Realpolitik in ISDS Reform: Will the Commission’s Proposal get us Anywhere?

Things for the Investor-State Dispute Settlement (ISDS) mechanism are not looking good lately. The system has been strongly criticised by civil society and representatives of governments all over the world and this has resulted in different proposals for review or even significant transformation of the system.

The mechanism was established in the ‘60s as a response to calls by international investors for stronger protection of their investments in countries whose judicial system was deemed not fully independent from the government. Despite the mechanism was designed as a tool to be used by investors from developed countries as a protection in developing countries, cases against developed countries have been skyrocketing in recent years and even surpassed those against developing countries. As it is also being the case for commercial disputes, the increasing resort to the arbitration in the presence of a functional national court system seems to reflect the higher specialization of arbitrators and the fact that the system is often more flexible and rapid than a national court procedure.

“[ISDS] has become a lobbying tool where the very threat of litigation creates a regulatory chill which inhibits legislators pursuing legitimate public interest policies”  From an Opinion of the European Economic and Social Committee

However, the opponents to the ISDS mechanism claim that the system is becoming a lobbying tool through which multinational companies inhibit the governments’ ability to regulate in critical areas, such as environment and health. Often-cited examples, in this regard, are the two cases brought by Vattenfall against the German government and the Philip Morris’ case challenging the introduction of plain-tobacco packaging by the Australian government.

The mechanism is considered to be not transparent and the lacking effective judicial review. Moreover, the ad hoc tribunals procedure is also considered to produce inconsistent law. This is mainly to relate to the fact that the international arbitration system does not have the concept of legal precedent, as it is instead the case of national and international courts. This means that arbitrators are not bound by a previous decision by other tribunals. This becomes an even greater problem if it is considered that certain provisions in the investment treaties are often vague, as it is the case of the fair and equitable treatment (FET) provision. In one cases, the panel might, for example, decide to interpret the FET clause broadly as protecting the legitimate expectations of investors and, in a similar case, another panel might interpret the clause narrowly. This leaves significant space for inconsistent rulings.

Several countries have recently pledged to abolish investor-State arbitration or withdrawing from the International Centre for Settlement of Investment Disputes (ICSID). However, as of today, it seems that States are rather continuing to provide for ISDS in their treaties (see, for example, the inclusion of ISDS clause in TPP, despite it being a bitter pill for Australia to swallow), but opting for increasingly qualifying access to the mechanism. The countries are identifying various exceptions to treaty obligations and doing so with significantly different approaches, which make it hard to envision a multilateral solution to reform the system.

Let’s have a look at the two main proposals on the table today, which aim to end once and for all the ISDS debate: the American-led proposal under the Trans-Pacific Partnership and the European Commission proposal which was presented last week on the TTIP negotiations’ table.

The TPP investment chapter was released on November 5th. The agreement aims to set a new standard for IIAs by incorporating a number of provisions which respond to the main criticisms against the current investor-State arbitration system. These provisions aim to ensure the governments’ ability to regulate in areas of public welfare, financial regulation, environment and health – including with an explicit “tobacco exception” which prevents claims based on tobacco regulations.

The agreement foresees a series of safeguards such as binding joint interpretation by the parties; increased transparency by open the hearings to the public as well as public notices of arbitration, pleadings, submissions and awards; a limitation of investors access to the mechanism (e.g. with an expedited review of frivolous claims); an explicit limitation of remedies to monetary damages; the possibility of third parties intervention by filing amicus curiae submissions; the review of the awards by either domestic courts or international review panels; and consolidation of different arbitration proceedings to avoid parallel proceedings.

However, a major backtrack from a US policy perspective has been the lack of an appellate mechanism, to which post-2000 US IIAs have either required or strongly aspired. The presence of an appellate mechanism has been often advocated as an important tool to correct erroneous arbitral awards if necessary and to lead to a more consistent system by ensuring a uniform interpretation of a specific agreement. This would enhance the legal certainty and predictability of arbitral awards and put an end to cherry-picked interpretations of certain provisions.

The second major path of reform on the table today is the European Commission proposal of an Investment Court System, whose final text was released last week. The proposal comes after almost two years since the suspensions of TTIP negotiations on investment protection in order for the EC to solicit comments on how to address public concerns of the ISDS mechanism.

