In Defense of Investor State Dispute Settlement

I first heard about investor state dispute settlement (ISDS) while studying at the University of Hong Kong in 2013. I didn’t have any friends in the country, and to say that I was miserable would be an understatement. To pass the time, I decided to take some of the more challenging courses at the Faculty of Law. That is how a third year law student ended up in a class titled, “The Law and Practice of Investment Treaty Arbitration” taught by Chin Leng Lim. I ended up writing a research paper for the course on sovereign debt restructuring in ICSID arbitration, because, well, I was bored so why not? Nonetheless, it was a very serious class, and I learned a lot.

Then things got weird. The TPP and the TTIP were being negotiated, and activists began to pick up on ISDS as a point of concern. Suddenly, this little-known topic in international law was a hot political issue. All sorts of vague, somewhat conspiratorial concerns began to gain traction. People in the UK seemed especially worried that including an investment chapter (and ISDS) in the TTIP would allow US companies to bring claims against the UK to force the privatization of the NHS. Those ideas went largely unchallenged.

Fast-forward to today, and criticism of ISDS has died down. Brexit and Trump happened, and as a result the US withdrew from the TPP. The TTIP was sent to treaty purgatory. The topic remains relevant, for example in NAFTA renegotiations, but isn’t quite the political issue it once was.

With that said, I want to write this post because I want to provide a defense of international investment law and ISDS. Trump and Brexit might have been fueled by right-wing lies, but I’m not sure the same tactics wouldn’t have worked on the left. Progressives aren’t going to point the finger at immigrants, but they sure seemed eager to point the finger at supposed “unaccountable secret international courts”. People were too quick to believe that ISDS was a corporate conspiracy against the masses, and in doing so made no attempt to understand why any non-corrupt individual would support such a thing. In this post, I outline the reasons behind my support for international investment law and ISDS.

What Is ISDS?

ISDS stands for investor state dispute settlement, and is a legal procedure that allows for an investor to initiate an arbitration claim against a state in certain circumstances. ISDS is a treaty right, most often found in bilateral investment treaties (BITs), and the content of the treaty defines the scope of the right. In the case of a BIT, each state party to the treaty agrees to certain standards of treatment that it will provide to foreign investors from the other state party, and agrees that if an investor feels such treaty rights are violated it is entitled to resolve the dispute through a binding arbitration procedure. An arbitration tribunal will decide the case, and in the event that the tribunal decides in favor of the investor, make an award (i.e. tell the state it has to pay some monetary sum to the investor).

Of course, there are a number of hurdles an investor has to clear in order to have any chance of success bringing a claim against a state. The investor has to actually be an investor:

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And the investor has to actually be an investor of the other state party to the treaty:

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The dispute must relate to an investment:

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And dispute must concern the breach of a treaty right covered by the agreement to arbitrate:

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Hopefully this quick run-through suffices to explain the underlying framework we are dealing with when talking about ISDS. In short, two states sign a treaty agreeing to provide certain rights to investors of the other state, and to allow an investor to bring a claim to arbitration if it believes the state has not acted in accordance with those treaty obligations.

So What Are These Rights?

ISDS is simply the enforcement mechanism used to ensure that investors’ treaty rights are respected. Whether it is good or bad cannot be known without actually analyzing the substantive obligations placed on a state. For the purposes of this post, I will introduce three main rights: the right to fair and equitable treatment, the right to national treatment, and the right to receive compensation in the event of expropriation.

Starting with fair and equitable treatment (FET), most BITs contain a provision that reads something like the following:

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So, states must treat investors fairly and equitably. Tribunals have interpreted FET rather broadly, finding states to have failed to provide FET treatment in a number of cases. For example, a FET violation can occur if a state denies justice to an investor, frustrates an investor’s legitimate expectations, makes arbitrary decisions affecting an investor, or discriminates against an investor.

There also is a national treatment standard, which looks something like this:

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This is pretty self-explanatory. Treat investors from the other state no worse than you treat your own investors in like circumstances. Of course, there’s the obvious question of what investors are “in like circumstances”, but arbitrators tend to do a lot of hand waving just to apply a simple smell test. This standard is fairly straight forward, and isn’t quite the mess you’ll find in the GATT.

Last, there is the no expropriation without compensation rule. In a treaty, it looks like this:

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Ok, so the rule is actually a little bit more complicated, but really all that matters is subsection (c). Provided the state pays prompt, adequate, and effective compensation, there isn’t going to be a dispute.

What Do Dumb Critics Say?

Critics would have you believe that ISDS is an evil, super-secret legal system that allows corporations to do just about whatever they want. According to this narrative, investment law is the enemy of sovereignty, and cannot be tolerated in a democratic system. Buzzfeed ran a whole “investigative series” on ISDS, which was truly horrible but not especially atypical for the genre.

