Investor-State Dispute Settlement: What Are We Trying to Achieve? Does ISDS Get us There?

Lise Johnson
Brooke Skartvedt Güven
Jesse Coleman
December 11, 2017

International investment agreements (IIAs) are often described as instruments aiming to advance four main objectives: (1) promote investment flows; (2) depoliticize disputes between investors and states; (3) promote the rule of law; and (4) provide compensation for certain harms to investors – objectives of varying degrees of importance to multinational enterprises, home states, host states, and other stakeholders. The investor-state dispute settlement (ISDS) mechanism contained therein is, in turn, cited as a necessary means of achieving those objectives.

While each of these objectives may seem desirable, it is important to consider what we mean by these objectives and how much we do or should seek to achieve them, particularly through IIAs. Moreover, evidence suggests that the inclusion of ISDS in investment treaties may not actually be effective, or optimally effective, in achieving any of these objectives, while at the same time, ISDS imposes significant costs on the sustainable development objectives of states.[ii]

This blog post raises some of the questions surrounding these issues, and is the first in a two-part series. Part two, Alternatives to Investor State Dispute Settlement, discusses alternatives to ISDS that may achieve these objectives in a more effective and less costly way.

Promoting Investment Flows

ISDS is frequently cited as being important for promoting international investment flows. Foreign direct investment (FDI), in particular, can help transfer necessary capital, know-how, and technology across borders, improving competitiveness, increasing productivity, creating jobs, and spurring economic growth and development.

But FDI does not always have net positive impacts. Investments in mineral extraction, for example, may generate relatively little in terms of job creation, tax revenue, or technology transfer for the host country, and may harm the environment and livelihoods and, in some cases, further entrench reliance on fossil fuels. Similarly, FDI may result from a company moving manufacturing from one country to another to take advantage of generous tax incentives, low labor costs, or lax environmental regulations. FDI lured by incentives may lead to a net-negative “race to the bottom” in tax policies, or labor, environmental and human rights standards, and may move quickly along to another jurisdiction when relevant incentives expire or a better offer comes along.[iii]

Presently, investment treaties are largely agnostic on those issues, protecting international capital flows irrespective of their nature or impacts. In an era in which evidence of the disparate impacts of globalization has mounted and the importance of public policies to shape impacts has been emphasized, governments need to be particularly strategic regarding the signals they send the private sector to catalyze certain types of investments and discourage others.[iv] It therefore seems anachronistic for governments to be expending limited resources crafting blunt legal instruments that protect all investment (even relatively volatile portfolio investment) irrespective of its negative externalities.[v]

Moreover, evidence that investment treaties are actually effective at increasing investment flows is inconclusive, and indicates that for the vast majority of investors, IIAs are neither directly nor indirectly determinative of FDI decisions.[vi] While an investor may naturally want the strong protections provided in an IIA, and may therefore structure its investment so as to ensure that it is favorably covered, investors’ decisions to invest in a particular host state are driven by determinants other than the existence of a treaty. At most, we may be able to say that investors will often seek to take advantage of all available legal protections when making and structuring an investment (particularly when, as in the case of investment treaties, the cost of protection is free).

Depoliticize Disputes Between Investors and States

As an initial matter, because proponents of ISDS have argued that dispute settlement mechanism is preferable to the “gunboat diplomacy” of the past, it is important to highlight that it cannot and should not be assumed that if ISDS were removed today, states would resort to use of force against other states in violation of international law in order to protect the interests of their investors. Neither does the removal of ISDS necessarily mean that a dispute between an investor and its host government will become a “political” problem between host and home states. Apart from ISDS, other legalized mechanisms of dispute settlement are available directly to investors;[vii] and disputes can be resolved on a state-to-state basis through legalized dispute settlement procedures that use third-party adjudicators to apply the treaty’s legal standards.[viii]

It is also important to question the underlying narrative that politicization of investor-state disputes is always undesirable. As Jason Yackee has stated:

Politicized dispute settlement need not entail, or even risk, resort to force. Indeed, it can be apparently successful, especially where home and host state governments, and perhaps also the investor, perceive mutual gains from continued cooperation. This does not mean that investors get everything they want, when they want it. In politicized dispute settlement the investor does not control the process—though he can certainly influence it—and the investor’s interests are not the only ones in play.[ix]

Putting aside the straw-man arguments (that removing ISDS means a return to gunboat diplomacy or even necessarily requires politicization), and recognizing that a political resolution may, at least in some cases, be desirable to a strictly legalized one,[x] it is unclear that ISDS even contributes to its stated goal. While evidence is limited, studies that consider the connection between ISDS and depoliticization suggest that the presence or absence of an IIA with ISDS does not seem to influence whether or not the investor’s home state is likely to place diplomatic pressure on – or take adverse diplomatic action against – the host state in connection with an investor-state dispute.[xi]

