Revised Investor-to-State Dispute Settlement Mechanism: New and Improved?

Review of the key criticism of the investor-to-state dispute settlement mechanism (ISDS) in the context of new FTA negotiations taking place, the recent changes to the ISDS mechanism and the future of ISDS in FTAs.

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Introduction

The investor-to-state dispute settlement mechanism (ISDS) is a provision of international law that allows foreign investors to directly bring claims over treaty breaches in arbitration against a host state[1]. Since the 18th century, various forms of international arbitration have been used to resolve investment disputes and protect investors from discrimination and direct and indirect expropriation. In its current form, the provision has been used since the 1960s in bilateral investment treaties (BITs) and trade agreements (for example, NAFTA).

Recently however, from being a relatively unknown form of international arbitration, ISDS became possibly the most contested and controversial element of many high-profile FTAs, including the Canada-EU Comprehensive Economic and Trade Agreement (CETA), the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP).

Over 3 million people signed the European Citizens’ Initiative petition to stop the TTIP and CETA, with ISDS being listed as the number one issue. In October 2015, hundreds of thousands of people, including environmental and civil rights groups, demonstrated on the streets of Berlin against the TTIP and its ISDS clause. ISDS was also the key reason for the delay in signing of CETA[2]. Initialled in September 2014, the agreement underwent a comprehensive legal review. Almost a year into the process, ISDS was still one of the most contentious issues and the text of the investment protection and investment dispute settlement provisions needed to be renegotiated[3].  

 
Key criticism of ISDS

One of the key arguments against ISDS is that it leads to preferential treatment of foreign investors. The purpose of investment protection provisions is to ensure that foreign investors have the same rights as domestic companies in line with WTO principles of non-discrimination, fair and equitable treatment, and national treatment of foreign investors. However, ISDS allows such investors to sue governments sidestepping the national legal system in tribunals consisting of private sector attorneys. Therefore, while the rights available to foreign investors under ISDS are the same as those available to local companies, the instrument used to exert these rights is not[4].

A widely used example of such “preferential treatment” is the claim submitted against Germany by a Swedish power company, Vattenfall, after the German government decided to phase out nuclear power plants in the wake of the Fukushima disaster. Vattenfall’s power plants in Germany were co-owned by a German company, E.ON. E.ON used property rights provisions under the German constitution to claim damages. The compensation E.ON is likely to receive under German law will almost certainly be lower than the EUR 4.7 billion Vattenfall supposedly claimed under ISDS.

While this can be viewed as a form of preferential treatment, it is worth remembering that ISDS disputes are quite rare; ISDS claims are expensive to submit, offer only a low chance of success and put the future of the company’s investment and operations in the host country at risk. As a result, while there are over 3,271 international investment agreements (mainly BITs and FTAs) that include some version of the investment-to-state dispute settlement mechanism[5], approximately 90% of these have never been subject to an ISDS investigation[6].

The structure of the ISDS process encourages negotiations and settlements[7]. About one third of all ISDS cases are settled in advance of a ruling. If a case does proceed to trial, the investors win in less than one in three cases[8] [9]. Finally, even if the ISDS tribunal rules in favour of the investor, the rewards are usually much lower than what has been requested[10].

The second key criticism of ISDS is that the provision allows large corporations to jeopardise the ability of governments to pass laws in the public interest. Under ISDS, investors are able to challenge national legislation which adversely affects their investment. In some cases, this might imply legislation relating to public health, environmental protection and even human rights.

In what is the most well-known ISDS case, the tobacco company Philip Morris used a BIT between Hong Kong and Australia to challenge the new tobacco packaging regulations introduced in Australia in 2011[11]. The company argued that the plain packaging policy affected its profits. In 2012, New Zealand decided to postpone the implementation of its clear packaging bill and commenced public consultations on the proposed legislation – a move often interpreted as a result of a chilling effect of the Australian ISDS case. However, Australia’s packaging rules have also been challenged by five other countries under the WTO dispute settlement mechanism for breaching the rules on packaging and labelling under the Trade-Related Aspects of Intellectual Property Rights (TRIPS). As Australia was the first country to introduce plain packaging, it became the testing ground for the new legislation. There is no evidence to suggest that the ISDS case was the key factor in New Zealand’s decision. The case brought by Philip Morris against Australia was subsequently dismissed in December 2015[12].

