Investor-State Dispute Settlement (ISDS) as the best option?!

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INTRODUCTION

Foreign investments are a key development factor in the modern economy, and jointly with the trade, represent the most important leverage of an enterprise, organization of production, supplying goods and services on a global scale. They provide faster exit to the international market and as the aftermath are ensuring improved the living standard of the society.

Increasing globalization of the world economy and the growth of international business transactions inevitably lead to disputes. These disputes require effective resolution methods to ensure continued business activity. There are two types of dispute resolution: diplomatic and judicial settlement.

  • In diplomatic dispute resolution, parties maintain direct control over the dispute and resolution methods, including negotiation, mediation, inquiry, and conciliation.
  • In judicial settlement, which often takes the form of arbitration, the result is a binding decision that is based on international law.

Furthermore, there are practical limitations on the process of diplomatic protection. This system requires even relatively small claims to be pursued through inter-State mechanisms, meaning that investor State disputes on particular points may be conflated into State-to-State disagreements. Given these difficulties, foreign investors often decline diplomatic protection where they have the option of securing remedies more directly by means of investor-State dispute-settlement mechanisms. In addition, capital-importing countries may wish to avoid the inconvenience of diplomatic protection by investors’ home States by agreeing to direct settlement procedures with investors.

Therefore, traditionally, dispute settlement under international law has involved disputes between States. However, the rise of private commercial activity undertaken by individuals and corporations engaged in international trade and/or investment has raised the question whether such actors should be entitled to certain direct rights to resolve disputes with the countries in which they do business.

Under customary international law, a foreign investor is required to seek the resolution of such a dispute in the tribunals and/or courts of the country concerned. In this regard, Investor-State Dispute Settlement (ISDS) has played an important role in the international arena since its creation.  ISDS allows an investor from one country to bring a case directly against the country in which they have invested before an arbitration tribunal. Investor-state dispute settlement mechanisms embodied in most investment treaties provide rights to foreign investors to seek redress for damages arising out of alleged breaches by host governments of investment related obligations.

As the number of investment agreements has risen, the cases brought to dispute settlement have become increasingly complex too, encompassing multiple contracts and hence multiple parties and issues. Fundamentally, ISDS provides an adequate forum to ensure that substantive commitments that countries have made to one another to protect mutual investments are duly respected. The ultimate goal of ISDS is to continue to drive foreign investment by providing foreign investors with security and confidence that their property and rights will be protected. In order to bring a case, an investor must claim that the Party has breached rules set out in the agreement. For example, an investment agreement will often say that a government can only take over or ‘expropriate’ (for example, nationalize) an investment if it pays adequate compensation to the investor. If a country seizes an investment or passes new laws which make it worthless (for example, it suddenly bans a product produced in a factory owned by a foreign investor) and pays insufficient compensation, or none at all, the investor could use ISDS to bring a claim directly against that country, claiming a breach of the expropriation provision in the agreement and seeking compensation.

By implementing ISDS, host countries hope to provide foreign investors with a neutral forum to address claims of expropriation by the host country, to prevent discrimination of foreign corporations by offering them the same rights as local corporations or third-country corporations, and to provide fair and equitable treatment to foreign investors.   Sine there are several examples of cases where a developed country has expropriated a foreign investor, not paid compensation and prevented them from going to local courts. In these circumstances, investors are left without anywhere to bring a claim for compensation, unless there is an ISDS provision in the investment agreement.

In this regard, the International Centre for Settlement of Investment Disputes of the World Bank Convention (ICSID Convention), together with the United Nations Commission on International Trade Law (UNCITRAL), set up in 1966 to provide harmonized rules for international trade, marked a shift to the ‘modern era’ of investment dispute resolution. They did not replace the older Courts of Arbitration in London and Stockholm and at the ICC, but built additional facilities and established a wider set of rules and principles than had previously existed. For example, at least 55 known treaty-based investor–State dispute settlement (ISDS) cases were initiated in 2019. As of 1 January 2020, the total number of known ISDS cases pursuant to international investment agreements (IIAs) had reached 1,023. To date, 120 countries and one economic grouping are known to have been respondents to one or more ISDS claims.UNCTAD’s Special Investment Policy Monitor (No. 4) and the World Investment Report 2020 (chapter III)  review investment policy responses to the COVID-19 pandemic, also highlighting the risk of ISDS proceedings under IIAs and the need to safeguard sufficient regulatory space in this regard.

