Will ‘Investor-State Arbitration’ Survive the COVID-19 Crisis?

[Somesh Dutta specializes in international dispute resolution. He is currently working with the Max Planck Institute Luxembourg for International, European & Regulatory Procedural Law as a Research Fellow and is a member of the International Max Planck Research School for Successful Dispute Resolution (IMPRS-SDR).]

In particular, developing economies with a large consumer base may have a crucial role in shaping the future of international investment adjudication, and thus an influence on the future flow of capital for global economic growth.

‘Arbitration’ remains a widely accepted method of dispute resolution globally for resolving commercial disputes, at least for over half a century, notably because of advantages like procedural autonomy provided to litigants including a say in the selection and appointment of adjudicators, and flexible adjudicatory processes as compared to court proceedings. In addition, the same is a predominant means for resolving international investment disputes in the form of ‘investor-State arbitration’ for several decades now. The said investor-State dispute settlement mechanism (ISDS) has further been characterized as a ‘hybrid’ mechanism in several scholarly works as it legitimized the resolution of investment related claims (where a State party representing a larger public interest faces a claim by a foreign investor) through arbitration, which was primarily understood as a mechanism suitable for the adjudication of private rights and interests.

However, after a short stint of success, ‘investor-State arbitration’ is facing a severe backlash  inter alia, for lack of independence and impartiality of arbitrators (as private individuals with varied interests including legal practitioners are eligible to be appointed as arbitrators), inconsistency in investment jurisprudence (because of the fragmented nature of international investment protection laws), and costs involved in the proceedings (with average costs exceeding $8 million per party). Such concerns have compelled the stakeholders to contemplate on its various shortcomings. The public perception against the existing ISDS mechanism was further influenced by the global media describing it as a method for settling investment disputes by ‘obscure tribunals’. Resultantly, the United Nations Commission on International Trade Law (UNCITRAL) in June 2017 decided to establish the Working Group III (the Working Group) to deliberate on possible ISDS reform options.

In light of the COVID-19 crisis, this work analyses the likelihood of the survival of ‘arbitration’ as a mechanism for the resolution of investor-State disputes, especially in light of a trend towards State-State dispute settlement (SSDS), and other mechanisms for resolving investor-State disputes including the resolution through a permanent court.

The Working Group on ISDS Reform

The UNCITRAL entrusted the Working Group with a mandate to work on the reform of ISDS. More than 100 UN Member States and 60 observer organizations are represented in the ongoing deliberations. Unsurprisingly, the status of the European Union (EU) as the largest source and destination for foreign investments made way for its proposal to garner maximum attention in scholarly works and, in general, in the global community.

To address the backlash against the existing ISDS mechanism (which includes both, procedural concerns like independence & impartiality of arbitrators and substantive concerns like the issue of inconsistency in international investment jurisprudence) the EU proposes to establish an investment court system (ICS) in lines with the existing dispute settlement framework of the World Trade Organization (WTO). In specific, this proposal (from the EU and its Member States) includes a mechanism with full-time adjudicators – no longer party-appointed arbitrators – and two levels of adjudication. The first instance tribunal would review facts and apply the relevant laws. The appellate tribunal would have the power to reverse legal findings or serious errors in the weighing of facts, but would not review facts. For addressing procedural concerns like independence & impartiality, adjudicators would fill full-time, long-term and non-renewable positions, without outside activities, and with salaries comparable to other court systems. To ensure competence and objectivity, adjudicators would be representative in terms of geography, expertise and gender diversity.

The new institutional set-up for the resolution of disputes between investors and States has been implemented with minor variations in the Canada–EU Comprehensive Economic and Trade Agreement (CETA), the EU–Singapore Investment Protection Agreement and the EU–Viet Nam Investment Protection Agreement. Any pre-existing bilateral investment treaty (BIT) between the EU member States and the relevant third country, including the ISDS mechanisms contained therein, are set for termination.

Further, several other States have submitted proposals for the ISDS reform. Various options include an investment court system with an appellate mechanism only where investor-State arbitration prevails at the ‘first instance’ (proposal by China), reforming the existing investor-state arbitration mechanism without a need for an investment court system (proposal by Russia).

To summarize, above-discussed proposals reflect two distinct approaches, with some applying a mix of both. The first approach deals with reforming the existing ISDS setup while maintaining the principles of an ‘arbitration-based’ ruling system. It includes reforms such as the establishment of an advisory centre and a code of conduct for arbitrators. On the other hand, the second approach favours making radical reforms to the existing ISDS with a two-tier adjudication mechanism like the one proposed by the EU.

In both approaches discussed above, investors are empowered to bring claims against sovereign States for measures affecting such investments. Does it mean there is an assumption that States are still willing to adopt ‘investor-State arbitration’, in specific, for the resolution of investor-State disputes in their respective international investment agreements (IIAs)? How the EU’s proposal for an ICS will affect investor-State adjudication? What if a considerable number of States, in specific large consumer economies, are taking a different route for addressing investment disputes like through SSDS?

