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Need for Reforms in Investor-State Dispute Resolution Mechanism


This essay has been authored by Gurjeet Singh from Delhi University. This essay was one of the Top 7 Honorable Mentions in the 2nd RGNUL Arbitration Essay Writing Competition, 2023 organized in collaboration with Centre for Trade and Investment Law (CTIL), Ministry of Commerce and Industry, Government of India.


The Present System and its Effects

Imagine getting a fine of 190 million dollars for trying to protect your country from environmental hazards and for keeping the fossil oil under the ground for protecting the healthy lives of your citizen. This is exactly what happened with The Italian Republic on 23rd August 2022 when an arbitral award was given by the International Centre for Settlement of Investment Disputes (ICSID).[1] This was done under the so-called Investor-State Dispute Resolution mechanism that turns the “Polluter Pays” principle on its head. Initially aimed at protecting the interests of investors against the risk of investing in other countries, it has now become a lobbying tool for the foreign investors to interfere in the sovereignty of the host-states. Rockhopper is a British oil and gas company which bought assets in Italy’s Ombrina Mare oil field located off the coast of Abruzzo to exploit its resources. However, the Italian government passed a legislation banning oil productions within 12 nautical miles from the coastline; this was done after environmental concerns were raised by Italy’s public and pressure groups. Rockhopper sued Italy in 2022 under the Energy Charter Treaty (1994) an International Investment Agreement (IIA) from which Italy withdrew in 2015.[2] Rockhopper was still able to raise claims because of the “sunset clause” according to which a host state will be responsible to the treaty for 20 years even after withdrawing from it.

Further, the tribunal that was appointed resorted to “Discounted cash Flows” (DCF) valuation to determine the cost of the award as argued by the claimant. Although controversial, this method is widely used in worldwide financial practices to ascertain the value of a project. This method results in a much higher value as it also considers the future profits that would have been made. The arbitrators came to the conclusion that even if the Italian government was trying to protect its environmental and human rights it still does not take away the right of Claimant (Rockhopper) for the compensation under the ISDS mechanism. They also emphasized that nothing of this award shall apply to Italy’s sovereign power to make a legislation but only to the rights of the investor as a result of those legislation. Thus, because of a dispute resolution mechanism which is inconsistent with global goals and even with the Paris Agreement, The Italian Republic had to pay for protecting its own environment and human rights.

The ideal aim of IIAs is to promote foreign investment especially in developing countries but because of the volatile political nature of developing countries the investors are provided security under these treaties. Under the ISDS regimes, the investors feel secure in investing in foreign countries. In case of a breach, or when the investors feel that their assets have been expropriated directly or indirectly, they can sue the host states directly to seek compensation for their losses. These cases are filed before an ad hoc international tribunal consisting of three arbitrators one from each side and the last one nominated jointly. ICSID, the Permanent Court of Arbitration (PCA), International Chamber of Commerce (ICC), Stockholm Chamber of Commerce (SCC) are some of the international tribunals that resolve the dispute between investors and states.

Criticism of the Mechanism

The goals and methods of the ISDS mechanism have been subjected to increasing scrutiny over the past few years. Critics say that the arbitral panel lacks transparency, and they produce results that are inconsistent and unpredictable due to a lack of system of precedence. Also, the perception of the foreign investors that developing countries lack the capability in their domestic courts for impartial adjudication has become more and more invalid. Moreover, when the world is aiming at sustainable environmental goals in order to bring down fossil fuel consumption, these companies use the mechanism as a lobbying tool as a result of which the governments become inactive on the issues of climate rights. The system of ISDS has been observed to be imbalanced and tilted in favour of the investors and thus the developing world faces huge financial risks if it cancels its fossil fuel projects, even if they are doing it to reach their sustainable development goals. For instance, Mozambique is under an ISDS risk of 29$ billion which is twice its annual national income.[3]

