Is it time to redesign or terminate investor-state arbitration?

CIGI | 11 April 2017

Is it time to redesign or terminate investor-state arbitration?

by Gus Van Harten

Key Points

  • Investor-state dispute settlement (ISDS) is among the most controversial elements of trade and investment agreements. It provides foreign investors with exceptionally powerful protections from laws, policies and other decisions of countries.
  • The European Union has proposed to replace ISDS with a multilateral investment court. The proposal should be evaluated by reference to criteria of judicial independence, procedural fairness, balance in the allocation of foreign investor rights and responsibilities, and respect for domestic institutions.
  • If the proposed court does not satisfy these criteria, it is preferable to withdraw the special protections for foreign investors in trade and investment agreements. These protections are Exhibit A for how rules of the global economy have been rewritten to favour large corporations and the super-rich at the expense of the general public.

ISDS or, more precisely, investment treaty arbitration is a controversial part of many trade and investment agreements. Political developments in Europe and the United States suggest that there are opportunities to address ISDS’s deep flaws, by redesigning or terminating it.

A key benefit of redesign is that it could replace ISDS in numerous existing agreements. A benefit of termination is that it is a clear step, not easily contorted by lobbyists or trade negotiators into something meaningless. This essay offers a basis to evaluate the two options, focusing on criteria for redesign that, if not satisfied, would make the case for termination.

Redesign or Termination?

Prospects for redesign have emerged in large part from Europe. Faced with widespread public opposition to ISDS, the European Union launched an effort to replace ISDS with a multilateral investment court in new agreements such as the Canada-EU Comprehensive Economic and Trade Agreement (CETA) and, potentially, in existing agreements. This proposal is a welcome change, although it could go badly wrong if it ends up institutionalizing ISDS without addressing the key flaws, or if it relies on existing ISDS fora instead of establishing a fresh start.

Alternatively, as an example of potential termination, the Trump administration has targeted the North American Free Trade Agreement (NAFTA) for renegotiation, albeit without singling out ISDS. Former Canadian trade negotiator Gordon Ritchie reacted by saying it should be easy for Canada to agree that NAFTA’s foreign investor rights and ISDS chapter — Chapter 11 — be “scrapped” (Ritchie 2017). Chapter 11, Ritchie said in an admirably candid way, was “ill-conceived and poorly drafted,” and Canada’s acceptance of it a case of “foolishness.”

How should those concerned with the ISDS threat to democracy and sovereignty approach these two paths? The choice should be guided by four criteria: independence, fairness, balance and respect for domestic courts. If a proposed ISDS makeover does not meet each criterion, then the notion of special rights for foreign investors, enforceable through international adjudication, should be rejected in favour of ISDS termination.

The Legitimate Controversy over ISDS

ISDS is an exceptionally powerful process to protect foreign investors. It gives generous rights to foreign investors (and no one else) without corresponding responsibilities. Foreign investors can bring ISDS claims against a country if they think that country — by its laws, regulations, court judgments or other decisions — acted unfairly or inequitably, betrayed foreign investors’ expectations, over-regulated their business, put controls on transfers of money in and out of the economy, or tried to boost the local economy in ways that disadvantaged foreign investors.

If a foreign investor brings an ISDS claim, the sued country must submit to a probing review by a tribunal of three lawyers sitting as arbitrators. The arbitrators have the power to order the country to compensate the foreign investor, without a cap on the amount that can be awarded. Orders by ISDS tribunals are enforceable against the country’s assets in other countries, making ISDS more enforceable than domestic court judgments or other international adjudicative decisions.

What’s Wrong with ISDS?

ISDS favours foreign investors by giving them special rights that go well beyond private rights in domestic law and other areas of international law. Except for the national government responding to a foreign investor’s claim, ISDS denies even the basic right of standing for others affected by the adjudication of the claim. With treaties that allow for ISDS, arbitrators have tended to interpret ambiguous language in ways that expand foreign investors’ rights to compensation and the arbitrators’ power to award it.

ISDS is not based on a judicial process. Instead, it uses for-profit arbitration to resolve one-way claims to public funds. The use of arbitration is inappropriate in this context, and operates to the systemic advantage of whoever brings the claims and to the disadvantage of those facing review and monetary penalty. The use of arbitration in this context also introduces myriad conflicts of interest, as ISDS arbitrators work on the side as ISDS lawyers and have an evident interest to encourage claims in order to grow ISDS as a business.

