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Focus: A different roadmap for investor–state dispute settlement?

23 July 2013

In brief: The United Nations Conference on Trade and Development has identified key shortcomings of the current system of investor–state dispute settlement, and has outlined five broad paths for reform in a recent report. The negotiation and implementation of these reforms will affect foreign investors and policymakers globally. Partner Rachel Nicolson (view CV), Senior Associate Hilary Birks and Lawyer Laura Bellamy report.

How does it affect you?

  • Companies investing in foreign jurisdictions are subject to a diverse and overlapping range of international investment agreements.
  • The content and function of these agreements will change to adapt to new investment issues.
  • Countries, including Australia, are already changing their approach to investor–state dispute settlement.
  • Proposals for reform, if implemented, could significantly affect the investor–state dispute settlement landscape and the process for the resolution of such disputes.
  • Interested parties should remain aware of developments and consider scope for their involvement in discussions on reform and related initiatives.

Background

Each year, the United Nations Conference on Trade and Development (UNCTAD) publishes the World Investment Report, a review of investment flows, policy and trends over the past year. This year, the report1 devoted significant attention to the need for fundamental reform of investor–state dispute settlement (ISDS) in order for the international investment regime to be effective and responsive to the needs of governments and investors. UNCTAD has published an issues paper setting out five broad paths to reform (IIA Issues Note).2

With the rapid proliferation of bilateral investment treaties (BITs) and other international investment agreements (IIAs) since the 1990s, recourse to ISDS has also risen. In 2012, at least 58 new ISDS cases were initiated, bringing the total number of known investor–state disputes to approximately 514.3 The tendency has been for foreign investors to pursue increasingly large monetary claims in relation to diverse areas of government policy. Despite the enthusiasm with which investors are taking to ISDS, there are growing concerns from both investors and governments about the limits of, and problems with, the system.

Concerns about the current ISDS system

The IIA Issues Note should be read with UNCTAD's Investment Policy Framework for Sustainable Development (2012) (the Framework for Sustainable Development), which identifies the objectives of inclusive growth and sustainable development as essential to the development of national and international investment policies.4 In this context, UNCTAD expresses concerns about the extent to which investor claims, and their determination by a private body, may hamper the pursuit of legitimate public policy objectives by government. It also identifies a number of 'systemic deficiencies' in the system, including:5

  • issues relating to the perceived legitimacy of privately appointed arbitrators deciding questions that have consequences for a state's policies and finances (for funding defences of claims and potentially paying significant sums in damages awards and costs) and a potential chilling effect on regulation;
  • ongoing issues of transparency of proceedings given that, despite some improvements, proceedings with important public policy consequences may be confidential;
  • the effect of 'nationality planning' by companies to facilitate access to ISDS;
  • the inconsistency of arbitral decisions in cases involving similar facts or provisions, which leads to uncertainty and a lack of predictability;
  • the effect of erroneous decisions, which cannot easily be reviewed or overturned;
  • perceptions that arbitrators are biased, or predisposed to side with a particular party, particularly given their rotating role as arbitrators and advocates and their incentive to be reappointed;
  • the high cost of engaging in ISDS, averaging US$8 million per case,6 which is of particular concern to small and medium enterprises and developing-country governments; and
  • despite claims to the contrary, the time-consuming nature of ISDS, where arbitrations may take several years to conclude.

Paths for reform

States are at a pivotal stage in the development of the international investment regime. UNCTAD estimates that, by the end of 2013, more than 1,300 BITs will be at the stage of termination, renewal or renegotiation. Additionally, the increasing number of regional agreements have the power to supersede older bilateral treaties. States now have a significant opportunity to change the operation of ISDS and remedy some of the systemic deficiencies identified.

In the IIA Issues Note, UNCTAD highlights five possible areas for reform identified from a range of debates and discussions about the challenges and opportunities of ISDS.

Promoting alternative dispute resolution

As is the case in many domestic jurisdictions, alternative dispute resolution (ADR) can be a useful means of reaching an expedited mutually agreeable solution. It is not going to be useful in all situations, but ADR mechanisms that are included in IIAs, or implemented at the domestic level, could complement existing ISDS mechanisms. Another possible measure is the introduction of a national investment ombudsman.

