THE EVOLUTION OF INVESTOR-STATE ARBITRATION: A CRITICAL ANALYSIS

This article is written by Saloni Sharma of Chanderprabhu Jain College of Higher Studies and School of Law, New Delhi, an intern under Legal Vidhiya

ABSTRACT

Enhancing the effectiveness and general calibre of arbitration has always been a priority for the international arbitration system. The various parties involved in arbitration work to maximise these variables, together with the openness and predictability of these variables, including the length and expense of arbitration. The ISDS system aims to foster trust between international investors and the host government. This trust promotes foreign businesses’ capital investments in other nations, therefore advancing those nations’ economies. This chapter will cover the development of the ISDS system and investor-state arbitration.

KEYWORDS

Investment arbitration, Investor-State dispute settlement, Investment Court System, arbitration, award, arbitration clause, international, investments.

INTRODUCTION

Investment arbitration is a process for resolving disputes and issues between foreign investors and the host countries (also called Investor- State Dispute Settlement or ISDS).

Investor- State dispute settlement ( ISDS), or the Investment Court System( ICS), is a set of rules through which states can take an action to sue by the foreign investors for certain state measures that are affecting the investments (FDI) by that particular investor by that state. Most frequently, it’s a transnational arbitration between a foreign investor and a nation. 

The ability for a foreign investor to bring legal action against the host country ensures that, should a dispute arise, he will have access to impartial arbitrators who will settle the issue and render a binding decision.

This enables the foreign investor to resolve the issue in line with the different protections offered by international treaties, avoiding national jurisdictions that can be seen as biased or lacking in independence. The host state must agree before a foreign investor can start an investment arbitration.

HISTORY OF INTERNATIONAL ARBITRATION

Early Theories of Arbitration before international conventions

Throughout history, the idea of arbitration has been applied to settle international conflicts; on occasion, early Roman Republic and Greek city states adopted arbitration as a legal procedure. An arbitration clause was established by Athens and Sparta in Greek antiquity, which stated that disputes would be handled by both parties maintaining peace and submitting to an arbitration authority. But when both sides tried to use arbitration, diplomatic relations collapsed, and the Peloponnesian War followed.

Later, the Romans served as arbitrators and mediators amongst Greek city states, however they were hesitant to use arbitration techniques to settle their own international conflicts. The Normans suggested the creation of an arbitration panel at the beginning of the fourteenth millennium in order to settle conflicts and preserve harmony throughout European kingdoms and feudal areas.

Philosophers of the Enlightenment, such as Jeremy Bentham and Jean-Jacques Rousseau, supported creating a system to settle disagreements between European powers. An arbitration clause was included in the Treaty of Guadalupe Hidalgo in 1848, and the Permanent Court of Arbitration was established during the first Hague Conference[1] in 1899. Following World War II, nations realised how important it was to establish trade agreements and a formal dispute resolution process.

The New York Convention[2]

The UN’s members started to see that arbitration might get compromised in the absence of a compliance system. The contracting states, who are members to the New York Convention, are required to acknowledge and uphold arbitration rulings rendered within their respective areas of authority.

In essence, the New York Convention serves to uphold arbitration verdicts obtained in connection with international business agreements. A subscribing state may announce that it will only recognise and uphold arbitration verdicts made in other signatory nations based on the principle of reciprocity.

Moreover, an adhering nation may specify that it will restrict the scope of the New York Convention to legal distinctions that it regards as commercial under its domestic legal framework. If the commercial arrangement was invalid under either party’s choice of law, if there was a legal infringement pursuant to the arbitration rules that both sides consented to, or if it would be against the public policy of the contracting state, the contracting state could choose not to recognise the validity of an arbitration award. As of right now, 172 states have ratified the New York Convention.

The ICSID Convention[3] and the Rise of Investor-State Dispute Settlements

Developed nations were worried that previous colonies might seize their citizens’ property as independence approached. Aware of the need to safeguard their abroad assets, powerful nations started incorporating arbitration as a mechanism for settling disagreements between foreign investors and the “hosting state” in bilateral investment treaties with developing nations.

The Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention) was approved by twenty states in September 1966. It is an international agreement created by the World Bank. The ICSID Convention listed methods for resolving conflicts between investors and states and aimed to promote private investment in developing nations.

