The debate about the law applicable to foreign investment disputes developed into an operational discussion at beginning of the twentieth century, when the number of private investments in foreign countries increased considerably. The debate gained momentum as a result of the spreading feeling that applying traditional private international law (or conflict of laws rules) rules to foreign investment disputes may not be entirely appropriate. The feeling was grounded on the observation that most foreign investment agreements were entered by sovereign States to fulfil their institutional obligations as acta jure imperii. Because of this, treating such relationships as mere commercial agreements seemed somehow inappropriate.
However, the suggestion that public international law should be applied was not received without controversy. It was indeed traditionally maintained that any legal relationship where one of the parties was not a subject of international law should not be governed by the rules of international law but rather by the domestic law of a country. This argument was supported by the famous words of the Permanent Court of Justice in the case of the Serbian Loans where it stated that: “any contract which is not a contract between States in their capacity as subjects of international law is based on municipal law of some country.”
The commentators favouring the application of international law, however, observed that investment agreements should be regarded as quasi public international or internationalised contracts because of “the brooding omnipresence” of international law in such transactions. It was indeed suggested that a foreign investment transaction is sui generis. For this reason, it should be regarded as a treaty or as a quasi-international self-contained instrument which, as such, should be, to the possible extent, be detached from domestic courts and domestic law.
Despite the fact that the suggestion to apply international law to foreign investment disputes involving a State was gaining currency, many doubts remained as to the feasibility of this suggestion. Indeed, many authors recognised that there was still little solid evidence that such an idea could find support within the existing international law.
The uncertain legal status of international investments led to the adoption of contractual devices which would provide for the highest possible detachment from the courts and the law of the contracting States. This was attempted through the adoption of arbitration clauses providing for international arbitration and choice of law clauses providing for international law as the law governing the contract.
However, such new approach was heavily criticised on the ground that it confused the separate domains of public and private international law. Furthermore, it was observed that in the absence of any choice of law clause providing for the application of international law, the presumption in favour of the law of the host State should still be regarded as valid and applicable.
Although the efforts to detach international investment agreements from the law of the host State was gaining momentum, by the beginning of the 1960’s there was still uncertainty as to the actual rules of international law which would be taken into account by arbitral tribunals in any given case.
An attempt to identify the rules of international law which may be considered applicable to foreign investments was made by the United Nations in 1962, when a number of resolutions relating to national sovereignty over natural resources were drafted. In particular, the General Assembly adopted a statement to the effect that “foreign investment agreements freely entered into by or between sovereign States shall be observed in good faith.” However, the General Assembly’s attempt failed to achieve more than that. Indeed, the task of the United Nations proved much more complex than originally thought. As a result, no decision was eventually taken by the Commission on the production of a draft Convention on State responsibility.
The ICSID Convention
Despite the somewhat unsatisfactory result of previous negotiations in the field of foreign investments, in 1962 the Executive Directors of the World Bank were asked to explore the possibility of establishing an institutional framework for the conciliation and arbitration of investment disputes between States and foreign private parties. After wide-ranging and lengthy consultations, on March 18, 1965, the Executive Directors of the World Bank submitted what would eventually become the so-called ICSID Convention to the World Bank’s Member Governments. The Convention was approved and entered into force on October 14, 1966.
Amongst other things, the Convention incorporated the International Centre for the Settlement of Investment Disputes (ICSID) which was given the task of providing administrative and operational facilities necessary for the settlement of investment disputes under the Contention. The ICSID Convention was adopted and ICSID was established because it was evident that foreign investment disputes could not be effectively resolved either in the domestic judicial forum of the host State, or in the national courts of the foreign investors. It was felt that the provision of a neutral forum for the settlement of investment disputes would improve the investment climate by reducing the “fear of political risks [which] operate as a deterrent to the flow of private foreign capital.”
Rather unsurprisingly, during the drafting of the Convention it appeared necessary to reconcile the above-mentioned factions that had formed on the issue of the law applicable to investment disputes. The compromise reached by the drafters of the Convention on the issue is fully reflected in the adopted text.
The system devised by the Convention: Article 42
As is well known, the Convention contains no substantive rules of law concerning investments in a State by nationals of another State. It is indeed believed that, if an attempt had been made to provide for such rules, the Convention would not have proved equally successful. The Convention limits itself to guaranteeing party autonomy and, in case no choice is made in the relevant contract, it provides for a default choice to be qualified, or limited, through the application of international law.
Article 42 of the Convention states that:
(1) The Tribunal shall decide a dispute in accordance with such rules of law as may be agreed by the parties. In the absence of such agreement, the Tribunal shall apply the law of the Contracting State party to the dispute (including its rules on the conflict of laws) and such rules of international law as may be applicable.