In the UK, opponents of TTIP expressed their concern over the fact that the agreement might be used to challenge the NHS and the public provision of healthcare, although David Cameron referred to this as “nonsense”[13].

While ISDS can potentially be used to challenge legislation passed in the public interest, such cases are rare. In 2008, an ISDS case under Chapter 11 of NAFTA was filed against Canada and its publicly-funded healthcare services[14]. The case was dismissed as lacking merit. In fact, several ISDS clauses include a provision that states that regulatory actions applied to protect legitimate public welfare objectives do not constitute expropriation and cannot be subject to an ISDS claim[15].

In addition, most ISDS clauses explicitly limit the outcomes of a claim to the recovery of damages and preclude the investor from seeking to change the introduced regulatory measures.

It is important to remember that while multinational corporations can attempt to use ISDS to further their interests, they are by far not the only users of international arbitration. On the contrary, the majority of ISDS claims filed in the US come from firms with fewer than 500 employees whose property has been expropriated without compensation and who used ISDS as a last resort[16].

The third main criticism of ISDS is that the proceedings, and in some instances even the outcomes, are often confidential. At the same time, they are funded by taxpayers’ money and sometimes relate to regulatory measures that can impact the wider public. Furthermore, the contents of FTAs, of which ISDS is a part, are also often negotiated, at least partially, in secret. This is mainly done to give negotiators time to finalise the agreement without domestic and international pressure. Once the agreement has been negotiated, the text becomes public and subject to domestic approval and ratification.

The secrecy surrounding FTA negotiations can cause concerns amongst domestic interest groups and the general public. The leaked chapters mentioning the ability of foreign investors to sue governments for large amounts of compensation funded by taxpayers’ money in trials conducted in virtual secrecy do not help. As a result, the need for increased transparency in ISDS cases has been discussed in various international forums.

 
Recent changes to ISDS

Both the EU and the members of the TPP have introduced a range of safeguards to the system, aiming to address the issues discussed above and limit instances of misuse of ISDS.

The evolution of the EU approach to investment protection was a response to the strong opposition to the TTIP negotiations. In March 2014, the European Commission commenced public consultations on ISDS and the TTIP. In July 2015, the European Parliament issued recommendations to the European Commission regarding the TTIP negotiations. It advocated setting up a new investment arbitration system with higher levels of transparency. Following on from that, in November 2015, the European Commission issued a proposal for an investment chapter under the TTIP that included the creation of a permanent bilateral Investment Court System (“ICS”) with a Tribunal of First Instance and an Appeal Tribunal[17]. The judges would be appointed for a fixed term by the Parties, subject to a code of conduct and prohibited from acting as counsel, expert or witness in any other investment protection dispute to ensure their independence.

Article 12 of the proposal sets the stage for establishing a multilateral investment tribunal and/or a multilateral appellate mechanism which would gradually replace the bilateral tribunals under TTIP and other EU’s bilateral agreements. This was also reflected in the Commission’s Trade for All communication published one month earlier than the November proposal. The document clarifies that the transition from the old ISDS provisions under existing bilateral FTAs to an Investment Court System will take place in parallel to “engaging with partners to build consensus for a fully-fledged, permanent International Investment Court”[18].

In addition to the ICS system, the November proposal introduces stricter conditions for submitting a case and further stresses the need for transparency of arbitration proceedings. It also provides for easier access to proceedings and faster processing of claims for SMEs.

In February 2016, the Commission and the Canadian Government agreed to include this new approach to investment protection in the revised text of CETA. The November 2015 proposal was also incorporated into the text of the EU-Vietnam FTA finalised in February 2016[19].

The TPP was signed in October 2015 by parties representing 40% of global trade. The text of the TPP agreement offered a more moderate departure from traditional ISDS provisions. The TPP excludes taxation measures from expropriation protection and allows respondent States to make a counterclaim in connection with the factual and legal basis of the claim.

Similar to the EU’s November proposal, the TPP requires full transparency in arbitral proceedings and restricts the ability of investors to lodge a parallel claim by requiring them to submit a claim waiver with an arbitration case. Both texts aim to prevent investors from using the mechanism to challenge legislation passed to protect legitimate public welfare objectives[20]. This is achieved by narrowing the definition of expropriation to the effect that regulatory actions applied to protect legitimate public welfare objectives, such as public health, safety and the environment, do not constitute expropriation and cannot be subject to an ISDS claim “except in rare circumstances”[21]. These circumstances however, are not clearly specified, leaving a loophole for potential claims. Finally, both texts include provisions for dismissal of unmeritorious claims. The respondent to an ISDS claim can file an objection stating that the claim is without legal merit or that the tribunal does not have jurisdiction over the claim. As such, both texts aim to limit the number of instances of unfounded claims being reviewed.

