January 7, 2015
This article is an attempt to on the one hand understand the root causes of the ISDS controversy and, on the other hand, to spell out a set of possible compromises over this sensitive issue. Hanging in the balance is CETA, the new generation treaty between the EU and Canada, then perhaps TTIP and the future of trans-Atlantic relations beyond trade.
ISDS stands for ‘Investor-State Dispute Settlement’ and is an international law instrument allowing an investor to sue the state hosting its investment if it believes the latter has treated it unfairly. The ISDS discussion became particularly heated when Philip Morris decided to sue the Australian government over its new rules on ‘plain tobacco packaging’ inter alia forbidding the use of all company logos or symbols that may make cigarette packets more visually attractive. The colour of packets was pre-defined to be unattractive for consumers, and ‘graphic health warnings’ must now cover 75% of the front of the packet. The sale of non compliant products was forbidden as of 1 December 2012. Philip Morris Asia, registered in Hong Kong, challenged the new Australian rules under a 1993 Bilateral Investment Treaty between Hong Kong and Australia containing an ISDS clause allowing investors to submit claims for arbitration. It argues that it has been deprived of its investment and was not accorded ‘fair and equitable treatment’. We have therefore a conflict between public (health) policy and corporate interest.
Another case relevant for the debate is the Vattenfall versus Germany dispute. Vattenfall is a state owned Swedish energy company that in May 2012 sued Germany over the withdrawal of its operating licenses for two German nuclear plants. The withdrawal of licenses flows from the latest (13th) amendment of Germany’s Atomic Energy Act, in the wake of the Fukushima disaster in March 2011, phasing out nuclear energy altogether by 2022. The claim is based on the ISDS clauses of the 1994 Energy Charter Treaty, and its amount is not known. According to a Vattenfall spokesman quoted by World Nuclear News on 16 October 2014, ‘based on the confidentiality of rules that apply for the process, Vattenfall cannot give any comments regarding the size of the compensation.’  Interesting remark for a state owned company suing another state, against the backdrop of the Swedish culture of transparency. Vattenfall has already sued the German government ISDS over a water quality license for a coal-fired power plant in 2009, leading, apparently, to an out-of-court settlement containing a softer environmental permit .
To complete the scene setter, the main institution dealing with ISDS cases is the International Centre for the Settlement of Investment Disputes (ICSID), a member of the World Bank Group, in Washington, D.C. The Centre functions under a 1966 Convention ‘on the Settlement of Investment Disputes between States and Nationals of Other States.’ The President of the World Bank is ex-officio chairman of the ICSID Administrative Council (with no vote), but the most powerful figure is the Secretary General of ICSID. The disputing parties to a case cover the costs of proceedings. Even if cases are by definition between investors and governments, the ICSID convention is international law. The basic rule in the ICSID convention is that arbitration is voluntary: the parties must give their consent for arbitration, and once given consent cannot be withdrawn (Article 25). The final award is ‘law’ and the loser must accept it and enforce it.
The EU has negotiated or is negotiating agreements that are significantly improved over older BITs, including those invoked in the two cases above. However, much of the controversy remains. My main reference for this analysis will be the published CETA text, but this is not an exhaustive or dedicated analysis of ISDS in CETA.
The root of the problem
We may start with the lesson and the message of the European elections this year: there is fundamental distrust in our societies towards political elites, including, worryingly, the political mainstream. Most people have lost confidence not only in their leaders, but also in the very menu from which they choose their leaders. If this is so for national politics, it is even more valid for Europe. European institutions are lopsided against emotion, suffocating in their hyper-rationality. It is difficult for ‘that’ to win the hearts, whereas the complexity puzzles the minds. I see the ISDS debate as an extension – for the worse- of this syndrome. If you are frustrated that you are losing control over your life to distant bureaucrats, if you believe your national leaders are overwhelmed by Brussels and/or big business, how can you possibly trust a mysterious ‘private tribunal’ appointed offshore which can arbitrate between your country and a big multinational challenging the already fragile rights that you still have, nationally, over your environment or tax money? The question contains the implicit assumption that you may not trust your government much, but you trust even less an ad-hoc institution set up abroad on which you do not have even remote, indirect control. You do not even want to look into the details or merits of arbitral tribunals and how they are going to help investment in your country, you simply do not like the idea, there is something alien, strange, unhealthy, about it, you plainly reject the principle itself. Moreover, you dislike Brussels even more for even considering doing this to you.
It would be utter blindness not to listen to these concerns and to simply dismiss them as irrational. Even if some of them were irrational according to a definition of pure economic rationality, society is a mix of emotion, anxiety, hope and reason, and democracy has to embrace and account for all that.
The building blocks of arbitration
But if you were to look into it nevertheless, what would you find that could reassure you?
The core issues on which trust depends are, I believe, the nature of arbitration, the process for setting up the arbitral tribunal, transparency of its proceedings, and the fairness of the whole arbitral process.
