Does Investor State Dispute Settlement Need Reform?

In its early years, during the 1960s, 1970s, and 1980s, the international investment law system, and its provisions allowing foreign investors to sue host governments directly in an international tribunal (Investor State Dispute Settlement or ISDS), was relatively uncontroversial. Taking widely accepted domestic law principles and using them as the basis for an international law framework to protect certain rights seemed like a good way to expand the rule of law and promote economic development and growth. Who could object to principles such as fair and equitable treatment or the protection of property rights?

As it turns out, however, the system was uncontroversial only because it was obscure and mostly unutilized. An investment treaty between the United States and Senegal, for example, did not have much practical impact because of the limited investment flows, and thus it did not raise many concerns. But when industrialized countries began to negotiate these agreements with other capital exporting countries (e.g., Canada and the United States in NAFTA), and investors started filing lawsuits, a backlash occurred. Now that people see what the obligations mean, many have risen up in protest.[1]

As the debate has heated up, it has deteriorated a bit. Some of those with the most passion are not very well informed on the substance. The truth is that there are good faith arguments to be made on both sides. In this essay, I lay out my critique of the existing system, and I look forward to hearing the responses of other participants.

 

How is foreign investment treated today?

The international investment law system looks out of date. It deals mainly with problems that existed a long time ago, while it ignores the current reality of international investment flows. If you look back at the situation of 60 years ago, foreign investors were often treated badly. At that time, the world was much less democratic. Many authoritarian governments shifted their views about foreign investment, alternately encouraging it and then expropriating it, in an effort to generate economic benefits for themselves. In the post-colonial world of the 1950s, 1960s, and 1970s, economic nationalism was on the rise, and newly empowered developing nations began to take back what they believed was theirs, often through expropriation of physical assets. This era was a challenging one for Western multinationals who had invested in the developing world. While they were not always angels themselves, the expropriation of their assets without compensation was clearly a violation of their property rights.

To deal with this situation, these companies lobbied their governments for international treaties that would give them recourse to neutral international courts, which could handle any disputes that arose. This approach appealed to the governments themselves, who did not like having to engage in the diplomacy of defending their companies’ rights. In the 1960s and 1970s, templates for such treaties were developed and applied, and soon they proliferated.[2]

As this was going on, however, negative attitudes towards foreign investment began to dissipate in much of the world. Economic nationalism faded and governments began to court investors. Today, a typical story about large foreign investments will note the subsidies offered by the government to attract that investment.[3]

To a great extent, then, bad treatment of foreign investment is a problem of a prior era. There are still some nations, scattered here and there, who threaten expropriation or actually expropriate, but the numbers are down considerably.[4] According to one study of the issue, the number of expropriation acts related to foreign investment was 136 in the 1960s and 423 in the 1970s, but has since declined to only 17 in the 1980s, 22 in the 1990s, and 27 instances in the 2000s through 2006.

In the face of this empirical data, it is not completely clear what problems investment tribunals should address. If expropriation is rare today, what exactly is the problem faced by foreign investors? And where is it a problem? This issue simply has not been studied. With no data on the nature and extent of the problems faced by foreign investors, it is hard to craft appropriate rules to address them. The “fair and equitable” treatment obligation is well-known as a general “catch-all” provision for government actions that harm companies. But to what degree do investors actually face treatment that is not “fair” or “equitable”? And what kind of treatment is this exactly? A few anecdotes aside, we have a very limited understanding. The result has been an explosion of litigation as creative lawyers seek to push the boundaries of the obligation.

In reality, the biggest problem in the world of foreign investment may not be bad treatment, but rather treatment that is too good: subsidies. As noted, subsidies to attract foreign investors have proliferated.[5] If there is any problem with foreign investment that needs to be addressed through international agreements, it is probably this one.

 

What is “Foreign” Investment in a Globalized Economy?