In contrast to a mechanism to resolve disputes between states, like the World Trade Organization’s dispute-settlement mechanism, it is not an instrument that ‘puts on trial’ laws and regulations in a host country, with the consequence that a government has to change a law or a regulation in the event they lose a case. Nor do investment-protection agreements demand that a country fully transposes the general principles of such an agreement into national laws and regulations.

Many governments have expressed concerns about the uncertainty linked to the perceived inconsistency of treaty interpretation in Investor-State dispute settlement (ISDS).Those opposed to ISDS usually claim that its impact on the government’s’ capability to implement reforms and policy programs related to public health, environmental protection and human rights, secrecy of procedures, the arbitrator’s legitimacy and automatic binding effect of the arbitral award clearly clash with the inherent powers of a sovereign state. The critics of the system lay down several factors such as lack of transparency, legitimacy, and consistency in decision-making to argue against ISDS.

This heavy backlash against ISDS arose from a number of voices arguing for reform of the institutional framework, or even the exclusion of its provisions from future IIAs.  As a matter of fact, ISDS reforms are already in motion in response to these claims: countries like the US, India, Canada and the EU have already made efforts towards better ISDS provisions, allowing for instance the participation of third parties on procedures, creating an appeal mechanism and so on. Arguably, the biggest criticism against ISDS focuses on the secrecy of all or some of its procedures. Since ISDS develops in a form of arbitration, the remnants of the institute end up being present in the context of ISDS, with strong emphasis on this issue.

HISTORICAL BACKGROUND OF THE INVESTOR-STATE DISPUTE SETTLEMENT (ISDS)

Before the ISDS regime emerged during the mid-twentieth century. An investor-state dispute that could not be resolved directly through investor-state discussion or proceedings within a domestic court were either not settled or handled by home State espousal of the claim through a number of diplomatic processes or, sometimes, by threats or using military force

Before BITs, international investment law found its source in customary international law. Later based on considerable experience the World Bank decided to continue to seek a solution for investor-state disputes, convinced that it would be easier to reach agreement on a procedure for dispute settlement than to reach agreement on international standards of treatment.

Then later the  choice of a dispute-settlement method is  one of the choices that an investor and State may have to make when seeking to resolve a dispute, for example some Latin American States  have historically maintained that disputes between an investor and a host State should be settled exclusively before the tribunals/ courts  which was referred to as the Calvo Doctrine.This viewpoint was manifested not only in the domestic legislation of individual countries; it also prevailed in certain regional agreements that prohibited member States from giving foreign investors more favourable treatment than national investors, demonstrating a clear preference for dispute settlement in domestic courts.t. Local settlement is convenient and there is a continuing need to recognize the validity of properly conceived and drafted national investment laws and other applicable laws and regulations  as a legitimate and valuable source of rights and obligations in the investment process.

Later foreign investors have traditionally maintained that, as regards developing countries, investor-State disputes should be resolved by means of internationalized dispute-settlement mechanisms governed by international standards and procedures, with international arbitration.

Provisions for Investor-State Dispute Settlement (ISDS) became fundamental components of International Investment Agreements (IIAs) since the initial bilateral investment treaty between Germany and Pakistan in 1959. The first BIT enabling ICSID arbitration was concluded in 1968. In these early years ICSID developed considerable experience in appointing ad hoc arbitrators and aiding in conciliations. At the same time, it became a knowledge centre for foreign investment law.

For now, the international investment agreements (IIAs) mostly prescribe for arbitration as a means of dispute settlement. The private law inspired model of the ISDS mechanism has been a fundamental component of IIAs since their inception. After the end of World War II   that arbitration consolidated its position as the main mode of settling investor states’ disputes, basically due to two major advances in this field: the enactment of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) and the creation of the International Centre for Settlement of Investment Disputes (ICSID).

SOME REASONS OF ISDS MECHANISM AND ITS FEATURES IN THE INVESTMENT RELATIONSHIP

The main objective was firstly, to depoliticize investment disagreements and secondly, to contribute to the enhancement of the rule of law with regards to investor-state affairs. ISDS is now the dominant mode for resolving disputes between a foreign investor and a host state.  The main reason is.

