Investor–state dispute settlement

Overview

Investor–state dispute settlement (ISDS), or an investment court system (ICS), is a set of rules through which states (sovereign nations) can be sued by foreign investors for certain state actions affecting the foreign direct investments (FDI) of that investor. This most often takes the form of international arbitration between the foreign investor and the state. As of June 2024, over US$113 billion has been paid by states to investors under ISDS, the vast majority of the money going to fossil fuel interests. ISDS most often is an instrument of public international law, granting private parties (the foreign investors) the right to sue a state in a forum other than that state's domestic courts. Investors are granted this right through international investment agreements between the investor's home state and the host state. Such agreements can be found in bilateral investment treaties (BITs), international trade treaties such as the 2019 United States–Mexico–Canada Agreement, or other treaties like the 1991 Energy Charter Treaty. To be allowed to bring an investor-state dispute before an arbitral tribunal, both the home state of the investor and the state where the investment was made must have agreed to ISDS, the investor from one state must have an investment in a foreign state and the foreign investor must put forward that the state has violated one or more of the rights granted to the investor under a certain treaty or agreement. ISDS claims are often brought under the rules of the International Centre for Settlement of Investment Disputes (ICSID) of the World Bank, the London Court of International Arbitration (LCIA), the International Chamber of Commerce (ICC), the Hong Kong International Arbitration Centre (HKIAC), or the United Nations Commission on International Trade Law (UNCITRAL). The ISDS system has been criticized for its perceived failures, including investor bias, inconsistent or inaccurate rulings, high damage awards, and high costs, and there have been widespread calls for reform. Since 2015, the European Union has been seeking to create a multilateral investment court to replace investor-state arbitration. Since 2017, multilateral negotiations for reform have been taking place in Working Group III of the United Nations Commission on International Trade Law.

Historical development

Hartley Shawcross and Hermann Josef Abs advocated for the creation of an international investor–state dispute settlement system after World War II. Abs saw it as a solution to unwanted nationalisations by states. The Treaty between the Federal Republic of Germany and Pakistan for the Promotion and Protection of Investments was concluded in 1959 and was the first investment protection treaty under international law. Under customary international law, an investor-state can vindicate injury caused by the host state by exercising diplomatic protection, which may include retorsion and/or reprisals. In addition to diplomatic protection, states can and do establish ad hoc commissions and arbitral tribunals to adjudicate claims involving treatment of foreign nationals and their property by the host state ("state-state-dispute-settlement" or SSDS), which can help avoid coercive resolutions and protect against reneging. Notable examples of this practice are the Jay Treaty commissions, the Iran–United States Claims Tribunal and the American-Mexican Claims Commission. However, these treaties were limited to the treatment of foreign investors during a past period of time, whereas modern ISDS allows investors to make claims against states in general and on a prospective basis.

Modern practice

As of 2024, the legal protection of foreign direct investment under public international law is guaranteed by a network of more than 2,750 bilateral investment treaties (BITs), multilateral investment treaties, such as the Energy Charter Treaty, and free trade agreements, such as the North American Free Trade Agreement (NAFTA). Most of these treaties were signed in the late 1980s and early 1990s before the increase of investor claims under the treaties began in the late 1990s. The majority of the treaties provide foreign investors with substantive legal protection (including the right to "fair and equitable treatment", "full protection and security", "free transfer of means" and the right not to be directly or indirectly expropriated without full compensation) and access to ISDS for redress against host states for breaches of such protection. Some of these protections are framed in vague terms and give extensive discretion to arbitrators for their interpretation and application. The overall number of ISDS cases reached 500 in 2012. Of these, 244 were concluded, of which 42% were decided in favor of the host state, 31% in favor of the investor, and 27% settled out of court.

Foreign investors can sue states under investment treaties, but states cannot sue foreign investors, because only states are the parties to the treaty, and therefore only states can be held liable to pay damages for breach of the treaty. Thus, a decision in favor of the state means that the state does not pay compensation, not that it will receive compensation from the investor (although litigation costs can be awarded against the investor). A state that wishes to sue a foreign investor does so through the state's domestic courts. Unlike the World Trade Organization, ISDS cannot overturn local laws which violate trade agreements, but the ISDS can grant monetary damages to investors adversely affected by such laws. According to the Office of the United States Trade Representative, ISDS requires specific treaty violations and does not allow corporations to sue solely for lost profits. Critics state that some treaties are written so that any legislation causing lost profits is by definition a treaty violation, rendering the argument null that only treaty violations are subject to ISDS. Critics also state that government violations may be difficult to foresee, and the threat of exorbitant fines may cause a chilling effect which halts regulation or legislation in the public interest (e.g. human health and environmental protection).

