A Turning of the Tide against ISDS?

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The Court of Justice for the European Union fired a significant shot at investor-state dispute settlement (ISDS) this week, and the result is likely to be much more than just a flesh wound. In deciding that the European Union did not have exclusive competence to enter into agreements including ISDS clauses, the Court made it significantly more likely that the EU would jettison these clauses from its Free Trade Agreements (FTAs) and seek to conclude separate, parallel agreements dealing with dispute resolution. Along with a series of other developments, this may mark a turning of the tide against the inclusion of ISDS clauses in trade and investment agreements.

Background to the European Court’s Opinion

This week’s landmark case concerned the European Union’s competence to enter into the EU-Singapore Free Trade Agreement. This is a newer style FTA that, in addition to covering classic trade issues, like reductions in customs duties, includes provisions on a range of other trade-related matters, such as intellectual property protection, investment, public procurement, competition and sustainable development. This FTA also included investor-state arbitration.

The question that the Court had to grapple with was whether the European Union had exclusive competence to enter into such agreements, or whether this competence was shared between the EU and the Member States (or even fell within the exclusive competence of the Member States), at least with respect to certain issues. The European Commission and Parliament wanted EU exclusive competence, but this received pushback from many of the Member States.

In many ways, the Court handed a significant victory to the European Union on these issues. Going further than had been suggested by the Advocate General’s Opinion in that case, the Court found that the European Union had exclusive competence over almost all aspects of the EU-Singapore FTA, which paves the way for them to enter into such agreements without requiring the approval of all of the Member States. But this general ruling was subject to two notable exceptions.

First, the European Union had exclusive competence over provisions concerning the protection of direct foreign investment, as provided for by the Lisbon Treaty, but not those concerning non-direct foreign investments (which are often referred to as “portfolio” investments that are made without any intention to influence the management and control of an undertaking). I’m not going to address that issue here.

Second, the European Union did not have exclusive competence to enter into treaties including ISDS provisions. The Court reasoned that the EU-Singapore FTA gave the claimant investor a choice between bringing a dispute before the courts of a Member State and submitting the dispute to arbitration. As the latter had the effect of removing disputes from the jurisdiction of the courts of the Member States, it could not be established without the Member States’ consent.

Reaction to the Court’s Opinion

I am not an EU lawyer, so I don’t plan to spend long addressing the merits of the Court’s decision. To a casual observer, the Court seemed to depart from its general approach that competence of the European Union to conclude international agreements on a particular topic necessarily entails the power to submit to the decisions of a court or body which is created or designated by such agreements as regards the interpretation and application of their provisions. From this, one might have assumed that if the European Union had competence over foreign direct investment, it would also have had competence to establish investor-state arbitration.

Without much explanation, the Court distinguished this case from the general rule on the basis that investor-state claims (unlike state-to-state claims) could be brought before the national courts of Member States, so the jurisdiction of such courts could not be removed without their consent. In doing so, the Court seemed to be reacting to the political controversy that has emerged about ISDS clauses, which often function as lightning rods for complaints about the excesses of economic globalisation. By giving Member States mixed competence to approve treaties containing ISDS clauses, the Court handed back power (and also responsibility) to these Member states.

The decision seemed political in another sense as well. International lawyers often have the impression that the European courts jealously guard their turf and their superiority. Here, the Court did not rule that ISDS was incompatible with EU law – that issue remains open. But by ruling that treaties with ISDS clauses were subject to mixed competence, the Court significantly reduced the chance of such clauses being included in future EU FTAs. In this way, the Court may have indirectly achieved the goal of limiting competition between European courts and international arbitral tribunals.

What does the Court’s Opinion mean for the future of EU FTAs?

I am not familiar with the ins and outs of EU voting laws and procedures, but it seems to me that the European Union would have at least four options in response to this ruling.

The first would be to keep going with negotiating broad, newer style FTAs and simply accept that these must be approved by both the European Union and the Member States as a matter of mixed competence. If the Court had found many issues to be subject to mixed competence, this might have been the obvious path. But it is less clear that this path would be followed now given that the Court ruled that the European Union had exclusive competence over everything except portfolio investments and ISDS. If these agreements are subject to mixed competence, then we can expect more drawn out and messy political fights of the kind the European Union witnessed last year when ratification of its Comprehensive Economic and Trade Agreement (CETA) with Canada was almost derailed by the objection of the regional government of Wallonia in Belgium.