  • Investors may not want to bring an action against the host country in that country’s courts because they might think they are biased or lack independence.
  • Investors might not be able to access the local courts in the host country. There are examples of cases where countries have expropriated foreign investors, not paid compensation and denied them access to local courts. In such situations, investors have nowhere to bring a claim, unless there is an ISDS provision in the investment agreement.
  • Countries do not always incorporate the rules they sign up to in an investment agreement into their national laws. When this happens, even if investors have access to local courts, they may not be able to rely on the obligations the government has committed itself to in the agreement.
  • The ISDS mechanism established by the thousands of IIAs and other international documents has three features that make it distinct from the majority of other institutions:
  • The legal basis of ISDS varies and is considered as complex, as a number of other dispute settlement mechanisms are anchored in properly defined treaty frameworks. It spreads across disputes resolution provisions that are in at least 3000 investment treaties.
  • ISDS enables a private party to bring forth a claim against a State; subject to various prerequisites set out in different investment treaties and is able to generate huge monetary awards. Few, if any, of the other mechanisms which allows a private party to compel a State to engage in dispute resolution procedures that involve monetary compensation of this magnitude.
  • ISDS’ institutional set-up is drawn immensely from commercial arbitration, e.g., ad hoc, party-appointed arbitration panels, stress on speed as well as finality of findings.

THE ROLE OF ARBITRATION IN THE INVESTOR-STATE DISPUTE SETTLEMENT (ISDS)

The ISDS agreement will typically stipulate the rules that will apply to the proceedings or permit the claimant to elect between certain rules which the host state has consented to in advance. Common rules include the ICSID Arbitration Rules, ICSID Additional Facility Rules, UNCITRAL Arbitration Rules and ICC Rules of Arbitration. The seat of the arbitration may be defined in the ISDS agreement. If it is not, it may be determined by the tribunal, once constituted, in accordance with the applicable rules. The seat is important because it establishes the supporting legal framework for the arbitration, including how and when the courts of the seat may intervene and the grounds for challenging any award.

In this regard, investment arbitration is a significant, but relatively new, phenomenon in international adjudication and law. It establishes that an investor, either an individual or corporate entity, may enforce international law obligations and receive monetary compensation from a state. In this regard, the main role of ISDS is evidently to provide a suitable locus through the use of arbitration for foreign investors to bring disputes related to IIA substantive regulations against host states. arbitrators on ISDS tribunals are selected by disputing parties depending on each individual case.

Typically, arbitrators are selected from a pool of names, which includes arbitrators from each host country that is a signatory to the agreement. The foreign corporation is responsible for appointing one arbitrator, the host country appoints another, and the third is chosen in a way that complies with the agreement between the parties.

Arbitration intuitions

An institutional arbitration is one in which a specialized institution intervenes and takes on the role of administering the arbitration process. Each institution has its own set of rules which provide a framework for the arbitration, and its own form of administration to assist in the process.

  1. International Centre for Settlement of Investment Disputes (ICSID)
  2. International Chamber of Commerce (ICC)
  3. Swiss Chambers’ Arbitration Institution (SCAI)
  4. London Court of International Arbitration (LCIA)
  5. Arbitration Institute of the Stockholm Chamber of Commerce
  6. Stockholm – Singapore International Arbitration Centre (SIAC)
  7. Hong Kong International Arbitration Centre (HKIAC)

Provided the parties approach the arbitration with cooperation, ad hoc proceedings have the potential to be more flexible, faster and cheaper than institutional proceedings. The absence of administrative fees alone provides an excellent incentive to use the ad hoc procedure. Under ad hoc procedures, the parties must agree on a method for initiating the claim. An institutional system prescribes a procedure. The principal aim of this procedure is to show that the dispute is submitted with the consent of the parties in accordance with any required procedural rules.

Some advantages of the Ad hoc arbitration such as:

  • ad hoc arbitration is less expensive than institutional arbitration;
  • no administration fees;
  • total flexibility and adaptability (tailor made);
  • control of the process, Parties and arbitrators are, in principle, in control of the proceeding;
  • in ad hoc arbitrations, the parties will have to agree the scale of remuneration;
  • with the arbitral panel and agree fees directly with the arbitral tribunal.

The State must be a party to the ICSID Convention for an investor to start ICSID arbitration against a State. However, membership in itself is not sufficient for a State to be sued under ICSID. ICSID’s jurisdiction over investor-State disputes rests on the notion of ‘consent’, which generally is a cornerstone of international dispute settlement involving States. In addition to ICSID membership, consent to ICSID arbitration must have been given by the State in a contract with a foreign investor, a national law of the State concerned, or an international investment agreement (‘IIA’) such as a Bilateral Investment Treaty.

