Investors vs. The State

By Doug Beazley
winter 2015-2016

Should trade deals like the TPP give foreign investors their own justice system to settle claims against states? Many say no – but can anyone agree on what should replace it?

It’s a system that has evolved to respond to the legal challenges inherent to the global trade environment. But as trade agreements continue to proliferate and take hold, the treaty process that manages conflicts between states and foreign investors is, after decades of operating as an obscure and largely confidential arrangement between lawyers, emerging as a global political flashpoint. Growing unease about the perceived flaws of investor-state dispute settlement, or ISDS, is now emboldening critics calling for reform.

Much of the current brawl started with the Trans-Pacific Partnership negotiations — and an advanced working draft of the trade agreement obtained by Wikileaks and published by the New York Times in early 2015. (The TPP negotiations ended in an agreement-in-principle in early October. A draft of the TPP agreement released by New Zealand in early November shows an ISDS system quite similar to those in other major trade deals, with three-person arbitral panels holding public hearings and delivering non-punitive monetary or restitution awards.)

The draft laid out the TPP’s approach to ISDS, a system by which foreign investors can sue states over government decisions that undermine their investments, through ad-hoc arbitration panels composed of lawyers — not judges. The working draft, dated Jan. 20, 2015, reflects the fact that negotiators expected the inclusion of ISDS to be controversial; the draft’s cover mandates that the ISDS chapter remain classified until four years after the TPP comes into force.

They expected controversy and they got it — from both directions. In Washington, prominent Democrats lined up to attack the ISDS provision as an assault on state sovereignty. “This continues the great American tradition of corporations writing trade agreements, sharing them with almost nobody, so often at the expense of consumers, public health and workers,” Senator Sherrod Brown of Ohio told the Times. Canadians were already talking about ISDS in connection with another trade deal – the Canada-Europe Comprehensive Economic and Trade Agreement – when the TPP draft was published. The NDP’s Tom Mulcair, then leader of the Official Opposition, told a French think-tank in late 2014 that the European Union should not enact CETA if it includes the ISDS mechanism. “Europe shouldn’t let itself be locked into an agreement that contains such a provision, especially since it’ll serve as the basis for an eventual agreement with the United States,” he said.

Opposition hasn’t been limited to the centre-left. The Cato Institute, an American libertarian think-tank, recently hosted a lively online debate about ISDS, with leading experts such as trade policy analyst Simon Lester arguing that the current ISDS model — with its one-sided emphasis on foreign investors suing states — amounts to a closed, fundamentally unfair system that favours the rights of investors over all others. “In international investment law, these rights are only provided to a limited group — that is, foreign investors — and under an uncertain and unpredictable quasi-judicial framework,” Lester wrote.

In Europe, ISDS is under attack not only from the usual suspects in the anti-globalization left, but from the right as well. Marine Le Pen, leader of France’s far-right National Front, ripped into the ISDS clause in the proposed EU-U.S. Transatlantic Trade and Investment Partnership (TTIP), calling it an attempt to “undermine the sovereignty of member states.” The Front’s ideological cousin in Great Britain, the UK Independence Party (UKIP), also wants nothing to do with ISDS: UKIP Member of the European Parliament Roger Helmer described the ISDS clause in the TTIP as “a private corporate-led arbitration court which would allow multinationals to sue states if their profits were challenged.”

“The notion of international law has always animated the extreme right in a negative way,” says Andrea Bjorklund, the L. Yves Fortier Chair in International Arbitration and International Commercial Law at McGill University. “But yes, these are some strange bedfellows.”

Conflicted views

It’s not hard to see why ISDS gets under people’s skin on both ends of the political bell curve. The system — as The Economist put it in a widely shared 2014 article — seems to many to have been designed “to convince the public that international trade agreements are a way to let multinational companies get rich at the expense of ordinary people.”

“There seems to be a pro-free-trade, conservative viewpoint out there now that sees ISDS provisions in trade treaties as dead weight,” says Gus Van Harten, an associate professor at Osgoode Hall Law School and one of the most prominent critics of ISDS in the world.

“ISDS is an interference in the marketplace. It displaces dispute settlement mechanisms in contracts. It’s an extremely costly process, so it gives an advantage to the wealthiest and largest foreign companies.”

