Over the past two decades, stabilization provisions in investment contracts (and in the domestic law in some developing countries) became a popular demand of investors into developing countries. Rarely used and largely unconstitutional in most developed countries, these provisions essentially limit the ability of governments to have new laws and regulations apply to a foreign investor that is the beneficiary of such a provision.
Andrea Shemberg’s study for the mandate of the United Nations Special Representative on Business and Human Rights, Prof. John Ruggie, categorized stabilization provisions in terms of their scope and nature. With respect to scope, two broad categories were identified: fiscal issues (taxes, royalties, rents, rates of payment for services provided, etc. paid to the government or by end users) and non-fiscal regulatory areas, such as environment, labour, health and safety. Closely related to this is the need to distinguish those provisions that address selling prices of goods or services produced for the government (such as water, highway tolls and electricity), usually under some form of public-private partnership agreement, and the much broader fiscal and non-fiscal provisions that are found, in particular, in natural resources sector contracts. The scope and impact of the former type is significantly narrower and more carefully defined than most stabilization provisions in relation to the extractive industries.
In terms of their nature, Shemberg identified the differences between freezing clauses that freeze the law applicable to an investment as that which existed at the time the investment was made; and financial equilibrium clauses that require government compensation for any costs incurred in meeting the new legal standards or a waiver from meeting them. While in principle freezing clauses can be more extreme than equilibrium clauses, in practice the impact is the same as most governments cannot afford to pay foreign investors to comply with changes in domestic law applicable to the investment. Nor can governments accept a situation where foreign investors are compensated but domestic businesses are not. Consequently, both of these types of clauses have significant impacts on the ability of governments to enact new legal measures in the pursuit of sustainable development objectives, including the protection and promotion of human rights.
Stabilization provisions were notionally developed to respond to significant political and legal instability that was presumed to exist in some developing countries, thereby making foreign investments too risky. However, they grew to become routinely advocated by organizations such as the OECD and World Bank Group as a means for governments to contribute positively to the “investment environment” for foreign investors. The need to generate such a welcoming investment environment often led to a contest among states born of a second presumption of the need to compete for foreign investors. In effect, their use migrated from addressing political instability to become a standard feature for advocates of an investment-friendly environment.
The rationale for stabilization clauses unraveled
The original rationale for stabilization provisions, it seems, was to use legal mechanisms to address political instability in, primarily, developing countries. This was seen as a requirement for some financing situations as well. Their migration to being seen as a standard feature of a “welcoming” investment environment, and the expanded scope and timelines for many of these clauses (Shemberg notes a 100 year operational time period for one such clause in her article in the present volume of ITN) raise multiple doubts as to their actual ongoing purpose.
A 2009 report by the International Council on Mining and Metals and the Commonwealth Secretariat questions whether the very legal and political stability that these provisions were meant to create may now actually be jeopardized by these provisions. One argument in this direction is that such clauses have appeared to lock in illegitimate and often inequitable deals for mining companies. Another is that by creating immutable legal conditions over lengthy periods, political leaders are being forced into more aggressive measures to review, revise or cancel contracts where appropriate adjustments are not available. In addition, it is increasingly evident that many of the most stringent stabilization provisions have been concluded with governments that may not have been elected, may have military origins and/or may have been subject to significant corruption, supporting the appearance of illegitimacy. Where democratic governments are now coming into more mature and stable circumstances, it is evident that political leaders are being called on to ensure fairer revenue sharing and other beneficial social conditions prevail at ongoing operations. Finally, where stabilization provisions are included in contracts obtained through corruption, it is also now increasingly unlikely that investors will find them enforceable in international arbitration. 
In an earlier ITN article Prof Robert Howse suggested that empirical analysis reveals such provisions are largely rent-seeking behavior by investors. After reviewing several economic studies which conclude that, from an economics perspective, government compensation for the cost impacts of regulatory changes is not efficient, Howse notes that, “If we begin from the default position that compensation for regulatory change is not efficient, then our preliminary conceptualization of a stabilization clause will be that it confers a benefit or rent on the firm.”
In other words, if the investors or their lawyers can get a stabilization provision, they will, as it increases the profit margin.