Tailoring the existing system through individual IIAs

The concerns listed above have already led some states to reform their ISDS obligations, particularly in new IIAs. While keeping the general operation of the system the same, some states have introduced limitation periods for claims, allowed for consolidated proceedings, agreed to greater transparency, allowed for the early dismissal of frivolous claims or adopted a combination of these features. States have also increased their ability to provide interpretations of agreement text, by providing joint binding interpretations, requiring panels to refer certain issues to the states and allowing for third-party intervention.

Due to concerns about the impact of ISDS on achieving legitimate public policy goals, many newer IIAs preserve a broader scope to regulate without risk of challenge under ISDS by including specific provisions, in particular on the environment, labour and health.

Coupled with the renegotiation of existing treaties and increasing regional integration, changes such as these could clarify and improve the law applicable to ISDS. However, there is also a risk that an ad hoc approach could increase the multiplicity and unpredictability of the applicable legal obligations.

Limiting investor access to ISDS

Restricting the subject-matter scope of ISDS, restricting the classes of investors who may access ISDS or requiring local remedies to be exhausted (or ineffective) in order to access ISDS could limit ISDS to a mechanism of later or last resort. This approach has been adopted by some countries. Others have gone so far as to exclude ISDS from IIAs completely, for example in the Australia–US Free Trade Agreement (FTA) and the Australia–Malaysia FTA.

The extreme consequence of this approach would, in effect, exclude ISDS as an option for a foreign investor to resolve an investor–state dispute. Such an exclusion neglects the benefits that can and should come from an effective ISDS system. While states may benefit from a reduction in investor claims, they will also lose out by not providing foreign investors with the confidence to invest in their market. Concerns about the effectiveness of domestic courts and remedies will remain, as foreign direct investment increasingly flows between developing and structurally weak economies.7 As the other reforms listed suggest, this system is able to be adapted and improved and should not be abandoned.

Introducing an appeals facility

An investment appellate body at the international level could enhance the consistency, predictability and perceived impartiality of decisions rendered by arbitral tribunals. There are challenges to this model, such as the logistics of selecting members, ensuring the timely resolution of disputes and the need to have a certain number of states participate before the system would be effective. However, mechanisms such as the WTO's Appellate Body provide a current model for an effective mechanism in this respect and a handful of FTAs contain provisions that contemplate the introduction of an appellate body in future.

Creating a standing international investment court

The most radical reform of ISDS would be to introduce a permanent international investment court. Depending on the system of appointment, this could remedy concerns about the legitimacy and impartiality of arbitrators, allow for greater transparency and predictability, and synthesise the wildly divergent ISDS mechanisms that currently exist. This would be the most difficult reform to achieve, given that there would need to be broad (if not universal) consensus to the establishment of such a court and related funding arrangements. However, as the ISDS system develops, this proposal may seem less and less extraordinary.

Implementation

The IIA Issues Note highlights the challenges that will be posed by pursuing these reforms. In each case, reforming the ISDS challenges the balances that have been struck in the system: between time and cost-effectiveness and correctness of decisions; between predictability and flexibility; between accessibility for investors and use of state resources; and ultimately between commercial and public interests. In any rebalancing, there will be losses as well as gains, which may make reform unpalatable.

For reform to be practical, useful and consistent with UNCTAD's Framework for Sustainable Development, it will need to be pursued jointly by a number of states. It will also require support from investors. Given the opportunities that are arising to renegotiate and further develop IIAs, now is the point at which further ideas for reform can be developed, debated and implemented.

Footnotes
  1. UNCTAD's World Investment Report 2013, Global Value Chains: Investment and Trade for Development.
  2. UNCTAD's IIA Issues Note: Reform of Investor State Dispute Settlement: In Search of a Roadmap (No 3, June 2013).
  3. Above, note 1, page 110. As there is no complete public registry of claims, the number of claims is an estimate only and is likely to be higher.
  4. UNCTAD (2012).
  5. Above, note 2, pages 2–4.
  6. Above, note 1, page 112.
  7. UNCTAD reports that in 2012, developing economies absorbed more foreign direct investment (FDI) than developed countries for the first time ever, accounting for 52 per cent of global FDI flows (UNCTAD's World Investment Report, above, note 1, page xii). Structurally weak economies saw a growth in FDI in 2012, despite a reduction in FDI across the developed world.

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