ISDS clauses are written into more than 3,000 trade treaties worldwide; the TPP would vastly expand the ISDS reach to cover 12 nations, 800-million people and 40 per cent of global GDP. Under ISDS treaty clauses, a foreign investor has the right to sue the governments of countries in which it invests for arbitrary actions that void or limit its property rights. The decisions that emerge from the process cannot be used to overturn a state’s policy — but they can order a state to pay vast sums in compensation. In a single ISDS claim brought against Ecuador after it cancelled an oil-exploration contract with U.S.-based Occidental Petroleum, the state was ordered by an ISDS tribunal to pay $1.77-billion US in compensation — roughly what Ecuador spends on health services annually. In 2013, the multinational pharmaceutical maker Eli Lilly sued Canada under NAFTA’s ISDS chapter for $500-million, accusing Canadian courts of illegally striking down two of its patents. (Canada is fighting the claim.)

“I always tell my students not to think of ISDS as a system, because it’s not a system,” says Debra Steger, a law professor at the University of Ottawa who wrote a widely read 2012 paper on establishing an appellate mechanism for ISDS.

“The weird thing about international investment law is that nothing in it happened by design. It’s a field that grew up by accident since the explosion in new investment treaties in the 1990s. It was based on commercial arbitration, which was not designed. It all evolved through practice, and that’s really important to keep in mind.”

An ISDS claim is judged by an ad-hoc panel of arbitrators, usually three of them — one appointed by the investor, one by the state and the third by mutual consent. These arbitrators are lawyers, not judges. They don’t have to follow legal precedent and their decisions are not open to appeal — although there are limited grounds for annulling an award under the International Centre for Settlement of Investment Disputes Convention, or for setting aside an award under a UN convention.

ISDS arbitrators are not public servants; they work case-by-case and bill by the hour or day. Top firms engaging in ISDS work can make $3-$5-million on a single case, or even more — a factor that ISDS’s foes say encourages arbitrators to prolong cases. Arbitrators aren’t salaried or employed by any constitutional state that could guarantee security of tenure — making them, according to ISDS’s critics, vulnerable to pressure to issue rulings that favour one side or another. And because arbitrators are not judges, they don’t have to observe judicial strictures on conflict of interest: they can work both sides of the fence — sitting on an arbitration panel in one case, acting for a foreign investor in another — a situation critics say is ripe for abuse.

“If you’re acting as an arbitrator and as a lawyer on the side, you have the potential to issue a ruling that favours one of your clients,” says Van Harten. “That’s why we don’t let judges work as lawyers — it’s a clear conflict. The parties can challenge the appointment of a particular arbitrator but, right now, that is the only safeguard.”

The ISDS model is based on commercial arbitration, a procedure that puts a premium on confidentiality. Most ISDS awards are now made public but most of the supporting documentation is not (except in the case of NAFTA, which publicizes most ISDS documents — but only covers about 15 per cent of ISDS cases worldwide). That standard of confidentiality can prove embarrassing for states forced to pay out large sums on investor-state claims without being able to tell taxpayers exactly why.

It’s on the matter of disclosure that the ISDS model has seen its most significant reforms over the past two decades. In 2001 the NAFTA states issued an interpretive statement to the effect that nothing in the treaty prevents the member states from making arbitrations public; even opponents of ISDS admit Canada, the U.S. and Mexico have been pretty good about disclosure. In the 2001 Methanex case — which saw the Canadian maker of a gasoline additive banned in California file for compensation under NAFTA’s Chapter 11 — the arbitration panel opted for the first time ever to let an outside party, the International Institute for Sustainable Development, file an amicus brief, widening the tight circle of ISDS participants ever so slightly. The United Nations Commission on International Trade Law’s transparency rules, which came into effect in April 2014, provide for the publication of tribunal documents, transcripts and awards. They also allow for third-party statements and require that most hearings be public. But the new UNCITRAL rules don’t apply to new arbitrations launched under existing treaties (the TPP draft includes transparency rules mandating that documents be made available online and that tribunal hearings be open to the public). In late 2014 the UN General Assembly adopted the Mauritius Convention on Transparency, which allows adopting states to apply the UNCITRAL transparency rules to existing treaties; Canada is one of the nations that have adopted Mauritius.

