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Executive Summary

International investment agreements (IIAs), consist of bilateral investment treaties (BITs) and certain other treaties with investment chapters. The first BIT was entered into in 1959, and now there are over 2,600 IIAs in force. These treaties are designed to attract and protect foreign investment.

IIAs provide for ad hoc arbitration of investor-state disputes (Investor-State Dispute Settlement, or ISDS). ISDS cases involve a wide range of industrial sectors. The vast majority of these arbitrations, whose number has dramatically increased in the last ten years, are held under the auspices of the International Centre for Settlement of Investment Disputes (ICSID), which is part of the World Bank. A number of other institutions and arbitral rules specified in the IIA or chosen by the parties may administer and govern ISDS proceedings, respectively.

IIAs, and the ISDS system, have come under a good deal of criticism in recent years. One problem is the lack of consistency among ISDS decisions. Arbitration panels are constituted on a case-by-case basis, and sometimes interpret the same provisions differently. Unlike the World Trade Organization, there is no appeal mechanism to iron out the inconsistencies. More importantly, particularly in recent years, there is a concern that governments may be inhibited from adopting legislation or measures designed to protect the public interest in areas such as health, safety, and the environment, fearing that foreign investors may initiate ISDS proceedings, on the grounds that, for example, the increased costs associated with the legislation amount to indirect expropriation or breach other protections in IIAs. Recent IIAs, such as the Trans-Pacific Partnership, have safeguards to protect public interest legislation from ISDS claims. A few countries, however, have gone so far as to terminate their BITs and withdraw from ICSID.

1.0 Background

The modern legal framework for promotion and protection of foreign investment consists mainly of a vast network of international investment agreements (IIAs). Most of these are bilateral investment treaties (BITs), concluded by almost every country in the world. The remainder are regional free trade agreements containing investment chapters, as well as some other multilateral treaties, such as the Energy Charter Treaty and the Unified Agreement for the Investment of Arab Capital in the Arab States. As of January 2018, countries had entered into 2951 IIAs and 373 treaties with investment chapters, out of which 2,363 IIAs and 310 investment chapters (a total of 2,673) were in force.¹ In addition, contracts between investors and states (usually relating to an individual project) normally contain protections that are similar to those provided by IIAs. Finally, a number of countries have domestic legislation on investment and taxation, which constitutes an important part of this modern framework.

Prior to the advent of IIAs, foreign investors had limited remedies at their disposal to protect their economic interests abroad when host governments expropriated or took other measures that harmed their investments. For example, one remedy would be recourse to local courts; but local courts in many countries are not perceived to be

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independent and may be inefficient.² Courts in an investor’s home state may not be able to provide an effective remedy either, as the courts may be wary of exerting jurisdiction over foreign sovereigns. Foreign sovereign immunity and doctrines such as the Act of State Doctrine further limit the possibility of obtaining effective relief.³

Another traditional remedy has been to sue the host state of the investment in “state to- state” dispute settlement. This method provided limited opportunities for foreign investors since international law (prior to the IIA era) did not allow companies or natural persons to sue a state directly. A private foreign investor would have had to persuade its home state to “espouse” a claim (this is also called “diplomatic protection”) against the offending state. Espousal, however, is not mandatory, and home states typically did not want to damage their diplomatic relationships with other governments over commercial matters, such as collection of debts owed by foreign governments to their nationals.⁴ Further, a pre-condition to espousal is “exhaustion of local remedies”, which is a technical term referring to the requirement that foreign nationals must pursue all legal avenues of relief in the host state of the investment (such as through the court system), before their home state can espouse their claim.⁵

2.0 The Emergence of BITs

Modern IIAs, however, have transformed the way international law protects foreign investors. The first BIT was entered into in 1959 by Germany and Pakistan. Since then countries around the world have entered into these treaties on the assumption that the protections afforded to foreign investors and investments in these treaties could help the countries attract foreign investment, as well as demonstrate their adherence to the rule of law. To this end, IIAs provide a range of basic protections to foreign investors. Most importantly, foreign investors are not required to sue host governments in local courts or seek diplomatic protection, because the majority of modern IIAs allow foreign investors to sue host governments directly in international arbitral proceedings, and do not require exhaustion of local remedies. This mechanism is known as “investment arbitration”, “investment treaty arbitration” or “Investor-State Dispute Settlement” (ISDS). ISDS includes arbitrations commenced pursuant to investment chapters of certain free trade agreements, such as the North American Free Trade Agreement (NAFTA), which in substance are similar to a bilateral investment treaty. The term “investment arbitration” also refers to arbitral proceedings commenced pursuant to national legislation for promotion and protection of foreign investments, or pursuant to an investment contract between the investor and the host state. International investment arbitration should be contrasted with “international commercial arbitration”, which is normally commenced based on an arbitration clause in a commercial contract and is usually between private companies or individuals.⁶

From the foreign investors’ perspective, there are several reasons why the ISDS mechanism is one of the most powerful tools that international law has provided to private companies and individuals. First, IIAs provide investors and their investments with a range of protections including: non-discrimination, no expropriation without compensation, and fair and equitable treatment. IIAs grant these protections to a wide array of tangible and intangible property and associated investment-related rights. Individuals and businesses, including corporations, sovereign wealth funds, or even non-profit organisations, may qualify as investors under the IIA’s definitions and be permitted to bring claims.