(2) The Tribunal may not bring in a finding of non liquet on the ground of silence or obscurity of the law.
(3) The provisions of paragraphs (1) and (2) shall not prejudice the power of the Tribunal to decide a dispute ex aequo et bono if the parties so agree.
The “rules of law”
Article 42(1) provides the parties with a broad discretion as to the identification of the law governing their relationship. It is interesting to note that the first sentence of Article 42(1) allows parties to agree on the “rules of law” applicable to the substance of their dispute. With this rather broad term, the Convention intends to make clear that the choice of the parties is not limited to one or more national laws or legal systems, but may, for example, “incorporate” a national law in existence at a certain moment in time or exclude certain provisions of such a law. As a matter of fact, the provision is believed to be so broad and permissive that the parties are not restricted to choosing a national law or part of it at all. The parties are indeed permitted to agree to have their dispute governed by general principles of law as well as rules of international conventions, even if not yet in force in the States concerned.
The permissive wording of the first sentence of Article 42(1) allows the application of complex choice of law clauses, which the parties can enter into by using, for example, well known techniques such as depeçage.
Application of domestic law(s)
The application of the host State law is perhaps one of the most frequent choices in investment transactions, even though the parties would normally qualify their choice by requiring the arbitral tribunal to settle the dispute by applying the law of the host State in conjunction with either another domestic law or international law. Equally, because of the dynamics of investment relationships, it is also uncommon for the parties to select the law of the foreign investor rather than the law of the host State as the governing law.
International law as the parties’ choice
A choice by the parties of international law as the only applicable law, although not frequently adopted, would be enforced by an ICSID Tribunal. This is normally done in order to provide for the highest level of internationalisation of the contract and therefore to protect the rights of the foreign investor from either a change in the domestic law of the host State. The choice of international law as the law governing the relationship between the parties has also been made in important international conventions.
Absence of agreement as to the applicable law
Cases involving no agreement as to the applicable law fall under the second sentence of Article 42(1) pursuant to which the dispute is to be resolved according to the law of the State party – including its rules of conflict of laws – and international law. Several important issues have been raised in this respect. Arguably, the most problematic of all such issues is the definition and role which international law must be given in adjudicating disputes falling under the provisions of Article 42(1) second sentence.
The relationship between domestic law and international law
The wording of the final version of Article 42(1) was adopted to balance the expectations of both capital-importing countries, which opposed the idea of giving ICSID tribunals the power to determine the applicable law, and capital-exporting countries, which feared that the exclusive application of the host’s State law could disadvantage foreign investors.
One of the issues which have arisen out of the final version of Article 42(1) is how the combination of host State law and international law should work. According to leading commentators, ICSID tribunals should normally apply the law of the State party. The result of the application of that law should then be tested against international law to detect any unfair outcomes. In case of inconsistency with or violation of international law the relevant ICSID tribunal may decide not to apply the host State’s law or part of it.
Several ICSID cases seem to have supported this view as to the interplay of international law and the host State’s law. It seems now settled and undisputed that the second sentence of Art. 42(1) gives international law two roles. One is complementary and comes into play in the case of lacunae in the law of the host State. The other role, the so-called corrective role, comes into play if the State’s law does not conform to the principles of international law.
International law as identified and applied by ICSID Tribunals
As regards the actual rules of international law to be applied by ICSID tribunals, the Report of the Executive Directors explains that the reference to international law which Article 42(1) makes reference to should be understood in the sense given by Article 38 of the Statute of the International Court of Justice (ICJ).
As suggested by leading commentators, it is open to discussion whether the list of sources provided by Article 38 of the ICJ Statute actually resolves the problem of the identification of the actual rules of international law to be applied in investment disputes.
The interesting aspect of the reference to Article 38(1) is that it provides ICSID tribunals with a broad range of sources on which the tribunals can rely upon to identify the most suitable rules of international law to settle the case. Indeed such reference provides ICSID tribunals with the same ample power for the identification of the actual rules of international law given to the ICJ even though ICSID tribunals should exercise such power bearing in mind the peculiar nature of investment disputes and investment arbitration.
Consequences for failure to apply the law
Section VII of the Convention avails the parties to ICSID proceedings the right to file an application for the interpretation, revision or annulment of an ICSID award in the presence of certain circumstances.
An application for annulment can be brought, pursuant to Article 52(1), in the presence of one or more of the following grounds:
- that the Tribunal was not properly constituted;
- that the Tribunal has manifestly exceeded its powers;
- that there was corruption on the part of a member of the Tribunal;
- that there has been a serious departure from a fundamental rule of procedure;
- that the award has failed to state the reasons on which it is based.