The second option would be to reverse the merger of trade and investment provisions and go back to the earlier world of separate trade and investment agreements. This would mean cutting out the investment chapter and the ISDS clause from the FTAs and making them subject to a separate agreement. This option might be appealing on the substance of investor protections because it would allow the European Union to deal with foreign direct investment and portfolio investment within a single treaty. But it is less attractive in the sense that the European Union already has exclusive competence over protections relating to foreign direct investments, so it may well want to keep these in the main FTAs.

A third option that some, like Rob Howse, have suggested is that the European Commission could try to make recourse to national courts a condition precedent to bringing an international claim and in this way seek to reinvolve national courts. But it is not clear that this approach would satisfy the concern that Member States need to consent to issues being removed from their jurisdiction if it would ultimately result in the introduction of an international level of dispute resolution to which they have not consented.

The fourth and, to my mind, most likely response would be for the European Union to remove ISDS clauses from its FTAs and make them the subject of a side agreement. The main FTA could still include a chapter with protections relating to foreign direct investment as well as state-to-state dispute resolution over the interpretation and application of those terms. The European Union could then have a parallel agreement or an optional protocol where the treaty parties agree to adopt a form of investor-state dispute settlement, most likely an investment court, with only that side agreement being subject to mixed competence. The main FTA could be ratified easily and it would stand regardless of whether, when or by whom the side agreement was ratified. It is easy to see why the European Union might favour this approach, but would the Member States be willing to accept this division given that it would mean giving up their veto power over the FTAs?

The European Commission now favours the use of an international investment court instead of investor-state arbitration, but this change would not in itself address the concern about Member States needing to consent to issues being removed from the jurisdiction of their national courts. Still, this ruling may well confirm the European Commission’s instinct that it should be working toward adopting a Multilateral Investment Court Convention along the lines of the Mauritius Convention that would be ratified by both the European Union and its Member States. Such a Convention could then be applied to the EU’s existing FTAs, including ones that do not provide for ISDS. In some ways, entering into a single multilateral Convention would be easier than entering into side agreements for every FTA. But one would still expect that the European Union would start out with the side agreements given that no one knows whether, or when, an agreement might be reached on a Multilateral Investment Court.

What does the Opinion mean for ISDS clauses more generally?

This decision of the European Court is the latest development in a series of setbacks for ISDS clauses. A number of other states have actively rejected the use of ISDS clauses or significantly limited their scope. Notable examples include:

  • Brazil, which has never ratified an investment treaty providing for investor-state dispute settlement. More recently, it has started signing Cooperation and Investment Facilitation Agreements that encourage the use of alternative dispute resolution mechanisms, such as conciliatory settlement of disputes through Ombudsmen that are subject to a Joint Committee of the treaty parties, and ultimately permit state-to-state arbitration but not investor-state arbitration.
  • South Africa, which began a process of terminating its investment treaties in 2012 and in their place has passed the Protection of Investment Act 22 of 2015, which gives primacy to domestic remedies, including mediation and domestic courts. This Act provides that South Africa may consent to international arbitration over an investment dispute, but this would be subject to exhaustion of domestic remedies and would also take place on a state-to-state, rather than an investor-state, basis.
  • India, which radically revised its Model BIT in 2015, to significantly limit access to ISDS. Before an investor can bring an investor-state claim under the Indian Model, it must first seek to exhaust domestic remedies for a period of up to five years. It may then proceed to arbitration, subject to a six-month negotiation period, provided that it brings the claim within six years of knowing about the measure that it is complaining about. These tribunals are also not permitted to review the merits of a decision made by domestic courts.
  • Australia, which has adopted some FTAs (e.g., with the United States and Japan) that do not include ISDS clauses.
  • Ecuador, which recently terminated 16 of its investment treaties, following the recommendation of a national Commission that Ecuador pursue new treaties which exclude investor-state dispute settlement mechanism and instead provide investors with access to national courts.

Perhaps one of the most significant effects of the European Court’s ruling will be to give cover to other states that are wishing to hit the pause button when it comes to ISDS clauses. At the moment, states have to buck the general trend if they wish to actively reject the use of ISDS clauses. This carries with it some stigma. But, with the European Union having to reconsider its approach, the exclusion of ISDS clauses from FTAs might become more mainstream and politically acceptable. Some states might happily put dispute resolution in a side agreement and be perfectly content for that agreement to never be ratified.

States often find safety in numbers and they are typically conscious of the company they keep. If more states start not including ISDS clauses in their FTAs and investment agreements, and the reasons for doing so become more varied, other states may feel comfortable in making the same choice without the fear that they will be branded as unfriendly to investors. If so, the opinion of the European Court may well end up being the tipping point against the inclusion of ISDS clauses in modern FTAs and other investment agreements, in Europe and beyond. And this may also serve as further incentive for the European Union to pursue a multilateral convention on investor-state dispute resolution.

