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									                The Environmental, Social and Human Rights Impacts of
                            Foreign Investment Contracts

                                      Executive Summary

NGOs, legislators, leading public institutions, journalists and legal scholars are
increasingly recognizing the impacts that foreign investment contracts in the extractive
and energy sectors have on environmental, human rights and social policies in developing
countries. These contractual relations—called foreign investment contracts and other
names—can supersede or deter host countries from strengthening their domestic policies
and dissuade them from meeting their international treaty obligations to protect human
rights and the environment. These foreign investment contracts demonstrate a larger
trend in investment liberalization that undermines democratic structures of government
and the rule of law.1

Foreign investment contracts should not be viewed as being limited to the sphere of
private international law but also a deep incursion into public policy-making that
deserves more widespread attention.

This paper builds an understanding of the way foreign investment contracts move beyond
private investment interests to usurp and supersede public policies in developing
countries.


                                          Introduction

Transnational corporations often secure the rights to develop extractive and energy
projects through foreign investment contracts, also sometimes called Production Sharing
Agreements, Power Purchase Agreements, or Host Country Agreements. Predictably,
these contracts establish the rights and responsibilities of the private and public parties,
including formulas necessary to calculate the amount of project revenues shared with host
governments. It is less well known that these contracts often supersede a country’s
environmental and social laws and regulations. As such, these contracts are policy
making documents. And, as pointed out by Susan Leubuscher, one of the first NGO
lawyers to research the policy impacts of industry contracts, these contracts:

        [Have the power to transform] multinational enterprises into ad hoc legal
        institutions with the power to dictate the law that governs their own relations with
        states and their activities within states.2

Most would agree that the public should be directly involved in the setting of public
policy and law. Yet, despite their deep incursion into the realm of law and regulation,
1
  Center for Int’L EnvtL.Law, The Baku-Tblisi-Ceyhan Pipeline Project Compromises the Rule of Law,
2004
2. Leubuscher, S., The Privatisation of Law, 2003
foreign investment contracts are rarely publicly disclosed, and community members
bound by their provisions typically have no input into their development.

Efforts to reform extractive and energy foreign investment contracts are becoming a
nexus for several areas of advocacy on issues including corruption, sustainable
development, the environment, human rights, labor rights, and participatory democracy.
In particular, reform efforts focus on public participation and transparency in investment
contract development, the tracking of public revenues that they generate, and efforts to
eliminate provisions that weaken environmental, social, labor and human rights
protections and obligations.

           History and the Context of Extractive Sector Investment Contracts

The roots of today’s extractive sector foreign investment contracts date back prior to the
turn of the 20th century, as foreign companies first began to use contracts to protect their
interests against what they considered to be unjust actions of host governments. In 1855,
a firm called Russian Lena Goldfields Company, in which the England-based Lena
Goldfields held a controlling share, was established to develop gold mining along the
Lena River in Siberia. Following the nationalization of mining properties in 1918 and a
subsequent renegotiation of the Lena Goldfields concession agreement, the government
established new policies that imposed stricter requirements on concessions with foreign
investors that Lena Goldfields viewed as hostile. Lena Goldfields’s investment contract
contained the first known provision for international arbitration, which the company
sought to invoke to protect its interests. An international tribunal determined for the first
time that a contract between a private party and a sovereign state could be
internationalized, and potentially based on law beyond that enacted by the sovereign
state.3

A hemisphere away, Mexico’s 1911 revolution led to constitutional changes that resulted
in Mexico treating foreign companies’ interest in oil resources as temporary concessions
rather than permanent titles. This was followed by the enactment of stronger labor laws
that applied to oil projects, a labor strike, a Supreme Court decision supporting labor
interests, and then a government expropriation order that essentially banished
transnational oil companies from the country, which led to the eventual establishment of
one of the world’s first state oil companies.

In subsequent decades, oil and gas concessions in the Middle East were frequently and
less dramatically altered through renegotiation with changing economic conditions and
political bargaining powers of the actors including the host governments and state oil
companies, cartels such as OPEC, and transnational companies.4



3
  Margarita T.B. Coale, Stabilization Clauses in International Petroleum Transactions, Denv. J. Int’L L. &
Pol’Y, Vol. 30:2, August 19, 2002, at 226.
4
  See generally E.E. Smith and J.S. Dzienkowski, A Fifty Year Perspective on World Petroleum
Arrangements, Oil, Gas & Energy Law Intelligence, Vol. 3, Issue 1, March, 2005


                                                                                                             2
Whether through nationalization, expropriation or renegotiation, these examples showed
that foreign extractive sector companies, despite their often powerful connections at
home, face considerable risks in distant countries where legal and political factors affect
their investment in ways that are beyond their control. Foreign investments in the
extractive sector are thought to be more vulnerable than those in other sectors because
typically the host country owns and/or controls the natural resource, while foreign
investors ostensibly assume the responsibility for large up-front financial outlay and long
exploration and development time before reaping commensurately large returns later in
the life of the project.5

Unforeseen changes to the stability of a project that are introduced by government actions
during the project lifecycle could decrease the value of their investment or even render it
worthless. These changes may come directly in the form of expropriation or
nationalization (the Russia and Mexico examples), and also indirectly when a
government changes the rules that apply to the project—rules which could partially
nationalize or expropriate the project (e.g., increasing taxes, fees, royalties, penalties,
manipulation of foreign exchange rates, etc). This is sometimes called “creeping
expropriation.”

    How Foreign Investment Contracts Create Environmental, Social, Human Rights
                            and Development Problems

The following sections describe how various kinds of foreign investment contract
provisions known as “stabilization clauses,” “equilibrium clauses,” and “international
arbitration clauses” seek to reduce the perceived risk to the investor of nationalization
and expropriation, but that also create an imbalance of rights between those of the local
people, communities and governments and those of transnational corporation. These
sections also describe how foreign investment contracts turn agreements between private
companies and host governments into international treaties and create a back door to a
free trade agenda that famously emerges in debates over controversial international trade
agreements.

