. The views expressed by the author(s) do not
reflect the opinions of CCSI or Columbia University or our partners and
supporters. Columbia FDI Perspectives (ISSN 2158-3579) is a peer-reviewed
series.*
** <#m_-7539441282534079566__ednref2> Karl P. Sauvant ([log in to unmask])
is Resident Senior Fellow, Columbia Center on Sustainable Investment, a
joint center of Columbia Law School and the Earth Institute, Columbia
University; Louis T. Wells ([log in to unmask]) is Herbert F. Johnson Professor
of International Management, Emeritus, Harvard Business School. The authors
are grateful to Boris Dolgonos, Herbert M’cloed and Eric Werker for their
helpful peer reviews.
[1] <#m_-7539441282534079566__ednref3> David N. Smith and Louis T.
Wells, *Negotiating
Third World Mineral Agreements* (New York: Basic Books, 1975).
[2] <#m_-7539441282534079566__ednref4> Raymond Vernon, *Sovereignty at Bay*
(New York: Basic Books, 1971).
[3] <#m_-7539441282534079566__ednref5> Juan Carlos Boué, “Conoco-Phillips
and Exxon-Mobil v. Venezuela: using investment arbitration to rewrite a
contract,” *ITN,* Sep. 20, 2013.
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[4] <#m_-7539441282534079566__ednref6> ICSID, “ICSID caseload: statistics,”
issue 2020—1, pp. 7, 12.
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*The material in this Perspective may be reprinted if accompanied by the
following acknowledgment: “Karl P. Sauvant and Louis T. Wells,
‘Obsolescence of the obsolescing bargain: Why governments must get
investor-state contracts right,’ Columbia FDI Perspectives No. 298,
February 22, 2021”. Reprinted with permission from the Columbia Center on
Sustainable Investment (**www.ccsi.columbia.edu*
<https://columbia.us6.list-manage.com/track/click?u=ab15cc1d53&id=6ab9df587e&e=763bcf158c>*).”
A copy should kindly be sent to the Columbia Center on Sustainable
Investment at **[log in to unmask]* <[log in to unmask]>*.*
For further information, including information regarding submission to the
*Perspectives*, please contact: Columbia Center on Sustainable Investment,
Riccardo Loschi, [log in to unmask]
*Most recent Columbia FDI Perspectives*
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- No. 297, Maria Borga and Monika Sztajerowska, ‘Divestments by MNEs:
What do we know about why they happen?,’ Columbia FDI Perspectives,
February 8, 2021
- No. 296, Rachel Thrasher, ‘Room to move: Building flexibility into
investment treaties to meet climate-change commitments,’ Columbia FDI
Perspectives, January 25, 2021
- No. 295, Stefanie Schacherer, ‘Facilitating investment through IIAs:
The case of the Regional Comprehensive Economic Partnership Agreement,’
Columbia FDI Perspectives, January 11, 2021
*All previous FDI Perspectives are available at *
*http://ccsi.columbia.edu/publications/columbia-fdi-perspectives/*
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*Other relevant CCSI news and announcements*
- *Last call for papers!* CCSI announces a call for papers for the 2020
edition of the Yearbook on International Investment Law and
Policy. Original contributions to be considered for publication in
the Yearbook will be accepted on a rolling basis until *February 28,
2021.* More information can be found here
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- *CCSI is accepting applications until March 31, 2021* for its
Executive Training on Sustainable Investments in Agriculture, which will
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Resident Senior Fellow
Columbia Center on Sustainable Investment
Columbia Law School - Earth Institute
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*Columbia Center on Sustainable Investment*
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