There are at present 165 nations that have ratified the ICSID Convention. Investors are granted procedural protections under the ICSID Convention. As per ICSID Convention, any financial awards rendered through arbitration are conclusive and legally enforceable. A contracting state may not ignore the judgement even if it disagrees with the arbitration’s outcome. In actuality, the arbitration ruling is agreed to be enforceable by each of the contracting states in their respective home jurisdictions as a final court decision. Nonetheless, in order to the ICSID Convention to have jurisdiction over the dispute, formal approval must be obtained from both the contracting state and a foreign national of another state that is a member.

Arbitration guidelines are provided by the ICSID Convention for conflicts resulting from foreign direct investments in member states. Certain conflict classifications may be excluded from the Convention’s jurisdiction by member nations. The only remedy available under the ICSID Convention is approval from the parties. While losing parties may seek modification or annulment owing to inaccuracies in paperwork or due process breaches, investors may only seek damages. A fresh panel is assembled to deliberate on demands for annulment. The ICSID Convention provides for the enforcement of any arbitral award that arises.

Panama Convention[4]

The Inter-American Convention on International Commercial Arbitration, sometimes known as the Panama Convention, was ratified by the Organisation of American nations’ member states in January 1975. Although there are a few significant changes, the Panama Convention is patterned after the New York Convention. The Panama Convention’s enforcement is often restricted to decisions reached by parties involved in arbitration internationally who are not citizens of the same state.

On the other hand, if an award results from either national or international arbitration, a party may file a lawsuit for enforcement in a foreign jurisdiction under the New York Convention; the parties are not required to reside in separate states.

Furthermore, unless the parties agree that they will opt out of these regulations, the Panama Convention only recognises the Inter-American Commercial Arbitration Commission’s established procedural norms. When it comes to implementation in the United States, the Panama Convention takes precedence over the New York Convention if the majority of the arbitration’s participants are citizens of states that have either ratified or joined to the Panama Convention.

World Trade Organization[5]

State-to-state conflicts under the World Trade Organisation (WTO) are handled differently than investor-state arbitration under the ICSID Convention. Established in 1995, the World Trade Organisation (WTO) settles disagreements among its 164 member nations about widely accepted trade rules, like reducing tariffs as well as trade obstacles. The WTO has a permanent seven-member appellate body and uses three-member panels to decide disputes. As stipulated in bilateral or multilateral investment treaties, investor-state arbitration, in contrast, develops on an as-needed basis and lacks both a permanent tribunal and an appellate body.

A state that has been wronged might use a favourable verdict from the WTO as grounds for imposing tariffs or punitive measures on the offending state. In spite of the WTO verdict and treaty restrictions, a state has the authority to unilaterally impose penalties. Additionally, some governments have the ability to postpone appointing judges to WTO tribunals, which might completely stop the adjudicatory process.

The creation of the ISDS mechanism has given investors a strong instrument for asset protection. States gain from foreign development and investment in exchange. However, it is worthwhile to investigate worries regarding possible misuses of the ISDS arbitration procedure.

ISDS: WHAT IS IT?

ISDS is an arbitration system often found in bilateral and international trade agreements. A method of resolving disputes outside of court is arbitration. Investors have the ability to file a dispute with foreign governments under ISDS. The process takes place outside of the standard court system because the legal processes is extrajudicial. In private tribunals, arbitrators are appointed to render verdicts.

The power dynamics between governments as well as investors are established by ISDS clauses in trade agreements. Certain trade accords, like the North American Free Trade Agreement (NAFTA), give preference to investors over governments. Others, like the Comprehensive Economic and Trade Agreement (CETA), give nations’ sovereignty precedence over investors’ interests. The ISDS provisions found in the TPP fall between those found in CETA and NAFTA.

PROBLEMS ASSOCIATED WITH ISDS

• ISDS Lacks Transparency

The primary criticism directed towards ISDS pertains to the confidentiality of all or a portion of its protocols. The ashes of the institute end up being present in the framework of ISDS, with a particular emphasis on this topic, since ISDS evolves in a form of arbitration. Every voice opposing ISDS typically at least asserts that ISDS lacks transparency, which is at odds with the public interest and responsibility of the State.