Foreign investors seek to reduce risks such as nationalism, outright expropriation and
creeping expropriation through foreign investment contracts that contractually bind a host
government from taking these kinds of actions. However, binding contracts between a
private party and governments have a dimension not present in contracts between two
private parties:

         The response of any legal system to a contract is that the parties to that contract
         must comply with the terms of their agreement and that, unless otherwise agreed,
         alteration can only be made with the consent of both sides. However, if one of the



5
 Coale, supra, at 219. See also B.O.N. Nwete, To What Extent Can Stabilization Clauses Mitigate The
Investor’s Risks in a Production Sharing Contract?, Oil, Gas & Energy Law Intelligence, Vol. 3, Issue 1,
March, 2005, at 2.


                                                                                                           3
        parties is a state, it will have the sovereign power to change the legislation to
        alter the terms of a contract without the consent of the other side.6

Stabilization Clauses: To address the investor’s concern that a host government may
unilaterally alter the terms of a foreign investment contract, provisions are included
called “stabilization clauses” that seek to ensure that future changes in legislation do not
alter the economic terms of the agreement.7 In other words, stabilization clauses attempt
to create a legal or regulatory status quo over time that gives an investment predictability
and stability. Thus, a stabilization clause is an attempt to provide the investor a way to
mitigate the risks of unforeseen alterations of requirements introduced by the host
government after an investment contract is signed.8

It is understandable that contract lawyers who draft stabilization clauses may see their
task as protecting their clients against any and every conceivable change in regulation
that could potentially cause negative financial impact. However, as is demonstrated
further on in this paper, contractual measures taken to protect companies from policy
changes which society would consider normal and reasonable, i.e. to protect the public
interest, can step way beyond the bounds of what is reasonable. As two scholars puts it:

        There may sometimes be excessive zeal on the part of lawyers wishing to "play
        God" with contract drafting under the illusion that the draftsman can draft away
        all the vagaries of the future. This prediction underlies investment agreements
        and, in particular, stabilization clauses.9

Stabilization clauses focus in part on the risk of unforeseen changes in fiscal regimes:
taxes, fees, royalty payments, currency exchange control or manipulation, etc. Project
revenues that are provided to the host governments become public funds, so the
equitability of revenue sharing between companies and governments is of obvious public
interest. So, it’s no surprise that a great deal of the tug-of-war between investors and
states concerns the fairness of these fiscal features of investment contracts.

Meanwhile, it’s much less widely known that the scope of stabilization clauses extends
far beyond fiscal issues to include what investors label:

        creeping expropriation [such as] progressive labour legislation, [and] [c]hange
        in the legal or regulatory requirements [including] changes in environmental
        law…10 [and political risk including] war, civil unrest, terrorists’ attack and



6
  Ozgur Can, Investment and Human Rights: Stabilization Clauses and Their Effects on Human Rights,
2004, at 5.
7
  Id.
8
  B.O.N. Nwete, To What Extent Can Stabilization Clauses Mitigate The Investor’s Risks in a Production
Sharing Contract?, Oil, Gas & Energy Law Intelligence, Vol. 3, Issue 1, March, 2005, at 3.
9
  Waelde & Ndi, Stabilizing International Investment Commitments: International Law Versus Contract
Interpretation, U. Tex. Of Law Publication, 1996, at 6.
10
   Nwete, supra, Table 1, at 10.


                                                                                                         4
         NGO interference with investment or property rights [which] will obviously affect
         the smooth running of the contract and its stability.11

In particular, the “imposition” of new environmental obligations stemming from
strengthened regulation or litigation is of high concern to the drafters of investment
contracts.12 Stabilization clauses can explicitly override existing regulation, as in the case
of the Sakhalin II oil and gas project Production Sharing Agreement, which overrides
Russia’s water code and its prohibition against the dumping of pollutants into the marine
environment. Stabilization clauses can freeze regulations at their current state or make
safeguard policies applying to a project be those of the foreign investors’ own country, or
peg applicable standards to those of a multilateral finance institution like the World Bank
Group.

Stabilization clauses may have originally been envisioned to protect against acts by the
host country, but the legal expert B.O.N. Nwete points out that risks to an investments
can arise from the project itself:

         “Cultural/Social risks [can arise when an] alien workforce may introduce a
         lifestyle which not only debases the moral fabric upon which the community lives
         but may encourage corruption, breaking of taboos, customs etc. The project may
         also destroy archeological, religious and cultural sites. A combination of these
         may trigger a volatile resistance which if not properly handled can crumble the
         project…With these the need for a Stabilization Clause…can be better
         appreciated…[for these risks the investor] can get a guarantee from the host
         government or take some other mitigating measures…”.13

Whether “volatile resistance,” or “NGO interference,” causes a government to react with
new laws and regulations may make no difference to the drafters of foreign investment
contracts: anything that threatens the stability and predictability of an investment can
become fair game for a stabilization clause to cover. Nwete suggests measures outside
the bounds of contracts to dampen the desire for legal or regulatory change such as
Corporate Social Responsibility and corporate philanthropy. But Nwete also
recommends devising foreign investment contracts with flexibility to allow for a host
government to enact safeguards in response to social and environmental problems created
by projects.

Equilibrium Clauses: NGOs, legal scholars and host governments have raised concerns
about the use of stabilization clauses to the point that they preclude the justifiable
improvement of host government laws and regulations to protect the public interest.
Responding in part to this concern, and in part to arbitration decisions that struck down
stabilization clauses, authors of investment contracts have devised a provision they call
an “economic equilibrium clause.” The equilibrium clause allows for changes in laws and


11
   Id, at 12.
12
   Coale, supra, at 222.
13
   Nwete, supra, at 12.


                                                                                            5
regulations to occur, but requires host governments to financially compensate the foreign
investor to the extent that these changes alter the financial “balance” of the project.

