Enabling Private Ordering - the University of Minnesota Law School

2009] UMBRELLA CLAUSES 81
the people, and is paramount to any rights under contracts
between individuals” and engaged in a balancing process of the
competing rights and interests. 224 Although the case concerned
contracts between private parties, the Court in Blaisdell already
implied that its reasoning applied to “all contracts, whether
made between States and individuals, or between individuals
only.” 225 Subsequently, the Court expressly extended the
principle to contracts between States and individuals. 226
The jurisprudence of international courts and tribunals as
well as the situation under several domestic legal systems thus
gives broad support to the conclusion that it is a general
principle of law that a State has the power to modify or even
terminate contracts with private parties in view of a
superseding public interest. It is, however, equally recognized
that the State has, in principle, to compensate the private
individual for damages incurred by such modification or
termination depending on how significantly the contractual
equilibrium is affected. This power of States is, in fact, so well
recognized that it has to be read as an implied exception to the
application and operation of umbrella clauses.
3. Contract Regulation, Contract Termination, and
Opportunistic Behavior
An implicit police power exception to the operation of the
umbrella clause for the regulation of contracts in the public
interest can not only be justified by having recourse to the
State’s duty to attend to the public interest and to protect rights
and interests of third parties. The police power exception can
also be justified in economic terms. In many cases, interferences
with investor-State contracts based on subsequent regulation
concern externalities, i.e. effects on unrelated third parties,
which result from the behavior of the investor. Externalities
come into existence because the parties to the contract do not
assume the full costs of their behavior and therefore act, from
an economic perspective, inefficiently. 227 Regulations of the
224. Blaisdell, 290 U.S. at 437 (1934) (quoting Manigault v. Springs, 199 U.S.
473, 480 (1905)).
225. Blaisdell, 290 U.S. at 435 (quoting Long Island Water Supply Co. v.
Brooklyn, 166 U.S. 685, 692 (1896)).
226. United States Trust Co. v. New Jersey, 431 U.S. 1, 14 (1977); City of El
Paso v. Geenberry Simmons, 379 U.S. 497, 506−09 (1965).
227. Lewis A. Kornhauser, An Introduction to the Economic Analysis of Contract
Remedies, 57 U. Colo. L. Rev. 683, 705 (1986).