Loosely put, ISDS gives foreign investors an enclave legal status based on their power to invoke rights, and access to public money through a process that is open only to them. Foreign investor rights are Exhibit A, as The Economist put it, in demonstrating that “international trade agreements are a way to let multinational companies get rich at the expense of ordinary people” (The Economist 2014). Corporate giants and the super-rich, alongside the ISDS legal industry, have been the main beneficiaries of ISDS by far, at significant expense and opportunity cost to countries and to those who would have benefited from laws and regulations that were deterred by ISDS.

Four Criteria for a Re-design

The simplest approach to fixing these foreign investor rights is to leave them out of trade and investment agreements. That option was not taken in proposed agreements such as the Canada-EU CETA, the Trans-Pacific Partnership Agreement or the Transatlantic Trade and Investment Partnership. For the first time since NAFTA, these agreements would apply ISDS to relations among developed countries that have court systems superior to ISDS, thus entrenching ISDS as a global institution. Such is the priority given by major governments to entrenching special rights for foreign investors and shifting judicial sovereignty to ISDS arbitrators.

Against this backdrop, it seems unlikely that the European Union or the United States will commit to a satisfactory redesign of ISDS. Even so, political winds are blowing unpredictably and it is important to offer guidance on how ISDS could be redesigned to make it independent, fair, balanced and respectful of domestic institutions.

Judicial Independence

To be independent, any process for resolving disputes involving foreign investors must incorporate classical safeguards of judicial independence: namely, secure tenure, set salaries, objective case assignment and bars on outside legal and arbitration work. These safeguards are integral to courts and, in turn, to public confidence in judicial decisions.

ISDS does not incorporate any of these classical safeguards, and is consequently open to reasonable concerns about bias arising from the private interests and entanglements of the arbitrators. In late-stage revisions of CETA, two of the safeguards — secure tenure and objective case assignments — were incorporated into an investment court system that would substitute for ISDS. Other safeguards may yet be added to a multilateral investment court. Without the classical safeguards, such a court would not deserve the name because it would lack institutional independence from executive officials and private actors.

It is also important for public confidence that a multilateral investment court be a new entity, rather than one grafted onto an existing non-judicial ISDS forum such as the International Centre for Settlement of Investment Disputes (ICSID) or the Permanent Court of Arbitration (PCA). Since the late 1990s, foreign investor protections have been taken in highly expansive directions by ISDS arbitrators through, for example, their widespread allowance of claims using corporate seats of convenience, their liberal approach to the concept of investment, their flexible approach to parallel treaty claims in the face of contractual dispute settlement clauses, and their application of concepts of “indirect” expropriation and “legitimate” expectations of foreign investors in ways that easily overlap with good faith, non-discriminatory forms of general regulation (Van Harten 2013; Van Harten 2016). The role of these arbitrators likewise has been managed in questionable ways by ICSID, the PCA and other arbitration houses, whose role arises primarily from their power to impose arbitrators on the disputing parties — at times even assigning the power to corporate organizations such as the International Chamber of Commerce or individual members of the ISDS industry — and their ability to influence and review decision making by ISDS tribunals.

A clean break is needed from these arbitration houses to alleviate public concern. A multilateral investment court should therefore have no association with organizations or individuals that have had a significant role in expanding ISDS during its 20-year boom. The court should have autonomous judges, not converted ISDS arbitrators; should have its own secretariat, not a reoriented ISDS administration; and should be free to interpret the treaties anew, against the backdrop of international law, unburdened by the tainted reasoning and conflicts of interest of ISDS arbitrators.

Procedural Fairness

A fair process of adjudication allows anyone whose rights or interests are affected by the proceedings to have standing in the process. If an affected party is denied the right of standing, the adjudicator cannot hear all sides and may not be able to consider relevant facts and arguments.

ISDS is unfair because it does not allow such standing for all affected parties, other than the claimant investor and the national government of the sued country. No one else whose rights or interests are affected can have standing, regardless of the extent of the potential impact on their rights or interests.

In its ISDS proposals of November 2015, the European Commission included a clause that went some way to addressing this flaw.1 Yet the clause in question did not find its way into CETA, suggesting that there was awareness of the problem and a choice somewhere along the way not to address it.

At a multilateral investment court, this issue would need to be addressed by providing for public notice of claims before the court and allowing time for all affected parties to apply for standing. The manner of implementing the principle could be left to the court itself, by giving it the power to determine its rules of procedure according to principles of fairness stipulated in the court’s constituting document.

Balance between Rights and Responsibilities

In ISDS at present, foreign investors have elaborate rights, with corresponding responsibilities for countries. Yet ISDS lacks actionable responsibilities for foreign investors. The underlying logic is flawed. If foreign investors require special international protections because domestic institutions are insufficient, then equivalent protections should be available to victims of mistreatment by foreign investors where those victims are left unprotected by domestic institutions. That is, foreign investor rights and responsibilities, based on international standards, should be ensured through access to equivalently enforceable processes of international dispute resolution.