However, economic equilibrium clauses do not exactly free host governments to change
laws and regulations as they see fit—since there is nothing free about it. When host
governments have to pay an investor when public laws and regulations are changed, this
creates a strong financial disincentive against strengthening policies to protect the public
interest. This has a chilling effect on the improvement of environmental and social laws
and regulations. Finance ministries and other branches of the government that receive
revenues are pitted against the typically weaker environmental or social protection
agencies—with predictable results. Also, the requirement for the host government to
compensate investors for changes in laws and regulations to protect the environment
upends the “polluter pays” principle, a cornerstone of environmental policy.14

Foreign investment contracts can also seek to indemnify project sponsors from harm
caused by their own negligence or transgressions. This can include harm caused by
security agreements between project sponsors and host governments. This is likely in
response to lawsuits under human rights law that were brought against Unocal in the
United States by Burmese plaintiffs alleging harm stemming from the oil company’s
security arrangement with the Burmese Government.15

Consider this observation of the Baku-T’blisi-Ceyhan (BTC) Pipeline foreign investment
contract:

        Whilst, for example, the project agreements oblige the states to take any action
        necessary to protect the pipeline – a highly worrying prospect given the human
        rights record of the three states16 – they also absolve the BTC consortium from
        any liability for any human rights abuses that might arise.17

Most investment contracts are negotiated in virtual or complete secrecy between
transnational corporations and host country representatives, often with limited oversight
by the host government’s legislative or administrative bodies that might otherwise be
responsible to enact reasonable and transparent public policy. In instances in which
investment contracts are eventually disclosed, this transparency typically occurs after the
contract negotiation is complete and is, as a practical matter, inaccessible to the average
individual and even to many legislators. Hence, the host country’s people and their
elected officials have little or no ability to participate in the shaping of this important
policy making process.


14
  Center for International Environmental Law, supra.
15
  Abigail S. Reyes, Protecting the 'Freedom of Transit of Petroleum: Transnational Lawyers Making (Up)
International Law in the Caspian, 24 Berkeley J. Int'l L. (forthcoming June 2006).
16. In Turkey, the Gendarmerie, a police force which has been repeatedly criticized for its human rights
abuses by the European Court of Human Rights, will be responsible for policing the project.
17
 Nicholas Hildyard, Turbo-Charging Investor Sovereignty; Investment Agreements and Corporate
Capitalism, The Cornerhouse, & Greg Muttitt, PLATFORM, 2005


                                                                                                       6
Although each foreign investment contract negotiation takes place in a different context,
there can be a combination of factors that lead to the drafting of these contracts in secret.
These include economic pressures on the host government to secure a deal quickly and in
the absence of public dissent, corruption, the desire of some host governments to
withhold information from their people about the fiscal, legal and regulatory impacts of
the contracts, political pressures from foreign governments that also want a deal
negotiated discretely and in a way that advances their geopolitical ambitions in a region,
and the tendency of negotiations to be led by Western law firms that typically operate in
an environment of private corporate negotiations.

International Arbitration Clause: International arbitration clauses require that disputes
between the investor and the host country be resolved in an international arbitration
tribunal administered by the International Centre for Settlement of Investment Disputes
(ICSID, part of the World Bank Group) and the International Chamber of Commerce in
Paris. This brings resolution of the dispute to a forum far beyond the reach of domestic
administrative or legal systems. One result of this is the absence of a requirement to
exhaust domestic remedies (a standard requirement in international tribunals) and the
concern that tribunals will therefore decide cases based on erroneous interpretations of
domestic law without the benefit of a domestic court’s interpretation. Another result is
that individuals from a host country have no legal standing in these international dispute
resolution forums to bring a claim, and virtually no ability to be heard, despite the fact
that the outcome can affect their lives and environment.18 Meanwhile, investors argue
that they need international arbitration to ensure disputes will be settled by bodies not
controlled by the governments they accuse of wrongful action. The result is that the
people living in the host country are denied rights to remedies that are enshrined in
international human rights law.

What’s more, these tribunals are frequently closed to the public, often with no public
hearing or public record of the proceedings.19 This practice is beginning to be challenged
by some public interest law firms including the U.S.-based Earthjustice and Center for
International Environmental Law, resulting in disclosure of a limited number of
arbitration documents (such as hearings transcripts) and the willingness of a small
number of tribunals to accept amicus curiae submissions (aka “friend of the court”
briefs). This does not necessarily mean the arbitrators are required to accept these briefs.
In one case Earthjustice attorneys even had to convince arbitrators to allow their
submissions after the submissions of the parties to the arbitration, so that Earthjustice’s
submission could be based on the actual substance of the case. Meanwhile, a limited
number of arbitration proceedings are now “open to the public,” insofar as they can be
viewed via closed circuit television in the building where the proceedings are taking
place (e.g., Washington DC, or Paris), though not so “open to the public” that people in
the host country have any practical ability to observe.20 The net result is the lack of any
practical ability for project-affected individuals and communities to witness or be heard

18
   Personal communications, Martin Wagner, Managing Attorney, Earthjustice, January 5, 2006.
19
   See, e.g., Martin Wagner, Trading Human Rights for Corporate Profits, Global Trade Policy Weakens
Protections for Health, the Environment, Race, Poverty and the Env’T, Summer, 2006
20
   Personal communications, Martin Wagner, Managing Attorney, Earthjustice, January 5, 2006.


                                                                                                       7
in international arbitration proceedings that affect their lives, much less to have legal
standing in these proceedings.