According to Article 24 of the Investment chapter of the CETA text, the respondent (the state being sued) ‘consents’ to all future arbitration cases by the very signature of the treaty. In contrast, Article 25 of the ICSID Convention requires consent for each separate case, when it happens. States signing ISDS treaties agree to give up that power to offer consent on a case by case basis.
How is the tribunal selected? ‘Unless the disputing parties have agreed to appoint a sole arbitrator, the Tribunal shall comprise three arbitrators. One arbitrator shall be appointed by each of the disputing parties and the third, who will be the presiding arbitrator, shall be appointed by agreement of the disputing parties.’ If the appointments do not happen in 90 days, ‘the Secretary-General of ICSID shall appoint the arbitrator or arbitrators not yet appointed.’ How? By selecting them from a list of 15 arbitrators agreed on by the two state parties signing the treaty. If the list has not been established, ‘the Secretary General of ICSID shall make the appointment at his or her discretion taking into consideration nominations made by either Party and, to the extent practicable, in consultation with the disputing parties.’ It is evident that the Secretary-General of ICSID plays a potentially key role in the setting up of the Tribunal.
On transparency: the CETA text makes reference to the UNCITRAL Transparency Rules. Those rules essentially say that everything is to be made public, except what is not to be made public. In the latter category: ‘confidential business information’ or ‘information that is protected against being made available to the public (…) under any law or rules determined by the arbitral tribunal to be applicable to the disclosure of such information’ (Art. 7.2). To be sure, ‘any determination as to whether information is confidential or protected shall be made by the arbitral tribunal after consultation with the disputing parties.’ (Art. 7.3.)
On the possibility of appeal to an arbitral decision, the CETA text is simply noting a decision to ‘consult’ on ‘whether and if so, under what conditions, an appellate mechanism could be created’. It could hardly be clearer that there is no appellate mechanism in the making.
ISDS arbitration versus national courts
The most legitimate way to assess the fairness of the whole ISDS process is to compare with the guarantees (imperfect as they may be) provided by national courts in the states with rule of law.
The following are trust-creating factors in favour of national court systems:
- magistrates are selected according to well established patterns and traditions, including accountability mechanisms, checks and balances, criminal penalties for wrongdoings;
- decisions can be overruled by higher courts, which is a crucial feature of rule of law systems, stemming from a wise approach to human and institutional fallibility;
- there is unitary interpretation of the law and converging jurisprudence, based on precedent and interpretation by the highest court of the land;
- national courts have the possibility to conduct thorough investigations, using the sovereign resources of the state;
- courts are perennial, not constituted for each case, avoiding potential conflicts of interests at least on jurisdiction matters;
- national courts ensure that investors operating in the same country enjoy equal treatment and the same jurisdiction; Vattenfall suing under ISDS has a different treatment than RWE or E.ON suing under German law. Naturally, local courts are more adept at balancing public and private interests then a special investor-dedicated jurisdiction and legal instrument .
National courts do not provide full transparency, either, as it is legitimate to protect confidential information, including business information. But they apply general rules adopted by Parliaments to balance public and private interests, so it easier to accept and check confidentiality in this context than in that of an arbitral tribunal creating its own rules.
In order to better understand the ISDS process, I have read fully a recent case published by ICSID: US nationals David Minnotte and Robert Lewis vs. Republic of Poland . It is a complex, fascinating case involving a project to fractionate blood plasma in Poland in the 1990s. The arbiters ruled in favour of Poland, and decided that the claimants should pay Poland more than a million dollars in compensation. The arbiters seem to me to be impeccable professionals, as I could not detect any feeling of, let alone argument for, pro-investor bias. In the same vein, it would be unfair to use the argument that the current Secretary General of ICSID is a Canadian national , or that the President of the World Bank is a US national, to suggest structural bias. The critical debate on ISDS should not create itself injustice against many honest professionals. The real discussion is not about individual people, but about process and the social legitimacy and acceptability of the ISDS process.
It is in this spirit that I now turn to proposing a few possible ways out from the ISDS conundrum.
Potential ways out
Without prejudging in any way on the final position of my group, as food for thought, I suggest that one or a combination of several of the following options might offer a way out. The common thread of all my suggestions is the attempt to address the core reasons for scepticism with regard to ISDS while not falling into the other extreme of by definition killing the instrument itself.
- The scope of ISDS should be limited to cases of denial of justice. If, for any reason, a company does not have access to the judicial system of a country, then it should be able to invoke the jurisdiction of an arbitral tribunal. In other words, if there a void, i.e. no jurisdiction to consider a case, there is no rule of law, and arbitration should be allowed. Denial of justice is the number one example of a breach of the obligation of ‘fair and equitable treatment’ in the CETA text. It is rightly so. The other types of breaches (manifest arbitrariness, targeted discrimination, etc.) can be dealt with by domestic courts.