Shemberg’s initial analysis noted above demonstrates that the practice is indeed inconsistent and spotty both across different countries with relatively similar political circumstances, and within countries. This again suggests, in this writer’s opinion, that factors other than legal certainty and economic need—as opposed to economic desires of firms—are the key issues in the spread of such clauses. The argument that they are indeed more about negotiating opportunism than critical need must be considered as a major factor.
From stabilization clauses to operational predictability
Stabilization provisions and operational predictability for an investor are not the same thing. While the stabilization clauses were intended to generate operational stability and thus predictability, this has not been the result. Contract reviews and renegotiations are continually taking place. Resource nationalism has expanded rather than contracted during the period of their increased use. Concepts of fairness and equity have grown in their wake and now override the legal value of the clauses anticipated by companies in most political contexts.
Similarly, precluding a government from regulating on key social and economic development issues or environmental sustainability is clearly not in the interests of promoting sustainable development and enhancing human rights. But the analysis of why the focus must change from stabilization clauses to operational predictability takes us much further than such generalities.
Modern investment theory and practice that incorporates sustainable development principles tells us at least two critical things. First, no investment today should be made without state-of-the-art technologies relating to the environment and human health being incorporated into the investment. This standard is not defined simply on the basis of legal compliance in the host state. Rather it is based on the fundamental view that it is inexcusable for any investor to use outdated technology, including by shipping outdated technology from one country to install it in another, just because it is legal for it to do so.
Second, every major business management standard today requires the investor to assess, plan for and routinely incorporate technological improvements over the life of a project as it relates to environmental, human health and social development factors, including human rights. Again, this is not just a legal compliance assessment, but a best practice assessment that focuses on improved social and environmental outcomes, and the ongoing reduction of external impacts from the investment. Acting on these management standards requires the investor to incorporate such costs into the financial planning of the investment from the beginning, rather than waiting for a governmental requirement to do so.
Seen in this way, it becomes evident that stabilization clauses can create a disincentive for investors to meet widely accepted business standards. Rather, it would pay an investor to wait for new legislation and pass on the costs to the host government, while the ongoing externalities of such behaviour—environmental or human health damage, for example—are also passed on to the local citizens.
Where does this leave stabilization at the conceptual and pragmatic levels? Perhaps a reconsideration of the underlying objectives behind stabilization provisions is important. For fiscal stabilization, one must ask now if the appropriate goal is complete stability, or whether it should be better understood as predictability? Must the tax and royalty regimes be the same year to year throughout a project, or must the investor and government understand how amounts may vary as the actual factors related to costs, revenues and profits fluctuate so that they are predictable, but variable? The difference is critical. Stability provisions have been designed to prevent alterations in the share of revenues irrespective of market price, cost inputs, or other factors. Predictability sets out the rules for adjusting rent sharing when significant changes in costs or revenues occur. Predictability, at least when married to a proper accounting and monitoring process, enhances stability by encouraging fairness in the allocation of rents from public resources rather than simplistic win-lose formulations. Windfall profits, often a key issue in this context, thus become a definable and regulated matter in the contract, rather than a factor that causes the very instability investors seek to avoid.
On non-fiscal issues, the rationale for stabilization has been based on both costs for the investment and the fear of arbitrary changes designed for ulterior reasons relating to the control of an investment. Considering the preceding analysis, however, the cost issue becomes largely a misdirection and reflects the rent-seeking objective that characterizes overly broad stabilization clauses. In the context of human rights, it becomes a barrier to the protection and promotion of such rights in contradiction to the protect and respect principles set out by Prof. Ruggie. As confirmed more directly in the Responsible Contracting documents issued by Prof. Ruggie, investors should not seek to lay off these costs on others. The examples of this used in the Responsible Contracting report highlight the indivisible linkages between human rights and sustainable development in this context.
That leaves the issue of arbitrary treatment. Here, specific language around arbitrary, or arbitrary and discriminatory treatment can and has been fashioned. Both the International Bar Association’s Model Mining Development Agreement and Prof Ruggie’s Responsible Contracting process recommend similar approaches. The focus here is to return to the original intent of stabilization provisions on significant political risk: to protect the investor against measures that are arbitrary, discriminatory or reflect bad faith of the government; in other words, nefarious conduct by the government rather than legitimate public interest measures.