• ISDS Arbitrators Lack Legitimacy

Concerns about the legitimacy of ISDS are another major source of criticism. Papers, opinions from think tanks, and even the State itself are replete with statements such as “Whether three individuals, appointed on an ad hoc basis, have sufficient legitimacy to assess the validity of States’ acts, particularly if the dispute involves sensitive public policy issues.” These statements refer to the legitimacy of ISDS procedures and the responsible arbitrators. Others raise concerns about bias and conflicts of interest in the selection of arbitrators, pointing out that only fifteen arbitrators—mostly from the US, EU, and Canada—have decided over half of all known investment treaty disputes.

• ISDS reduces the state’s ability to regulate

In addition, ISDS is held accountable for undermining the State’s ability to enact new regulations, even when those regulations are not intended. This is because investors could sue states indefinitely based on how they interpret a particular IIA breach or loss, which would make the State reluctant to approve necessary public policies and lead to what is known as a regulatory chill. A phenomenon known as “regulatory chill” might occur when a government’s future potential to implement welfare-enhancing changes is further limited by ISDS restrictions. Investment clauses that guarantee “fair and equitable treatment” and “indirect expropriation” are the reason for this “chilling.”

REFORMS OF ISDS IN TREATIES

Significant alterations are underway; nonetheless, the great majority of investment treaties (about 90%) currently in effect globally were signed as “old generation treaties” and feature customary ISDS clauses. In fact, the bulk of ISDS lawsuits that are now known to exist are founded on treaties from earlier generations.

1. Certain treaties from old generations have undergone reform, either through revisions or complete replacements. For instance, the US and the Republic of Korea signed an addendum to their 2007 pact in 2018. The amendment removes ISDS procedures outside the purview of the most-favored-nation (MFN) provision and clarifies what is meant by the minimum standard of treatment. It also establishes a joint committee to investigate ways to satisfy the goals of both countries while making adjustments to the ISDS provision.
2. The most well-known ISDS system in North America is outlined in Chapter 11 of NAFTA. After months of strenuous talks on a number of important issues, Mexico, Canada, and the US signed the United States-Mexico-Canada Agreement (USMCA), a new NAFTA, in 2018, partly in response to President Trump’s election on the platform of eliminating NAFTA. The negotiators did not spare ISDS from their examination. The new deal would completely remove Canada from ISDS, leaving ISDS in effect only between the US and Mexico, but for a more limited range of disputes. It has not yet been ratified by all three nations.
3. In actuality, the European Commission (EC) is pursuing two separate reforms in an effort to modernise investor-state dispute resolution. First, its goal is to create investment courts, which would sit in judgement over bilateral EU investment agreements that are being negotiated now or in the future, in lieu of international arbitration tribunals. Both the EU-Vietnam Free Trade Agreement (EVFTA) and the EU-Canada Comprehensive Economic and Trade Agreement (CETA) have similar clauses. In accordance with these accords, disputes will be brought before permanent tribunals made up of a defined number of members appointed from the EU, Canada, and Vietnam in addition to members from neutral nations. In order to guarantee their availability, tribunal members will receive monthly retainers and be obliged to uphold particular independence requirements. Both agreements have an appeals process as well, with a tribunal for appeals established similarly to the lower tribunal.

INITIATIVES FOR MULTILATERAL REFORM

A variety of reform attempts are underway, including those by the OECD, WTO, UNCITRAL, and ICSID, in addition to these modifications in particular countries.
Through Working Group III (the Group), for instance, UNCITRAL is in charge of a State-driven ISDS reform endeavour. Here is what the Group’s mandate is: The Working Group’s tasks were to:

(a) Identify and take into account concerns about investor-State dispute settlement;

(b) Assess whether reform was desirable in light of any concerns identified; and

(c) Develop any pertinent solutions to be recommended to the Commission if the Working Group concluded that reform was desirable.

According to the Group, there are four main areas of issues.

1. Reliability, coherence, accuracy, and consistency of arbitral decisions.
2. Decision-makers and arbitrators.
3. The duration of time and cost of ISDS cases (focusing on arbitration procedures)
4. Third party funding.