Many developing country governments do not have attorneys that specialize in foreign
investment contracts and arbitration, meaning that when disputes arise they must hire
private counsel, typically US or European lawyers, which is often prohibitively
expensive. This creates a chilling effect on many countries’ willingness to bring
international arbitration cases against companies, or to enact laws and regulations that
they fear may be subject to international arbitration challenges by companies. Even the
cost of defending against a frivolous claim brought by a company may cost millions of
dollars and can be more than some countries may be able or willing to pay.21

Imbalanced Rights: While foreign investment contracts decrease the rights and abilities
of people in host countries, they increase the rights of the companies involved. For
example, it has been observed that the Intergovernmental Agreement governing the BTC
pipeline’s project agreements delineates the host governments’ commitment to:

        an intergovernmental treaty among the host states to ‘ensure[s] the principle of
        the freedom of transit of Petroleum,’ a ‘freedom’ that, inter alia, includes a
        virtual freeze of future developments in local regulatory law, an expedited process
        for the expropriation of land needed for the pipeline, the elimination of otherwise
        applicable taxes on foreign investors and contractors, and the indemnification for
        any liability for human rights violations resulting from pipeline security control.22

The principle of freedom of transit of petroleum is similar to principles of freedom of
movement of goods, which are the basis for the world’s trade regimes and a perfectly
normal legal structure if used properly to regulate movement of goods without causing
harm. However, while applying this principle while simultaneously reducing the rights
of a host country’s people, the BTC foreign investment contracts present a legal structure
that subordinates the rights of a country’s poor to those of wealthy foreign investors.

Transforming Contracts into Treaties: In cases where extractive project infrastructure
crosses the borders of several countries (such as pipeline projects), foreign investment
contracts can be nestled within accords that are jointly signed by the countries, giving
them the force of international agreements and even treaties trumping current and future
laws and regulations of the respective countries, sometimes for up to several decades.
Examples of this type of arrangement include the array of agreements underpinning the
Baku-Tblisi-Ceyhan pipeline (Azerbaijan, Georgia, Turkey), including the Host
Government Agreements, the Intergovernmental Agreement, and other associated
agreements, and the West Africa Gas Pipeline Project Treaty (Nigeria, Ghana, Benin,
Togo). As George Goolsby, a lead lawyer in the development of the BTC contracts
explained:

21
   Personal communications, Martin Wagner, Managing Attorney, Earthjustice, January 5, 2006. See also
Martin Wagner, Trading Human Rights for Corporate Profits, Global Trade Policy Weakens Protections
for Health, the Environment, Race, Poverty and the Env’T, Summer, 2006
22
   Reyes, supra.


                                                                                                        8
           [w]ithout having to amend local laws, we went above or around them by using a
           treaty.23

A Back Door to the “Free Trade” Agenda: Foreign investment contracts accomplish
for individual projects what “free trade” promoters have long sought for the entire world
through international trade agreements such as the failed Multilateral Agreement on
Investment (MAI)24 and Bilateral Investment Treaties (BITS).25 The MAI and BITS seek
to insulate all foreign investors from “distorting” host country regulation (including
otherwise normal environmental and social safeguards) just like stabilization clauses in
foreign investment contracts. In the event a regulation is found to be “distorting”
investment, these agreements require the host country to financially compensate the
investor, just like equilibrium clauses in foreign investment contracts. And these
international agreements contain investor-state dispute mechanisms that preclude a host
country’s people from having legal standing, just like international arbitration
requirements in contracts. What’s more, foreign investment contracts sometimes contain
“umbrella clauses” that nest them within bilateral investment treaties, so that disputes
between investors and one government escalate into legal fights between a powerful
developed country and a weaker developing country.26

Some argue that countries are simply exercising their sovereign right to enter into foreign
investment contracts (and for that matter, international trade agreements). But this
ignores the fact that many of these countries have unequal bargaining power compared to
transnational corporate sponsors of these projects (some of whom are financially more
powerful than the country in question), who in turn obtain political support from their
home governments in Europe, North America, and Japan. Whatever efforts to involve
the local project-affected communities of these poorer countries in public policy making
is undermined when policies are controlled by the obligations to transnational
corporations found in foreign investment contracts.

                     The Pursuit of Revenue and Contract Transparency

Foreign Investment contracts typically contain the formula necessary for determining
eventual revenue sharing between project sponsors and host governments. These
revenues can be used ideally for the betterment of the country’s development or,
conversely, for buying arms for disputes with rivals or neighboring countries, or end up
in a Swiss bank account of a corrupt government official. Either way, the amount and
end use of these revenues are matters of great public interest.



23
     Daphne Eviatar, Wildcat Lawyering, AMERICAN LAWYER, Nov. 4, 2002
24
   The attempt to establish the MAI was scrapped by governments in the mid 1990s amidst growing civil
society opposition world-wide.
25
   Unlike the MAI, BITs are more frequently negotiated between two countries, avoiding the opposition of
the larger international community.
26
   Hildyard, supra.


                                                                                                       9
Host countries may find their ability to derive fair and adequate revenue sharing from
projects is weakened by foreign investment contracts. For example, some
investor/government revenue sharing schemes are based on revenues generated after
project costs are covered, and in the event that a project’s internal costs inexplicably
increase, governments lose their anticipated public revenues (see Sakhalin II section
below). In the event that the host government then alters a project’s fiscal regime to
recoup this loss, it may find itself subject to litigation by the company in an international
court of arbitration and be forced to compensate.

Foreign investment clauses can be negotiated with provisions that allow governments to
stabilize their share of revenues, or, in the case of rising market prices, to increase their
revenues along with those of the investor. So an important issue is not only whether
these contracts can be viewed as unfair to one party or the other, but also whether the
process of their negotiation ensures protection of the public interest as market and other
conditions change.

Publish What You Pay Campaign and Extractive Industries Transparency
Initiative: Since foreign investment contracts contain formulas used to determine the
amount of revenues that should flow from a project, the disclosure of these contracts is of
increasing concern to both governments and non-governmental revenue transparency
advocates. For example, the Publish What You Pay coalition is an international network
of NGOs that has launched a multi-dimensional campaign to demand the mandatory
disclosure of extractive sector contracts and revenues. Publish What You Pay seeks to
hold host governments accountable for the management of revenues from extractive
projects with an aim to root out corruption, conflict and social divisiveness, and to
redirect revenues to eliminate poverty, and promote sustainable development paths.
Publish What You Pay presses companies and governments to disclose extractive sector
revenues and contracts, and also to make disclosure a condition of financing from
multilateral development banks and export credit agencies.