Promoting the Rule of Law

Investment treaties are often cited as being important to promote the “rule of law”. While it would be unpopular and unwise to assert that this is not, generally, an important goal, it is nevertheless crucial to examine more closely what, in fact, we are talking about in the context of IIAs. There are different views as to what the “rule of law” means, some limited to procedural issues like the requirement to provide fair hearings, and others that address more complex substantive norms, such as the legal protections given to property holders and what kinds of procedures are required to change those protections.[xii] For example, even in western democracies that are deemed to have relatively clear and strong property rights, applicable rules have in reality ebbed and flowed throughout modern history. As David Kennedy has stated:

the invention of the limited liability corporation, the abolition of slavery, the establishment – or later privatization – of state enterprises or quasi-public institutions to manage new modes of infrastructure, the establishment of zoning regulations, changing rules about securitization, the invention of commodity futures, or the changes in intellectual property rules which have accompanied technological changes… Changes in modes of economic activity have as often destroyed entitlements and settled expectations about access to resources and the value of assets as they have given rise to new rights, new duties, new privileges and new obligations. New modes of property have continually been devised to empower new types of actors in new kinds of economic relationships, exploiting new forms of knowledge or new resources. Existing entitlements can and often have been reallocated, either slowly or quite precipitously as part of a conscious project of social and historical renewal or struggle.[xiii]

All of these changes to substantive norms of property protection involved disagreements among different stakeholders. Seen in this light, what version of the “rule of law” should international treaties seek to advance? Are international investment treaties the right instruments to advance a thick/substantive or even thin/procedural version of the rule of law in host countries? Are arbitrators equipped to balance these competing legal, political and sociological boundaries largely rooted in a domestic context?

Even considering a “thin” conception of the rule of law, focused on procedure as opposed to substance, there are a number of reasons why ISDS may be undermining, rather than improving, the rule of law in host states. First, by creating a privileged and parallel legal system available to a certain set of foreign investors (actors who are often relatively politically powerful with their host states), ISDS potentially reduces incentives for host governments to strengthen domestic governance and judicial systems.[xiv] Second, by failing to require exhaustion of remedies, ISDS eliminates opportunities for domestic judges and administrative agencies to consider and address the substantive problems faced by investors and to develop corresponding domestic law and expertise. Third, the persistent lack of full transparency (and having cases filed and decided in a language other than the official language(s) of the host country) can prevent governments (particularly the various branches and levels of government) from understanding or seeking to internalize any of the principles or guidance that might emanate from ISDS decisions.

Fourth, because ISDS is a system created for the benefit of one particular set of economic actors, and is able to produce binding and enforceable awards of significant monetary damages, it can create incentives for host-governments to favor the concerns of foreign investors over other constituencies.[xv] This system of unequal treatment is inconsistent with the rule of law and counters the very call for equal protection that allegedly justifies the ISDS mechanism in the first place. Fifth, by generating costly litigation and ordering often significant monetary damages for procedural failings (e.g., in administrative or judicial proceedings),[xvi] ISDS diverts often scarce resources away from public budgets – budgets that could be used to strengthen institutions and courts – to individual claimants.

Provide Compensation for Harms to Investors

Finally, ISDS may be most effective at providing compensation to multinational enterprises and other international investors. But is that in all cases an optimal objective? The question of due compensation for harms that result from government conduct is rife with complex considerations and value judgments that inform whether, when, and how much compensation should be paid. Should, for example, states be ordered to pay damages for good faith conduct (that may be part of an effort to realize other domestic or international legal obligations) that results in any economic harm to investors? What are risks of over-deterring legitimate regulatory conduct in the public interest? Should investors be compensated for government decisions preventing investors from pursuing harm-causing activities? Does that generate moral hazards, violate the “polluter pays” principle, or discourage states from causing investors to internalize their externalities? Do the answers depend on utilitarian considerations of what types of conduct should be encouraged or discouraged? Or do they depend on more ethical and normative considerations of fairness and justice?

Courts and legislators in legal systems worldwide have provided different answers to these same questions, and have often concluded that the government can and should be held liable for a range of actions and omissions, but have also limited government liability in certain contexts where other policy considerations outweigh the case for compensation. Such balancing recognizes the limitation of compensation as a remedy for harms caused: it recognizes that even if a remedy is required, compensation is not always the proper remedy for the victim, or the proper sanction against the wrongdoer.