States have recognised the need to keep a clear line between unjustified fears—which are based on opinions—and well-founded concerns, which are backed by facts and actual study. States have also agreed that, through interpretive pronouncements or revisions, some of the issues brought up about ISDS can be addressed within the parameters of international investment treaties.

ICSID, the preeminent arbitral body for ISDS, is committed to change. Although there are currently no plans to alter the ICSID Convention itself, the ICSID Secretariat has been actively facilitating lengthy discussions over the ICSID Arbitration Rules in order to

• Adopt new regulations based on case studies.
• While upholding due process and striking a balance between investors and States,
• Make the process more efficient in terms of both time and money.
• Reduce the amount of paper used in the process and use technology more often to transmit papers and handle case procedures.
• Expanding upon its August 2018 publication, the ICSID Secretariat released its second working paper in March 2019 with suggestions for rule changes.

Whether these reform efforts will result in significant advancements is still up for debate. Regarding procedural enhancements of ISDS, a prominent practitioner is said to have bemoaned a “collective failure of imagination” at a recent London session. It’s also unclear if the proposed changes will satisfy ISDS’s ardent detractors, many of whom seem intent on doing away with the programme completely in any of its existing guises.

RELATED CASE LAWS

Ethyl Corporation v. Canada[6]

Ethyl, a chemical company based in Richmond, Virginia, used ISDS provisions in investment treaties to target environmental laws. In 1997, Canada banned the importation and interprovincial sale of Methylcyclopentadienyl Manganese Tricarbonyl (MMT), a fuel additive that increases the octane level of unleaded gasoline, over concerns that it poses a significant public health risk. 

Ethyl invoked arbitration through Chapter 11 of NAFTA[7], claiming the restrictions violated NAFTA’s national treatment performance requirements. The Canadian government initially requested dismissal of the claims, but the tribunal allowed them to proceed on merits. Canada settled with Ethyl for $15 million, demonstrating the potential for investors to exploit ISDS provisions in investment treaties.

Philip Morris Asia Limited v. The Commonwealth of Australia[8]

The ISDS mechanism allows investors to neutralize public health and safety laws, such as those designed to combat smoking risks. Philip Morris International, a subsidiary of Philip Morris Asia Limited, initiated a restructuring process in 2010 when it purchased all shares in the Australian subsidiary. The Australian government argued that the plain packaging legislation constituted expropriation and resulted in damages exceeding a billion Australian dollars.

The arbitration tribunal dismissed the claim, stating that Phillip Morris was aware of the legislation and had ordered its Hong Kong subsidiary to purchase shares in its Australian subsidiary. Despite the favorable outcome, the Australian government spent nearly $39 million over a six-year period to defend against Phillip Morris’s claim. Phillip Morris had to reimburse Australia for its legal expenses, but the Australian taxpayer had to make payments during the pendency of the arbitration action.

Occidental v. Ecuador[9]

An ICSID tribunal granted Occidental Petroleum a $1.8 billion verdict against the Ecuadorian government in October 2012. Ecuador was additionally compelled to pay half of the tribunal’s costs and $589 million in delayed interest payments, for a total penalty of about $2.4 billion. The South American nation terminated the oil corporation’s contract, citing a breach of the company’s need to obtain authorization before selling its rights to another company. Although the tribunal acknowledged that the violation had occurred, it found that the corporation had not been treated fairly or equally in the arbitration.

Phillip Morris Brands Sàrl v. Oriental Republic of Uruguay[10]

A legal case was brought against the international tobacco firm Phillip Morris in Uruguay in accordance with the Switzerland-Uruguay Bilateral Investment Treaty. In order to comply with new laws, cigarette brands were only allowed to make one presentation in 2008 and 2009. As a result, Phillip Morris was unable to promote distinct brands under names like “Marlboro Red,” “Marlboro Gold,” “Marlboro Blue,” and “Marlboro Green (Fresh Mint).” As a result, marketing several variations for every brand was discontinued. Uruguay has implemented the “80/80” law, which mandates that warning labels about the risks of smoking appear on 80% of cigarette packaging.

