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Article: July 2015: International Arbitration Update

July 01, 2015
Business Litigation Reports

ISDS Arbitration Provisions—Worth the Investment. Trade agreements have always been the subject of intense public dialogue, so it should come as no surprise that negotiations over the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership have sparked strong opinions from public figures and citizens around the world. What is unique to the debate over these agreements is the intense focus on the technical subject of investment arbitration. Both treaties provide Investor-State Dispute Settlement systems (“ISDS”), international arbitration systems that allow private investors to enforce treaty obligations against a country that has failed to honor the substantive protections afforded to investors in the investment treaties. Although ISDS have long been a common feature in bilateral and multilateral investment treaties, in recent years the concern that these provisions may undermine governmental sovereignty and impede public interest regulations has increased, primarily because of perceived examples of abuse. But despite these criticisms, ISDS remain an efficient, useful, and fair mechanism for encouraging foreign investment and protecting the rights of foreign investors.

ISDS: Promoting the Rule of Law, and Investment. Before the 1960s, international law provided no direct remedy for foreign investors who were the targets of government takings, which was a relatively common occurrence at the time. When investors had grievances associated with measures implemented by a foreign government that negatively affected their investments, they had to seek the assistance of their “home” governments to advocate on their behalf and seek redress from the foreign government. This process was cumbersome and often ran into political and diplomatic obstacles. As a result, governments began to enter into investment agreements to establish binding rules that would govern the treatment of cross-border investors. These rules were specifically designed to encourage investment flows by protecting the property and other rights of foreign investors from nativist policies and expropriation. Today, these agreements typically require signatories to ensure fair and equitable treatment of foreign investments, promptly reimburse investors in the event of an expropriation of their investment, provide non-discriminatory treatment, and participate in neutral, international arbitration of disputes that may arise for alleged breaches of the protections afforded by each country to foreign investors within the investment treaties.

ISDS offer a unique form of dispute resolution. Under the traditional trade agreements that existed before ISDS, treaty violations were addressed through state-to-state dispute resolution procedures; relief usually was prospective and individual investors rarely received compensation. In contrast, ISDS permit foreign investors to bring claims directly against host governments and receive monetary compensation for past wrongs. This ability to bring individual actions ensures that investors are made whole without being subject to the whims of the international political system.

By providing this protection, ISDS encourage companies to take advantage of economic opportunities around the world, giving them the comfort that should a foreign government act to impinge on their rights as investors in a way that violates the subject treaties, they will have a neutral forum that will address their grievances. Such treaties are particularly important in countries with weak legal systems and a history of expropriation, such as Argentina and Venezuela, two of the most frequent ISDS respondents. But even in countries with more efficient judicial systems, investment agreements still provide important remedies that would otherwise be absent for foreign investors. In a recent survey of senior corporate decision makers, 20 percent responded that they would not invest in a foreign country without the protection of an investment treaty and 60 percent considered the treaties to be a “very important” factor in their investment decisions.

The Potential Threat to the Regulatory System. Investment agreements in general, and ISDS in particular, are not without their critics. Investment agreements have risen in prominence since the 1990s, and today there are approximately 3,268 such agreements in force around the world. As the level of foreign investment has increased, the number of disputes also have risen. The outcomes of some of these disputes have lead to intense scrutiny of the trade-offs that governments are required to make by agreeing to ISDS.

A primary concerns is that ISDS might allow opportunistic corporations to intimidate governments into repealing democratically-enacted laws, or to prevent them from enacting laws that they believe might be challenged in an ISDS proceeding. Though ISDS do not permit arbitrators to enjoin governmental regulations, critics contend that corporations can threaten governments with billion-dollar claims, forcing those governments to either repeal targeted laws or face massive expenditures of taxpayer dollars in defending them. An oft-cited example of this potential threat is Philip Morris Asia’s challenge, brought in an ISDS proceeding under the 1993 Agreement between the Government of Australia and the Government of Hong Kong for the Promotion and Protection of Investments, to Australia’s regulation of cigarette packing pursuant to the Tobacco Plain Packaging Act of 2011. Philip Morris Asia claims that Australia’s regulation of cigarette packaging constitutes an expropriation of its Australian investments.  Critics cite Philip Morris Asia’s claim as an example of a corporation using an ISDS arbitration provision as leverage to pursue profits at the expense of the government’s ability to regulate corporate activity for the sake of human health and safety (in this case, by requiring tobacco companies to take specific measures with respect to packaging— including minimizing branding and maximizing warning labels—in order to warn smokers of the health risks inherent in smoking cigarettes and otherwise to dissuade smokers from purchasing cigarettes).  Philip Morris Asia’s claim originally was filed in 2011 but have not yet proceeded to a merits hearing before the panel. Critics contend that the structure of ISDS will exacerbate these kinds of regulatory challenges. Compared to most judicial systems, there is a perceived lack of transparency in investment arbitrations and the awards themselves are subject to very limited review. As a result of such concerns, many public figures have called for the dissolution of existing ISDS provisions and the elimination of ISDS from proposed trade agreements. Such requests are short-sighted. There are ample protections built into the ISDS procedures for the selection and appointment of arbitrators, including mechanisms for challenging arbitrators who lack independence and impartiality. Eliminating ISDS from investment and trade agreements, as some have urged, would be harmful, as the present ISDS system, generally speaking, works well.

The Path Forward. Eliminating ISDS would be a drastic step and would undermine foreign investment. While some critics have voiced legitimate concerns, the history of ISDS indicates that these concerns are largely exaggerated. Since the first Bilateral Investment Treaty was concluded in 1959, countries have not been stymied in their efforts to improve public welfare through regulation. Indeed, over 90 percent of all Bilateral Investment Treaties currently in force have never led to a single dispute. Moreover, there is no indication that ISDS arbitrations suffer from systemic bias. In disputes that actually reach a decision, investors prevail only one-third of the time. And there is strong evidence that, by providing a forum for foreign investors to protect their property rights, ISDS play an important role in encouraging foreign investment.

Conclusion. Investment agreements, and ISDS in particular, are important sources of protection for foreign investment. These agreements and dispute settlement procedures provide foreign investors with basic tools to protect their foreign investments from state abuse and establish arbitration systems that help depoliticize disputes and ensure that treaty violations can be remedied. Critics should bear in mind that ISDS have operated successfully for decades and have lead to economic growth and greater respect for the rule of law. Thus, concerns that ISDS may inhibit governments from enacting legislation for the public good must be balanced against the public good that the provisions create. Debate over ISDS is healthy, to be sure, but the debate should focus on how to improve ISDS rather than whether they should be thrown out altogether because of a few perceived examples of abuse.