Second, and more importantly, unlike classic public international law which is criticised for lacking an effective enforcement mechanism and failing to afford protection to non-state actors, IIAs allow foreign investors to protect their investments by commencing ISDS and enforcing arbitral awards⁷ worldwide under two widelyaccepted international conventions. First, the ICSID Convention, which established the the International Centre for Settlement of Investment Disputes (ICSID), an arm of the World Bank, located in Washington, DC; and second, non-ICSID awards can be enforced by contracting states under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. These conventions allow international arbitration awards to be enforced by parties in more than 150 countries through a

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procedure that converts an award into a local court judgment. There is no similar mechanism for enforcing court judgments worldwide, which makes international arbitration a very attractive option.

Where applicable, ISDS allows aggrieved investors to commence an arbitration directly against a state. ISDS also provides a means for investors who prevail in an investment arbitration to enforce awards against Contracting States.

3.0 Introduction to IIAs and IIA Rules

The great majority (521 out of 855 as of July 2018) of the publicly-known ISDS claims were submitted to ICSID.⁸ This is due in part to the fact that enforcement of ICSID awards by local courts is automatic. Also, ICSID provides the venue, and using a team of experienced professionals, effective administrative support for arbitrations. The Permanent Court of Arbitration, based in The Hague, ranks second, with 100 cases. A list of the principal arbitration institutions is provided in the table at the end of this chapter. Among various IIAs, as of July 2018, the Energy Charter Treaty, followed by NAFTA Chapter 11, had been invoked to bring investment treaty claims more often than any other IIA.

3.1 Arbitration Rules

Investment agreements are usually enforced through arbitration based on rules mandated by an IIA, selected by the investor, or agreed by the parties. For example, arbitrations arising under the ICSID Convention are subject to the ICSID Rules of Procedure for Arbitration Proceedings.⁹ For arbitrations arising under the Energy Charter Treaty, the investor may choose between ICSID Rules, the rules of the United Nations Commission on International Trade Law (UNCITRAL Rules),¹⁰ or the rules of the Arbitration Institute of the Stockholm Chamber of Commerce.¹¹ Likewise, investment disputes arising from regional trade agreements might be subject to various sets of rules chosen by the claimant or agreed by the parties. For example, under NAFTA investors may initiate an arbitration against a NAFTA Party under UNCITRAL Rules¹² or the ICSID Additional Facility Rules (explained below).¹³

Many regional trade agreements and BITs apply the rules developed by UNCITRAL — a legal body in the United Nations system that works to modernise and harmonise international business rules.

The UNCITRAL Arbitration Rules provide a comprehensive set of procedural rules upon which parties may agree for the conduct of arbitral proceedings arising out of their commercial relationship and are widely used in ad hoc arbitrations as well as administered arbitrations. The Rules cover all aspects of the arbitral process, providing a model arbitration clause, setting out procedural rules regarding the appointment of arbitrators and the conduct of arbitral proceedings, and establishing rules in relation to the form, effect and interpretation of the award.¹⁴

While UNCITRAL rules, and variations on UNCITRAL rules, are frequently designated in BITs, unlike ICSID, UNCITRAL does not offer institutional support. However, the applicable agreement may designate another entity to provide institutional support. For example, Article 27 of the Energy Charter Treaty designates the Permanent Court of Arbitration, which sits in The Hague, to provide institutional support in certain instances.

Although the majority of investment disputes arise under ICSID, not all states are ICSID Contracting States, and not all investors are from ICSID Contracting States. In such cases, the rules of the ICSID Additional Facility may be applicable.

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The ICSID Additional Facility offers:

• Arbitration or conciliation of investment disputes between a state and a foreign national, one of which is not an ICSID Contracting State or a national of an ICSID Contracting State;
• Arbitration or conciliation of disputes that do not arise directly out of an investment between a state and a foreign national, at least one of which is an ICSID Contracting State or a national of an ICSID Contracting State; and
• Fact-finding proceedings instituted by any state or a national of any state.¹⁵

The rules established by ICSID and UNCITRAL are applied most frequently in investment arbitration. Investors, through their counsel, should fully understand the applicable, and potentially applicable, arbitration rules before initiating arbitration. If ICSID rules are inapplicable, investors should ascertain whether the rules of the Additional Facility might apply. If UNCITRAL rules are selected or otherwise applicable under a particular IIA, Investors should read the agreement to ascertain whether the agreement designates an institution to support the arbitration.

3.2 Scope of Investment Arbitrations

Numerous businesses involved in a variety of industrial sectors such as oil and gas, mining, construction, telecommunications, insurance, and agribusiness have taken advantage of the ISDS mechanisms to resolve investment disputes with host governments. Oil, gas and mining account for more cases than any other sector. The chart below, which was prepared by ICSID, shows a distribution of claims registered at ICSID by economic sector.