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Joshua Paine says

May 19, 2017

Thanks Anthea for a typically thoughtful post. Just to add slightly to your list, IA reporter recently reported on a new Investment Protocol adopted by the Mercosur member states which follows Brazil's newer investment treaties in using an ombudsperson, a Joint Committee, and ultimately State-State (but not investor-state) arbitration: https://goo.gl/6hEeJM (subscription needed).

Alessandra Asteriti says

May 19, 2017

I wondered some time ago whether the backlash against ISDS would result in a return to investment contract arbitrations (after all, this was the original purpose of the ICSID Convention). I might have to look for data to see if it bears out, but would certainly dovetail nicely with your predictions. One thing for sure: investors are not going to accept the demise of ISDS without a fight back.

Jakob Cornides says

May 19, 2017

First and foremost, the Court's opinion is to a very large extent a formidable victory for the European Commission. Contrary to what one could read in the Advocate General's conclusions, it was found that in all areas except the two mentione above the EU indeed has exclusive competence to conduct trade negotiations and conclude trade agreements. After the TTIP/CETA crisis of last year, this is certainly reassuring. The two issues can be isolated and made subject to separate agreements, but for everything else the EU's competence is now confirmed, and the trade policy can be advanced with greater legal certainty.

With regard to ISDS the various options you have set out above are available - but my expectation is that ultimately Member States will see that it is in their own interest to have such dispute settlement systems, and one may thus expect that the ratification process, even if conducted one-by-one, will not be that difficult.

The opposition against TTIP and CETA was, in my view, never about the two issues that the Court now has found to touch on Member States' competences. Instead that opposition was driven either by unbridled anti-americanism (in the case of TTIP), anti-americanism by extension (CETA), or perhaps a fundamental opposition against free trade. Issues like ISDS were pretexts, not reasons, to be against. And of course this provided a marvellous occasion for irresponsible regional chieftains like Wallonia's Paul Magnette to hold 27 1/2 Member States hostage over what in reality was simply a stand-off with the Belgian central government.

Now that the competences of the EU have been clarified, the wider public will lose its interest in the ISDS issue.

It will soon be business as usual.

Anthea Roberts says

May 20, 2017

Dear Alessandra

Yes, I think that any squeeze on investment treaties will lead to an increased focus on investment contracts. You can see this, for example, in the Commission's recommendation to Ecuador to consider negotiating investment contracts after terminating older-style investment treaties. But this movement will largely work to protect (1) bigger companies, not small to medium sized ones, as they will have more clout to be able to ask for such contracts and (2) companies that are directly dealing with the government rather than cases where there are private-to-private dealings but state responsibility is invoked due to the actions of domestic courts, for instance, in relation to those private dealings.

But there will be another pressure to move toward contracts. To the extent that states continue with investment treaties and investment arbitration, we can expect those states to guarantee greater protections to public interests and greater transparency etc given the increased focus on the public nature and importance of these agreements and this form of dispute resolution. If so, some of the investors who have the choice of bringing a case on a more commercial basis (e.g., on an investment contract) or before a more commercial institution (e.g., the ICC instead of ICSID or an UNCITRAL arbitration subject to transparency) well come to prefer that course of action over time.

I have not seen any empirical investigations of this point, and some of these trends would be hard to track, but I set out the general argument about this potential move in Clash of Paradigms: Actors and Analogies Shaping the Investment Treaty System, AJIL 2013, p 90 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2033167), which states in relevant part:

As states begin drawing more heavily on public international law and public law paradigms in the field’s adolescence, for instance, investors will likely respond by championing paradigms that privilege their role (such as the commercial arbitration and narrow human rights approaches) and promoting analogies to suit their purposes within the more public-oriented paradigms (such as by developing concepts like due process, good faith, and legitimate expectations). If they perceive systems, such as ICSID, as becoming too public, they may opt for less public dispute resolution under the UNCITRAL and ICC Rules. If they view treaties as being too accommodating of state sovereignty, they are likely to press for investor-state contracts with stabilization clauses. Whether states would respond by, for example, only permitting ICSID arbitration or not agreeing to contractual stabilization clauses remains to be seen and may vary based on the interests and relative power of the state and investor in question.

