The crisis of legitimacy in international investment agreements and investor-state dispute settlement

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Judicial Power Project | 9 January 2018

The crisis of legitimacy in international investment agreements and investor-state dispute settlement

by Jane Kelsey

In the thirty years since the World Trade Organisation (WTO) was established, international economic agreements have intruded ever deeper into states’ regulatory and judicial domain, to the point that they now face a multi-faceted backlash. The popular discontent that has erupted in the United States and Europe is a response to the socio-economic fractures of the financialised capitalism and neoliberal agenda of which these agreements are part, and a profound sense of disempowerment from decisions that affect people’s daily lives.

Challenges to the legitimacy of these agreements are often more fully articulated under the rubric of a ‘democratic deficit’. This deficit comprises four elements: the secrecy of negotiations, sometimes extending beyond the publication of the final text; constraints on future governments’ ability to regulate in areas that include taxes, food, health, financial services, and property rights; mandatory presumptions and procedures that governments at all levels must follow when they regulate; and enforcement of these rules by foreign states and foreign investors through extra-territorial arbitral tribunals, which have power to impose economic or financial penalties on sovereign governments. The degree of the backlash against each element varies. Secrecy attracts the most broad-based condemnation, including from legislators whose future authority is being constrained without their knowledge or consent. Investor-state dispute settlement (ISDS) comes a close second for the diverse reasons discussed below.

Views from the left generally overlay these concerns with a political economy perspective. The new generation of mega-regional agreements, such as the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP), have become the favoured means to advance an insatiable and unstable form of transnational financialised capitalism and the associated neoliberal regime. The rules themselves are the problem — not just the processes to adopt, implement, and enforce them. Moves to reform the process elements, such as the controversial system of ISDS, fail to address the systemic bias of the agreement in favour of capital and the minimalist state. The mega-agreements are particularly potent, seeking to bind future governments to an extreme version of these rules at a time when the morbid symptoms that are erupting in many countries show it is unsustainable.

There is, of course, no single ‘left’ perspective. Internationalists who are sceptical of the state, which they see as an instrument for capital tend to seek alliances that can strengthen their voice regionally or globally to constrain the nation state and the state-finance nexus. Internationalists in Latin America, for example, have built successful alliances to resist mega-agreements they see as a common threat, such as the Free Trade Area of the Americas in 2005, and campaign against ISDS in the wake of crippling damages awards to foreign corporations in countries like Bolivia and Ecuador. The embrace of the European Union by many on the left in Europe is often puzzling to those who view economic integration and supranational governance as less benign. Yet the protests in post-crisis Greece shows that embrace is far from universal. Democratic socialists and social democrats have a more ambivalent view of the state as a contested zone where the socially destructive tendencies of capital can be restrained. They, too, have combined within Europe, and across TPP countries, to oppose the new mega-agreements.

Many critiques from the left also have a geopolitical dimension, especially from the global South. The process and substance of pacts like the Central American Free Trade Agreement (CAFTA) or the European Union’s Economic Partnership Agreements (EPAs) with African, Caribbean, and Pacific countries are riven with power asymmetries that mirror the imperialism they notionally replace.
As this brief survey indicates, positions on the left tend to converge in opposition to the investor rights and enforcement provisions in these agreements. This essay begins by describing the rapid growth of international investment agreements (IIAs), before setting out the broad-church criticisms of ISDS that have provoked a crisis of legitimacy in the investment arbitration regime. This is overlaid by rejections from the left of moves to re-legitimise the investment regime through adjustments to investor protection rules and the dispute process, but which fail to address the imbalance that is intrinsic to their role as instruments of international capital.

The rise of international investment agreements

There are three kinds of international investment agreements: bilateral investment treaties (BITs), investment chapters in broader free trade and investment agreements (FTIAs), and sector specific agreements, notably the Energy Charter Treaty. Some investment contracts may also be enforced through IIAs, under what are known as ‘umbrella clauses’.

There are currently over 3000 IIAs. The majority are BITs that date back to the 1980s and 1990s, when governments signed them with little understanding of their implications. In those days, disputes were rare. More recently, investment chapters have been incorporated within broader FTIAs; the rapid rise in disputes since the late 1990s has made their negotiations much more controversial, even though the bulk of disputes are under old BITs.

These investment agreements allow investors to enforce their protections directly against governments. Disputes are typically heard by ad hoc arbitral panels established under the auspices of the World Bank’s International Centre on the Settlement of Investment Disputes (ICSID), or under the United Nations Commission on International Trade Law (UNCITRAL) rules. Occasionally, they may be entirely ad hoc.