Important to notice in this regard, it is that the EU has exclusive competence on foreign direct investment only since the entering into force of the Lisbon Treaty in 2009 (Article 207 TFEU). Therefore, what we have today is a noodle bowl of the agreements on investment protection concluded bilaterally by individual Member States, which will be replaced by EU-wide investment agreements. The extent of the EU’s power in respect of foreign direct investment has been a controversial issue since 2009 and it is not clear yet how this competence stretches out. Several Member States argue that the powers ceded to the EU relate only to the admission of investments and to the narrow category of FDI. Under their interpretation, the type of portfolio investments and investment protection covered by Investment Treaties (including ISDS) does not fall within the term “FDI” and such issues would remain a shared competence, needing approval from both the EU and individual member states. This month a critical opinion of the European Court of Justice on the European Commission’s competence to enter into EU-Singapore FTA is expected to shed light on this issue. As for now, the EC is exercising its exclusive competence on investment by proposing an alternative ISDS mechanism.

The EC proposal aims to fundamentally transform the current arbitration tribunals into a court system. The new Investment Court System would be composed of a First Instance Tribunal and an Appeal Tribunal, with publicly appointed judges and with a limited and precisely defined scope. Building on the FTA negotiated with Canada (CETA) and with Singapore, the proposed system also covers a wide range of safeguards similar to those presented in TPP investment chapter. They include full transparency of all documents and hearings, a ban on forum shopping, government control of interpretation, a strict code of conduct for arbitrators, early dismissal of unfounded claims, a losers pays principle to avoid frivolous claims and a system to prevent parallel claims.

Last week, ECIPE has hosted an event on the realpolitik of ISDS with a broader discussion of the EC proposal. According to Prof. Steffen Hindelang, Associate Professor in Constitutional and Administrative Law at the Department of Law of Freie Universität Berlin, with its recent reform proposal, the EC has failed to put forward a fundamental justification for investment protection in EU agreements which can legitimately rebut the concerns, fears and critics associated with the current ISDS regime. Three points have been put forward by the professor: the proposed system does not solve the inherent bias of investment arbitration, it is not effectively accessible to SMEs and perpetuates the problematic relationship between the ISDS system and domestic courts.

In his first point, Prof. Hindelang has presented the evolution of the system of appointment of arbitrators. While in the Energy Charter Treaty (ECT) and in BITs signed by the Member States the arbitrators were freely appointed by the disputing parties, the CETA and EU-Singapore FTA have introduced freely established rosters of arbitrators designated by the parties, from which the arbitrators can be chosen by the parties. This change was put forward with the view to prevent arbitrators from being biased in favour of the party which is choosing them. In fact, as pointed out during the event, the ad hoc selection of the arbitrators has led, in some cases, to a significant pressure by the disputing parties.

The EC proposal goes a step further. Arbitrators would be substituted by judges with high technical and legal qualifications, which would be appointed by the Governments. The Investment Tribunal would be composed by 15 judges (five EU nationals, five US nationals and five nationals of third countries) and the disputes would be allocated randomly, so that the parties have no influence on which of the judges will be hearing a particular case.

Would this be enough to insulate judges from any real (or perceived) risk of bias? According to Prof. Hindelang, this won’t be enough. The judges would still be paid per diem (and are therefore still incentivized to relax case admission standards and prolong the proceedings) and could be biased to support a certain party as they can be appointed to sit as arbitrators in other tribunals outside TTIP. Furthermore, as pointed out by one of the participants, there is the risk of politicisation of the appointments – which is exactly what international arbitration is set to avoid.  

The solution? First of all, avoiding closed list of arbitrators (or judges) and rather support an increase in the number of qualified active arbitrators (or judges) in order to prevent the system to be shaped by few. Secondly, provide a fixed payment rather than per diem system of payment. Even if this might be seen as an unjustified use of taxpayers money (when, for example, only few cases are submitted to the court), the fact that the trustworthiness of the mechanism is at stake and that this mechanism involves claims up to billions of euros of taxpayers money seem enough to justify a fixed payment of the judges. This issue would be easier to address in case of an international Permanent Investment Court, for which the likelihood of judges being involved in cases will be higher.  

The second point raised by Prof. Hindelang relates to the cost associated with the use of the ISDS mechanism, which might be prohibitive for certain actors. SMEs often lack access to political and administrative channels of communication with the State hosting their investments, by which possible conflicts can be solved at an early stage. These actors are, therefore, not only more vulnerable to discrimination and unfair treatment, but also have less means to defend their rights than other companies.