The failure to identify and apply the correct applicable law is believed to amount to an excess of power for the purpose of applying Articles 50 and 52 of the ICSID Convention.
In MINE v. Guinea the Ad Hoc Committee confirmed the view that failure to decide the dispute in accordance with the applicable rules of law would constitute an excess of power leading to the annulment of the award.
More recently, in the annulment proceedings related to the cases of Enron v. Argentina and Sempra v. Argentina, the relevant Ad Hoc Committees annulled the arbitral award because the Arbitral Tribunals had exceeded their powers by failing to apply the applicable law. In those cases the Arbitral Tribunals had rendered decisions on the basis that Argentina was precluded from relying both on Article XI of the USA/Argentina BIT and the principle of necessity under customary international law. Identifying the applicable law proves particularly complex an exercise in cases, such as the two just mentioned, arising out of bilateral investment treaties which – as opposed to those arising out of investment contracts – are often thought to require no reference to a domestic law. While this might be true generally, sometimes this may not be the case since some bilateral investment treaties do make reference to domestic law for the settlement of certain issues such as the definition of investment.
Domenico Di Pietro is a Lecturer of International Arbitration at University “Roma Tre” in Rome and Fellow of the Center for Transnational Litigation and Commercial Law of New York University School of Law. This is an abridged, revised and updated version of the author’s article Applicable Law Under Article 42 of the ICSID, in Weiler, ed., International Investment Law and Arbitration: Leading Cases from the ICSID, NAFTA, Bilateral Treaties and Customary International Law, 2005.
 See the Serbian Loans case 1929 BCIJ, series A, No’s 20, 21 & 41.
 This interesting description was made by Lillich The Law Governing Disputes Under Economic Development Agreements: Re-examining the Concept of Internationalisation in Lillich & Brower International Arbitration in the Twenty-first Century, Towards Judicialization and Uniformity, 1993 at 92.
 United Nation Documents A/5100 ADD1 1962).
 Garcia Amador’s reports appear in Yearbook of International Law Commentaries 1957, 1961.
 Broches, The Convention on the Settlement of Investment Disputes between States and Nationals of other States (1972) Recueil des Cours at 343.
 See Shihata & Parra, Applicable Substantive Law in Disputes Between States and Private Foreign Parties: The Case of Arbitration Under the ICSID Convention (1994) 9 ICSID Review, 183.
 The term “rules of law” (rather than “law” as in Art. 33(1) of the UNCITRAL Arbitration Rules) was subsequently used in Art. 28(1) of the UNCITRAL Model Law on International Commercial Arbitration.
 Broches Convention on the Settlement of Investment Disputes between States and Nationals of Other States of 1965 Explanatory Notes and Survey of its Application Yearbook C. A. XVIII (1993) 627.
 As clearly stated in the UNCITRAL Model Law on International Commercial Arbitration which adopted the ICSID formula (Report of the Commission, U.N. Doc. A/40/17, para. 232).
 The principle of parties’ freedom allows the use of the so-called depeçage technique which consists in subjecting the contract to certain provisions of different domestic laws.
 The applicable law provision provided by Article 1131 of the NAFTA for example reads: “A Tribunal established under this Section shall decide the issues in dispute in accordance with this Agreement and applicable rules of international law.”
 See Broches, Convention on the Settlement of Investment Disputes between States and Nationals of Other States of 1965 Explanatory Notes and Survey of its Application Yearbook C. A. XVIII (1993) at 627.
 International Bank for Reconstruction and Development. Report of the Executive Directors on the Convention on the Settlement of Investment Disputes between States and Nationals of other States (1965) at 13, 1 ICSID Reports 25.
 This provisions, which is considered a most authoritative statement of the sources of international law, reads at paragraph 1: The Court whose function is to decide in accordance with international law such disputes as are submitted to it shall apply:
(a) international conventions whether general or particular establishing rules expressly recognised by the contesting states;
(b) international custom as evidence of a general practice accepted as law;
(c) the general principles of law recognised by civilised nations;
(d) subject to the provisions of Article 59, judicial decisions and the teaching of the most highly qualified publicists of the various nations as subsidiary for the determination of rules of law.
 Schreuer, The ICSID Convention: A Commentary, 2001, at 610. See also the 2009, second edition, by the same author with Malintoppi, Reinish and Sinclair.
 Kahn, The Law Applicable to Foreign Investments: The Contribution of the World Bank Convention on the Settlement of Investment Disputes, 44 Indiana Law Journal 1 (1968) at 28.
 Maritime International Nominees Establishment v Government of Guinea, 5 ICSID Review (1990) at 95.
 ICSID Case No. ARB/01/3, annulment proceedings
 ICSID Case No. ARB/02/16, annulment proceedings