The State of the Global Economy & Current Trends to Deal with International Investment Disputes

In this time of uncertainty, one aspect remains certain – the dent to the global economic growth. In January 2020, the global growth was projected to rise from an estimated 2.9% in 2019 to 3.4 % in 2020 and 3.4% for 2021. However, the Global Pandemic has already affected the economies of the major players in the global trade, and as per the International Monetary Fund (IMF) it will turn ‘sharply negative’ in 2020 anticipating a crisis worse than the Great Depression.

Considering such estimates, it would not be far-fetched to argue that after the normalization of the current public health situation, we may expect ‘protectionism’ in the form of dramatic regulatory actions as States may get under immense pressure from domestic industries for business sustenance. In such situations, States would unsurprisingly want to provide minimum protections to foreign investors including an impact on how to deal with legal claims in case of a dispute with a foreign investor.

Irrespective of the repercussions caused by the Global Pandemic, States (with varying economic and political power) through their recent IIA treaty practice have already started to shift to other methods for addressing investment claims, thus limiting the resolution of investor-State disputes through arbitration.

For example, the USMCA (also popularly known as the new NAFTA) which is a free trade agreement (FTA) with an investment chapter between the United States of America, the United Mexican States, has limited the scope of investment claims to be brought by foreign investors against host states. As per the agreement, U.S. investors already present in Canada have been allowed to use investor-State arbitration for another 3 years. After the said time period, the disputes will be resolved by Canadian courts, just like a dispute brought by a domestic investor against the State. In relation to investments in the U.S. and Mexico, an annex has been negotiated between the contracting parties allowing investors to bring claims through arbitration in well-defined circumstances only (claims regarding expropriation and non-discrimination and not for concepts like fair and equitable treatment). It is to be noted here that such claims by investors can be brought only after the claimants have attempted to resolve issues in domestic courts before bringing disputes to the international level (the principle of exhaustion of local remedies).

Another approach reflects a transition from ‘investment protection’ to ‘investment cooperation and facilitation’. Brazil is spearheading such an approach. The Investment Cooperation and Facilitation Treaty (ICFT) between India and Brazil limits the resolution of investment disputes through investor-State arbitration, and allows only for State-State dispute settlement returning to the concept of ‘diplomatic protection’. As per the Treaty’s dispute prevention procedure, the resolution of disputes between ‘parties’ will be done by a joint committee. It is only after the completion of the proceedings by the joint committee (time limit of 120 days after the first meeting) or in case of non-participation of a party in the proceedings before the joint committee, that aggrieved party is allowed to submit the dispute to arbitration. Interestingly, the purpose of such an arbitration is to decide on treaty interpretation and the arbitral tribunal is not authorized to award compensation. 

Further, the Regional Comprehensive Economic Partnership (RCEP) which is a multilateral agreement among 10 countries from the Association of Southeast Asian Nations (ASEAN) and five of ASEAN’s free trade agreement (FTA) partners—Australia, China, Japan, New Zealand, and South Korea have agreed to exclude ISDS. India, for the time being, has opted to remain outside the said agreement. The investment chapter (which is yet to be finalized) signals another—and major—blow to ISDS in the Asia-Pacific region, confirming earlier signals sent especially by India, Indonesia, Japan, and Australia. RCEP also shows China’s flexibility regarding dispute-settlement arrangements or even their absence, despite its increasing outward FDI and the Belt-and-Road Initiative: the China-Australia FTA foresees a bilateral court system. It is to be noted that not only developing economies, but also capital exporting economies like Japan, Republic of Korea and Australia have agreed for the exclusion of ISDS.

Conclusion

Investor-State adjudication and its survival is one thing, and investor-State adjudication in the form of ‘investor-State arbitration’ is another. For ‘investor-State arbitration’ to remain a preferred mechanism for resolving investment disputes, it must be reformed to the satisfaction of States addressing all concerns raised in the Working Group deliberations. However, its utilization after reforms would still be dependent on the approach adopted by various States in their respective IIAs.

In the near future, the global flow of capital in the form of international investments, which, arguably, is also influenced by the dispute resolution mechanism, would highly depend on the approach adopted by large consumer economies (as investments need a robust market for reflecting economic growth). The RCEP States, including India, which account for half of the world’s population and around 30% of the global GDP, and the BRICS (Brazil, Russia, India, China & South Africa) States which cover over 40% of the world population may have a crucial role to play in shaping the future of international investment adjudication.

In relation to the ICS, assuming that the RCEP investment chapter (when finalized) refers to the same for the resolution of investment disputes; it remains unclear whether it would be utilized for investor-State adjudication or for State-State adjudication.  Moreover, subject to the outcome of the ongoing deliberations at the UNCITRAL, other States might accept the ICS with the following possibilities;

• ICS can be used for investor-State adjudication with permanent judges,
• ICS can be used for investor-State adjudication with permanent judges at the appellate level, and the investor-State arbitration survives at the ‘first instance’ ,
• ICS for State-State dispute settlement (which is the case under India-Brazil ICFT),
• ICS for state –state dispute settlement along with an appellate mechanism.