It is therefore critical to ensure that the cost of investment arbitration makes the system accessible to them. The ECT and BITs signed by Member States (as well as any other international investment agreement) do not foresee any rule on cost allocation and any specific clause which makes the system for accessible for SMEs. The CETA and EU-Singapore have started to look into this issue by promoting specific rules on cost allocation as well as the possibility to submit claims to a sole arbitrator. However, the problem was not tackled sufficiently.

The latest version of the EC proposal suggests new means to support SMEs. In addition to the possibility to submit claims to a sole judge, it has been introduced a specific provision on voluntary mediation to solve the dispute amicably before the first formal steps of dispute settlement – this will be possible by establishing a small group of individuals that can quickly step as mediators. Moreover, procedural deadlines have been proposed (the overall proceedings cannot last more than two years) and a specific adjustment for SMEs under the losers pay principle, which would set a limit to the costs that the SMEs would be required to pay in case they lose a case.

These developments are all welcome. However, Prof. Hindelang proposes to go a step further by setting a special schedule of fees for counsel and arbitrators for small claims, which would depend of the amounts in the dispute. Colin Brown, Deputy Head of Unit for Dispute Settlement and Legal Aspects of Trade Policy at the European Commission Directorate-General for Trade, who provided his comments during the event, responded to this suggestion by arguing that this is seen as a step beyond what the EC is able to do. The EC considered that an FTA is not the right tool to regulate the fees of lawyers and arbitrators involved in the cases.

Finally, the third point raised by Prof. Hindelang concerns the coordination of well-functioning domestic courts with the ISDS mechanism. None of the previous investment agreements explicitly encourages the use of domestic remedies. The latest agreements and the proposal for TTIP text only introduce a waiver, by imposing to private companies the need to withdraw from any domestic proceeding that they have started before submitting a claim to the Investment Tribunal.

Prof. Hindelang argues that any accusation of granting privileges to a certain group of actors can only be avoided by cutting back investment law to the concept’s initial idea, which is to provide a safety net in case the primary means of redress available in the host state fail to prevent or remedy the abuse of sovereign power. A preference to domestic judicial systems which are functioning and effective could be given, for example, by introducing a referral to domestic courts as a precondition for access to ISDS.

The response by Colin Brown is that, first of all, it is hard to point out which countries have a trustworthy legal system and those which don’t. The EC certainly wants to avoid being in the awkward political position of having to grant a special status to certain countries, especially while it is negotiating an important investment agreement with China. The second point raised by the EU official is that the notion of the ISDS system interfering with the domestic legal system is not seen as a correct interpretation of reality. Arbitration tribunals to not apply national law and they are necessary to grant to investors a minimum level of investment protection, which national legal systems may actually fail to provide.  For example, the US domestic law does not encompass any provision that prevents discrimination against foreign investment.

Overall, Prof. Hindelang considers that, while the Commission’s approach in CETA and Singapore FTA was rather hesitant when it came to reforming the heavily criticized international investment law regime, its new proposal of an Investment Court System for TTIP appears somewhat over-eager. Not only that America’s appetite for just another international institution has hardly increased. The project appears to be more of a long term vision, at best. What he is suggesting, together with several researchers in a recent publication by the Free University Berlin and the Association of German Chambers of Commerce and Industry, it is a system which includes a combination of arbitral tribunals and a standing appellate mechanism.

My take-away from the discussion? The difficulty to find an agreement on how to best reform the system is well justified by the complexity of the challenge faced by policy makers today. However, given the magnitude of TTIP, we have to make sure not to waste a one time opportunity to influence the future shape of the international law regime as a all. The EU and US together cover 65% of global outward FDI stocks and 75% of the global number of known ISDS claims. They are therefore in the ideal position to set the basis for a modernized and legitimate ISDS system.

It remains to be seen how the discussion between the US and the EU will unfold in the light of the recent proposal. While the US has already issued some skeptical noises, it is in their negotiating mandate the requirement to establish an international appellate mechanism for investment. Therefore, TTIP might be seen as one step forward rather than an alternative to the system proposed in the Pacific rim.

In any case, any bilateral (or regional) solution will hardly make the trick given the globalized nature of investment today. Even though the proposal of the EC to set up a permanent International Investment Court might appear over-ambitious, the aspiration for a multilateral solution is well justified. Whether this should be achieved with a mixed solution of arbitral tribunals and a standing appellate mechanism or the establishment of a new multilateral institution or perhaps by opening up of the WTO dispute-settlement system to ISDS or by reforming of the current ICSID system, it remains open for discussion.