Who is at a disadvantage now?

ISDS was conceived as a parallel legal stream to protect foreign investment in countries with shaky court systems, or where the line between the judicial and executive branches is blurry at best. So it’s attractive to countries like Canada that are highly dependent on the extractive sector: while a foreign manufacturer can always down tools and pull out of a country which refuses to respect its property rights, a resource company — a mining or a logging firm — has to go where the resources are.

“In some countries the courts aren’t necessarily equipped to protect a foreign investor’s legal rights,” says Bjorklund. “And there’s a more generalized concern about foreigners being at a disadvantage in a country’s courts because of bias against them. The argument is much less strong in countries with effective court systems. But even among the 28 members of the EU you have countries with very weak justice systems.”

And that is where ISDS’s supporters part company with many pro-trade conservatives. ISDS grew up in a very narrow context — one consisting mostly of North American and European investors operating in mostly non-Western nations, where the local justice systems weren’t considered experienced, honest or independent enough to protect outside money. But the trend in trade over the last two decades has been toward very large multi-nation treaties that put those same Western nations together under the ISDS umbrella; while foreign investors from small states might not have the resources to go after, say, the United States, a Japanese multinational certainly would. “[The United States Trade Representative] will say the U.S. has never lost a case, but you’re going to see a lot more challenges in the future,” Senator Brown told The Times. “There is a huge pot of gold at the end of the rainbow for these companies.”

“It’s a scary thing for governments to face, and you’re seeing a political backlash now,” says Louise Barrington, a chartered international arbitrator who splits her time between Toronto and Hong Kong.

“Once one’s own country gets burned by an ISDS award, one tends to pay more attention. When it was just Americans, Canadians or Europeans going into, say, Nepal with investments, few people in those countries noticed — not until the tables were turned.”

In other words, the “political backlash” against ISDS is really about national sovereignty — about whether investor-state arbitration rulings have the power to undermine or reverse decisions made by sovereign governments. ISDS tribunals don’t have the power to order a state to overturn or modify a law or regulation — but the vast sums of money involved could convince a government to back down, especially if the parties reach a settlement before a ruling is issued.

“Yes, there could be a knock-on effect from an ISDS award to an investor. The nation involved might think twice about such a policy initiative in the future,” said Bjorklund. “But remember — investors lose more than half of the cases they bring through ISDS.”

As proof that ISDS cases have the potential to change government policy, critics often cite Germany’s 2011 move to settle a 1.4-billion Euro claim by the Swedish energy company Vattenfall over the government’s decision to impose strict water use restrictions on a coal-fired power plant the company was planning to build; Germany subsequently withdrew the restrictions. More infamous still is the still-unsettled case of cigarette maker Philip Morris, which is taking the United Kingdom to court over its move to impose “plain packaging” as a health measure and already has launched a challenge of Australia’s plain-packaging law under an Australia-Hong Kong investment treaty.

The Philip Morris case is also cited as a prime example of another flaw in ISDS — so-called “treaty shopping,” where an investor reorganizes its corporate structure in order to exploit an ISDS clause in a bilateral treaty. Australia has accused Philip Morris of shifting its regional headquarters to Hong Kong to take advantage of the treaty.

At the same time, proponents of the trade deal point to provisions that recognize the right of governments to pass laws in the public interest, namely in environmental and public health matters.

No precedent

But many critics say the real problem with ISDS isn’t the potential for conflict of interest, or the risk that states might make policy decisions based on the threat of a successful claim — it’s the fact the ISDS system isn’t designed to fix its own mistakes.

In an ordinary court of law, judges are expected to follow precedent and their rulings are subject to appeal — two factors that are supposed to ensure that the law is applied consistently and without bias. ISDS doesn’t work that way; its annulment mechanism is based on procedure, not law, so it’s not meant to correct errors in law. In a sense, lack of consistency is a design feature of ISDS: as Bjorklund points out, imposing precedent and appeals on the ISDS process might be seen by state parties to investment treaties as a constraint on their sovereign right to enter into those treaties.