The author of the Buzzfeed piece claims, “a company could turn to this super court and sue the whole country for daring to interfere with its profits, demanding hundreds of millions or even billions of dollars as retribution.” That is the contention at the heart of most opposition to ISDS: that investors can sue a state because the state made some decision that resulted in the investor losing money.

It is utter nonsense. Nothing in the rights discussed above says that. There’s no natural reading that brings you from “you must treat investors fairly and equitably” to “investors are entitled to profit”. And tribunals have not found that to be true either, and often state, “BITs are not insurance against business risk” (see MTD v. Chile or Maffezini v. Spain).

It’s also worth noting that we’re always just talking about money: states can do whatever they want; they just have to pay up if it violates an investor’s rights under a BIT. This is a function of sovereignty. In the context of developing countries, the risk of a large award might be a deterrent (although I’m skeptical of even that), but for developed countries it certainly is not. The US is going to do what the US is going to do, and the financial consequences will get sorted out at a later date.

There are all sorts of ideas that stem from this misunderstanding, such as the worry that the UK will be forced to privatize the NHS. Not only is this wrong for the reason explained above (i.e. it’s just a question of money), it also is wrong because treaties often contain an express statement that “existing measures” cannot be found to violate the minimum standard of treatment required. Of course, stating this is totally unnecessary: an investor wasn’t treated unfairly because of a state’s existing policy that it knew about before investing. But for the avoidance of doubt, the treaties often make this express.

What Do Smart Critics Say?

Not all critics are so ignorant, although many are happy to let the less scrupulous make absurd claims in furtherance of their shared agenda. But here, I’ll address three points made by intelligent, informed ISDS critics.

First, some critics think ISDS is problematic because of the inequality it creates between foreign and domestic investors. If a foreign investor is harmed it can seek a remedy through ISDS, whereas no such international remedy is available to the state’s own domestic investors. As one critic put it, “why give foreign investors a remedy, but ignore ordinary citizens?”

I think this objection is without merit. It makes no reference to whether investment law is actually good, but rather focuses exclusively on equality. If a state was going around killing people randomly, and then an international system succeeded in stopping the state from killing the foreigners, I don’t think anyone would really want that system to be removed. Fewer people are being killed! That’s a good thing.

Second, some critics argue that the existence of ISDS removes the incentive to develop a strong domestic legal system. Maybe you don’t buy the argument above on its own (and you shouldn’t), but it makes more sense if you believe that the existence of an effective regime for protecting foreign investors’ property rights actually removes the incentive to ever develop such a system for nationals. Property rights are important, and maybe ISDS means states feel no pressure to push forward in protecting property rights for all.

I would fully agree with that argument if it were true, but I see no evidence to suggest that it is. Furthermore, intuitively it makes little sense. ISDS is a system of rights, obligations, and remedies, but the best way for a state to comply with its obligations is just to have strong domestic institutions for everyone. States with high levels of corruption are a lot more exposed to potential investment disputes compared to states where the rule of law is the norm. So contrary to the assertion, an effective international regime for protecting foreign investors’ property rights probably incentives states to develop strong domestic systems. However, I admit I’m flying blind here; I’d love to see some data.

Third, and finally, there is a concern that ISDS is simply a transfer of risk from investors onto the state. And I agree, it is! However, this doesn’t seem like a problem to me. In fact, it seems efficient. Generally with risk we want to allocate it to the party best able to mitigate it, right? It seems to me that the state is in a unique position to mitigate the risk of expropriation by not expropriating. The investor, in contrast, has no real control over this risk. So, is ISDS a transfer of risk from investors to the state? Yes. But is that a problem? I don’t think so.

Conclusion: I’ve Probably Been Unfair

Somewhere in the ISDS criticism there is a grain of truth. The cost of arbitration is staggering. This is a regime that only large corporations have access to. The rights are often too vague and open ended, and as a result the protection has probably gone beyond the scope of what was intended by the negotiators.

But the scare stories are kind of ridiculous. We live in a paradox where people don’t know this legal regime exists, but it also is influencing the behavior of governments and corporations everywhere. I have news for you: the people making big decisions at companies aren’t thinking about international investment law. The vast majority of these big-league decision makers don’t even know it exists. Investment law is something your lawyers tell you about the fact. As for governments, I’d find the idea of regulatory chill more persuasive if so many legislators weren’t just as surprised as activists were to hear about ISDS. It is like they heard about this legal regime for the first time in 2015, yet somehow it had been influencing their decisions for years before that.

If ISDS is doomed to the past, I won’t shed a tear. It’s just not that important. But you definitely shouldn’t celebrate its demise either.