Reforming Investor-State Dispute Settlement: Reflections on the UNCITRAL Working Group III and Beyond

Güneş Ünüvar

Senior Research Fellow at Max Planck Institute for International, European and Regulatory Procedural Law (Luxembourg)

First published on 9 May 2019 on the Turkish Law Blog.

1. Why Reform ISDS?

International investment law (IIL) is at a crossroads. An obscure legal domain virtually unknown for most of its hitherto existence, it came to prominence only after the surge of investor-State disputes filed by foreign investments against their host states from late 1990s onwards. After twenty years, it is easily one of the fastest-changing and most topical international legal-political domains. Throughout 80s and 90s, states have entered into (very vaguely worded) bilateral and plurilateral international investment agreements (IIAs) with one another, promising to extend ‘fair and equitable’ treatment to foreigners; to refrain from expropriating investments without prompt, adequate and effective compensation; as well as to treat foreign investments no less favorable than national and ‘the most favored’ third country investors. As research shows[1], many states did not exactly understand the broader consequences and the international obligations that these IIAs have created. It was only after hundreds of arbitration cases that the legal and economic consequences of these treaties became apparent: host states, now respondents in a variety of different investor claims, were ordered to pay millions (if not billions) of dollars in compensation and settlements, often due to IIA violations through regulatory acts that they would allege to be within their sovereign prerogatives.

At the core of these ‘unintended consequences’ in arbitral awards lie, at least in part, vaguely worded international obligations for states under IIAs. One prominent criticism of the system has been its alleged ‘pro-investor’ bias and inconsistent (or outright incorrect) awards. This stems largely from a series of seemingly pro-investor interpretations of treaty provisions. Having been framed as ‘promotion and protection’ agreements for foreign investment, these IIAs led to some questionable (according to some, excessive) awards disproportionately favoring foreign investors with little to no regard to states’ regulatory competences, public health, security, environmental protection and so on as counter-balancing factors.

In addition to issues related to substantive provisions in IIAS, procedural issues related to the choice of arbitrators, lack of an appeal mechanism, third party funding and limited or non-existent amicus curiae participation in proceedings are among other topics of contention. This conjuncture ultimately resulted in one of the most publicized legitimacy crises in international economic law.

Why, indeed, have a fully-fledged international legal system, based on a confidential and private dispute settlement mechanism that focuses exclusively on protecting foreign capital at the expense of everyone and everything else? If we were to have such a system, can there be a balance between different stakeholders?

In the last decade, policy-makers have come up with a variety of proposals to address these issues. More recently, confidentiality and transparency of ISDS proceedings have been under the limelight. In 2017, UN Convention on Transparency in Treaty-based Investor-State Arbitration  (Mauritius Convention) entered into force. Its rules deal with, inter alia, public access to proceedings, documents, as well as third party submissions.[2] There have been a series of other national and regional responses to this legitimacy crisis – some aim to enhance, improve, and streamline the system, and others to opt out of it. The US has revised its Model IIA in 2004 and again in 2012, and included explicit provisions and clarifications for its less clear rules.[3] Canada has gradually expanded upon its 2004 Model BIT by incorporating provisions regarding, among others, corporate social responsibility (CSR). Norway similarly revised its Model IIA in 2007 and in 2015 – the latter is particularly heavy on language regarding regulatory authority, as well as preserving and protecting public interest. The European Commission has been negotiating a series of new free trade agreements (FTAs) with investment chapters throughout 2010s in order to remedy these perceived problems. Extensive carve-outs to protection against expropriation, qualified ‘fair and equitable treatment’ provisions, regulations and exceptions with regard to human rights and environment are also incorporated to publicly available treaty texts of EU FTAs.[4] The Netherlands, the former champion of the ‘gold standard’ of IIA protection, has significantly revised its position on foreign investment protection in line with the EU’s approach. On the other hand, a number of states started terminating their BITs – either to do away with them, or to renegotiate newer, more favorable IIAs. India, South Africa, Indonesia, Ecuador, and Venezuela are but a few examples. Other significant global actors, such as Brazil, do not have IIAs that allow ISDS.

