stabilization clause

USA

A clause often included in a host government agreement (HGA) or other international investment agreement that addresses how changes in law following the execution of the HGA are to be treated and the extent to which these changes modify the rights and obligations of the foreign investors under the HGA. A stabilization clause is a means for foreign investors to mitigate or manage the political risks associated with their project.

The most common types of stabilization clauses are:

• Freezing clauses: These clauses fix or freeze for the term of the project the applicable domestic legislation or regulations affecting the project to those in effect as of the date of the HGA. Under these clauses, legislation adopted after the date of the HGA do not apply to the foreign investors or the project unless the investors agree.

• Economic equilibrium clauses: Under these clauses, changes in law occurring after the execution of the HGA apply to the project and its foreign investors except that the host government must usually indemnify the investors from and against the costs of complying with the new laws. For example, the host government may impose new emissions standards concerning a power plant, but the costs of modifying the plant's design or re-fitting the plant will be borne by the government. These clauses are intended to preserve the economics of the project. The scope of the host government's indemnification obligation depends on the negotiating strength of the parties and the host government's need for the proposed investment.

• Hybrid clauses: A combination of the freezing and economic equilibrium clauses. Under these clauses, foreign investors are not automatically exempted from the application of new laws. Rather, these clauses provide that the investors may be granted an exemption. Hybrid clauses may also require compensation for certain specified changes in law as opposed to all laws that may affect the project and its foreign investors.

Although stabilization clauses are beneficial to foreign investors and are perceived as helping host governments attract foreign investment, they can prevent host governments from taking the actions necessary to protect their citizens' rights and enforce national laws that apply elsewhere in the country. Domestic investors generally do not like these clauses because foreign investors may receive better terms than they do. Stabilization clauses have also been criticized by international human rights organization, Amnesty International, as placing a price tag on human rights because they may exempt either explicitly (through the freezing clauses) or implicitly (through economic equilibrium clauses by making it expensive for the government) foreign investors and their projects from complying with human rights laws.

For more information on stabilization clauses, see Practice Note, Understanding Stabilization Clauses in International Investment Agreements (www.practicallaw.com/1-501-7863).