International Investment Arbitration 101

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International Investment Arbitration 101

Granting investors a considerable say in matters that concern public interest wouldn’t seem like a good idea and defies all logic. Then why is this practise in use all around the globe and likely to increase over the coming years instead of being properly addressed as the threat it poses?


7. April 2017 - "When I wake up at night thinking about arbitration, it never ceases to amaze me that sovereign states have agreed to investment arbitration at all [...] Three private individuals are entrusted with the power to review, without any restriction or appeal procedure, all actions of the government, all decisions of the courts, and all laws and regulations emanating from parliament."

Not only is this quote remarkable in that it shows how a highly controversial, highly intransparent procedure, used between countless governments and investors worldwide, has the capacity to keep an experienced expert up at night, it also goes to the heart of the problems with investment arbitration.

One of the main reasons for this ever growing amount of power corporate actors hold in international legislation and regulation is investment arbitration. The so-called Investor-to-State Dispute Settlement (ISDS) is a system that grants foreign investors the ability to sue a country over investment matters.

There are several issues clearly problematic with this measure. First, an arbitration tribunal works differently from any classical court. The cases are negotiated in large part without public access and with little to no transparency when it comes to proceedings. Verdicts and the measures taken to reach them can be kept largely secret. At the same time, these rulings are binding and immediately enforceable.

What makes this even more bizarre is the fact that ISDS provides no means of appeal when it comes to the court’s decision. Verdicts can only be contested on the grounds of severe wrongdoing or corruption; in which case they may be annulled. They can also be altered if new relevant information is presented or interpreted slightly differently.

The sums awarded by the tribunals are staggeringly high, and even where investors are not clear winners, so in the case of a settlement, states are still obliged to pay compensations on top of horrendous legal fees. All of this on the expanse of taxpayers, something especially smaller or economically less developed countries are bound to struggle with.

The people who decide upon these investment disputes, the so-called arbitrators, are also chosen differently than in federal and international courts. The arbitration tribunal consists of three arbitrators, one of which is chosen by the opposing sides each plus one arbitrator that is ideally agreed upon by both parties or otherwise appointed by the institution. So, not only are “judges” not randomly assigned but the arbitrators are in most cases highly-paid lawyers from internationally acclaimed law firms versed in investment law. Often these firms also function as representatives for those same investors in other legal aspects. That, in combination with the fact that arbitrators don’t receive a fixed salary like judges but rather are being paid per case is likely to lead to an increased readiness in ruling in the investor’s favor - choosing investment interests over human and civic interests - and great willingness to further ever more investment arbitration cases. This is an unfair bias in an overall unfair mechanism: ISDS is only an option for foreign investors. Neither domestic investors, nor foreign governments enjoy the same privileges, to say nothing about civilian groups or individuals.

To make matters worse, ISDS is often implemented in Bilateral Investment Treaties (BITs) that were written with investors’ best interest in mind, thus giving them almost countless grounds on which to make their claim.

Now, why would any sensible government agree to treaties like that?

Because they all thought they would benefit from these agreements. As it turns out they were all wrong.


Investment arbitration in BITs

BITs have been around for decades, the first one having been signed between Germany and Pakistan as early as 1959. The first BIT that contained ISDS followed in 1966 between the Netherlands and Indonesia. At this time BITs were generally agreements between an industrialized state and a former colonial or otherwise under-developed country.   ISDS was introduced under the assumption that both sides would profit. To developed countries investment arbitration presented a way to protect their investment, even in countries where courts were highly unreliable and the executive branch infested with corruption. Developing countries in turn believed to have an instrument to attract more foreign direct investment by granting the privilege of investment arbitration. Technically the same rights were open to investors from developing countries, practically the balance was not only severely tipped in favor of investors but also of industrialized countries, as there were virtually no investors from developing countries at that time that could have made claims against their host state.

In recent years, studies have shown that BITs have hardly any effect on foreign investment whatsoever. Still there are over 3200 of them in practise nowadays,the vast majority containing ISDS. So, not only did the BITs not generate the desired outcome but by failing to adopt them to modern times have generated a landslide of possibilities for corporate actors to enforce their interests worldwide - even if these clash with public interest.


Investment arbitration in FTAs

In addition to bilateral agreements, Free Trade Agreements (FTAs) also frequently include ISDS. FTAs cover a wider scope of trade related topics than BITs do - even aspects as varied as food security and services. In addition they may comprise not only trade issues between two countries but multiple states or even regions. This enlarges the thematic and geographical reach of investor’s influence.