Supporters of ISDS point to bad treatment of “foreign” companies in domestic political/legal systems as the problem they are trying to address. In their view, “foreign” companies face discrimination and prejudice, and cannot always get fair treatment. But the notion of “foreign” and “domestic” companies looks increasingly outdated in today’s globalized world. A hundred years ago, the global economy could much more easily be divided along national lines. Many companies had a clear nationality, and when they invested their money abroad, they maintained that nationality to a great extent. Foreign investment often meant big Western companies investing in developing countries (and this is where problems with bad treatment typically arose).

The modern economy looks different from this older period. Today’s foreign investment flows in much more varied ways. It is not just Western companies investing in the developing world. It is a wide range of companies of many nationalities, investing all over the world and creating global supply chains and operations. Companies might have their headquarters in one country, develop technology in another, and produce in several other countries. And the nationality of the owners might not match up with any of these countries.

In this context, the notions of “foreign” and “domestic” investment have much less meaning. Looking to recent headlines to illustrate this point, Burger King recently merged with the Canadian coffee and donut company Tim Horton’s, and, in the process, created a parent company in Canada.[6] If Burger King is now owned by a Canadian company, can the parent company sue the U.S. government under the NAFTA investment rules when a future Mayor Bloomberg mandates size limits on donuts because of health concerns? Clearly, the formal nationality of companies has become less important over the years, and it may not serve as a good basis for imposing investment obligations on governments.

 

From Gunboats to ISDS to Modern Treaties: Can International Investment Law Evolve?

In the colonial era and its immediate aftermath, Western companies suing developing country governments in international tribunals had a certain logic: It was an extension of the existing economic relationship between the West and the developing world. Prior to the rise of investment treaties, Western governments had sometimes resorted to military action in response to expropriation of their companies’ property in developing countries (“gunboat diplomacy”). Neutral arbitration of these issues seemed like a substantial improvement. It was a more civilized way for Western companies to assert their rights in the colonial arrangements that existed at that time.[7]

But today’s era is very different, as there is a more even balance of power. It is not Europe, the United States, and Japan above everyone else; economic power is distributed much more uniformly around the world. As noted, investment flows in all directions today; investment issues are no longer all about the West versus the rest. Thus in the modern era we need treaties that reflect this change, by relying on states to manage their relations through state-state dispute settlement, as used in other international agreements.

In addition to the procedural issue of which entities — companies or states — may bring a complaint, we also need to think carefully about the substance, that is, what these international obligations should say. It is one thing to say that governments should promise not to discriminate against each other’s foreign investments. The benefits are clear, and the scope is limited. Non-discrimination is at the core of international economic relations. It includes both national treatment, which means not discriminating against foreign goods, services, or capital; and most favored nation treatment, which means not discriminating among goods, services, or capital of different nations. Such a rule promotes good international relations and is good economics. Without it, protectionist measures can proliferate, and economic alliances can stand in the way of peaceful relations.

A non-discrimination rule is narrow and bounded. Under such an obligation, a government can regulate however it likes, and on whatever policy it chooses, as long as the measure is non-discriminatory.

By contrast, creating a general “due process” type obligation for governments, such as “fair and equitable” treatment, is exceedingly broad. It shifts a good deal of power from national legislators and regulators to international courts, and it deserves more debate than it has seen so far. “Fair and equitable” treatment has been the subject of much criticism in the context of the investment system. Concerns about its scope have led governments to try to put boundaries on it. However, these attempts do not show much promise. A recent effort by the EU and Canada as part of their Comprehensive Economic and Trade Agreement leaves us with obligations that still look quite broad and undefined. The CETA includes “manifest arbitrariness” and “fundamental breach of due process” as examples of such treatment.[8] Unfortunately, even if such terms are narrower than previous obligations, they raise more questions about the scope of the obligations than they answer. What exactly are the limits of these obligations? Which government actions might violate them? No doubt creative lawyers are already thinking about the possibilities, even before the CETA is signed.