To make this approach effective, one final element is needed: ensuring a safe haven wherein a government is presumed to be acting for good faith reasons, absent proof to the contrary. This can be achieved by clarifying that regulations that take a host state to levels of regulation seen in more advanced regulatory states are not arbitrary or discriminatory. These levels may be found in Europe, the United States, Canada or other jurisdictions, or in the limited number of international standards that might be relevant here. This safe zone helps make it clear where the responsibility of both governments and industry lie.
Whatever may have been the original intent, it is clear that the focus on expansive stabilization provisions as a “required” element for an investment friendly environment led to a breadth and depth for such clauses that went beyond what sound investment policy would support. Efforts are now underway to re-characterize the notion of stabilization towards predictability and the protection from arbitrary government acts. This provides a much more limited interference with the right of states to regulate in the public interest, while maintaining a useful protection for investors, when needed. Critically, it also removes stabilization away from the rent seeking behaviour that has characterized investment contract negotiations more broadly. This will be an important part of an overall shift to more balanced contracts between host states and investors.
Author: Howard Mann is Senior International Law Advisor to the IISD.
 It is a widely accepted principle in most developed countries that one legislature cannot bind a future legislature, and that an executive act of government cannot bind a legislative body. Stabilization provisions often violate these precepts.
 Shemberg, Andrea “Stabilization Clauses and Human Rights”, 11 March 2008, http://www.ifc.org/ifcext/enviro.nsf/AttachmentsByTitle/p_StabilizationClausesandHumanRights/$FILE/Stabilization+Paper.pdf
 International Council on Mining and Metals (ICMM) and Commonwealth Secretariat, “Mining Taxation Regimes: A review of issues and challenges in their design and application”, February 2009. See in particular Chapter 3, including Box 3.1.
 This is the result of an increasing number of arbitration decisions that highlight international corruption as a singular scourge against international public order, rather than notion of business as usual that may have prevailed in a previous era. As a result, arbitrators are increasingly refusing to hear arbitrations based on contracts obtained by corruption of government officials.
 Howse, Robert, “Freezing government policy: Stabilization clauses in investment contracts”, Investment Treaty News, 4 April 2011, http://www.iisd.org/itn/2011/04/04/freezing-government-policy-stabilization-clauses-in-investment-contracts-2/
 See, e.g, ICMM, Sustainable Development Framework, 10 Principles, Principle 2 and 6, at http://www.icmm.com/our-work/sustainable-development-framework/10-principles. For a recent iteration on these lines, see the OECD Guidelines for Multinational Enterprises, Recommendations for Responsible Business Conduct in a Global Context, May 2011, Principle 6, Environment and the related discussion, pp. 40-44.
 The ICMM appears to take a similar approach, referring to the strategic negotiating goal of creating a balanced fiscal regime over the long term of a mining concession, rather than stabilization of the regime. See “Taxing Challenges II: A studied Approach to Minerals Taxation Regimes” ICMM Spotlight Series 13, September 2008.
 Protect, Respect and Remedy: a Framework for Business and Human Rights, Report of the Special Representative of the Secretary-General on the issue of human rights and transnational corporations and other business enterprises, John Ruggie, 7 April 2011, http://www.business-humanrights.org/Links/Repository/965591
 Report of the Special Representative of the Secretary-General on the issue of human rights and transnational corporations and other business enterprises, John Ruggie: Principles for responsible contracts: integrating the management of human rights risks into State-investor contract negotiations: guidance for negotiators, 25 May 2011, http://www.business-humanrights.org/media/documents/ruggie/report-principles-for-responsible-contracts-25-may-2011.pdf
 Responsible Contracting, Ibid, see the discussion under Principle 4 at pp. 12-14; International Bar Association, Model Mining Development Agreement 1.0, Articles 13.2 and 14, April 2011.
 There are very few such standards with specific details for performance purposes. Still, an array of potentially relevant standards can now be found collected at http://www.sdsg.org/archives/links-for-sustainable-development-of-natural-resources/