PPPs and ISDS: A Risky Combination
By Brooke Guven and Lise Johnson
May 24, 2018
This blog was originally published on UNCTAD’s Investment Policy Hub here.
Investment in infrastructure, as a general matter, is a necessary prerequisite to sustainable development. The breadth and depth of a country’s transportation, electricity and telecommunication networks along with its water and sanitation, health care, and education facilities are the backbone of economic productivity and competitiveness, and, when done well, also support a healthy human and natural environment. While governments were traditionally viewed as playing a legitimate and indispensable role in leading the provision of public infrastructure and services, recent years have seen a distinct and increasing turn toward public private partnerships (PPPs) as a way of structuring public infrastructure investments. Notably, this shift has been accompanied by a monumental and fundamental shift in the international development policies of individual governments as well as international institutions; development resources are now often used to catalyze private investment and enlist the private sector in solving development challenges. In the context of infrastructure, this means that host governments (often with the support of international development institutions) are more frequently partnering with private companies to develop and provide what is typically thought of as distinctly public works and services.
Whether and under what circumstances a PPP may be the optimal solution to advance infrastructure investment, development and/or management remains unclear with benefits largely undemonstrated and costs well-documented. It is also now apparent that many countries do not have the capacity to properly implement PPPs, and that not all proposed PPPs are rigorously evaluated or the appropriate structure. Furthermore, the financialization of infrastructure investments as an asset class, involving hedge funds and institutional investors, further complications the relationship between the state, other stakeholders, and PPP investor(s) and the ability of the state to participate in and/or effectively regulate infrastructure investments.
For many decision-makers a big draw of PPPs is that they can enable governments to shift costs and liabilities off their balance sheets in the near term. But PPPs may impose longer-term risks and contingent liabilities that are not adequately measured, tracked, or accounted for, and which can have significant implications for governments and their constituents. Additionally, while there are diverse stakeholders whose basic needs and fundamental rights can be directly and severely impacted by the performance, cost, availability, and governance of infrastructure and related services, private ownership and operation of such services can impact, often negatively, those stakeholders’ abilities to hold infrastructure owners and operators accountable for providing quality, accessible, and affordable services. Whereas the first questions that decision-makers should focus on are whether and under what circumstances a PPP should be considered, it is too commonly assumed that public infrastructure will be more efficiently provided by the private sector, with the key question instead becoming how to structure the deal.
Investment treaties and PPPs
When foreign investors are involved in an infrastructure-related PPP, either directly as the PPP contract counterparty and/or as direct or indirect shareholders in those entities, international law can have important implications for how those PPPs are governed, or, more specifically, the extent to which the host government can act to ensure that the PPP is meeting public needs and priorities.
In particular, international investment treaties (commonly referred to as “bilateral investment treaties” (BITs) or “international investment agreements” (IIAs)) impose rules on governments regarding how those governments treat foreign shareholders and foreign-owned investments. Additionally, these international investment treaties also commonly include provisions allowing foreign investors in contracting parties to the PPP to sue their host governments through arbitration (commonly referred to as investor-state dispute settlement (ISDS)). That arbitration may be conducted with little, if any, transparency, and can take place in another country, and/or another language, limiting the public’s ability to understand, much less participate in, the proceedings.
One common narrative characterizing these kinds of cross-border infrastructure investments (particularly into low and middle-income countries) points to the phenomenon of the “obsolescing bargain,” in which an investor, once it has significant fixed assets in a country, is at the whim of host government power and discretion. As such, it is often asserted that in order to ensure a level playing field between the foreign investor and its host government, the foreign investor could and should usefully seek international legal protection by structuring its investment so as to take advantage of a favorable investment treaty (or insert contractual clauses much to the same effect) that will protect the investor and the investment in the face of any adverse government action. As noted above, these treaties almost universally include investor-friendly substantive provisions and provide for dispute resolution through ISDS, which will allow the foreign investor to enforce treaty-based standards by directly suing the host government in international arbitration, rather than proceeding through the domestic courts (applying domestic law) of the host country. This added layer of investor protections enforceable through ISDS profoundly complicates already problematic PPPs in infrastructure.
Importantly, some evidence indicates that, rather than exploiting evolving power dynamics, government parties to infrastructure PPPs may more commonly be the victims of power shifts, often having to respond to investors’ attempts to change the terms of the deal after that deal had been agreed. In one study of roughly 1000 concession contracts awarded in Latin America and the Caribbean between the mid-1980s and 2000, for instance, researchers found renegotiations occurred in 55% of transportation concessions, and 74% of water and sanitation contracts. Strikingly, 57% of the transportation concession renegotiations were initiated by the investor alone (27% by the government alone and 16% by both the government and the operator); even more jarring, 66% of the water and sanitation contract renegotiations were initiated by the operator (24% by the government and 10% by both the government and the operator). It thus appears that, in many cases, private firms secure contracts based on their commitments to provide a certain level of service to a certain number of users at a certain price, only to subsequently pursue renegotiation in order to reduce their obligations or increase the price charged to users. Thus, the obsolescing bargain-based case for special investment treaty and ISDS protection for investors may be weaker than typically thought.
