The future of investor-state arbitration

We live in interesting times for investment arbitration. There is wider public engagement with investment protection than there has ever been, prompted by the European Commission’s public consultation on the proposed Transatlantic Trade and Investment Partnership (TTIP) between the EU and the US, and the agreement in principle of the text of the Comprehensive Economic Trade Agreement (CETA) between the EU and Canada.

Unfortunately, this engagement is by and large negative. Some have railed against the treaties themselves, expressing the view that such protections privilege foreign investors over domestic investors, that they bypass the operation of domestic law and national courts and stymie the right of states to regulate. Others have criticised the investor-state arbitration process, claiming that it allows partisan, self-interested arbitrators to secretly overrule governments with no right of appeal.

This story of a system biased against impoverished states, used as a weapon by “big business” intent on flexing its muscles, is a compelling one, bolstered by a small number of high profile cases which (whether rightly or wrongly) add fuel to the fire. Those few small voices of calm trying to put the case for free trade, protection of investment and a non-national, neutral and pacific method of dispute resolution are easily overlooked in the debate. Yet there is a strong case to be put.

Limitations of recourse to national courts and diplomacy

Before the introduction of investment treaties, if a national of one state was poorly treated, their assets commandeered, or their safety threatened in another state, they may (in theory) have been able to pursue a remedy in the national courts of that state. The difficulties of this course are readily apparent. The investor may not have access to an independent judiciary untouched by political or other influences. A final remedy may take years to achieve and enforcement against the state in question may be impossible. The main recourse was instead through diplomatic channels. The investor would need to get its own government interested in the issue and willing to engage in international diplomacy to seek to resolve the situation.

A government may be more inclined to act in the context of an outright taking, but host state actions are increasingly more subtle than this. The success of that state-to-state diplomacy would ultimately depend on the relative strengths of the states involved and whether any other, more pressing diplomatic issues took precedence. Failing diplomacy, a national would need to rely on its home state being willing to “send in the gunboats” to enforce or protect its rights.

Investment treaties as a vehicle for investment protection

Diplomacy might be an option in a world in which international investment and business transactions are extremely limited, but in the 21st century, few states would be willing or able to elevate events affecting one commercial party to the level of international diplomacy. Investment treaties offer states the opportunity to de-politicise these kinds of disputes. Germany entered into the first bilateral investment treaty (BIT) with Pakistan in 1959 (a fact which now seems ironic given Germany’s position in the current debate on the inclusion of investor-state dispute settlement (ISDS) in the TTIP).

In the world’s 3000+ investment treaties, states agree between themselves standards of protection that they will offer to investors of the other. They then allow individual investors to enforce those standards against a host government, without needing the assistance or support of their own government. It is a system invented and developed by states for their own benefit, to attract foreign investment in order to boost their own economies.

These treaties have considerable importance for states in underpinning their viability as a place of investment. They contain protection standards with which few could take issue. They promise non-discrimination, fair and equitable treatment and compensation for expropriation of assets. In short, they ensure that foreign investors are treated fairly by the host state in which they invest.

In order to ensure that these standards of protection are concrete and enforceable, the treaties provide for investors who claim their investments have been damaged by the host state to claim recompense for that damage before an international arbitral tribunal. That arbitral tribunal is comprised of three individuals, one chosen by the state, one by the investor and the third by the co-arbitrators, to rule on whether the treaty standards have been breached by the host state and, if so, what compensation is payable. The tribunal sits outside the sphere of any domestic courts, free from the risk of domestic bias or political or other influence.

Potential for reform of the current ISDS system

As a basic proposition, the idea of investment treaties and “international” dispute resolution is a solid and positive one. Yet being a supporter of the idea of investment protection and investor state arbitration does not mean that one must also support the current system in its entirety. The reality of present-day investment arbitration is that states have created a system with flaws which need resolving in the light of modern experience.

1. Clearer standards of protection

Let us start first with the allegation that the protections offered by investment treaties favour foreign investors over domestic investors and stifle regulation. The language used in these treaties has historically been wide and open to interpretation. This has resulted in a lacuna which investors have sought to interpret to their advantage, just as they would the obliquely worded language of a commercial contract. Similarly, arbitral tribunals are criticised for upsetting the balance of the treaty or going “off script” in rendering an investor- friendly decision. Yet where there is lack of clarity, there is scope for interpretation. While we might not like the outcome of a particular award or the interpretation offered by a tribunal, few can disagree that clearer, narrower standards of protection would remove that scope for interpretation and many of these concerns.

