Companies take large risks when investing abroad, and countries have an important self-interest in attracting foreign investment. The Investor-State Dispute Settlement (ISDS) mechanism allows foreign investors to sue their host countries when government actions harm their investments. ISDS claims are up slightly in 2020, with over 60 claims filed as of December 15, already matching 2019’s total. Many have argued that the ISDS should be abandoned altogether, but it should not be. The mechanism can and should play an important role in providing confidence for foreign direct investment (FDI). While the current status of ISDS is not perfect, efforts to reform it should continue.
The system’s future is uncertain. The United Nations Commission on International Trade Law delegated broad authority to Working Group III to evaluate areas of possible ISDS reform. After first convening at the end of 2017, the next session is scheduled to meet for the eighth time in February 2021.
The low-key ISDS came into mainstream discussion during the public debates on the Trans-Pacific Partnership (TPP) and was criticized by Democratic Senators Elizabeth Warren and Bernie Sanders. Their fear is that the ISDS can be used by investors to seek large monetary awards from countries, particularly developing nations, for exercising their sovereignty. For example, a German company brought a claim against Iraq this year seeking $1 billion in compensation for the Iraqi government’s alleged takeover of a cement factory.
2019 saw a small decrease in the amount of ISDS cases, with under 60 cases being filed according the United Nations Conference on Trade and Development. On average, from 2015 to 2018, around 80 cases were filed per year. The 2020 uptick could be COVID-related. With governments across the globe taking unprecedented action in fighting the global pandemic, the response from foreign investors should not be surprising. This is especially true in light of the widespread economic downturn.
It is worth contrasting cases that arise out of contracts with those that arise out of international trade agreements (ITAs). Freedom of contract is a core concept in an open and free economy. That should not change, including in international trade. Including ISDS provisions in trade agreements is more concerning. As with other trade-unrelated issues such as labor and environmental standards, the ISDS muddies the waters in trade negotiations and should not be part of them.
The ISDS has been de-emphasized in several multilateral and bilateral trade agreements in recent years. It was curtailed to a great extent in the USMCA in comparison with the previous NAFTA provisions. The new Asia Pacific trade agreement, the Regional Comprehensive Economic Partnership, likewise omitted the ISDS, but allows for the system to be reconsidered in five years.
China has been a strong opponent of the ISDS in the past but has shown more openness to it in recent years. The Chinese have made a concerted effort to shape the discussion on the ISDS within Working Group III, pushing for more predictable standards and procedures as well as advocating for more fairness in the selection of arbitration panelists—both valid concerns.
At present, the system allows for what is essentially forum shopping, permitting investors to go to wherever is most likely to yield the best outcome. Some possible venues include the International Centre for Settlement of Investment Disputes (ICSID), International Chamber of Commerce (ICC), Permanent Court of Arbitration (PCA), and the London Court of International Arbitration. And these competing forums are incentivized to essentially compete for business.
Paul S. Reichler, partner and co-chair of international litigation and arbitration at Foley Hoag, LLP, explains:
Who is their constituency, whether it’s ICSID, ICC, or the Secretary General of the PCA? Their constituency is the community of investors. Why? Because [almost] all of these cases are brought by investors against states. … So, you have these different forums competing with one another to get the business. Because they are bureaucratic entities, they require constant nutrition in the form of new cases, new business, and new clients.
China also continues to express concern about the appointing of arbitrators. An ISDS panel has three arbitrators. Each side appoints one, and the administrating institution appoints the third, who is also president of the tribunal. Unsurprisingly, each party appoints an arbitrator sympathetic to its position. More often than not, it is the president of the tribunal, appointed by the administrating institution, who casts the deciding vote. According to Reichler, one knows how a tribunal will rule as soon as the panel is composted. “They are often decided even before you get to the hearing. They are decided when the president is appointed,” he said.
The ISDS continues to garner attention and criticism from both developed and developing nations. The current system is imperfect and needs reform. But scrapping the ISDS altogether, as Sens. Warren and Sanders propose, would create more problems than it would solve. There is a need to strike a balance between investors’ confidence in FDI and countries’ ability to maintain their sovereignty. A uniform system, preferably established by a stand-alone treaty, would distance the ISDS from its current commercial orientation.