According to Phillip Morris, these rules amounted to expropriation under the treaty, unfair treatment, and impairment of investments. Uruguay won the arbitration tribunal’s decision, which said that when police power is used in good faith to protect public health and is proportionate and non-discriminatory, it does not amount to expropriation. The panel mandated that Phillip Morris pay Uruguay $I7 million in costs associated with their legal defence.

CONCLUSION

Although ISDS has a noble goal and many advantages, businesses have occasionally abused and taken advantage of ISDS for financial gain. To create a stronger framework for resolving investor-state disputes, ICSID is developing new mechanisms for interim measures of relief, motions to dismiss, publication of awards, and arbitrator transparency. Even though the modifications are small, they show that investor-state arbitration is increasingly moving towards greater openness, public involvement, and a readiness to take inspiration from litigation-based conflict settlement approaches. The practical implementation of these measures will determine their actual impact on investor-state arbitration. In addition to this, the field of investment arbitration is constantly changing. Originally, it followed the procedures of the International Commercial Arbitration, which meant that both the proceedings and the award were confidential and not available to the public. However, as ICSID has developed, this principle has changed to take into account how investments impact the host state’s infrastructure and socioeconomic conditions, which in turn affect the population as a whole. As a result, the procedures and decisions made in relation to investment arbitration have changed the way that secrecy is understood.

REFERENCES

1. Scholar.smu.edu https://scholar.smu.edu/cgi/viewcontent.cgi?referer=&httpsredir=1&article=1314&context=lbra (visited on 13^th February, 2024)
2. scholarcommons.sc.edu https://scholarcommons.sc.edu/cgi/viewcontent.cgi?article=1257&context=scjilb (visited on 14^th February, 2024)
3. Lexology https://www.lexology.com/library/detail.aspx?g=9f656686-709d-4151-a277-c05d52fb9368#:~:text=ISDS%20and%20Termination%20of%2058%20BITs%20with%20other%20States&text=Most%20importantly%2C%20it%20allows%20individual,Settlement%20(%E2%80%9CISDS%E2%80%9D).  (visited on 13^th February, 2024)
4. Wikipedia https://en.wikipedia.org/wiki/Investor%E2%80%93state_dispute_settlement#Examples (visited on 13^th February, 2024)
5. international-arbitration-attorney https://www.international-arbitration-attorney.com/investment-arbitration/#:~:text=Investment%20arbitration%20is%20a%20procedure,State%20Dispute%20Settlement%20or%20ISDS). (Visited on 14^th February, 2024)
6. ssrn.com https://deliverypdf.ssrn.com/delivery.php?ID=573003097124109022108017028107075102004031054052030066103127100126127083090025064007006034063101028059032066016109005127073098046016071077042066004080086065126072096068080057089027003095067086002092121070123087073001119025029003028124077109023104086104&EXT=pdf&INDEX=TRUE ). (Visited on 29^th February, 2024)
7. nortonrosefulbright.com https://www.nortonrosefulbright.com/en-in/knowledge/publications/74ae9c49/recent-developments-in-isds-reform#section2  (Visited on 29^th February, 2024)
8. nortonrosefulbright.com https://www.nortonrosefulbright.com/en/knowledge/publications/e17ef991/the-eus-proposed-reform-of-isds (Visited on 29^th February, 2024)

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[1] Hague Conference, United States and Mexico, 29^th July, 1899

[2] The New York Convention, 10^th June, 1958

[3] The ICSID Convention, 14^th October, 1966

[4] Panama Convention, 30^th January, 1975

[5] World Trade Organization, 15^th April, 1994

[6] Ethyl Corporation v. Canada, (1998), 7 ICSID Rep 12, (1999), 38 ILM 708, IIC 95 (1998), 24th June 1998, Ad Hoc Tribunal (UNCITRAL)

[7] North American Free Trade Agreement (NAFTA), Ch. 11, 17^th December, 1992

[8] Philip Morris Asia Limited v. The Commonwealth of Australia, (2015) PCA Case No 2012-12 (Official Case No), IIC 665 (2014) (OUP reference)

[9] Occidental v. Ecuador, (2004), LCIA Case No. UN3467

[10] Phillip Morris Brands Sàrl v. Oriental Republic of Uruguay (2016), ICSID Case No. ARB/10/7

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