Both BITs and FTAs contain certain mechanism as a standard that are frequently used by investors to either bully governments into adopting favorable regulations, dropping or loosening disadvantageous regulations or at least into paying ridiculously high sums of money in compensation.

For example, the agreements contain a clause on Fair and Equitable Treatment of investors. Unfair or inequitable treatment constitutes anything that is “creating [...] hurdles with a view to disrupting a business”. Virtually anything can fall under this definition.

Investors are also protected from indirect expropriation, meaning that corporate actors have to be compensated even if property is seized in public interest and not directly.

Investors are also guaranteed a stable regulatory environment, supposed to facilitate long-term invest, but in reality paralyzing governments.

A clause on the expected profits further raises sums awarded. If an arbitration tribunal finds that a measure taken by a host government runs down or delays the investor’s profit, the state might not only have to compensate the investor for any inconveniences but also reimburse them for any profits lost as result of their actions. This method is highly questionable as the expected outcome is exactly that - expected.  It might be based on very optimistic figures or even serve as a means to cover up the fact that a business idea has in fact failed, as the case of Gabriel Resources in Romania shows.

The fact that through all of these mechanisms the threat of an investor claim is ever immanent, in many cases leads to a regulatory chill amongst legislators. This translates into a reluctance to change regulation reducing investor influence unless urgently necessary. The agenda thus changes from working towards improving conditions in public and federal interest towards trying to cause least harm. This approach is especially dangerous and harmful where public health and security or environmental and sustainability issues are touched upon.


Investment arbitration in TTIP and CETA

The most controversial - and at least for the European Union most relevant - trade agreements of the last years are the Comprehensive Economic and Trade Agreement (CETA) and the Transatlantic Trade and Investment Partnership (TTIP) between the European Union and Canada and the USA respectively. There has been stark public opposition against CETA which has already been signed by the European Commision but still needs to be ratified by EU member states, as well as against TTIP which is still being negotiated. An impressive 3,2 million Europeans signed a petition to stop the agreements and when the European Commision issued a consultation on TTIP and its components, an overwhelming 97% of participants spoke out against granting foreign investors special rights via ISDS. Far from taking these public concerns seriously, the authors of TTIP have simply re-branded ISDS to appease Europeans without touching upon what lies at the heart of the problem. The newly-proposed Investment Court System (ICS) is essentially old wine in new bottles. Ongoings in general are said to get more transparent and ICS calls for an appellate body whereas ISDS is sorely lacking one. Still it doesn’t do away with the injustices of investment arbitration.

It doesn’t touch upon the problem that those people who suffer from investor’s actions and the lack of accountability and responsibility when it comes to human rights or environmental safety are not entitled to use the same mechanisms open to the investors, let alone have the balance tipped in their favor. This puts countries and public in a defensive and largely impotent role at all times.

The ‘new’ system also does not address properly the restrictions put on states’ right to regulate by investment arbitration. Effectively, through ISDS od ICS arbitrators ultimately decide what is necessary and legitimate when it comes to regulatory measures and changes.

Whatever actions states take and for whatever reasons, they have to be prepared to prove that their legislation isn’t excessive and doesn’t put undue strain on investors.

This they have to prove to judges who also under ICS aren’t judges at all, but can - and mostly are - private arbitrators. This also means, they are still being paid by case instead of having a fixed salary, thereby granting their impartiality. When it comes to personnel the requirements of ICS are not strict or clear enough, with little framework on the important ethical topic of conflict of interest. Shockingly, there is “no explicit ban in being paid for related work while sitting as an arbitrator.” All this turns the proposed investment court into something far from an independent court.

Lastly, there is simply no need for the implementation of ISDS in FTAs in any form. Besides public opposition to it, the case of the FTA between the USA and Australia - that doesn’t include ISDS in any form - clearly shows that foreign investment can be attracted without granting extensive special rights to investors.

Also, any changes to the investment arbitration system would have only marginal effect if the respective clauses in CETA are not changed as well - which they are not likely to be up until now. US-investors could thusly in many cases sue a host country through a subsidiary in Canada - which most US companies have - if CETA conditions seem more advantageous.The same essentially holds true for other FTAs.


The future of investment arbitration

The proposition to implement a permanent Multilateral Investment Court (MIC) in the long term also holds causes for concern. While allegedly many of the features that are highly worrisome in ISDS and ICS would be improved, a MIC would only serve to enshrine investment arbitration as a method in international relations, creating a “parallel legal universe”.