There is an urgent need to reform this practice and even the Chief Justice of India, Justice D Y Chandrachud, in a recent conference of UNCITRAL observed that there is a need for reforms for the resolution in investor-state disputes. He was quoted saying that any “formulation of new system” must be a “fair and balanced system”.[4] While forming reforms, the developmental goals of the Global South deserve close attention which faces most of the brunt of environmental hazards even when they contribute the least in comparison to the developed Global North when it comes to the greenhouse gases and making the climate warmer. Further, climate inaction has increased on the part of host states because of the threats that they face under this regime. Denmark and New Zealand were seen admitting that the threat of Investor-State lawsuits have hindered their climate policy and caused inaction towards climate on their part. New Zealand Admitted that it could not join the Beyond Oil and Gas Alliance because doing so “would have run afoul of investor-state settlements”[5]

There are presently 175 environmental ISDS cases and 80 of them have invoked ECT (1994) to claim the arbitral awards.[6] Along with the financial risks that the host-state faces with ISDS when the investors invoke various outdated IIAs like the ECT, there is an even greater risk to the climate because of the International Investment treaties. How is it fair that it costs states in millions and billions of dollars to keep the fossil fuel underground?

In the present decade the problems of ISDS are not limited to only developing countries but have transcended to the developed countries as well. In 1994 U.S signed a treaty known as North American Free Trade Agreement (NAFTA) with Canada and Mexico and it included a clause for ISDS. TransCanada aimed at transporting tar sands to the Gulf of Mexico through a Keystone XL pipeline project, Trans Canada had already invested 3.1$ billion in the project when they sued U.S for $15 billion under NAFTA.[7] In 2017 TransCanada dropped its claims when President Trump reversed the earlier orders that prompted TransCanada to threaten the claim. However, in 2021 the company brought back its claim when the Biden administration cancelled the permit for the Keystone XL pipeline project. Although, NAFTA expired in 2020, the investors were still able to file a suit because of the sunset clause.

The investors are able to do this because of two reasons; Firstly, because the process of ISDSs is often overlooked as they are held in closed doors and the companies are saved from the public outrage and all the while promoting the practice of “double hatting”. Secondly, because the ISDS systems are written into thousands of treaties and there is no system of precedence thus making the arbitral awards unpredictable.

Measures Taken and Recommendations

The United Nations Commission on International Trade Law (UNCITRAL) observed the growing dissatisfaction with the current mechanism of Investment Arbitration and appointed UNCITRAL’s Working Group 3 to draft a proposal for reforming investor-state dispute settlement with a due date in 2026. It recently completed a draft of code of conduct for arbitrators in investor- state disputes in its 45th session held in New York.[8] It consisted of 12 articles, along with commentaries explaining the reason and context for each provision. The code will apply to all kinds of adjudicators, including arbitrators, ad hoc committee members, candidates to become adjudicators, and judges and appeal judges. This code was presented in the fifty-sixth session of Commission for adoption and finalisation.[9] This code is a positive step forward to combat “double hatting” amongst the arbitrators although many more important agendas are being discussed in the different sessions of the working group.

Proposals for ISDS reforms need to be focused on improving the current system instead of upheaving the complete system such that the reform imposes stringent ethical practices to improve transparency and drops the curtain of bias. ISDS are usually initiated in privacy and the rights of host states for prior domestic hearing are undermined, but more importantly the voice and claims of indigenous communities are overlooked.  Many older IIAs are outdated and need to be restructured so that it can meet the demands of the present time and the most pivotal example is of ECT. Further there are proposals for the most important:

(1)   the establishment of a multilateral investment court; and

(2)   the creation of an appellate mechanism. Out of these two the second proposal of appeal mechanism is more likely to be accepted by the international community than that of the creation of a multilateral investment court.

The Indian Stand

Amongst other countries India has also been an active propagator for the appellate mechanism as it is expected to improve the quality and consistency of arbitration awards when we move toward a precedent-based system. In fact, UNCITRAL working group 3 is currently discussing possible scopes and standards of review for an appellate mechanism. In this context, the consolidated draft provisions on an appellate mechanism and enforcement include a reference to article 6(1) of the New York Convention, which could leave room for intervention on domestic grounds of arbitrability and public policy. India, being a developing country and an emerging world centre for trade, commerce and now even arbitration, stands at a very important position when it comes to the reforms concerning the practices in ISDS.