Somewhat parallel to the Publish What You Pay campaign, the Extractive Industries
Transparency Initiative is an initiative spearheaded by the United Kingdom Department
for International Development. Voluntary in nature, the Extractive Industries
Transparency Initiative aims to ensure that the revenues from extractive industries
contribute to sustainable development and poverty reduction. The Extractive Industries
Transparency Initiative includes multiple stakeholders such as governments, international
organizations, companies, NGOs, investors, and business and industrial organizations.
The Extractive Industries Transparency Initiative has made progress in countries like
Nigeria, which has adopted a pilot project to promote revenue transparency. And while
the Extractive Industries Transparency Initiative focuses primarily on revenues generated
following the signing of contracts, some experts believe changes made in Equatorial
Guinea’s 1998 Production Sharing Contract and Hydrocarbon Law—which include cost
caps and a stabilization clause that protects the economic equilibrium of both the state
and the investor—will ensure that there are will be more government revenues to track




                                                                                            10
over time.27 Whether these provisions are included in subsequent foreign investment
contracts negotiated on specific projects remains to be seen—and underscores the
importance of transparency of these contracts.

Proponents of non-disclosure of foreign investment contracts say confidentiality is
needed if investors are to take financial risks on projects that help those developing
countries advance. However, the argument for contract confidentiality is increasingly
being disabused—and not just by NGOs. For example, the International Monetary Fund
states:

        The public availability of information on all resource-related transactions is
        central to fiscal transparency. 28

According to the IMF, best practices for natural resource legal frameworks include:

        [That] individual agreements and contracts regarding production from a license
        or contract area are disclosed. These practices are relatively standard in the
        advanced economies, but, in part because of limited administrative capacity, they
        are not well observed in many developing countries. 29

Even in more competitive contexts, such as negotiated deals (in contrast to open bidding),
the IMF argues that contracts should be disclosed:

        The reason usually advanced by governments (and to some extent by companies)
        is that in case of disclosure their bargaining power for future contracts would be
        eroded. In practice, however, the contract terms are likely to be widely known
        within the industry soon after signing. Little by way of strategic advantage thus
        seems to be lost through publication of contracts. Indeed, it could be argued that
        the obligation to publish contracts should in fact strengthen the hand of the
        government in negotiations, since it has to disclose the outcome to the legislature
        and the general public. Where conditions do not permit disclosure of contracts or
        individual company payments, an option could be the disclosure of individual
        company payments to an independent third party (e.g., the aggregator approach
        as suggested by the EITI).30

Meanwhile, the call for more transparency in extractive sector investment contracts and
revenue has been supported by the World Bank’s Extractive Industries Review, and is a
key part of the 2006 US Foreign Operations Appropriations Bill signed into law in
November 2005.



27
   Hilda Yumiseva, Can Production Sharing Contracts Promote Transparency in the Management Of Oil
Income? The Case of Equatorial Guinea, Oil, Gas, Energy Law Intelligence, March 2005, at 7.
28
   International Monetary Fund Guide on Resource Revenue Transparency, June 2005, available at
http://www.imf.org/external/pubs/ft/grrt/eng/060705.pdf
29
   Id.
30
   Id.


                                                                                                11
          Raising Environmental Standards Through Investment Contracts?

Proponents of foreign investment contracts may argue that these contracts improve
environmental protection in host countries by introducing international petroleum
standards. However, there is no definitive source of international petroleum standards;
rather this is a vague reference to those standards typically employed internationally by
an industry. This can create a kind of circular logic because it can require that a project
adhere to international practices that are established by the very same project.

Proponents argue that foreign investment contracts improve upon a host country’s level
of environmental protection by contractually requiring adherence to the industrial
standards of the investor’s home country. However, this ignores the question of whether
industrial standards in the investors’ home country are adequate—indeed, many (e.g.,
International Organization for Standards) are criticized as being too lenient or focusing
on production processes at the exclusion associated environmental impacts (e.g., plywood
manufacturing standards that do not consider impacts on forests). Also, a country’s
overall system of environmental protection is typically a combination of industry
standards and process protections for ensuring a people’s right to protect their health and
environment (e.g., the right of access to information and the right to go to court). These
process protections, be they from the investor’s home country or the host government—
are never included in the foreign investment contract, and would be nullified in any case
by the contract’s international arbitration clauses.

These proponents also argue that foreign investment contracts could improve the host
country’s environmental and social standards by contractually imposing the safeguards of
a multilateral development bank, such as the European Bank for Reconstruction and
Development or the World Bank Group. It’s no secret that the adequacy of these
standards has been questioned by civil society groups for decades. Indeed, NGOs are
highly critical of the International Finance Corporation’s (IFC, the private sector arm of
the World Bank Group) proposed weakening of its environmental and social policy
framework, questioning whether IFC will be able to be respected as an international
benchmark.31 Moreover, investment contracts may use these multilateral development
bank standards as ceilings rather than floors to build up from. Efforts by countries with
weaker environmental or social regulation to progressively evolve their policies would be
stunted at the point that they reached the multilateral standards.