Lawyers with a cross-specialty in commercial and investment arbitration are also likely to protect their turf. Some may encourage their clients to repackage potential investment treaty disputes as commercial disputes. Others may argue that broad distinctions between commercial and investment treaty arbitration are unhelpful, as commercial arbitration has dealt with similar public law issues for many years and can thus adequately handle the challenges posed by investment arbitration. (It is unclear whether this analysis should lead to the conclusion that investment arbitration does not require specialized scrutiny and procedures or that critical attention should also be paid to certain “commercial” arbitrations.) Some may seek to develop a more nuanced private international law paradigm, while others are likely to educate themselves in public law, trade law, human rights law, and public international law to demonstrate that such expertise can be developed from within and does not require the entry of new participants.

Best, Anthea

Alessandra Asteriti says

May 20, 2017

Thanks Anthea for your detailed and informative answer. And of course you are right to point out that the biggest losers, at least in the short term, will be small investors, with limited contractual power, who could rely on treaty protection.

Anthea Roberts says

May 20, 2017

Dear Joshua and Jakob

First of all, thanks to Joshua for the reminder about Mercosur. I had clocked that when IA Reporter did the story on it but I had forgotten to add it to my list. Yes, it is another example of this developing trend. Still a minority trend, of course, but one that I believe will gain momentum in the coming years. I also suspect that this approach might be of interest to the RCEP negotiating states. Someone told me that Mercosur does not have a mandate to negotiate investment or ISDS clauses (not sure which). I have not confirmed that but, if that is true, then the EU-Mercosur FTA that is being negotiated might hold some interesting clues on the way forward.

Second, Jakob, you may well be right that the EU Member States will ultimately find that it is in their interest to accept ISDS. It may certainly be in the interests of some of the more powerful Member States, but I doubt that all of the Member States would be so welcoming to it. What you suggest would not foreclose the EU from going down the path of making dispute resolution subject to separate ratification in side agreements to be on the safe side. If the Member States wanted to include ISDS in the main FTA, they would then probably need to give a fairly high degree of assurance that they would not use this “power to veto” the agreement to “actually veto” the agreement, which creates a strange, topsy-turvy dynamic that is hard to predict, esp. for a non-EU law person like me.

Third, on Jakob’s idea that the concern about ISDS is going to die down and this is all going to go back to business as usual, I disagree. We are witnessing a relatively profound backlash against economic globalization that, in my view, has both economic and cultural causes. I don't think that this is going away anytime soon. I believe that ISDS will continue to be a focal point for these sorts of concerns bc it provides a very clear example of powerful private actors being able to sue states before transnational tribunals - something that many of those who oppose economic globalization will hate. Whether or not you agree with the sentiments expressed by these people and groups, I think that the opposition is significant and will be around for a while and that ISDS will remain a flashpoint for this sort of controversy.

The last point relates more broadly to the point I was making about the political quality of the Court’s decision. The effect of the Court’s decision is likely to be that either ISDS clauses will no longer be included in FTAs or, if they are included, this will be with the express consent of every Member State. Given that ISDS clauses have proved to be one of the most contentious parts of FTAs, I wonder if the Court was really trying to protect the EU’s legitimacy by limiting the EU’s reach. Would the Court have reached the same decision had the same issues played out in the mid-2000s before the backlash against globalization and the investment treaty system developed? I suspect not. If so, then this Opinion is somewhat of a reaction to the zeitgeist of this age.

Best, Anthea

Jakob Cornides says

May 21, 2017

"The effect of the Court’s decision is likely to be that either ISDS clauses will no longer be included in FTAs or, if they are included, this will be with the express consent of every Member State."

Indeed, including them would subject the entire FTA to ratification by each Member State, with the risk that one Member State (or perhaps even one region within one Member State) can hijack the proces, like we have seen in the case of CETA. Of course no reasonable negotiator would want to run that risk, therefore you should henceforth not expect to see ISDS clauses included in FTAs, even if Member States were to give their consent beforehand. (After all, the hijacking always takes place when the FTA is ready for signing, not earlier... and no democracy can give ex-ante assurances how its parliament will vote on a given subject at a given moment.)

You should be aware that all ISDS clauses in all FTAs that the EU has ever negotiated, including CETA or TTIP, have been put there with the express consent of the Member States: it is called "negotiating mandate".

What I meant and wrote is: people are likely not very concerned about ISDS clauses, which (for the export-oriented industries) are a perfectly useful mechanism that has been tested hundreds of times. But it results from the CJEU's opinion that ISDS clauses will turn an FTA into a mixed agreement that needs to be ratified by each Member State individually, and thus into an easy target for anti-trade-campaigning. Therefore it is necessary to remove them, and possibly deal with the matter in separate agreements.

The point is: the hot-button issues are not necessarily the same that, like ISDS, raise questions of competence.