India has successfully raised the concerns of the Global South in the world forum and also taken a proactive approach in UNICITRAL’s working group 3 which is working on the reforms of ISDS mechanisms. India revised its Model BIT text in 2015 which was a welcome step in this direction, however only 4 countries have entered this new phase of Investment agreements of India.[10] Definitely, there is a scope for improvement in the present Model BIT as well and along with it there is an issue of foreign dependency for arbitration In India. The government pays hefty amounts and often to foreign arbitrators to fight its arbitration cases. It is now a necessity to build a domestic panel of lawyers and law firms with the required expertise in investment arbitration to represent India.

Concluding Remarks  

To conclude, it is clear that there is a need for holistic reform in the ISDS mechanism which serves the purpose of both the Investor and the State. The cases mentioned above indicate that a significant risk of the diversion of resources away for climate action hovers over us if adequate reforms are not implemented soon in the current ISDS mechanism. 94% of the investors belong to the developed countries and thus the developing countries and especially the ones in the Global South faces a Greater Financial risk. The “polluters pays” principle should be adopted in principle and spirit by the agencies so that it is the polluter that bears the cost of prevention and implementation for the pollution measures. It is the right of every species for a healthy and sustainable environment and this right should always supersede the rights of capitalist investors and over their fictitious profits. At last, India should strive for a driving seat in the arbitration market of the world, and local expertise in this field should be built up to voice our opinion as world leaders on this important global issue. Domestically, government officials should be trained and New Delhi International Arbitration Centre should be brought up as a future hub for international arbitration.

 

Endnotes

[1] Rockhopper Exploration Plc, Rockhopper Italia S.p.A. and Rockhopper Mediterranean Ltd v. Italian Republic (ICSID Case No. ARB/17/14).

[2] Tropper, Johannes “Withdrawing from the Energy Charter Treaty: The End is (not) near” kluwerarbitration.com, (2022) https://arbitrationblog.kluwerarbitration.com/2022/11/04/withdrawing-from-the-energy-charter-treaty-the-end-is-not-near/

[3] Kyla Tienhaara, Rachel Thrasher, B. Alexander Simmons & Kevin P. Gallagher (2023) Investor-state dispute settlement: obstructing a just energy transition, Climate Policy, 23:9, 1197-1212

[4] Kumar, Pramod, “CJI: Need a system for fair resolution of investor-state dispute”, The Statesman (2023) https://www.thestatesman.com/india/cji-need-a-system-for-fair-resolution-of-investor-state-dispute-1503222390.html

[5] Meager, E., “Cop26 targets pushed back under threat of being sued”, Capital Monitor (2022). https://capitalmonitor.ai/institution/government/cop26-ambitions-at-risk-from-energy-charter-treaty-lawsuits/

[6] IIA Issues Note, No. 4, “TREATY-BASED INVESTOR–STATE DISPUTE SETTLEMENT CASES AND CLIMATE ACTION” (2022)

[7] TransCanada Corporation and TransCanada PipeLines Limited v. United States of America (I) (ICSID Case No. ARB/16/21

[8] Report of Working Group III (Investor-State Dispute Settlement Reform) on the work of its forty-fifth session (New York, 27–31 March 2023)

[9] Singh, Jyoti, “Draft code of conduct for arbitrators in international treaty arbitration cases: Will the final outcome meet its ultimate objective?”, Bar and Bench (2023) https://www.barandbench.com/columns/the-draft-code-of-conduct-for-arbitrators-in-international-treaty-arbitration-cases-will-the-final-outcome-meet-its-ultimate-objective

[10] Dutt, Shubham, “Standing Committee Report Summary India and Bilateral Investment Treaties” PRS Legislative Research (2021)

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