                                    Evolution of Expectations

Foreign investment contracts may not always provide investors with an iron-clad means
to freeze government laws and regulations. For example, in January 2006 a US based
corporation, Bechtel, gave up its claim for $50 million from Bolivia in a case filed before
the International Centre for Settlement of Investment Disputes that alleged a cause of
action under a Bilateral Investment Treaty and that included an element concerning the

31
  Letter from International Accountability Project, Forest Peoples’ Program, et.al, to World Bank Group
President Paul Wolfowitz concerning the weakening of IFC environmental and social policies, December
10, 2005


                                                                                                      12
validity of the Bolivian government’s contract with the company on the Cochabamba
water privatization scheme. This followed years of domestic and international public
protest against Bechtel after its Bolivian project company raised water rates by 50%,
leading to civil unrest that ultimately drove Bechtel out of the country.32 Also, Venezuela
recently increased taxes and royalties despite supposedly being prohibited from doing so
through foreign investment contracts—and in the face of companies that could exercise
contractual provisions for international arbitration. Yet, most companies are nevertheless
staying in Venezuela because they need access to the oil. Also, Russian President Putin
recently warned Royal Dutch Shell officials that he will not accept a $10 billion cost
overrun on the Sakhalin II project, which may significantly decrease the government’s
share of revenues—in the face of a foreign investment contract that allows cost overruns.
And as B.O.N. Nwete points out,

           Again the rich lifestyle of oil workers in the midst of poverty stricken land-owning
           communities may provoke social sentiments that may lead to civil unrest. This
           may not only hold up productions but may also cause damage to flow stations and
           oil wells. No Stabilisation Clause can stand against this. A new government
           especially an undemocratic one may also terminate the contract or seek
           renegotiation of the terms despite the Stabilisation Clause...33

These examples show that like other stabilization schemes—such as the Soviet Union’s
ill-fated Five Year Plans—society and governments evolve and cannot be frozen in time.
Still, most countries do not exercise these kinds of prerogatives due to all kinds of fears
of international legal actions and political pressure.

                                             Moving forward:

Supporters of investment contract reform can draw parallels from efforts to shape
international trade agreements in order to protect the public interest. This next section
provides recommendations from a variety of international bodies:

             1. United Nations Commission on Human Rights recommends:

                    a)      Including the promotion and protection of human rights among the
                    objectives of investment agreements. Given States’ international responsibilities
                    with regard to the promotion and protection of human rights, States should
                    consider including an explicit reference to the promotion and protection of
                    human rights among the objectives of investment liberalization agreements.

                    b)      Ensuring States’ right and duty to regulate and the flexibility to induce
                    new regulations to promote and protect human rights and the environment.
                    Broad interpretations of expropriation provisions could affect States’ capacity
                    and willingness to regulate for health, safety or environmental reasons.
                    Therefore interpretations, or even explicit declarations by parties to agreements,


32
     E.g.,Press Release, Bechtel Surrenders in Bolivia Water Revolt Case, Earthjustice January 19, 2006.
33
     Nwete, supra, at 18.


                                                                                                           13
                 that recognize and protect States’ responsibility to fulfill human rights are
                 encouraged.

                 c)      Promoting investors’ obligations alongside investors’ rights. There is a
                 need to balance the strengthening of investors’ rights in investment liberalization
                 agreements with the clarification and enforcement of investors’ obligations
                 towards individuals and communities. 34

          2. United Nations Commission on International Trade Law recommends:

                 Compensation for legislation that affects the costs and value of the investment
                 should only be paid where the changes in legislation “are of such a nature that
                 the concessionaire could not reasonably be expected to have taken them into
                 account at the time the concession contract was negotiated or to have avoided or
                 overcome their consequences.”35

          3. United Nations Commissions on Trade and Development recommends:

                 Balance “between the legitimate commercial expectations of the investor party
                 and the right of the host country party to oversee the evolution of the resulting
                 relationship in a manner that is consistent with national development policies” 36

          4. Organization for Economic Cooperation and Development recommends:

                 The financial consequences that might be compensated through a stabilisation
                 clause must be “clearly and precisely defined”, as must be the nature of future
                 legislation that would be covered by the clause. 37

Other options for reforming socially and environmentally harmful practices in investment
contracts that deserve further articulation include:

     •   The establishment of host country laws that limit the scope of stabilization clauses
         in subsequently negotiated contracts to allow for the appropriate evolution of
         environmental, social, human rights and developmental policies (though this
         approach could get up-ended if a government subsequently negotiates a foreign
         investment contract that supersedes such a host country law
     •   The incorporation of standing in international arbitration proceedings for the
         people and regulatory agencies of a host state;
     •   The advance disclosure of contract terms for public comment prior to the
         finalization of negotiations;

34
   UN Commission on Human Rights’ 2003 Report on Human Rights, Trade and Investment
35
   United Nations, UNCITRAL – Model Legislative Provisions on Privately Financed Infrastructure
Projects, Prepared by the United Nations Commission on International Trade Law, New York, 2004, p.27,
Model provision 40.
36
   United Nations Conference on Trade and Development, State Contracts: UNCTAD Series on Issues in
International Investment Agreements, United Nations, Geneva, 2004
37
   Multilateral Centre for Private Sector Development Istanbul, Basic Elements of a Law on Concession
Agreements, OECD and Federation of Euro-Asian Exchanges,
www.oecd.org/dataoecd/41/20/33959802.pdf


                                                                                                   14
     •   The conditioning of multilateral development bank (MDB) and export credit
         agency (ECA) support on this advance disclosure and public participation;
     •   The conditioning of MDB and ECA support to preclude the financing of projects
         undertaken on the basis of investment contracts that weaken host country
         environmental and social laws and public avenues of enforcement and redress for
         violations of these laws.

With regards to human rights, Amnesty International recommends that public finance
institutions, including export credit agencies38:

         [E]nsure that their institutions do not support projects underpinned by legal
         agreements that could undermine the ability of the host state to meet its
         international human rights obligations through clauses that can be interpreted as
         either (1) curtailing the host state’s ability to fulfil its human rights obligations;
         or (2) discouraging the host state from fulfilling its human rights obligations;

         [E]nsure that the agreements they sign with host states cannot be interpreted so
         as to undermine the ability of the host states to respect, protect, fulfill and
         promote human rights; and

         [E]ndorse the principle that all parties to project agreements make them
         available for public scrutiny before they become effective.