Figure 1 .1 Distribution of All ICSID Cases by Economic Sector as of 30 June 2018¹⁶

Overall, according to the United Nations Conference on Trad^ee and Development (UNCTAD), as of July 2018 foreign investors had brought more than 850 investment arbitrations against various governments, including mega-cases like those filed by the Yukos shareholders against the Russian Federation, initially seeking more than US$110 billion, as well as smaller cases.¹⁷ As demonstrated in the chart below, the majority of these claims have been filed during the past ten years.

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Figure 1. 2 Total Number of Cases Registered by ICSID as of 30 June 2018¹⁸

The distribution of claims among developed and developing countries have changed too. In the early days, only developing countries were defendants. But, with the entry into force of NAFTA in 1994, numerous claims have been filed against Canada and the United States. This trend has continued and today many countries in Europe, including Germany, Italy, Belgium, the Czech Republic and Spain, have been sued under various treaties. The chart below shows the distribution of ICSID claims by region. Argentina has been sued most often, followed by Venezuela, the Czech Republic and Spain. Most claimants were from the US, followed by the UK and Germany.

Figure 1. 3 Geographical Distribution of ICSID Cases by Region as of 30 June 2018¹⁹

Overall, a recent UNCTAD report suggests that investors have prevailed in 60% of the cases and states in 40%.²⁰ The majority of these awards have been based on a violation of the fair and equitable treatment standard, followed by indirect and direct expropriation.

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4.0 Criticism of IIAs

From a host government’s perspective, IIAs and ISDS have proved to be controversial and some have argued that they have not fulfilled their original objective of attracting foreign capital. Various studies suggest that there is no direct correlation between entering into IIAs and increases in inflows of foreign investment, although other studies have come to the opposite conclusion.²¹ Further, it has been maintained that ISDS claims target a wide range of regulatory measures that could in some situations create a regulatory chill, preventing legislators from enacting legislation to protect the public interest.²² Arbitral practice shows that almost no government measure may be immune,²³ although more recent IIAs contain safeguards to ensure that measures adopted for reasons of public health, the environment and in some situations balance of payment difficulties are generally protected.

The ISDS mechanism, therefore, has attracted a host of critiques. A well-known practitioner has called the IIAs “weapons of legal destruction”.²⁴ Civil society groups and others have also been critical of the ISDS mechanism and voiced their concerns on a variety of grounds such as regulatory chill noted above, as well the legitimacy of the ISDS tribunals to second-guess various measures adopted by national governments and designed to protect the public interest.²⁵ What some critics have called a “legitimacy crisis” has been partly fuelled by inconsistent decisions of ISDS tribunals which stem from the fact that ISDS tribunals are constituted on a case-by-case basis (currently there is no permanent court or tribunal hearing investment disputes), and, therefore, from time to time they interpret similar provisions differently. Further, unlike the WTO Appellate Body, there is no appeal mechanism in the ISDS system to fix these inconsistencies. The limited annulment and set-aside available in the ISDS process (see Chapter 23) is not meant to fix such inconsistencies; it only ensures that the disputing parties are afforded some degree of due process. Other bases for the “legitimacy crisis” include perceptions of arbitrator bias.²⁶

As a result, in the past several years, a small number of countries have taken steps to curtail the right to ISDS by: terminating their BITs²⁷ and withdrawing from ICSID.²⁸ They have also added a number of safeguards to enable governments to enact regulations to protect public health, environment and public finance without being liable to ISDS claims, and have narrowed the scope of protection granted to foreign investors.²⁹ For example, the Trans-Pacific Partnership (TPP)³⁰ provided that:

Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health, safety and the environment, do not constitute indirect expropriations, except in rare circumstances.³¹

In addition, Article 29.5 of the TPP allowed Parties to disallow ISDS claims relating to tobacco products.

The most complex reaction has perhaps been seen in the European Union where the European Commission initially held that all intra-EU BITs needed to be terminated.³² Instead, however, efforts are currently underway in the EU to create an investment court to limit criticism of the international arbitration model described above.³³

The administration of President Trump has arguably contributed to this backlash by pulling the United States out of the TPP, a treaty signed by 12 Asia-Pacific countries, including Canada, Mexico, Japan and Australia. Notably the TPP’s investment chapter included ISDS provisions similar to those found in NAFTA but, as noted above, with greater protection for non-discriminatory regulatory measures. However, at least in the US business community, there appears to be strong support for maintaining the ISDS mechanism in US investment treaties, particularly in the renegotiation of NAFTA that began in the summer of 2017.³⁴

Despite these developments, IIAs remain powerful tools at the disposal of foreign investors and would not lose their relevance even if they were all terminated today, as they normally have so-called sunset clauses that extend their protections for ten or

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more years to investments already made. Nevertheless host governments need to carefully analyse the benefits of these treaties and if warranted amend, revise, or terminate them as many countries have done in recent years.

Table 1.1 Principal Arbitral Institutions Involved in ISDS

Notes

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