NAFTA Chapter 11

An example of ISDS is NAFTA Chapter 11. NAFTA went into effect in 1994 between the parties of Canada, Mexico, and the United States. Chapter 11 allows investors of one party to bring claims against another party before an international arbitral tribunal. NAFTA Chapter 11 was the first instance of an ISDS provision receiving widespread public attention, especially in the United States in the wake of the Methanex case.

Transatlantic Trade and Investment Partnership

Resistance from European Union to the US proposal to include an ISDS clause in the draft Transatlantic Trade and Investment Partnership (TTIP) treaty caused this clause to be removed from the draft treaty in September 2015. In its place, the European Commission proposed an investment court system (ICS). Not long afterwards, ICS was declared illegal by the German Association of Magistrates, though the Commission dismissed the magistrates' judgement as based on a misunderstanding. As of February 2016, the US wants an ISDS clause reinstated. According to a 2019 study, ISDS is the single most important factor motivating opposition to TTIP among Germans.

Local remedies

Because NAFTA Chapter 11 Article 1121 waives the 'local remedies' rule, investors are not required to exhaust local remedies before filing Chapter 11 claims. While this fact has been criticized, proponents of ISDS assert that speedy dispute resolution through ISDS is critical in modern economic environments and would be not possible if local remedies needed to be exhausted first. Critics argue that all other situations in international law require a private party to first show that the state's domestic courts are unreliable before the private party can sue the state. Factors in the growth of investment treaty claims since the late 1990s may have been the removal of duty to exhaust local remedies, as well as the growth in the number of bilateral free trade agreements since the breakdown of the multilateral WTO Doha round in the mid-2000s.

Regulatory capacity

Much debate and criticism has arisen concerning the impact of ISDS on the capacity of governments to implement reforms and legislative programs related to public health, environmental protection, and human rights. In July 2023, David R. Boyd, the United Nations Special Rapporteur on human rights and the environment, found compelling evidence that ISDS has had a chilling effect on governments' ability to enact essential regulations to address the environmental crisis and the human rights crisis. Other critics argue that ISDS threatens democracy and the rule of law, in part because investor state claims (or the threat of them) inhibit the ability of domestic governments to pass legislation addressing public concerns, such as health and environmental protection, labor rights or human rights. For climate, Global ISDS Tracker reports that the $80 billion awarded to fossil fuel firms exceeds the total climate finance provided by developed countries for developing countries. Proponents of ISDS argue that governments retain their regulatory ability if the agreements in question specify that regulations protecting health, the environment, labor rights, and human rights are allowed. The International Bar Association (IBA) states that "while investment treaties limit states' ability to inflict arbitrary or discriminatory treatment, they do not limit (and, in fact, expressly safeguard) a state's sovereign right to regulate in the public interest in a fair, reasonable, and non-discriminatory manner." The Office of the United States Trade Representative similarly states that "ISDS does nothing that takes away the sovereign ability of governments [to] impose any measure they wish to protect labor rights, the environment, or other issues of public welfare." The White House notes that investment protections are a component of more than 3,000 trade agreements, the vast majority of which have some form of neutral arbitration. As of February 2015, the United States is party to at least 50 such agreements, has only faced 13 ISDS cases and has never lost an ISDS case. In a February 2016 op-ed against the Trans-Pacific Partnership (TPP), U.S. Senator Elizabeth Warren used the example of a French company suing Egypt because Egypt raised its minimum wage, as an argument against the ISDS provisions of the TPP. The editorial board of The Washington Post noted that "Veolia of France, a waste management company, invoked ISDS to enforce a contract with the government of Alexandria, Egypt, that it says required compensation if costs increased; the company maintains that the wage increases triggered this provision. The case — which would result, at most, in a monetary award to Veolia, not the overthrow of the minimum wage — remains in litigation." According to the International Bar Association (IBA), as of June 2017, states have won a higher percentage of ISDS cases than investors, and that around one-third of all cases end in settlement. Claimant investors, when successful, recover on average less than half of the amounts claimed. IBA notes that "only 8 per cent of ISDS proceedings are commenced by very large multinational corporations." IBA challenges the notion that ISDS is biased against developing countries, noting that there is "no correlation between the success rates of claims against states and their income levels or development status". IBA notes that ISDS is necessary even in countries with sophisticated domestic legal systems because those domestic courts rule according to domestic laws, not international law. IBA notes that "increasingly, awards require the losing party to pay arbitration costs and legal fees to the winning party", which deters investors from initiating unmeritorious cases. A 2017 study found that the success rate of investors in investor-state disputes has sharply fallen over time because most legal challenges today seek compensation for regulation implemented by democracies, not expropriation by non-democracies. The author of the study argues that the likely goal of investors is not to obtain compensation through ISDS, but to impose costs on governments contemplating regulations and therefore deter the regulatory ambitions of governments. A 2019 study shows that ISDS clauses consistently sparks significant public opposition to treaties. This trend is observed irrespective of individuals' various characteristics, such as their skill levels, access to information, and national sentiments, which are typically considered crucial factors influencing trade attitudes.