International judicial review is not objectionable in and of itself, of course. But the nature of the obligations, who has access to them, and how enforceable they are need to be considered carefully, and the legal obligations must be written precisely. Having open-ended provisions that are available only to foreign investors contributes to the perception that international economic law is a corporate handout, with ordinary people ignored. Depending on how the courts later rule, that perception may become a reality.

At the same time, it would be a great idea for investment generally, both foreign and domestic, if we could elevate property rights and discourage expropriation through international law. Unfortunately, current efforts in the international arena are weak and isolated. In international investment law, these rights are only provided to a limited group — that is, foreign investors — and under an uncertain and unpredictable quasi-judicial framework. If we want property rights to be taken seriously, we need to promote them as a matter of domestic law. Conversations about such issues in international fora are useful, but to really push them forward, perhaps an international treaty on expropriation could help. Such a treaty could establish global minimum standards and encourage their adoption in domestic law.

Along the same lines, more general principles of due process, transparency and good governance would also be valuable to domestic legal systems. If the criticism is that some domestic courts are biased and corrupt, isn’t the ideal solution to find ways to make them less so? Again, allowing foreign investors to escape the corruption of a domestic court does not help the local citizen who has no other option. International cooperation to improve the functioning of domestic courts would be a better focus.

 

Let Foreign Investors Take Responsibility for Themselves

Finally, foreign investors need to take more responsibility for their business decisions. All investments carry risk; there is more risk when investing in some countries than in others. Companies have a responsibility to know this and plan for it, and, in fact, it is not hard to do so. Companies who make foreign investments can buy political risk insurance, and they can demand arbitration clauses in any foreign investment contracts they sign with host governments. This approach is better than running to the government to lobby on their behalf for special treaties. It addresses the problem without creating an overbroad international judicial system.

The actors involved usually have significant resources and a lot of experience in these matters. When governments step in to help big corporations and rich investors, and when they ignore those without similar wealth, it gives off the appearance of special favors for those with wealth and influence. When you look around the world today, you see many people in dire straits. People who are being oppressed on the basis of their religion, race or gender; people whose property has been stolen; and people who are being treated unjustly for no reason at all. Do any of these ordinary people have access to enforceable international law to assert their rights against governments? For the most part, a couple regional human rights treaties aside, they do not.[9] But foreign investors do. As a result, the criticism of the investment law system as constituting special favors for the wealthy seems, on its face, to be credible.

 

Conclusion

As people start to rise up against the international investment system, it seems to me the task now for the investment law community is to figure out what its purpose is. What is the problem you are trying to deal with? What is the best way to address it? In the field of trade law, much of the problem is obvious for anyone to see. For example, tariffs are written down clearly in domestic tariff schedules, which identify tariff rates for specific products; anti-dumping tariffs are imposed on the basis of a quasi-judicial procedure and result in published tariff rates; and even domestic laws such as Buy National procurement policies are usually publicized clearly. As a result, dealing with these issues in an international agreement is fairly straightforward. International obligations to address protectionist trade policies such as these are not difficult to construct.

By contrast, with foreign investment, the problem is often a bit obscure. When there is an approval process to make a foreign investment in the first place, the discrimination issue is clear, and international rules to address this make sense. But when the issue is the proper treatment of foreign companies in domestic law, it becomes hard to identify the specific behavior that is supposedly of concern. What does “denial of justice” look like exactly in the context of the treatment of foreign investors and investments? How can international courts appropriately judge the behavior of domestic governmental actors? These problems do exist in the real world, but they are not easy to define and construct international obligations to confront. The universe of problems experienced by foreign investors (and others) in domestic legislation, regulatory agencies, and courts remains unclear.

Thus, the task of ISDS supporters should be to study today’s problems, analyze them, and quantify them. The current model is based on 1950s era, pre-globalization situation; it is time to move into the modern era, with an evidence-based agenda.