Applicable law

In cases of international arbitration, two choice of law questions arise: which law governs the procedure of the tribunal and which substantive law governs the resolution of the dispute. The choice of governing law and the scope of the dispute the tribunal may hear are typically articulated in the agreement between the signatories. In ad hoc procedures, the parties need to determine these issues. These may already have been determined by the investment agreement governing the investor-State relationship, typically reflecting the relative bargaining position of each party. However, such agreements may at times be unclear or even be silent on these important questions, especially where the parties cannot accept each other’s preferred governing law or laws. In such cases, the parties need to agree on the choice of law issues in the arbitration agreement that founds the tribunal and its jurisdiction.

Arbitration rules

There are several sets of rules for arbitrating investor-state disputes. The claimant may submit a claim under one of the following alternatives:

  1. The ICSID Convention and the ICSID Rules of Procedure for Arbitration Proceedings, provided that both the respondent and the party of the claimant are parties to the ICSID Convention;
  2. The ICSID Additional Facility Rules, provided that either the respondent or the party of the claimant is a party to the ICSID Convention;
  3. The UNCITRAL Arbitration Rules; or d) Any other arbitration institution or any other arbitration rules, if the claimant and respondent agree.Non-ICSID arbitrations commonly proceed under the arbitration rules of the United Nations Commission on International Trade Law (UNCITRAL), focusing on the supposed secrecy problem of ISDS, in an attempt to foster ISDS transparency and accountability given its evident public component.

It should be noted that the most common are those of the United Nations Commission on International Trade Law (UNCITRAL) and the International Center for the Settlement of Investment Disputes (ICSID). The ICSID operates like an administrative court under the auspices of the World Bank.

If the award is an ICSID award, it may be enforced under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention). That convention provides that ICSID awards are to be treated as final court judgments of Contracting States. There are 153 Contracting States to the ICSID Convention.In the case of non-ICSID arbitrations, the award may be enforced under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention). There are 157 Contracting States to the New York Convention. The New York Convention facilitates award compliance by constraining the grounds on which a court may refuse to recognize or enforce a foreign award.

CONCLUSION 

The countries most frequently in need of foreign investment are those building their economy. The lack of sophisticated legal systems in developing countries creates an inability to protect the investments of foreign corporations and detracts from interest in investing in that country. In this  regard, Investor-State Dispute Settlement (ISDS) is a legal instrument in Bilateral Investment Treaties (BITs), or BIT-like bilateral and international agreements such as the Energy Charter Treaty, that grants investors the right to call for arbitration in the event they believe that a government has violated such an agreement. Proponents of ISDS argue that the system achieves this goal by providing neutrality, diplomacy, and protection to foreign investors. ISDS prevents conflict between foreign States, provides safeguards to multinational corporations abroad, and offers potential investors greater confidence that the law will be enforced in the host countries

The International Centre for Settlement of Investment Disputes of the World Bank (ICSID) and United Nations Commission on International Trade Law (UNCITRAL) are the most commonly used institutions for the governing of ISDS and creation of model rules. The system has been strongly criticized by civil society and representatives of governments all over the world. The main criticisms include contradictions in decision making, lack of sufficient regard by certain arbitral tribunals towards the host state’s authority to regulate when interpreting an IIA, concerns over not having enough independence. Investor–state dispute settlement (ISDS) which allows foreign investors to sue governments through international arbitration has become increasingly controversial. Reasonable observers disagree about the value and fairness of the mechanism, but ISDS has become politically toxic even in capital-exporting states.

[1]Abbott, Roderick; Erixon, Fredrik; Ferracane, Martina Francesca, 2014: Demystifying Investor-State Dispute Settlement (ISDS), ECIPE Occasional Paper, No. 5/2014, European Centre for International … Continue reading

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Aida Bektasheva has over 10 years of international development experience (UN -FAO, UN-RCO, UNDP Search for Common Ground, International Alert, and others) in the field of governance, law, and peacebuilding. Her knowledge of policy decisions, rule of law, conflict transformation, democracy combined with her skills in research, analysis, and project management make her well qualified to serve in this position. She has worked in Central Asia, Russia, Sweden countries and is fluent in Russian and English.

References

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