Social movements and local populations

In 117 ISDS cases, the foreign corporate activity, for example, fossil fuel drilling or other mineral extraction, was protested by a social movement or the local community affected. The foreign corporations often initiate litigation under ISDS to fight back against putting a halt to the activities.

Economic impact

The Peterson Institute for International Economics (PIIE) claimed in 2015 that ISDS provisions are necessary, as they boost investment: "empirical evidence has shown that treaties including these provisions have a positive effect on foreign direct investment (FDI) flows between signatory countries." On the other hand, Hallward-Driemeier (2003) analyzed the impact of Bilateral Investment Treaties (BITs) and, after conducting several tests with different dependent variables – absolute amount of FDI, the ratio of FDI to host country's gross domestic product (GDP) and the share of host country's FDI in total FDI outflows of a home country – concluded that BITs do not serve to attract additional FDI. Additionally, Emma Aisbett (2007) found "no evidence for the claim that BITs signal a safe investment climate". Yackee (2007) also concluded that "the apparently positive effect of BITs on FDI largely (and in some cases entirely) falls from significance", which is consistent with empirical findings that "potential investors seem to have little awareness or appreciation of specific BITs". The impact of FDI on the GDP of developing economies is, itself, a matter of research. While some research (Olofsdotter, 1998; Reisen and Soto, 2001) finds a positive impact on developing countries, other authors (Mencinger, 2003; Carkovic and Levine, 2005; Johnson, 2006; Türkcan, Duman, and Yetkiner, 2008; Herzer, 2012) find a negative impact, and some (De Mello, 1999) find the data to be inconclusive. A fourth conclusion was proposed by others (Alfaro et al., 2004; Li and Liu, 2005; Batten and Vo, 2009): FDI may have a positive or negative impact on the GDP of developing economies depending on the existence of adequate policies to "filter" speculative or predatory investment. Thus, opponents of ISDS warn that these systems may harm the government's ability to filter FDI more favorable to development, and therefore harm GDP. The Cato Institute warns that the creation of a two-tier justice system, by which foreign investors are subject to a set of rules different from domestic investors, apart from being contrary to the principle of the Rule of Law, is itself a market distortion prone to inefficiencies that are bound to harm GDP. Finally, opponents of ISDS also argue that these systems increase inequalities, harm public services, threaten labor and consumer protections, threaten financial stability and the environment, all of which have significant economic consequences.

Conflicts of Interests

PIIE challenges the claim that ISDS "arbitrators lack integrity", noting that arbitrators take an oath of impartiality and both sides of a case choose arbitrators. Critics argue that, in addition to the system lacking safeguards regarding individual abuse, the most important problem is systemic. These critics note that arbitrators are paid on a case-by-case basis, and therefore they are personally benefited by an increase in claims. Because governments may not use the ISDS system to sue investors, if arbitrators have any bias toward investors, this will encourage further claims and the arbitrators will personally benefit financially. The vague terms of most BITs allow this kind of bias regarding the interpretation of treaties by arbitrators. This bias, fueled by the conflict of interest in the core of the system (that need not assume any lack of integrity on a personal level on the arbitrators side, but solely the cognitive difficulty in overcoming a bias when one's personal interest is at stake) may help explain the significant growth in the number of ISDS cases in the 2000s and 2010s.

