Investor-State Dispute Settlement at a Crossroads: Who Should Decide Transatlantic Investment Disputes?

By: Maria Nicole Cleis |

This week, the ninth round of negotiations on the Transatlantic Trade and Investment Partnership (TTIP) took place in New York. The mega-trade deal between the United States and the twenty-eight Member States of the European Union was initially scheduled to be finalized by the end of 2014, but, due to disagreements on various issues, the negotiations are dragging on. The window for concluding the agreement will close in mid-2016, just before US presidential elections in November.

Whether or not the hotly debated investor-state dispute settlement (ISDS) chapter will become a part of the TTIP—or opposition against it will bring down the entire deal—will remain uncertain until the final phase of the negotiations. In the interest of an effective ISDS system within and outside of the TTIP, the US and EU negotiators should make every effort to draw up an investment chapter which addresses existing flaws of ISDS, instead of omitting the chapter. Of all available dispute resolution mechanisms, investment arbitration is the lesser evil.

Mandates Granting the Authority to Negotiate the TTIP

The negotiations of the TTIP are led by the Directorate-General for Trade (DG Trade) on the European side. DG Trade is a subdivision of the European Commission, which derives its authority to negotiate trade and investment agreements on behalf of the EU Member States from the Lisbon Treaty. In June 2013, the Member States’ governments explicitly mandated the European Commission with negotiating the TTIP, setting out the key topics and goals to be pursued. If a consensus is reached in the TTIP negotiations, the European Parliament and the individual Member States’ governments will need to approve the final draft of the agreement for it to become binding on all EU Member States.

On the American side, the Office of the US Trade Representative (USTR) is in charge. It is part of the Executive Office of the President, who has the power to make treaties with the advice and consent of the Senate, by virtue of the US Constitution. At the same time, the Constitution endows Congress with the authority to “regulate commerce with foreign nations”. The Trade Promotion Authority (TPA) legislation, which was introduced last week, would disentangle this complex web of responsibilities and allow for a more contemporary and expedited decision-making within the constitutionally defined framework. It establishes clear objectives for international trade negotiations, and guarantees an up-or-down vote by Congress on trade agreements which conform to said parameters. At the same time, it provides for the removal of issues that are not covered by the objectives set out in the TPA from the fast-track process.

The TPA and the European Commission’s mandate both refer to investment arbitration as the desirable mechanism for resolving future investment disputes arising under the TTIP. Even if these references are not always specific and sometimes conditional upon a satisfactory outcome of the entirety of the negotiations, they document the parties’ initial intent to include investment arbitration in the TTIP.

Investor State Dispute Settlement: Nothing New

In the light of existing ISDS mechanisms, it is not surprising that the United States and the European Union aimed to include ISDS in the TTIP when the negotiation process began in mid-2013. Investment arbitration is the dispute settlement mechanism of choice in most bilateral investment treaties (BITs) and multilateral agreements, such as the North American Free Trade Agreement (NAFTA) or the Energy Charter Treaty (ECT). It allows investors to bring claims directly against the countries hosting their investments without the intervention of their home countries’ governments, or (usually) the involvement of the host countries’ courts. ISDS is therefore said to provide investors with a de-politicized and reliable process for the resolution of their claims against host states—at least in comparison to the former dependence on diplomacy for the resolution of such disputes. Whether ISDS is an effective tool for attracting and maintaining foreign direct investments remains controversial.

Opposition Against Investment Arbitration

Despite the ubiquity of investment arbitration in existing investment treaties, its inclusion has become a major stumbling block for the conclusion of the TTIP. Opponents in the United States and Europe are numerous and vocal, and distinguished scholars are expressing concerns, arguing mainly that the threat of investor claims would have a chilling effect on the governmental regulation of legitimate public interests. Health and environmental protection, labor rights, and human rights are frequently mentioned as potentially affected spheres.

Indeed, the opponents’ arguments are not entirely unjustified. There have been instances in the past where investor claims for substantial damages were based on environmental or health regulations. Two examples are cited time and again: Vattenfall v. Germany, an ECT claim by a Swedish operator of German nuclear plants, based on Germany’s post Fukushima nuclear power phase-out; and Phillip Morris v. Australia, where the tobacco company’s claim for damages was based on Australia’s tobacco plain-packaging measure.

Europeans seem to be particularly concerned because of the relative litigiousness of American investors and their penchant to challenge public health and environmental policies. Indeed, US investors have filed the most investment disputes by far. Europeans fear that the currently low number of claims directed against them is a result of the fact that only a few BITs between the United States and EU Member States exist—nine BITs with “new” member states, to be precise—and that the number of claims would dramatically increase if ISDS was included in the TTIP. After all, the United States and the European Union maintain the world’s largest investment relationship.

No Need for ISDS in Treaties between Countries with Evolved Legal Systems?

Another frequent argument against ISDS in the TTIP is that the strength and fairness of the American and European judicial systems make investment arbitration unnecessary. Historically, investment arbitration was conceived to provide a fair and rules-based mechanism for the resolution of disputes between investors from capital-exporting countries and developing countries (North-South setting). Accordingly, some of its opponents argue that it is only needed in countries with protectionist policies and notoriously corrupt courts.

Foreign investment and the disputes arising from it have, however, evolved beyond the described North-South setting to encompass South-South, North-North and even South-North constellations. The issues involved in those settings are no less politically fraught. As neutral as the courts in developed host countries (and particularly in the European Union and the United States) may generally be, to expect them to always decide impartially when charged with balancing the pecuniary interests of foreign investors and their own country’s public interests is quixotic. Of course, neither European nor American courts disregard the rule of law systemically—but it is only reasonable to anticipate that, given the considerable room for interpretation that investment protection guarantees leave, domestic courts would disadvantage foreign investors to some degree. As a consequence, domestic decision-makers should not have a central role in the adjudication of such disputes—at least not by themselves.

In an international setting, where different legal cultures, political priorities and public expectations collide, it makes sense to delegate the resolution of investment disputes to decision-makers outside the host countries’ legal and political systems. Disinterested arbitrators remain the most suitable agents for this task. That is not to say that the current investment arbitration regimes are beyond reproach. The European Commission’s report on its ISDS consultation highlights the most important deficits of existing mechanisms, which will require particular attention in the negotiations of the ISDS chapter in the TTIP. In this regard, the ISDS provisions in the Comprehensive Trade and Economic Agreement (CETA) between Canada and the European Union, which served as a blueprint for the negotiations of the ISDS chapter of the TTIP, are a step in the right direction.

The Catalyst Function of a Well-Designed ISDS Chapter in the TTIP

Even if one takes the stance that the risk of unfair adjudication in US and EU courts is so negligible that ISDS is unnecessary, its inclusion would still be desirable from a systemic perspective.

Including an investment chapter that constructively addresses existing flaws of ISDS in a deal as important as the TTIP harbors the potential to recalibrate ISDS and influence the negotiations of various BITs that are about to be renewed. Considering the current legitimacy criticisms facing investment arbitration, the change could only be for the better: it is in the hands of US and EU negotiators to strike a more appropriate balance between investor protection and regulatory sovereignty, and to address other common ISDS concerns. Most importantly, the negotiators should include effective safeguards against frivolous cases, clearly define the requisite level of arbitrators’ independence and impartiality, make proceedings transparent, and consider the desirability of a mechanism of appeals or oversight.

Maria Nicole Cleis is a Visiting Scholar at the University of California, Berkeley.  She is a contributor to Travaux.