Treaty exclusions

Treaty exclusions (also known as treaty exceptions or escape clauses) are one of the most evolving features of international investment treaties. Pursuant to Article 1.7.1 in the Guide to Practice on Reservations to Treaties adopted by the International Law Commission in 2011, in order to achieve results comparable to those affected by reservations, States and International Organizations may also have recourse to alternative procedures such as “a) the insertion in the treaty of a clause purporting to limit its scope or application”.

Exception clauses are designed to permit a treaty party to lawfully perform its regulatory and legislative functions by taking measures directed towards a specific regulatory purpose, policy, industry or sector that might be conflicting with the interests of foreign investors. Exceptions could be viewed as an insurance policy against the potential of a tribunal making comprehensive interpretations of BIT obligations, by assuring potential claimants and arbitrators that the objective and purpose of the treaty was not merely to protect foreign investments at the expense of the right of the host State to perform its public policy objectives. In short, if a measure falls under exceptions, a State shall be exempt from liability, as they are the ultimate flexibility mechanism or escape clauses for States.

Exceptions have become an increasingly prevalent mechanism in investment treaties appearing progressively in most of the investment treaties concluded between 2011 and 2019. This change in the design of treaties has had an impact on the use of precedents in investment arbitration and eliminated the formal rule of precedents therein.

The rationale behind designing treaty exceptions was to exempt host States from liability towards foreign investors for justifiable measures seeking public welfare objectives on the one hand, while on the other hand, to exclude certain types of measures and/or sectors from the scope of the treaty.

Several States took early measures to make treaty exceptions for the following reasons:

1. Concerns that BITs excessively restrict a host State’s right to regulate in the public interest after being on the respondent side of multiple investment disputes;
2. Several signed BITs were too vague and unresponsive to the balance between investment and non-investment concerns, leaving blanks for arbitrators to unduly fill;
3. To increase legal certainty in investment arbitration by offering more precise reference to the public interest and essential security considerations; and
4. To enable investors to evaluate the risk of unfavorable State action in the exempted policy areas when calculating investment costs before starting an investment.

The clauses usually include the following elements:

1. General public policy exceptions, which concern an exhaustive list of permissible policy objectives such as the protection of human, animal or plant life or health, and the conservation of natural resources,¹ via² “right to regulate clauses”;³
2. Security exceptions, which are only applicable in extraordinary circumstances⁴ by giving a treaty party flexibility to respond to security-related matters;⁵
3. Carve-outs, which exempt an entire policy,⁶ area,⁷ or sector from all or some⁸ of the treaty obligations⁹ (see Taxes, Taxation exclusions for instance);
4. Excluding certain policy areas and measures¹⁰ from ISDS;¹¹
5. Precision and exactness in the treaty provisions¹² by explicitly clarifying the intended interpretation of substantial provisions and defining the conduct and discretion afforded to parties to an agreement in complying with its norms;¹³ and
6. Denial of benefits clauses. 

Treaty exceptions confront tribunals with a substantive interpretive question if they should be treated as carving out certain State conduct from the scope of the treaty (a question of jurisdiction).¹⁴ Accordingly, exceptions determine whether or not a treaty applies as it limits the jurisdiction "ratione materiae" of arbitrators. Contrary to general and security exceptions, carve-outs operate more as jurisdictional matters due to their precise terms for the types of measures and/or industries they exclude from the scope of the treaty.¹⁵ 

To consider a “treaty exception as a limitation on the scope of the treaty obligations means that where the State raises the exception, the claimant must prove that the challenged measure does not come within its purview”.¹⁶ 

Interpreting exceptions as an affirmative defense justifying prima facie unlawful State conduct (a question of merits). Thus a State relying on exceptions as a defense would be deemed conceding that it had failed to comply with its treaty obligations, but would seek to justify the consequences of its actions by proving that its conduct was permissible within the scope of the exception clause.

General and security exceptions operate more as a matter of defenses due to their relatively open-textured design.¹⁷

Considering an exception as an affirmative defense would place the burden of proof on the respondent State to prove that the exception was applicable.

Characterizing exceptions as a limitation on the scope of the treaty’s substantive obligations would limit the competence of an arbitral tribunal but would presumably be reviewable under the ICSID or New York Conventions.¹⁸ Alternatively, if exceptions are characterized as an affirmative defense on the merits, they would then inevitably fall outside the limited grounds for subsequent annulment or domestic court proceedings.

Lacking a clear definition for the term “Essential Security Exception”¹⁹ resulted in an approach of considering the exceptions connected to the state of necessity in customary international law. This approach allowed arbitrators to examine the facts of a dispute in light of the requirements provided in Article 25 ILC.²⁰ Alternatively, another approach abandoning that understanding found that although they share the same purpose and practical effects, exception clauses under BITs cannot however be equated with the state of necessity, on the grounds that they are both different in scope, requirements and legal nature.²¹ See further Necessity, Section IV.

Tribunals adopted another similar approach based on considering exceptions as a lex specialis expression of the necessity defense, thus characterizing an exception as an agreement between treaty parties to modify the defense of necessity, allowing the special norm (exceptions) to override the other lex generalis norm (plea of necessity).²² See further Necessity, Section IV.

A similar approach of invoking customary international law in connection with exceptions was adopted by respondent States, arguing that its measures fell within its police powers and under the treaty’s general exceptions. Tribunals reacted differently to such defense by considering general exceptions and police powers as separate defenses.²³ Alternatively, general exceptions were considered to exclude the application of police powers (lex specialis).²⁴ See also Police powers, Section V.

Henckels, C., Permission to Act: The Legal Character of General and Security Exceptions in International Trade and Investment Law, International and Comparative Law Quarterly, 69 (2), 2020. 

United Nations Conference on Trade and Development, Taking Stock of IIA Reform: Recent Developments, 2019. 

Alschner, W. and Hui, K., Missing in Action: General Public Policy Exceptions in Investment Treaties, in Sachs, L., Coleman, J., Johnson L. (eds.), Yearbook on International Investment Law and Policy, Oxford University Press, 2018. 

Berge, T.L., Dispute by Design? Legislation, Backlash and the Drafting of Investment Agreements, 2018. 

Henckels, C., Should Investment Treaties Contain Public Policy Exceptions?, Boston College Law Review, Vol. 59, Issue 8, 2018. 

United Nations Conference on Trade and Development, Review of ISDS Decisions in 2018: Selected IIA Reform Issues, 2018. 

Henckels, C., Scope Limitation or Affirmative Defense? The Purpose and Role of Investment Treaty Exception Clauses, in Paddeu, F. & Bartels, L. (eds.), Exceptions and Defenses in International Law; Society of International Economic Law, 2018. 

Singh, K. and Ilge, B. (eds.), Rethinking Bilateral Investment Treaties: Critical Issues and Policy Choices, Madhyam & SOMO, 2016. 

Newcombe, A., General Exceptions in International Investment Agreements, in Cordonier Segger, M.C., Gehring M.W. and Newcombe, A. (eds.), Sustainable Development in World Investment Law, Alphen Aan Den Rijn, 2011. 

Mann, H., Investment Agreements and the Regulators State: Can Exception Clauses Create a Safe Haven for Governments?, Background Paper for the Developing Country Investment Negotiators’ Forum, 2007.