Moreover, and more problematically, it appears that investors are using investment treaties in ways that can significantly frustrate government efforts to effectively and adequately regulate PPPs in the public interest, and in ways that may be required by international human rights law. Foreign-owned parties to PPP contracts or their shareholders can, for example, sue governments for
- Raising the minimum wage;
- Resisting investors’ efforts to raise tariffs for essential public services;
- Penalizing investors for failing to comply with contractual or legal obligations in terms of service standards or other duties;
- Requiring the infrastructure operation to source its inputs from local providers, or to give special consideration to those providers;
- Trying to bring investors back to the negotiating table, or resisting investors’ attempts to renegotiate the deal; and
- Modifying the underlying legal or fiscal frameworks governing the PPPs to, for example, ensure taxes charged or subsidies granted are appropriate, or that environmental performance standards reflect current knowledge and best practices.
It is often recognized that private partners in PPPs do not necessarily have the same priorities or interests as their government partners or infrastructure users and that, indeed, the private and public objectives might conflict. It is therefore also recognized that, in order for PPPs to function notwithstanding those actual or potential conflicts, the government must play a central and effective regulatory role. This is particularly the case with respect to the long-term and public nature of infrastructure investment and service delivery. Investment treaties and ISDS, however, threaten to place undue limits on the government’s ability to perform its regulatory functions; and those limits, in turn, weaken the underlying premise that governments can effectively resolve the problematic conflicts otherwise present in PPPs. Furthermore, poorly negotiated PPP agreements, when coupled with the strong procedural and substantive rights afforded to foreign investors pursuant to contractual terms, domestic law, and an international investment agreement, result in outcomes in which the benefits, protections and powers related to the investment potentially flow disproportionately toward the private party while users, surrounding communities, the environment, and taxpayers bear the vast majority of the risks and losses.
In the context of investment in public infrastructure in which long-term contracts are often the norm and effective regulation is essential, careful consideration must be given to the appropriateness of a PPP, as opposed to more traditional forms of government finance or development assistance, to further infrastructure investment, and the rights of all stakeholders must be considered. When a foreign investor benefits from ISDS and treaty protections, the negative consequences may be felt for decades, while the promised benefits of the relevant PPP may fail to materialize.
 For example, the World Bank Group supports PPPs as a development tool. See The World Bank, “Infrastructure and Public Private Partnerships,” available athttp://www.worldbank.org/en/topic/publicprivatepa… (accessed 15 Feb 2018); IFC “Public-Private Partnerships,” available at http://www.ifc.org/wps/wcm/connect/Industry_EXT_Content/IFC_External_Corporate_Site/PPP. MIGA also provides guarantees and other financial services to support PPP investments. Similarly, the G20, through its Global Infrastructure Hub, seeks to facilitate infrastructure development. See https://www.gihub.org/.
 E.g. European Court of Auditors, “Public Private Partnerships in the EU: Widespread shortcomings and limited benefits” (March 20, 2018), available at https://www.eca.europa.eu/en/Pages/NewsItem.aspx?nid=9917. See also The World Bank Group, “Government Objectives: Benefits and Risks of PPPs” (last updated Oct. 31, 2016).
 The Economist, Intelligence Unit, Infrascope PPP Index, available athttp://infrascope.eiu.com/; Antonio Estache and Caroline Philippe, “The Impact of Private Participation in Infrastructure in Development Countries: Taking Stock of about 20 years of Experience,” No ECARES 2012-043, Working Papers ECARES, Université Libre de Bruxelles (2012).
 UNCTAD has analyzed clauses that are typically included in IIAs and are particularly relevant to PPPs with suggestions for more careful treaty drafting. See UNCTAD, Mapping of IIA clauses available at http://investmentpolicyhub.unctad.org/Pages/mapping-of-iia-clauses#definition. This builds on UNCTAD’s long lasting work on sustainable development-oriented IIA reform, culminating, for example in UNCTAD’s “Reform Package for the International Investment Regime” (including the UNCTAD’s Road Map for IIA Reform (2015) and UNCTAD’s 10 Options for Phase 2 of IIA Reform (2017) ) and UNCTAD’s “Investment Policy Framework for Sustainable Development”.
 For a general discussion of the costs and benefits of investment treaties see Joachim Pohl, “Societal benefits and costs of International Investment Agreements: A critical review of aspects and available empirical evidence,” OECD Working Papers on International Investment, 2018/01 (2018); see also Lise Johnson & Lisa Sachs, “The Outsized Costs of Investor-State Dispute Settlement,” AIB Insights 16(1) (2016). For an analysis of why investment treaties do not meet their own objectives see “Lise Johnson, Brooke Skartvedt Guven, and Jesse Coleman, “Investor-State Dispute Settlement: What Are We Trying to Achieve? Does ISDS Get us There?” CCSI Blog (Dec. 11, 2017).
 For an in-depth analysis of the ways in which investment treaties impact governance of investments in infrastructure see Lise Johnson, “The Impact of Investment Treaties on Governance of Private Investment in Infrastructure,” Robert Schuman Centre for Advanced Research Studies, Research Paper No. RSCAS 2014/32 (2014).