2. UNCITRAL Working Group III

The United Nations Commission on International Trade Law (UNCITRAL) Working Group III (WGIII) represents the most recent multilateral attempt at addressing some of the perceived shortcomings of the ISDS system. Since December 2017, WGIII has convened four times to discuss ISDS reform. UNCITRAL entrusted Working Group III with ‘a broad mandate’, which allowed the Working Group ‘to identify and consider concerns regarding [ISDS] … second, consider whether reform was desirable in the light of any identified concerns, and … third, if the … reform was desirable, develop any relevant solutions”.[5] This being said, WGIII reports also indicate that “the mandate of the [WGIII] was to work on the possible reform of ISDS rather than reform of substantive standards in [IIAs] and that the focus of its work should be on the procedural aspects of ISDS”.[6] According to this mandate, WGIII has not, and will not be dealing with the reform of provisions concerning substantive principles such as expropriation and fair and equitable treatment.

WGIII has already identified a number of concerns where reform would be desirable within the confines of its mandate. Some of these concerns are (a) independence and impartiality of arbitrators, (b) the costs in ISDS and security for costs, and (c) third-party funding.[7] During its fourth and (at the time of writing) latest meeting on ISDS, which took place between 1 and 5 April 2019 in New York[8], third party funding in particular was discussed extensively. Countries further identified other topics of interest. Among these further identified concerns during this session were means other than arbitration to settle disputes (such as mediation), exhaustion of local remedies, third-party participation, counterclaims by states, as well as the risk of regulatory chill (the situation in which a state refrains from regulating or acting for public interest in order not to face an ISDS claim). Among these further identified concerns during this session were (a) means other than arbitration to settle disputes, (b) exhaustion of local remedies, (c) third-party participation, (d) inconsistent and incorrect awards, (e) the issue of counterclaims by states, as well as (f) the risk of regulatory chill (the situation in which a state refrains from regulating or acting for public interest in order not to face an ISDS claim).

One particularly noteworthy point of consideration has so far been the inconsistency of arbitral awards. In order to address this issue, WGIII has outlined possible reform options, including reforming the ISDS by, inter alia, incorporating a system of preliminary ruling and/or an appeal mechanism. In addition to ISDS reform, other possible options include a multilateral investment court and the abolishment of ISDS. While all reform options, at least in theory, offer extensive systemic overhaul, ICS is outstanding in this regard. As noted by the UNCITRAL Secretariat, “by sitting permanently and deciding cases over time, judges could deliver consistent decisions … [a] court could be conceived as a first instance tribunals, with or without an appeal tribunal and be composed of judges, obliged to adhere to underlying ethical standards.”[9] While a multilateral investment court in the near future seems unlikely, CJEU’s recent Opinion 1/17[10] largely ensured the establishment of future bilateral investment courts which will function on overhauled procedural and substantive rules with important additions pertaining to concerns related to transparency, regulatory authority, protection of health and environment, adjudicators’ ethics and qualifications, third party participation, and so on. Their adjudicatory output -awards, interim decisions, other relevant documents- will potentially serve as a ‘beta’ test towards perfecting a possible multilateral initiative procedurally and substantially.

3. Conclusion

Categorizing procedural and substantial issues (and thus dealing with each of them separately) is not a novel method to address systemic shortcomings in a legal system. The last century is marked with subsequent failures in achieving broad consensus regarding substantive principles in IIL. This being said, IIL took important strides with regard to its procedural rules since before the establishment of ICSID (which is a procedural reform in itself) in mid-20^th century. In more recent years, several successful subsequent initiatives, such as the ongoing amendment process of the ICSID Rules[11] as well as the entry into force of the Mauritius Convention on procedural transparency are noteworthy efforts towards addressing some of the most pressing shortcomings of the system, as briefly mentioned above.

As WGIII slowly but surely proceeds with its task, it might soon reveal the procedural and institutional skeleton of a ‘new-age’ legal framework. While procedural reform is surely necessary and desirable (as also maintained during the WGIII second phase), this begs the following question: can a meaningful reform initiative outright exclude the pressing need for reform in substantive rules? It is clear that consistent interpretation of substantive protection principles, in particular controversial provisions such as indirect expropriation and fair and equitable treatment, cannot be truly captured within a mandate limited to procedural matters. Their procedural features and implementation notwithstanding, possible reform topics such as investor obligations and state counterclaims require elaboration on what exactly these obligations are as treaty provisions in future IIAs. Without such substantive steps, procedural consensus will not suffice to address criticisms targeted at the ISDS and the IIA system.