Transparency

Opponents of ISDS argue that arbitrations are sometimes carried out in secret by trade lawyers who do not enjoy the typical safeguards of judicial independence and procedural fairness, who earn income only if a case is brought and proceeds, and who are not accountable to the public or required to take into account broader constitutional and international law human rights norms. PIIE agrees "that secrecy has gone too far" in many ISDS cases, but notes that agreements such as the Trans-Pacific Partnership did ensure greater transparency in ISDS. Proponents of ISDS point out that confidentiality is a standard feature of all arbitration and one that enables a constructive, de-politicized and fact-oriented atmosphere of dispute resolution. On the other hand, such traditional confidentiality is limited to disputes that affect the parties in question and not the broader public. Also, most ICSID awards, although confidential, are de facto published by consent of the parties. However, many awards under other arbitration rules are not public and, in the case of investor-arbitration at the ICC, there is a requirement for blanket confidentiality for all aspects of a case. It is further pointed out that judges are not elected in most countries outside the US, so that "public accountability of judges" may not be considered a standard of public international law. In any event, they say, the qualification of ISDS arbitrators matches or exceeds the qualification of most court judges. In response, critics make the point that any judge, whether domestic or international, who is part of a legal system not shown to be systematically biased or unreliable, has a greater claim to independence than an arbitrator because they are insulated from conflicts of interest that arise when arbitrators work on the side as lawyers, and is assigned cases in an objective manner rather than by the discretion of a disputing party or an executive official. Arbitrators are appointed by both parties at dispute, so such conflicts of interest may arise on both sides. While ISDS has traditionally been confidential as any other arbitration, the general trend in the last decade has been to allow for more openness and transparency. On the other hand, there is still widespread confidentiality in the system. Under Art. 29 of the U.S. Model-BIT of 2004, all documents pertaining to ISDS have to be made public and amicus curiae briefs are allowed. However, no investment treaty allows other parties who have an interest in the dispute, other than the claimant investor and respondent government, to obtain standing in the adjudicative process. Under the Trans-Pacific Strategic Economic Partnership, the tribunals shall, subject to the consent of the disputing parties, conduct hearings open to the public. The tribunal will make available to the public documents relating to the dispute such as the notice of intent, the notice of arbitration, pleadings, memorials, minutes or transcripts of the hearings of the tribunal, where available; orders, awards and decisions of the tribunal. In addition, third parties can and increasingly do participate in investor-state arbitration by submitting amicus curiae petitions. The World Bank's International Centre for the Settlement of Investment Disputes (ICSID) is required by ICSID Administrative and Financial Regulation 22 to make public, information on the registration of all requests for arbitration and to indicate in due course the date and method of the termination of each proceeding. It also publishes the vast majority of awards with the consent of the parties. If the parties do not consent, ICSID publishes excerpts showing the tribunal's reasoning. The ICSID website has published awards for most completed arbitrations, and decisions in investor-state arbitrations outside of ICSID are also publicly available online. On 1 April 2014, the UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration entered into force. Article 3 foresees a general duty to publish all documents pertaining to an ISDS-procedure under UNCITRAL Rules, where the treaty establishing the ISDS-mechanism has been concluded after 1 April 2014 or where the parties so consent, subject to certain overwhelming confidentiality interests listed in Article 7. Original proposals to make all UNCITRAL arbitration under investment treaties public were not adopted after opposition by some states and by representatives of the arbitration industry who participated in the UNCITRAL working group negotiations as state representatives. On 17 March 2015, the United Nations Convention on Transparency in Treaty-based Investor-State Arbitration ('Mauritius Convention') was opened for signatures in Port Louis, Mauritius. The Mauritius Convention will render the UNCITRAL Rules on Transparency in Treaty-based Investor State Arbitration also applicable to disputes arising out of investment treaties that were concluded prior to 1 April 2014 if both parties to the investment treaty are also party to the Mauritius Convention. The convention has not yet entered into force since the three required ratifications have not yet been submitted. 10 States have signed the Mauritius Convention so far.

Reciprocity

Development under the draft Pan-African Investment Code, envisaged strengthening the role of defending states by allowing them to initiate counter-claims against investors. A counter-claim may be a way of rebalancing investment law, by allowing states to file claims against investors, as a means to sanction investor misconduct.