IIAs, however, have been interpreted to allow the objective of compensating foreign investors for harms to their interests and investments to dominate other competing considerations, thereby permitting foreign investors to be compensated in a number of situations in which compensation would not be permitted under domestic laws, when it might frustrate rights or interests of other stakeholders, and/or might not be the optimal remedy or sanction for various reasons, including the behavioral signals it sends to investors and/or the government.[xvii] In a diverse range of areas such as protections for shareholders,[xviii] the use of conceptual severance to determine whether an indirect expropriation has taken place,[xix] the duties of government to protect against terrorism,[xx] governmental liability for regulatory change,[xxi] or decisions taken to protect the environment and human rights,[xxii] international investment law is often more favorable to investor claimant/plaintiffs than domestic law,[xxiii] but fails to offer compelling legal or policy rationales for its departure.

Although a relative strength of ISDS is in offering compensation to multinational enterprises and other international investors, even there the mechanism is lacking. As even ISDS arbitrators recognize,[xxiv] ISDS decisions are infamously inconsistent and unpredictable, undermining the desirability of the system for its users. Moreover, cases reportedly cost nearly USD 10 million to litigate (roughly USD 4.5 million per side for litigation costs plus approximately USD 750,000 for the fees and expenses of the arbitrators), meaning that it is not a viable option for many potential investors. Finally, while ISDS is often described as sacrificing legal and factual correctness in the interest of efficiently and quickly producing enforceable awards, the multi-year arbitration and enforcement process raises questions about whether investors (and states) have forsaken the goal of correctness in vain.

What are alternatives to ISDS?

Putting aside for the moment the fundamental underlying question of whether any or all of the four main objectives – as currently rather simply stated by many proponents of ISDS – are the objectives that international investment treaties should be prioritizing, or whether instead the mission of international economic law needs to be fundamentally reconsidered, there is mounting evidence that ISDS is not even effective in advancing its purported aims.

Therefore, in order to advance discussion and debate on the merits of ISDS, it is necessary to consider whether there are other instruments, mechanisms, or approaches that might better serve its purported aims, and might do so with less of a cost. Because, it is important to highlight, the costs of securing and maintaining ISDS are significant. These include, in addition to the costs noted above (e.g., regarding subsidizing investments that undermine sustainable development, and exacerbating inequalities), other costs that are well documented elsewhere, such as financial and political costs of negotiating and securing ratification of treaties, costs of defending cases, potential liabilities arising from awards in ISDS cases, loss of legitimate policy space, and reputational costs associated with ISDS claims.[xxv]

Our second blog post in this series will consider this question – what are the existing alternatives to ISDS that help us better achieve appropriate objectives?  — and will look at four main paths: (1) strengthening domestic legal systems (including through use of intergovernmental mechanisms for technical and financial support), (2) investors’ use of political risk insurance, (3) use of human rights mechanisms, which aim, inter alia, to protect relevant rights of access to justice, due process, and freedom from nationality-based discrimination, and (4) state-to-state mechanisms.

[i] Lise Johnson is Head of Investment Law and Policy at the Columbia Center on Sustainable Investment (CCSI). Brooke Skartvedt Güven and Jesse Coleman are Legal Researchers at CCSI.

[ii] See Lise Johnson and Lisa Sachs, “The Outsized Costs of Investor-State Dispute Settlement,” 16 AIB Insights 1, 10 (2016).

[iii] See, e.g., Rethinking Investment Incentives: Trends and Policy Options (Tavares-Lehmann et. al. eds.) (Columbia University Press 2016)

[iv] See e.g., Lise Johnson “Green Foreign Direct Investment in Developing Countries,” United Nations Environment Program, GreenInvest (2017).

[v] E.g. Brooke Skartvedt Guven and Lise Johnson, “International Investment Agreements: Impacts on Climate Change Policies in India, China, and Beyond,” in Trade in the Balance: Reconciling Trade and Climate Policy (2016).

[vi] Lauge N. Skovgaard Poulsen, “The Importance of BITs for Foreign Direct Investment and Political Risk Insurance: Revisiting the Evidence,” Yearbook on International Investment Law and Policy 2009/2010 (K. Sauvant ed.) (2010).

[vii] Other legalized resolution of investor-state disputes can occur through investor claims against states

  • in domestic processes before domestic courts,
  • in contract-based dispute settlement mechanisms, and
  • under human rights instruments (though the ability of corporate entities to bring these claims is limited in some fora).

Investors are also able to recover compensation through political risk insurance.

[viii] This can occur through inter-state dispute settlement under IIAs, WTO agreements, and human rights treaties. As discussed in our companion piece, mechanisms can be adopted by the home state unilaterally or by the treaty parties to limit the discretionary nature of government decisions regarding whether and how to intervene on behalf of their states, rendering those decisions less “political” and more “legal”.