The European Commission has issued a public consultation via survey in the first month of 2017 and will probably publish first findings in summer of the same year. But just as in the case of TTIP it is highly questionable they will listen to public demands.



Former shareholders of Yukos vs. The Russian Federation

The former shareholders of Russian gas and oil giant Yukos took the Russian Federation a arbitration court over alleged unfair treatment in connection with tax evasion. Not only did they claim they had been unduly harshly treated by the government but also claimed Russia through their action was indirectly responsible for Yukos’ ensuing bankruptcy in 2006.

Even though the arbitration tribunal admitted that Yukos were partially to blame for events through their omission to pay taxes, but this merely resulted in a 25% reduction of the awarded sum. The tribunal saw it as proven that the Russian Federation had violated fair and equitable treatment of Yukos which resulted in a payment of almost 50 billion USD to the shareholders in 2014. This is, to this date, by far the largest sum awarded in any investment arbitration case.


Eureko vs. the Republic of Poland

The case of Eureko vs. Poland shows that investors don’t always have to win to cost a host country ridiculously high amount of money.

Poland announced its plans to privatize the formerly state-owned insurance company PZU and selected Eureko from the Netherlands as one of the buyers. This investor planned to increase its shares in the insurance company from 30% to over 50%.When Poland decided to reverse the privatisation of insurance services in the public interest, ISDS enabled Eureko to make claims in front of an arbitration tribunal on the grounds that they were now no longer able to become majority shareholders in PZU.

The case was settled in 2005. Over 4,3 billion USD had to be paid by Poland. This award was by far the highest sum agreed upon in an investment arbitration in 2005 and still today is the second largest sum ever to awarded by such a tribunal. It also translate into almost 2% of Poland’s GDP that year.


Vattenfall vs. The Federal Republic of Germany

The swedish energy company Vattenfall sued Germany twice via ISDS within few years. The second time was in 2012 after Germany’s decision to phase out of nuclear energy. Even though this had happened as a direct reaction to the nuclear reactor catastrophe in Fukushima, Japan, Vattenfall still claimed it was in breach of fair and equitable treatment and the assurance of a stable regulatory environment. The closure of Vattenfall’s power plants as two of the first nuclear reactors in Germany was part of a bigger federal plan and an answer to public concern and demand.

Even though the case is still pending, it shows how investor rights can effectively clash with civic rights and environmental security and any improvement for the situation of the public might come at a high cost.


Chevron vs. Ecuador

When Chevron was ordered by Ecuador’s national court to pay for the clean-up of the pollution they had caused to both land and water through decades of oil exploitation, the company took the fight to an arbitration panel. Far from admitting they were responsible for the immense destruction of the environment, Chevron claimed Ecuador was in breach of contract when it allowed Ecuadorian farmers and indigenous peoples to sue Chevron in the first place. The breach in their eyes was even worse as Ecuador did not prevent the plaintiffs from seizing Chevron’s assets through courts in other countries.

This battle has been fought for many years now and is not likely to come to an end any time soon. The case of Chevron in Ecuador shows how big companies can circumvent any responsibility for their harmful actions while at the same time being given the possibility to bypass national judicial verdicts by calling on investment arbitration panels.

Gabriel Resources vs. Romania


OceanaGold vs. El Salvador

A slightly positive sign when it comes to investment arbitration in the field of energy and environment can be seen in the case of OceanaGold vs. El Salvador.

After extensive explorations for years the company prepared to start mining for gold in El Salvador but was refused a license to do so. Following this, OceanaGold claimed compensation from their host country, reasoning they had been lead to believe El Salvador - through their interest in and support of the exploration - was also supportive of their mining plans. Following this logic, their refusal to grant the permit not only constituted unfair treatment but also cheated OceanaGold out of their expected profits. El Salvador on the other hand stated that OceanaGold lacked the rights to much of the land they plan their mining pits on, as well as the necessary environmental and safety assessments.

The claim - at over 250 million USD higher than the annual international aid for El Salvador -  put a chill on the whole country, the money spent on the case being direly needed elsewhere. The government moreover acted on public demand and in public interest when refusing the license to OceanaGold, with over 80% of El Salvadorans opposed to mining in their country and the already scarce water supplies at risk of being further depleted or polluted by the company’s mining effort.

OceanaGold’s claims have been dismissed and the company ordered to pay the legal fees that ensued from the case for El Salvador. The case is far from closed, the verdict will be contested, but it sets a precedent and bold statement in the direction of investors trying to enforce their interests via investment arbitration.

Still, it took seven years from the claim to the refusal of a case that should not have been permitted in the first place.


Read the article in German >>