The TPP however, does not envisage a multilateral investment tribunal. Article 9.23 of the agreement states that if an appellate mechanism for reviewing investment disputes is developed under other institutional arrangements, the members will consider whether awards rendered under TPP should be subject to that appellate mechanism.

The response to the two texts was mixed. As the TPP does not introduce a new system of arbitration, the agreement was criticised for falling short[22]. While the EU Trade Commissioner, Cecilia Malmström, stated that the EU’s November proposal represents a modern approach to investment protection and dispute resolution, a number of groups, including some members of the European Parliament, continued to express strong criticism and voiced the opinion that ISDS should be removed completely from the TTIP and other FTAs[23]. Some suggested that the proposal is simply a “rebranding” effort for what at its core was still the old ISDS[24].  

 
The future of ISDS

ISDS has become a symbol and focal point of the criticism and fears surrounding FTAs and the influence of large corporations on national and international legislation. While there are a number of aspects of ISDS that could be improved, it is certainly not an imminent threat to the environment, public health and democracy, as some critics suggest[25]. This one-sided view held by a number of lobby groups has led to a strong response from the general public and continues to hinder the process of negotiating FTAs.

The opposition to ISDS diverts attention from other aspects of the negotiated agreements. For example, European and Canadian traders are still paying customs duties on a number of products eligible for preferential treatment under CETA and they are also encountering other non-tariff barriers to trade. The European Commission estimated that European traders could save up to EUR 470m a year in customs duties on industrial products alone – duties they have continued to pay since the agreement was initialled due to delays in signing of the agreement resulting mainly from opposition to ISDS[26].

ISDS is here to stay. Investment chapters under FTAs have become the main platform for international investment policymaking between developed economies, and dispute resolution mechanisms are needed to ensure fair and equitable treatment for all investors as well as to prevent treaty breaches.

At its core, ISDS is a mechanism that protects foreign investors. It contributes to a stable and predictable investment environment that supports economic growth and international trade. Yet, like any other trade policy instrument, ISDS can be used in a way that distorts its original purpose. For that reason appropriate safeguards should be introduced.

The TPP and the EU’s TTIP proposal offer a different perspective on how this could be done. While the TPP introduces new provisions within the existing ISDS structure, the EU seems to be moving in a different direction; towards a permanent international investment tribunal that would extend beyond any bilateral FTA. In August 2016 the Commission issued a proposal for a Council Decision authorising the Commission to negotiate a convention to establish a multilateral tribunal on investment on behalf of the EU.

Such tribunal would have a number of advantages foremost enabling the EU to gradually transition to a common investment dispute resolution policy. The EU Member States are currently parties to over 950 investment treaties which include ISDS provisions[27]. These agreements coexist with treaties signed by the EU which also include provisions on investment however, not all of these treaties set the same high standards with regards to dispute resolution. The Lisbon Treaty established the EU’s exclusive competence on foreign direct investment as part of the common commercial policy. Transitional arrangements were introduced under which the current BTIs were to remain in force until they were replaced by investment agreements of the Union allowing for a gradual formation of EU’s investment dispute resolution policy[28]. A multilateral tribunal would introduce a consistent and unified set of ISDS provisions on an EU-wide level that would replace those contained within the existing BTIs and FTAs. This would in turn lead to a more stable and predictable investment environment.

It remains to be seen how such tribunal would work in practice. For example, it is uncertain whether the tribunal would conflict with the jurisdiction of the EU courts.    

The ISDS provisions under the TPP and the revised approach to ISDS currently contained in CETA and the EU-Vietnam agreement may not fully eliminate all contentious issues but they demonstrate a step in a new direction and a much-welcomed attempt to address the three key points described above[29]. The wording of these safeguards may not necessarily be sufficient to prevent instances of misuse but it does provide a baseline that can, and should, be strengthened and periodically reviewed. The creation of a multilateral, permanent EU investment tribunal could ensure transparency of ISDS rules and consistency in terms of how ISDS cases are reviewed and handled. The public debate should therefore focus on how to implement the tribunal system in the EU and what types of safeguard are required within ISDS provisions in a broader context, rather than on whether or not ISDS should be included in previously negotiated FTAs. Excluding the provision from CETA, TTIP, TPP and other currently negotiated FTAs would not solve the problem: it would still leave the EU and other regions with the issue of coexisting treaties with often old-style ISDS provisions.  