                                           Conclusion:

NGOs, legislators and leading public institutions, journalists and legal scholars are
increasingly recognizing the impacts that extractive and energy sector foreign investment
contracts have on environmental and social safeguard policies, and the human rights
obligations of developing countries. It is becoming more widely understood how these
contracts usurp public policies while precluding or deterring host governments from
meeting international obligations including those to protect human rights. This paper
attempts to help build an understanding of the way investment contracts move beyond
private interests to become an incursion into public policy. Such an understanding is
becoming an integral tool in the larger toolbox of reform that has included approaches
aimed strictly at host governments, international institutions and corporate campaigning.

As awareness of the significance of investment contracts grow, so too will the
opportunities to propose reforms. Since investment contracts represent a kind of
synthesis of public and private interests, it is correct to conclude that both sets of interests
should be protected by reforms—for practical and political reasons. However, it is also
fair to conclude that in the century over which investment contracts have evolved
corporate interests have been defended through the relatively large coffers of project
sponsors while the people and community groups of host countries have been mostly
38
   Amnesty International, Contracting Out of Human Rights; The Chad-Cameroon Pipeline Project, 2005,
at 41-42.


                                                                                                  15
unaware and their interests largely unrepresented. Meanwhile, national interests have
been looked after by small segments of governments including agencies whose primary
concern is energy supply or government finance—at the exclusion of environmental and
social protection agencies, and in some instances national legislatures.

Despite the fact that the roots of today’s investment contracts stretch back over a century,
NGOs, legislators and leading public institutions are still at the early stage of reform
efforts. Much more legal and policy research and direct attempts at reform are necessary
to build momentum and achieve progress. It is hoped that with the upswing of awareness
of the importance of investment contracts that the pendulum will swing in the direction of
governments and people and that future investment contracts will not be so exceedingly
slanted in favor of just one interest—the transnational corporation.




                                                                                         16
                                  Annex I: Case Studies
Sakhalin II: Located on and off-shore of Sakhalin Island, Russia, the Sakhalin II oil and
gas project is said by project sponsors to be the largest integrated oil and gas project ever
undertaken. If fully completed, Sakhalin II will involve three off-shore platforms, 800
kilometers of on-shore pipeline, and one of the world’s largest liquefied natural gas plants
and tanker export terminals. The Sakhalin II project is being implemented on the basis of
a Production Sharing Agreement (PSA)— a contract between project sponsors and the
Russian Government signed in 1994.39 In 1997, OPIC provided US$ 116 million in
financing for Sakhalin II. The project now seeks up to US$ 5 billion in public financing
from the export credit agencies of the US (Ex-Im Bank), UK and Japan, and the
European Bank for Reconstruction and Development.

Project sponsors hail the economic and developmental benefit it will purportedly bring to
the Russian Federation and to Sakhalin Island:

         The Sakhalin II PSA brings direct benefits to the Russian people and government
         through gas, oil and hard currency revenues.40

         The Russian Federation government will receive an increasing proportion of
         revenues from production as the project progresses. If profitability exceeds
         certain specified levels then the Russian Federation government receives an
         increasingly bigger share of the extra revenues, which can be as high as 70
         percent.41

         The effects of the Sakhalin II project development will be overwhelmingly
         positive. Substantial benefits have already accrued to the Sakhalin region and
         beyond from Phase 1 – by the end of 2003 Sakhalin Energy had made paid almost
         US$ 330 million in taxes, royalties and bonuses to the Russian Federation,
         including a US$100 million contribution to the Sakhalin Development Fund.42

The Sakhalin II PSA was never publicly disclosed, a fact that caused many observers to
wonder if these claims are based in reality. However, in the early 2000’s the Sakhalin II
PSA was leaked to non-governmental organizations monitoring the project. Several of
these organizations then commissioned a PSA expert, Dr. Ian Rutledge, to evaluate the
contract.43

39
   Although Royal Dutch/Shell is now the operator of Sakhalin II, at the time of signing of the PSA project
partners included Marathon Oil (30%), McDermott (20%), Royal Dutch/Shell (20%) and Mitsubishi
Corporation (10%)
40
   Community; Sakhalin Energy Investment Company (SEIC) website;
http://www.sakhalinenergy.com/community/com_intro.asp
41
   What is a Production Sharing Agreement, SEIC Website;
http://www.sakhalinenergy.com/about/abt_psa.asp
42
   Project Benefits, SEIC Website; http://www.sakhalinenergy.com/about/abt_benefits.asp
43
   Ian Rutledge , The Sakhalin II PSA: A Production ‘Non-Sharing” Agreement; Analysis of Revenue
Distribution, 2004; http://www.pacificenvironment.org/PDF/SakhalinPSA-www1.pdf


                                                                                                         17
Dr. Rutledge’s findings are startling: he describes the highly unusual provisions of the
PSA in which the Russian government is set to receive the bulk of its share of the
revenues later, after the company’s profit is assured; yet, most unusual for a PSA, there is
no cost-cap. At the time of the report, these findings were particularly concerning given
that project sponsors had recently announced a 20% cost overrun, from US$10 billion to
US$12 billion. The report also belies the project sponsor’s boast that the Russian
Federation will receive US$ 5.2 billion in direct income over the 49 year lifetime of the
project. However, this figure is misleading because it simply represents the sum of
amounts to be received each year of the project in “Money of the Day,” rather than the
discounted Net Present Value, and because, as Rutledge points out, "no oil company
would measure its own cash flow or profits in this manner, as it ignores the fact that for a
long-lifetime project, income is worth far more early in the project than later.”44 The
report finds that this and other aspects of the contract represent a “major departure from
standard PSA terms worldwide and are losing Russia considerable amounts of income,”
and that “[t]he benefits which flow to the Russian party…fall a long way short of those
which would have been received had a ‘standard’ type PSA been used [in which] the
Russian party would receive 45% more economic rent.”