The total number of disputes brought by investors against governments is unknown, as most old agreements do not require disclosure of information, including the existence of a dispute or the outcome. The United Nations Conference on Trade and Development (UNCTAD) has the most reliable depository. It records only 767 known disputes. However, that number has grown exponentially from a handful in the 1990s to 62 known cases initiated in 2016; that was slightly down from 74 in 2015, but above the average of 49 over the previous decade. The rapid growth in cases is linked to the rise of entrepreneurial lawyers advising clients to bring disputes they would never have conceived of a decade ago. The emergence of third-party funders, who underwrite the costs in exchange for a share of any final award, also creates financial incentives to bring disputes. The vast majority of disputes have involved services; relatively few relate to traditional investment in agriculture or manufacturing.

A total of 109 countries are known to have been sued, although the number is probably higher. Historically, developing countries were the targets. By 2015, affluent countries were respondents in 45 per cent of disputes, falling back to 29 per cent in 2016. Inter-EU disputes accounted for one quarter of the total in 2016. The amounts claimed ranged from $10 million to $16.5 billion (a mining dispute against Colombia), but the sums claimed were only made public for half of the known cases. The highest proportion of disputes use US and Netherlands treaties. Large transnationals that are sufficiently aware (for example in the mining industry) may structure themselves to benefit from agreements or do so when they see storm clouds gathering.

Only 41 of the 57 known substantive decisions delivered in 2016 are in the public domain. The total known outcomes show an interesting pattern. Of the 495 known cases concluded by the end of 2016, one third were decided in favour of the state, one quarter awarded damages to the investor, one quarter were settled (meaning a partial win for the investor) and the rest were discontinued or made no monetary award. Over half of those won by the state were for lack of jurisdiction, which, in the eyes of one seasoned arbitration lawyer, shows many should never have been brought. The investor wins the majority of cases on the merits, which is unsurprising given the pro-investor rules and perceived bias of the panels. There is no appeal. The ICSID provides for annulment on specific grounds; of the eight publicly known proceedings in 2016, two partially succeeded, in favour of the investor.

Investment tribunals comprise three arbitrators, one appointed by each side who in turn appoint the chair. They are paid by the hour. A small number of boutique international law firms dominate as counsel and arbitrators, playing multiple roles within the system. An investigation of the industry in 2012 observed that it ‘has become normal for investment arbitrators to constantly switch hats: one minute acting as counsel, the next framing the issue as an academic, or influencing policy as a government representative or expert witness’. There are minimal to no conflict of interest rules. The TPP text promised to develop a code, but it was not in the agreement itself. It is extremely difficult for one side, usually the state, to secure removal of an arbitrator for a conflict of interest. As of 2012, just fifteen arbitrators, nearly all from Europe, the U.S., or Canada, had decided 55 per cent of all known investment treaty disputes.

A growing legitimacy crisis for ISDS

The UNCTAD’s 2012 World Investment Report attributed mounting questions about the usefulness and legitimacy of ISDS to ‘deficiencies in the system (eg. the expansive or contradictory interpretations of key IIA provisions by arbitration tribunals, inadequate enforcement and annulment procedures, concerns regarding the qualification of arbitrators, the lack of transparency and high costs of the proceeding, and the relationship between ISDS and State–State proceedings)’.

Speaking in a similar vein, as an insider, investment lawyer George Kahale has catalogued ten troubling aspects of ISDS: bad old treaties that are open to abuse; a process developed for commercial disputes in which arbitrators are not appointed for their training and are beholden to appointing parties for ongoing work; substantive concepts that are open to abuse, notably ‘fair and equitable treatment’ and the most-favoured-nation clause; a premium on speed and finality rather the proper administration of justice, with an absence of appeals to correct manifest errors of law; massive claims that exceed the GDP of many nations and awards that are arbitrary and compound the interest; the high bar for disqualifying arbitrators; outcomes that are predictable as soon as the arbitrators are known; claimants’ exaggerated claims; the rise of third-party funders of disputes; and the perceived bias against states.

Judges have objected to investment tribunals overriding their jurisdiction. An open letter from more than 100 legal professionals, including former judges, parliamentary officers, senior politicians, and academics expressed dismay at the potential incursions of the TPP’s investor-state dispute process on nations’ domestic judicial systems. Legislators have objected to handcuffs on their right to regulate in TPP and TTIP.

Legal scholars have identified risks of regulatory chill from a threatened or actual dispute, for instance on tobacco policies. As the OECD has noted, compensation claims of hundreds of millions, or sometimes billions of dollars ‘can seriously affect a respondent country’s fiscal position’. Empirical research by van Harten and Scott shows a more systemic effect, as government ministries changed their approach to decision-making to account for concerns about ISDS.

These are mainstream actors. The legitimacy crisis facing investment agreements has deeper political origins on the left. Disputes over water privatisations in Bolivia and against Argentina following its financial crisis in 2001 became causes celebre that brought ISDS to attention of the left. The 59 known disputes under North American Free Trade Agreement (NAFTA) did the same in the US, Canada, and Mexico. The prospect of greater exposure to US corporate claims under the pro-investor rules in TPP and TTIP heightened opposition to both.