Note: ​The views are those of the author and do not necessarily reflect the views of her employer

Notes

[1] This arbitration is subject to international law, notably the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention) and the United Nations Commission on International Trade Law (UNCITRAL) Arbitration Rules.

[2] Canada, France and Germany have all voiced their concerns over the clause. In September 2014, Germany’s Minister of Economy, Sigmar Gabriel, stated that his country would not approve the CETA agreement with ISDS.

[3] The EU Trade Chief Cecilia Malmström, June 2015 (POLITICO 2015).

[4] The independent tribunal was initially introduced within ISDS as a way to protect foreign investments in developing countries with a weak legal system.

[5] UNCTAD (2015).

[6] Hicks, G.N. and Miller, S. (2015). 

[7] For example, Article 1118 of NAFTA requires parties to attempt to settle the claim through consultation and negotiation. There is also a mandatory “cooling-off” period in most ISDS provisions.  

[8] Hicks, G.N. and Miller, S. (2015). 

[9] For example, the Office of the United States Trade Representative argues that over the past “25 years, under the 50 agreements the U.S. has which include ISDS, the United States has faced only 17 ISDS cases, 13 of which were brought to conclusion” while “during that same time period, the United States government was sued in U.S. courts hundreds of thousands of times – more than 1,000 of those for alleged takings” (Office of the United States Trade Representative 2015).   

[10] Hicks, G.N. and Miller, S. (2015). 

[11] In 2010, the company also filed a claim against Uruguay under the Uruguay-Switzerland BTI for increasing the size of health warnings on cigarette packages.

[12] However, the fact that the case has been dismissed based on procedural issues and not ruled in favour of Australia based on the substance of its legal arguments means that the tobacco industry’s legal battle against plain packaging continues. Marc Firestone, Philip Morris International senior vice president, commented that nothing in the decision “addresses, let alone validates, plain packaging in Australia or anywhere else” (The Guardian, 2015).

[13] Financial Times (2015a).

[14] Centurion Health v Canada case.

[15] For example, Annex B of the 2012 U.S. Model Bilateral Investment Treaty specifies that any action designed and applied to protect legitimate public welfare objectives, such

as public health, safety and the environment, does not constitute indirect expropriation.

[16] Hicks, G.N. and Miller, S. (2015). 

[17] The proposal was then circulated for consultation to the Member States and the European Parliament and finalised and discussed in the subsequent rounds of TTIP negotiations.

[18] The European Commission 2015b.

[19] The ICS is also included in the EU negotiations with China, Myanmar, Tunisia, Morocco, Japan, Philippines and Mexico, as well as planned negotiations with Indonesia, Australia, New Zealand and Chile.

[20] Under the Article 9.16 of the TPP and Article 2.1 of the November 2015 TTIP proposal.

[21] Under Article 3B of Annex 9-B of the TPP and Article 3 of Annex 1 of the EU November proposal.

[22] For example, by the International Institute for Sustainable Development.

[23] The campaign group Transport and Environment stated that, as a result of ISDS, “citizens will continue to unfairly shoulder private risks taken by foreign investors, while lawmakers will be deterred from regulating in the public interest” (The Parliament Magazine, 2015). The UK Trade Union Council Group rejected the proposal before it was published stating that it was “against any privileged access to justice, whatever it may be called” (Touch Stone, 2015).

Furthermore, in February 2016, a group of German judges objected to the new investment court as it would “create special courts for certain groups of litigants” and change the EU legal landscape (BBC 2015).    

[24] Corporate Europe Observatory (2016).

[25] For example, the Centre for International Environmental Law Press Room.

[26] The European Commission (2016).

[27] UNCTAD, Investment Policy Hub database.

[28] The European Parliament (2012).

[29] There have also been efforts to increase transparency of investment arbitration on a multilateral level; for example, the United Nations Commission on International Trade Law (UNCITRAL) Rules on Transparency and the Convention on Transparency in Treaty-Based Investor-State Arbitration