Eight months later, on July 13, 2005, Royal Dutch Shell announced that the project costs
had skyrocketed to US$ 20 billion. Observers wondered whether Russia would ever
receive the benefits they were promised from Sakhalin II. These concerns were tempered
somewhat in the coming months of 2005 when the price of oil skyrocketed. However,
this global increase in the price of oil is immaterial to the question of whether the
Sakhalin II PSA will deliver to Russia its fair share of this growing largess. Thus,
Sakhalin II stands as an important example of why extractive industry contracts should be
disclosed in order for civil society to understand the fiscal impacts of a project on state
budgets.

BTC Pipeline

One of the best known examples is the Baku-T’blisi-Ceyhan (BTC) Project. With
financing from the World Bank’s International Finance Corporation (IFC), the European
Bank for Reconstruction and Development, US Overseas Private Investment Corporation
(OPIC), and the Export Credit Agencies of the US, UK, Italy, Germany, France and
Japan, the controversial 1,700 kilometer BTC pipeline through Azerbaijan, Georgia and
Turkey will be implemented on the basis of private law contracts known as Host Country
Agreements (HGAs) between the project consortium (BTC Co.)45 and each country,
which is incorporated by annex into an Inter-Governmental Agreement (IGA) between
the three governments. These private law contracts and international agreements have
vast implications for the states’ public policy regimes:

           Touching everything from land acquisition and tax codes to environmental regulations
           and indemnification against liability for military security actions, the contracts supersede

44
     Rutledge, supra, 3-5.
45
     British Petroleum is the lead operator of BTC Co.


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         all conflicting domestic legislation… The agreements don't trump only current domestic
         laws, but also all future laws -- for up to 60 years. Any subsequent environmental
         regulation in Georgia or Turkey, for example, cannot apply to the consortium project.



The BTC Host Government Agreements and Inter-Governmental Agreementss:

     •   Override the countries’ existing social and environmental laws, that conflict with
         the HGAs and the IGA for 40 to 60 years (except their constitution);
     •   Preclude countries from taking new measures to protect public health, the
         environment, safety and security if those measures delay or negatively impact the
         project’s “Economic Equilibrium” (contractually guaranteed level of project
         profitability);
     •   Require the government to compensate project sponsors in the event that
         international agreements, treaties, laws, policies, decrees, are enacted that
         negatively impact the project’s “economic equilibrium” (i.e., result in lower
         revenues or higher costs);
     •   Undermine the concept of eminent domain, which holds that a government can
         only take private property for public benefit, by allowing the state to take private
         property for the benefit of other private parties;
     •   Provide governments with less money than is necessary for fair and equitable
         resettlement and rehabilitation of people who have been displaced;
     •   Allow corporations to act in place of the national government in their project
         areas;
     •   Provide corporations with exclusive land rights and preferential water rights,
         which supercede rights given to local people;
     •   Greatly limit third party rights to demand compensation from the consortium
         (such as local people who have been harmed by the project);
     •   Establish dramatically unequal bargaining power between the corporations and
         the governments in the event of disputes.46


Unlike many extractive sector contracts, the BTC HGAs and IGA were disclosed
following their negotiations. The analysis that stems from their disclosure demonstrates
the need for the requirement of disclosure of other extractive sector contracts and the
need to expand the debate about the appropriateness of contract provisions that have such
vast impacts on public policy. However, public disclosure was not enough to prevent the
inclusion of provisions in these agreement that override environmental laws and
regulations. Hence, the boasting of project sponsors of the benefits of this disclosure is
overshadowed by the lack of meaningful public participation that could have resulted in
the terms of the contract leaving peoples’ rights and remedies unharmed.

Chad-Cameroon Pipeline
46
  See Philip Moser, “Counsel’s Opinion,” In the Matter of the Baku-Tbilisi-Ceyhan Pipeline, Barrister,
Eur. Law Group, 2003. http://www.bakuceyhan.org.uk/opinino_moser_redacted_april%2003.doc


                                                                                                         19
Amnesty International has documented that, in the case of the Chad Cameroon pipeline,
investment contracts can prevent or deter the state’s willingness and ability to fulfill
human rights obligations by:

                •   Hold[ing] back the governments of Chad and Cameroon from taking steps
                    to improve human rights protection;
                •    Encourage[ing] the governments of Chad and Cameroon to ignore their
                    human rights obligations;
                •   Be[ing] relied upon by the consortium in an attempt to frustrate efforts of
                    Chad and Cameroon to fulfil human rights obligations.47

Amnesty International finds that stabilization clauses’ restrictions on government actions
for the life of projects, which can be decades, can be used to frustrate the efforts of a
government to enact regulations that are needed for it to fulfill its human rights
obligations. For example, economic equilibrium clauses that cause a host government to
have to financially compensate an investor in the event of new regulations could have a
chilling effect on any new regulations aimed at achieving human rights protection. Also,
international arbitration clauses can potentially result in an international arbitration body
blocking a new or existing host government regulation aimed at protecting human rights.

As a tangible example:

           Chad has agreed with the consortium that, within a perimeter of protection of the
           pipeline, it is forbidden for ‘any person to undertake activities which may
           interfere with the construction, operation and maintenance of the TOTCO
           Transportation System’. Cameroon has agreed to a similar clause, which states
           that it is prohibited ‘for any person to undertake activities which may interfere
           with the construction, operation and maintenance of the Cameroon
           Transportation System’. Amnesty International believes that these provisions
           should not apply to any interference by the host states undertaken for the
           protection of human rights. However, the broad language used in this provision
           seems to provide a contractual duty for the states to protect COTCO and TOTCO
           from any ‘interference’ with the pipeline, even where such interference is as the
           result of the exercise or protection of human rights – such as those of local
           communities or industry workers [including the] rights to health and to safe and
           healthy working conditions [and the] rights to freedom of expression and freedom
           of assembly”[e.g., labor strikes].48




47
     Amnesty International, supra, at 12.
48
     Id, at 13


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