Some argue that this design feature undermines ISDS’s reason for existing in the first place.

“The whole point of treaties is to secure some level of certainty and predictability in the way nations deal with each other,” says Steger. “International investment law is completely fragmented, which is why you see very different rulings on cases that have very similar facts. I know of three separate ISDS tribunals that issued rulings against Mexico for three different companies — the cases were all very similar, but the rulings were all different. And that’s under just one treaty.

“So yes, it’s a bit of a crapshoot. That lack of certainty, of consistency, in the outcomes is not a good thing for government or business planning.”

A better ISDS regime?

What all of these criticisms boil down to is this: the ISDS model is now deeply controversial in the capitals of the West. Negotiations on the European Union’s proposed trade and investment deal with the United States — the Transatlantic Trade and Investment Partnership — had bogged down on multiple fronts by late September, but it was widespread European hostility towards ISDS that threatened to kill the deal entirely. In July, the European Parliament voted to support the TTIP on the condition that ISDS is replaced with something closer to a conventional court system.

“There has been, and is, a fundamental lack of trust by the public in the fairness and impartiality of the old traditional ISDS model,” European Commission Trade Commissioner Cecilia Malmström told journalists in September as she was announcing the EC’s pitch for a replacement system: an international investor-state dispute settlement court.

The proposed court, or Investment Court System, would employ 15 independent judges appointed publicly by the European Union, the U.S. and a third country, thus addressing the problems of conflict and independence inherent in ISDS. The ICS would hold open hearings. It would have an appellate level with six judges — meaning it would be able to correct errors in rulings and follow precedent. The ICS proposal would ban treaty-shopping (although it’s not clear how), limit and define the types of discriminatory state behaviour that could trigger a claim by a foreign investor, and explicitly affirm the right of states to regulate for the public good.

In short, the ICS model is an attempt at compromise — and like all such attempts, it isn’t making anyone particularly happy. Those in the arbitration sector question the need for a new bureaucratic body at the international level — with the threat of politicization and deadlock that implies.

“I think this could end up being like the United Nations — an institution that looks great on paper but which gets captured by political interests,” says Martin Valasek of Norton Rose Fulbright in Montreal, who works in arbitration. “There is a risk that judges appointed to this court would feel obliged to represent the interests of the nations that appointed them.

“And what happens if we get an international court of appeal for investment and it makes a bad decision? You have to live with it. ISDS is flexible, it’s a blank slate because it isn’t strictly bound to precedent.”

Barrington sees a potential problem with credibility: “Many states with developing economies feel the arbitration system is already weighted in favour of the West. Imagine how they would react to a group of old guys making these decisions in some Western capital.”

Bjorklund sees practical problems — starting with the fact that the proposed ICS is only intended to apply to the TTIP and possibly future treaties. “Would every treaty go through a single appellate body, or just one appellate body per treaty? Would such a body not violate the sovereign right of states to enter into treaties? The idea of a single international investment treaty looks like pie in the sky at this point.

“If you want to eliminate the risk of conflicts of interest, you’re going to have to pay arbitrators a salary so they’re not tempted to take other jobs. Who’s going to pay for it?”

Van Harten says that while the ICS model would solve some of the problems with ISDS, it wouldn’t address the main one: the fact that foreign investors have access to a justice system all of their own, exclusively devoted to investor claims against states.

“Imagine a Charter of Rights that only protected multinational companies and wealthy foreigners, based on uncapped orders of compensation,” he says.

Still, if governments are serious about reforming the way investor-state disputes are settled (and assuming they don’t want to go back to the bad old days of gunboat diplomacy) some sort of international body is probably the way to go. Reconciling it with 3,000-plus separate trade treaties — that’s going to be the tricky part.

“Unless we start thinking about this stuff now, how are we ever going to get out from under this ad-hoc process that nobody seems to be very happy with?” says Steger. “I don’t mean the arbitrators themselves — they’re lobbying tooth and nail to keep things as they are.

“There is a policy purpose to these treaties, and ISDS can be reformed. The whole reason for ISDS in the first place was that foreign investors cannot sue in domestic courts for the remedies ISDS provides. We don’t need to throw the baby out with the bathwater.”

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