The answer must therefore be in clearer drafting. States are alive to the need to clarify the protections given: the CETA text and TTIP consultation show that states can actively seek to draft the treaty protections they are willing to offer. It remains to be seen whether this awareness will in future also prompt more states to utilise their rights under the Vienna Convention on the Law of Treaties (Article 31) to seek to agree a binding interpretation of their existing stock of BITs with their state counterparties (in a system akin to that provided by the North American Free Trade Agreement (NAFTA)).

2. Greater transparency

Similarly, the lack of transparency in the arbitral process has, rightly, been criticised. Lack of transparency has enabled allegations of “secret courts” to abound. Most now accept that, in order for investment arbitration to retain legitimacy, transparency is required. Increasingly, some transparency is becoming the norm.

Most investor-state arbitrations take place under the rules of either the International Center for the Settlement of Investment Disputes (ICSID), an autonomous institution within the World Bank that can facilitate the resolution of disputes between investors and signatory states to the ICSID Convention, or as an ad hoc arbitration under the UNCITRAL Rules. ICSID has a process that requires transparency (with greater transparency planned) and the UNCITRAL Transparency Rules have introduced a more transparent and open system, whilst still offering necessary protection for commercially sensitive information.

3. Development of an appeal mechanism

Criticism of the ICSID annulment process is also hard to refute. Whether by design, over-reaching of the tribunals appointed in annulment proceedings, or misuse by the (mostly state) parties seeking annulment, the process has turned into a very different creature from that which the ICSID Convention originally intended. There remains real scope for states, investors, practitioners, academics and interest groups to give thought to a way in which the annulment process could be improved or, indeed, replaced. As yet, however, the suggestions being offered, including some form of appeal mechanism, remain embryonic.

4. A more streamlined process

It is also fair to complain about the length of time taken to bring an investment treaty to a conclusion. In the light of a recent study finding that an ICSID arbitration takes an average of 3.6 years, many may believe efforts can and should be made by all concerned to make the process more efficient and cost effective.

The future

So what does the future hold? States need to decide whether there is still merit in offering investment protection in the form of treaties or free trade agreements (FTAs). Some, like South Africa, appear to have decided to the contrary, and Australia has determined that ISDS will be considered on a case by case basis. Yet it is worth bearing in mind that both these states are resource-rich nations that will always attract investment. For other states this is a highly nuanced picture: Is it necessary between developed nations with established and reliable domestic court systems? Is it necessary for states negotiating with the EU, where not all courts create the same level of confidence in the eyes of foreign investors? Should investor protection be part of, or separate to, free trade negotiations?

Even once those questions are resolved, states who do decide to enter into investment treaties must acknowledge that investors can only claim the protections that are offered to them. If states wish to retain the right to regulate certain parts of their economy, to limit the ability of treaty-shopping shell companies to claim, or to limit the meaning of certain protections, the power rests with them to enter into new treaties on that basis. Given the backlash against CETA and the TTIP, we should and must expect real developments in this sphere over the coming years.

And finally, what is the future for arbitration in resolving disputes under investment treaties? If we decide that investment protection is important, then we must also acknowledge that in many regions of the world, the best custodians of that protection may well not be national courts. If we accept this to be the case, then an international system of dispute resolution is required. ICSID was established with this aim. Current fledgling proposals regarding standing international tribunals of state-appointed arbitrators do not appear to resolve concerns about legitimacy, and run the risk of being far more expensive and less reliable than the current system.

While we should anticipate change in the scope of investment protections offered going forward, and increasing revision of past treaties, the future for investor-state dispute settlement is far less certain. I, for one, hope that the benefits of arbitration do not get lost in the debate.

For further information, please contact Matthew Weiniger QC, Partner, Vanessa Naish, Professional Support Lawyer or your usual Herbert Smith Freehills contact.

Matthew Weiniger QC
Matthew Weiniger QC
Partner
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+44 20 7466 2364
Vanessa Naish
Vanessa Naish
Professional Support Lawyer
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+44 20 7466 2112

The above article has been written by Matthew Weiniger QC for the inaugural Global Law Summit which takes place in London next February to celebrate the rule of law and mark the 800th anniversary of the signing of the magna carta. The Summit will consider as one of its key themes, ‘Law at the heart of 21st century business – from internal governance to regulation, competition and arbitration/dispute resolution’.

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