For ISDS to be made balanced, foreign investors must be required to respect international standards of appropriate conduct in their treatment of workers, consumers, shareholders or the environment, for example. A redesigned ISDS must also make foreign investor responsibilities actionable through the same process as foreign investor rights. A modest starting point would be to allow a country to bring a claim against a foreign investor or related company in response to a foreign investor claim against the country. More robust steps would give countries or victimized parties a right, alongside foreign investors, to initiate proceedings in the first place.

If a multilateral investment court does not incorporate foreign investor responsibilities, it will exacerbate a fundamental imbalance in ISDS. In such circumstances, it would be better to terminate these special rights for foreign investors in favour of the protections available to all market actors through contracts, contract-based arbitration, domestic courts, private or state-backed risk insurance, political processes and diplomacy.

Respect for Domestic Courts

For a variety of reasons, international adjudication should supplement more suitable venues for dispute resolution, not replace them. In turn, it is a standard feature of international law for a person to be obliged to resort to the domestic courts of a country, unless it can be shown that those courts do not offer justice, before bringing an international claim against the country.

Remarkably, in ISDS, foreign investors are not required to seek a resolution in a country’s courts before bringing an international claim. They are not even asked to supply evidence that domestic courts cannot ensure effective protection before resorting to ISDS. In effect, it is assumed in ISDS that courts fail systematically to offer justice in all countries subject to ISDS, and that ISDS is independent and fair in the manner of a court which, as noted above, it is not.

At a multilateral investment court, this lack of respect for domestic courts must be remedied by incorporating the duty to exhaust reasonably available local remedies into the court’s constituting document. To preserve party autonomy and sanctity of contract, there should also be a duty of claimants to resort to any forum to which they have previously agreed to submit the relevant dispute. Why should foreign investors not be required to go to domestic courts or contractually agreed fora if they cannot show that the courts or other fora do not offer justice, ensure compensation for expropriation and so on?

Or Termination?

Without a compelling case for creating special rights for foreign investors, there is no reason for ISDS in any form. Granting special legal status and access to public money for any actor, let alone for the largest companies and wealthiest individuals in the world, calls for clear justification based on evidence of a public benefit to outweigh the major risks and costs to the public and other actors.

Otherwise, one would proceed with a major expansion of foreign investor protections by institutionalizing them at the multilateral level, incorporating existing investment treaties into the multilateral facility, and facilitating new agreements (such as CETA) among numerous developed countries that currently do not allow ISDS in their extensive foreign investment relations. Moreover, one would proceed in this way without accounting for the threat to public budgets, the constraints on regulatory decision making, the skewing of markets and the challenge to established structures of public accountability and the rule of law.

Any redesign of ISDS must therefore satisfy certain criteria for it to qualify as independent, fair, balanced and respectful of domestic institutions. If the criteria are not met, it is preferable to terminate ISDS and withdraw these special rights for foreign investors.

1 Transatlantic Trade and Investment Partnership, Trade in Services, Investment and E-Commerce, European Union Proposal, Chapter II — Investment, released 12 November 2015, online: <> (“The Tribunal shall permit any natural or legal person which can establish a direct and present interest in the result of the dispute (the intervener) to intervene as a third party…” at art 23).

Works Cited

Ritchie, Gordon. 2017. “Canada can’t afford to play nice if Trump triggers NAFTA talks.” The Globe and Mail, January 9.

The Economist. 2014. “Investor-state dispute settlement: The arbitration game.” The Economist, October 11.

Van Harten, Gus. 2013. Sovereign Choices and Sovereign Constraints: Judicial Restraint in Investment Treaty Arbitration. Oxford: Oxford University Press.

———. 2016. “Arbitrator Behaviour in Asymmetrical Adjudication (Part Two): An Examination of Hypotheses of Bias in Investment Treaty Arbitration.” Osgoode Hall Law Journal 53.

About the Author
Gus Van Harten is a professor at Osgoode Hall Law School. Previously he was a faculty member at the London School of Economics. He specializes in international investment law and administrative law. His books include Investment Treaty Arbitration and Public Law (Oxford University Press, 2007), Sovereign Choices and Sovereign Constraints: Judicial Restraint in Investment Treaty Arbitration (Oxford University Press, 2013), and Sold Down the Yangtze: Canada’s Lopsided Investment Deal with China (Lorimer, 2015). His academic articles are freely available on SSRN

source: CIGI