Re-legitimation strategies

The legitimacy deficit has prompted a series of responses. Institutionally, UNCTAD has taken the lead. In 2013, UNCTAD identified five paths for reform: promoting alternative dispute resolution; tailoring the existing system through IIAs; limiting investor access to ISDS; introducing an appeals facility; and creating a standing international investment court. By 2015, UNCTAD’s World Investment Report described the IIA regime as going through a period of ‘reflection, revision and review’. The report promulgated eleven principles to guide policy making, and identified a number of policy options ranging from ‘mainstream’ (reformist) to ‘more idiosyncratic’ (rejectionist). The ‘roadmap’ identified two stages: first, reform through new generation treaties; and second, fixing the old generation BITs.

In relation to stage one of the roadmap, UNCTAD observed that new IIAs contain some reform-oriented elements, but also impose more far-reaching obligations on states, such as broader definitions of investment or new investor-protections. Legal scholars writing on the TPP observed that it did not address some major concerns about the investment rules and enforcement. ‘Left’ critiques were especially critical of the expansive definitions of investment and the vaguely worded investor protections that gave arbitrators abundant scope for pro-investor interpretations.

There is equal scepticism about collective attempts of major capital-exporting countries to re-legitimise the investment treaty regime. The G20 agreed a list of non-binding principles for global investment policymaking in 2016. The principles mirror the current regime, with some vague wording about the right to regulate. Significantly, they bring the major Southern countries under the umbrella of those principles, including India and South Africa, that have been withdrawing from their agreements.

In a more concrete move, the EU and Canada incorporated a standing investment tribunal and appellate mechanism into their bilateral agreement in 2016, and committed to promote the establishment of a multilateral investment tribunal. The EU has made the investment court a standard requirement for its FTAs. The initiative addresses some procedural concerns about investment tribunals, but leaves the systemic bias of the rules they enforce intact. Even the moderate European Trade Union Federation concluded that CETA’s investment chapter ‘failed to meet the mark’ because ‘investors will still be granted special rights over other groups in society to sue governments for policies that threaten their profits or business interests’.

Reject and reform

The most consistent position from the left, sometimes shared by other lawyers, legislators, and academics, has been to omit investment chapters, or at least ISDS, from new agreements. Some countries, such as Australia, have adopted a ‘case-by-case’ approach. Other countries have taken a broader rejectionist approach since around 2007, and have renounced some or all their BITs and/or have withdrawn from international instruments linked to arbitral facilities. The UNCTAD reports that 212 BITs were terminated as of March 2017: 19 jointly and 59 unilaterally, while the majority were replaced by a new treaty (which may still be pro-investor).

Terminations were usually responses to bad experiences in investment arbitrations. The early momentum came from left governments in Latin America: in 2007, Bolivia notified withdrawal from the ICSID Convention and its intention to revise 24 BITs; Ecuador followed suit on ICSID in July 2009, and later terminated twelve investment treaties.

Other countries took a reject and reform approach to rebalancing investors’ rights and the national interest. Their solutions were country specific. The South African government terminated nine BITs and replaced them with domestic legislation. The Protection of Investment Act 2015 puts the constitution at the centre as it seeks to balance the rights of all investors, foreign and local, with other domestic priorities. Investor rights are enforced through the domestic courts unless both parties consent to arbitration. That approach now permeates regional approaches in Southern Africa.

Prior to 2015, Brazil had no investment agreements in force, because the legislature had refused to ratify them. In 2013, the government developed a new Cooperation and Investment Facilitation Agreement, which Brazil has promoted regionally and in the WTO. Brazil’s model emphasises prevention of disputes, followed by mediation, with vague provision for arbitration. It retains some, but not all, of the problematic investment rules in old BITs; obligations on foreign investors are comparatively weak.

In 2016, India notified more than 50 treaty partners with whom BITs had expired that it would not renew them. A model BIT was adopted in December 2016, which promotes exhaustion of domestic remedies with a short window to initiate subsequent arbitration. India’s model is more protective of the state’s regulatory autonomy and imposes some social obligations on foreign investors, although many of the social protections in the earlier consultation draft were omitted. Again, many of the problematic investor protections remain intact.

The legitimation crisis facing IIAs is entering a new phase. Capital exporting states have regrouped to defend an investment regime that serves their corporate interests. Large developing countries are promoting alternatives that offer a new balance between their offensive and defensive interests. Governments in rich and poor countries continue to face potentially crippling investment disputes that are often designed to intimidate their regulatory decisions. Boutique law firms and third-party funders are intent on defending a lucrative source of income.

As the turbulence in the global economy and backlash against neoliberalism continues, opposition to the international investment regime and ISDS from the left seems destined to grow. A system in which rules that privilege capital are enforced through a biased extra-territorial dispute process cannot be fixed. The South African remedy that brings the disputes back into the domestic jurisdiction may be the best of the current alternatives. For many on the left, however, that would presage a return to the more traditional contest over the authority of the legislative and judicial branches of the state in relation to capital.

Jane Kelsey is a Professor of Law at the University of Auckland.