[ix] Jason Yackee, “Politicized Dispute Settlement in the Pre-Investment Treaty Era: A Micro-Historical Approach,” University of Wisconsin Law School Legal Studies Research Paper Series Paper No. 1412 3 (2017).

[x] See, e.g., James Bacchus, “The Case for a WTO Climate Waiver,” Centre for International Governance Innovation (2017) (arguing that WTO member states should make a political decision to limit WTO cases challenging certain climate change measures as breaches of WTO law).

[xi] See Srividya Jandhyala, Geoffrey Gertz and Lauge N. Skovgaard Poulsen, “Legalization and Diplomacy: American Power and the Investment Regime” (preliminary draft) (2016).

[xii] For a discussion of how rule of law and other indicators are produced and used see The Quiet Power of Indicators: Measuring Governance, Corruption and Rule of Law (Merry, Davis & Kingsbury eds.) (2015).

[xiii] David W. Kennedy, “Some Caution About Property Rights as a Recipe for Economic Development,” Brown University – Law, Social Thought, & Global Governance Research Paper No. 1; Harvard Public Law Working Paper No. 09-59 (2009).

[xiv] Mark Fathi Massoud, “International Arbitration and Judicial Politics in Authoritarian States,” 39 Journal of Law & Social Inquiry 1 (2014); Benjamin K. Guthrie, “Beyond Investment Protection: An Examination of the Potential Influence of Investment Treaties on Domestic Rule of Law,” 45 NYU Journal of International Law & Politics 1151 (2013); Tom Ginsburg, “International Substitutes for Domestic Institutions: Bilateral Investment Treaties and Governance,” Illinois Law and Economics Working Paper Series, Working Paper No. NE06-027 (2006).

[xv] Lise Johnson and Lisa Sachs, “Investment Treaties, Investor-State Dispute Settlement and Inequality: How International Rules and Institutions Can Exacerbate Domestic Disparities” (2017).

[xvi] In a number of cases, the violation found by the tribunal was procedural in nature – resulting from an alleged failure by the government to adhere to the proper process. (See, e.g., TECO Guatemala Holdings, LLC v. Republic of Guatemala, ICSID Case No. ARB/10/23, Award, December 19, 2013; upheld in part and annulled in part, April 5, 2016; Gold Reserve Inc. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB(AF)/09/1, Award, September 22, 2014; Copper Mesa Mining Corporation v. Republic of Ecuador, PCA No. 2012-2, Award, March 15, 2016). But, in contrast to what is often seen in the domestic context, the remedies granted/relief ordered for such procedural failings are not declaratory relief – decisions affirming that the government indeed breached its obligations and indicating what would have been consistent with the treaty – and/or orders for the relevant government entity to redo the proceedings in accordance with proper processes (which may or may not affect the substantive outcomes). Rather, the damages seem to assume that the claimant would have been successful in its case or would have secured its investment if the proceedings had been properly conducted, arguably awarding the investor a windfall, and depriving the government of funds it could otherwise use in improving its legal system (or performing other public functions).

[xvii] For a discussion of these issues, see Jonathan Bonnitcha, Substantive Protection under Investment Treaties: A legal and economic analysis (Cambridge University Press 2014).

[xviii] David Gaukrodger, “Investment Treaties and Shareholder Claims for Reflective Loss: Insights from Advanced Systems of Corporate Law,” OECD Working Papers on International Investment, 2014/2, (2014).

[xix] Ampal-American v. Egypt, ICSID Case No. ARB/12/11, Decision on Liability and Heads of Loss, Feb. 21, 2017).

[xx] Rob Howse, “ICSID Arbitrators Turn Investment Treaty into Insurance Policy Against Terrorism,” International Economic Law and Policy Blog (2017).

[xxi] E.g. Micula v. Romania, ICSID Case No. ARB/05/20, Final Award, Dec. 11, 2013.

[xxii] E.g. Bilcon v. Canada, UNCITRAL, PCA Case No. 2009-04, Award on Jurisdiction and Liability, March 17, 2015; Copper Mesa Mining Corporation v. Republic of Ecuador, PCA No. 2012-2, Award, March 15, 2016.

[xxiii] See Lise Johnson, Lisa Sachs and Jeffrey Sachs, “Investor-State Dispute Settlement, Public Interest and U.S. Domestic Law,” CCSI Policy Paper (2015).

[xxiv] See, e.g., remarks by Gabrielle Kaufman-Kohler, representing the government of Switzerland at the UNCITRAL meetings, November 30, 2017, from 16:06:41-16:08:57 of English sound recordings.

[xxv] For a discussion of these costs, see, e.g., Lauge N. Skovgaard Poulsen, Jonathan Bonnitcha, and Jason Webb Yackee, An Analytical Framework for Assessing the Costs and Benefits of Investment Protection Treaties (March 2013).