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.