- An argument invoked by proponents of ISDS is the length of judicial proceedings in EU Member States, with some founding member states being given as example. It is reasonable for any citizen or company to expect a fairly quick resolution of their case. Therefore, we could imagine an automatic right for an investor to trigger ISDS if its case has not reached the final level of jurisdiction within say 36 months from the date of the initial claim. This would create an incentive for legislators and judiciaries, too, to speed up judicial proceedings. I disagree with The Economist suggestion that firms should first ‘exhaust domestic legal remedies before arbitration can begin’ . Arbitration should not become higher than the highest court of a democratic country. Once a final ruling has been achieved, that should be just that.
- In meetings with stakeholders representing the business world I have repeatedly heard the argument that ISDS will be more useful for SMEs than for large multinational companies, as the latter have resources, armies of lawyers and access to governments, so they can look after themselves. Well, then, let’s make ISDS available only for SMEs, the really potentially vulnerable companies. We would have to agree on a ceiling based on turnover and/or number of employees for eligibility for ISDS. This would remove the core suspicion that ISDS is an instrument in the hands of big business against civil society: let it make the weak stronger.
- A possible systemic solution is the one suggested by The Economist in its 11 October article ‘A better way to arbitrate’ : turning ISDS into either a state-to-state mechanism, with the choice of arbiters by the states themselves. It would be even better if there could be permanent arbitral courts, to prevent charges ad-hoc-ness and allow for jurisprudence to accumulate. In the ‘state-to-state dispute settlement’, the state of the investor would take up the claim itself and would either represent it before the other state or subrogate into its right for the purpose of the case. After all, it is rights and obligations created by the treaty between the two states that are alleged to have been breached. The award or penalty would then need to be passed on to the investor, minus the charges involved. A softer version of ‘state-to-state’ is to still allow for investor-state-dispute, but with the consent of both governments, as provided by Article 11.16 of the Australia-US FTA. This would take the automaticity out of the process and would introduce a filter, basically requiring the consent of both governments before the arbitration process would start. When consent is given by both governments, most likely good faith prevails and the public interest is safeguarded, as no government would tell anyone ‘sue me’ if it did not believe it was right. ‘State-to-state’ has the advantage of more social control and more relative legitimacy, despite the lack of confidence in national politics mentioned earlier and arguably, a state is more likely not to pursue an abusive or partisan claim against another state than a corporation. In fact, this scenario would offer an answer to a question begged by the whole ISDS debate: why would states desist from pursuing their roles in defending their nationals, including companies? Why would they privatise that function? Aren’t they making their already serious social confidence problem worse?
Last but not least, an appellate body, modelled on the WTO, should be introduced in the ISDS architecture, for appeals on issues of law, composed of more – and more senior – arbitrators than the first layer of jurisdiction. Perhaps the seven-member Standing Appellate Body of the WTO itself could be used by for ISDS appeals, since it is there already and dispute settlement is viable pillar of the multilateral trading system. Perhaps this would require a strengthening of WTO Appellate Body, and generally the move would not harm the WTO, quite the contrary.
A combination of some all or all of the above may be envisaged, too. While for cases of denial of justice all investors should be eligible for ISDS, for the other cases SMEs could have an automatic right to ISDS, while large companies would need to go through local courts or, in the other scenario, have their case taken over by their government. This might also prove an incentive for companies to ‘stay home’ rather than wonder about in fiscal paradises.
Small companies have a much harder time to get their government’s (or the European Commission’s) attention than big corporations. It is difficult for them to make their voice heard in the host countries where they may invest. And the argument that classic litigation is expensive is much more serious for them than for multinationals. In terms of public concerns, small companies are much less likely to create suspicion with the public opinion in the host country that they would try to change public policies, or in any case that they would have the lobbying power to do so. A world of ISDS for SMEs is therefore a world where small players are empowered in relation to both governments and the big players, without threatening societal choices. Last but not least, SME claims are likely to be small in financial terms, so not a threat to the public purse.
I believe the importance of ISDS is blown out of proportion by its supporters, some of whom may suffer from a degree of strategic blindness: it is simply not going to be the end of the world if ISDS clauses are eliminated, circumscribed, remodelled or limited in scope as suggested above. On the contrary, it is a major strategic mistake to sacrifice carefully negotiated new generation trade agreements on the altar of ISDS, if public opinion does not accept it. It is a threat to the already frail legitimacy of trade negotiations and to the further economic integration of the Atlantic world that is simply not worth pursuing. Moreover, it is not so clear that non-Western countries with which we are or will be negotiating might not want ISDS if we do not have it as standard in intra-Western trade agreements. The unfamiliarity of 28 legal systems for companies from these countries might be a strong incentive for them to want ISDS. For example, there is evidence that China had a strong preference for ISDS in the FTA negotiation with Australia . We should treat ISDS on its merits, in all negotiations, rather than using it for scare mongering.