 See, e.g., J. Luis Guasch, “Granting and Renegotiating Infrastructure Concessions: Doing it right” (The World Bank, 2004); see also J. Luis Guasch and Stéphane Straub, “Infrastructure Concessions in Latin America” (World Bank Policy Research Working Paper 3749, October 2005).
 Guasch, supra note 13, at 84-85.
 When these changes are sought because of a firm underbidding to secure the tender, such post-establishment changes are particularly problematic from a public policy perspective.
 UNCTAD provides a mapping of PPP-related investment claims, with a focus on the economic sectors relevant to the Sustainable Development Goals (electricity, water and sanitation, transportation, construction, and human health) and a description of the PPP contexts that have led to ISDS claims. UNCTAD, “Mapping of PPP-related ISDS cases” available at http://investmentpolicyhub.unctad.org/Pages/mappin…
 UN Committee on Economic, Social and Cultural Rights, “General Comment No. 24 on State obligations under the International Covenant on Economic, Social and Cultural Rights in the context of business activities,” E/C.12/GC/24 (Aug. 10, 2017).
 E.g. Veolia Propreté v. Arab Republic of Egypt, ICSID Case No. ARB/12/15 (pending).
 E.g. Teco v. Guatemala, ICSID Case No. ARB/10/17, Award (Dec. 19, 2013) (finding that Guatemala’s tariff review process violated CAFTA-DR). But see Iberdrola v. Guatemala, ICSID Case No. ARB/09/5, Award (Aug. 17, 2012), a related case with respect to a different investor in the same investment in which a different tribunal came to the opposite conclusion based on similar facts.
E.g. Occidental v. Ecuador, ICSID Case No. ARB/06/11, Award (Oct. 5, 2012) (holding the government liable for terminating the contract as a result of the private party’s actions transferring its obligations under the contract without prior government authorization; the contract had expressly permitted the government to terminate the contract in response to such unauthorized transfers); Renco v. Peru, UNCT/13/1, Final Award (Nov. 9, 2016) (dismissed on jurisdictional grounds, but involving a case in which the company was suing the government for the government’s efforts to enforce the company’s contractual obligations). These were not infrastructure investments but their issues and principles would apply to infrastructure investments.
 E.g., Mobil v. Canada, ICSID Case No. ARB(AF)/07/4, Award (Feb. 20, 2015) (performance requirements in the extractive sector deemed to violate NAFTA).
E.g., Suez, Sociedad General de Aguas de Barcelona S.A., and Vivendi Universal S.A. v. Argentina, ICSID/ARB/03/19, Decision on Liability, July 30, 2010 (para. 247: concluding that “Argentina’s actions in refusing to revise the tariff according to the framework of the Concession and in pursuing the forced renegotiation of the contract contrary to that legal framework violated its obligations under the applicable BITs…); AWG v. Argentina, UNCITRAL, Decision on Liability, July 30, 2010 (same);.Urbaser v. Argentina, Award, December 8, 2016 (para: 845: concluding that Argentina violated the BIT’s fair and equitable treatment clause due to the province’s conduct of renegotiations); PSE&G v. Turkey, ICSID Case No. ARB/02/5, Award (Jan. 19, 2007) (para. 246 investors are “entitled to expect that [their] negotiations will be handled competently and professionally.”). See also Saluka v. Czech Republic, Partial Award (March 17, 2006) (para. 364: the treaty’s FET provision required the state to “take seriously a proposal that has sufficient potential to solve the [relevant] problem and deal with it in an objective, transparent, unbiased and even-handed way.”). See also Frontier Services v. Czech Republic, Final Award (Nov. 12, 2010).
 See, e.g., Eiser Infrastructure Ltd. v. Spain, ICSID Case No. ARB/13/36, Award, May 4, 2017; see also, Luke Eric Peterson, “Breaking: Spain is held liable in another renewables case; tribunal finds government in breach of Energy Charter Treaty in a new award, order 53 million eur in damages,” IAReporter (Feb 16, 2018).
 E.g. Windstream v. Canada, PCA Case No. 2013-22, Award (Sept. 27, 2016).
 Notably, government counterparties have international (as well as domestic) legal obligations to the users of infrastructure and other stakeholders, including in areas of human rights and the environment, the fulfillment of which could be deemed to violate investment treaty norms and investor protections.
 Long-term contracts, as a general matter, are frequently renegotiated, either pursuant to the terms of the contract (intra-deal renegotiations occurring pursuant to contractually mandated events) or when one party is dissatisfied with the contractual arrangement or performance and seeks to renegotiate rights and obligations to rebalance the contractual costs and benefits (extra-deal renegotiations). See Jeswald Selacuse, “Renegotiating International Business Transactions: The Continuing Struggle of Life Against Form,” 35 The International Lawyer 4, 1507 (2001). In cases in which PPP investments in infrastructure are not characterized by careful consideration of the terms, long-range outcomes and interests of all stakeholders, extra-deal renegotiations may occur with more regularity. For an in-depth analysis of extra-deal renegotiation in the context of PPPs and ISDS see Johnson, supra note 8.