Foreign Investors
Paragraph 1
Governments of developing countries occasionally enter into economic development agreements with foreign investors who provide capital and technological expertise that may not be readily available in such countries.
Besides the normal economic risk that accompanies such enterprises, investors face the additional risk that the host government may attempt unilaterally to change in its favor the terms of the agreement or even to terminate the agreement altogether and appropriate the project for itself.
In order to make economic development agreements more attractive to investors, some developing countries have attempted to strengthen the security of such agreements with clauses specifying that the agreements will be governed by “general principles of law recognized by civilized nations”—a set of legal principles or rules shared by the world’s major legal systems.
However, advocates of governments’ freedom to modify or terminate such agreements argue that these agreements fall within a special class of contracts known as administrative contracts, a concept that originated in French law.
They assert that under the theory of administrative contracts, a government retains inherent power to modify or terminate its own contract, and that this power indeed constitutes a general principle of law. However, their argument is flawed on at least two counts.
Paragraph 2
First, in French law not all government contracts are treated as administrative contracts. Some contracts are designated as administrative by specific statute, in which case the contractor is made aware of the applicable legal rules upon entering into agreement with the government. Alternatively, the contracting government agency can itself designate a contract as administrative by including certain terms not found in private civil contracts.
Moreover, even in the case of administrative contracts, French law requires that in the event that the government unilaterally modifies the terms of the contract, it must compensate the contractor for any increased burden resulting from the government’s action. In effect, the government is thus prevented from modifying those contractual terms that define the financial balance of the contract.
Paragraph 3
Second, the French law of administrative contracts, although adopted by several countries, is not so universally accepted that it can be embraced as a general principle of law. In both the United States and the United Kingdom, government contracts are governed by the ordinary law of contracts, with the result that the government can reserve the power to modify or terminate a contract unilaterally only by writing such power into the contract as a specific provision.
Indeed, the very fact that termination and modification clauses are commonly found in government contracts suggests that a government’s capacity to modify or terminate agreements unilaterally derives from specific contract provisions, not from inherent state power.