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The Future of Investment Arbitration: An Examination of Reform Proposals and Alternatives to ISDS Mechanisms

This essay has been authored by Shivam Kumar and Nancy Anand from Central University of South Bihar. This essay was one of the Top 7 Honourable Mentions in the 2nd RGNUL-CTIL Arbitration Essay Writing Competition 2023.


Introduction

How would you feel if a foreign company could sue your government for implementing laws or policies that affect its benefits, even if they are in the public interest? This is the situation faced by many countries in terms of investment arbitration, Investor-State Dispute Settlement (hereinafter ISDS), an instrument of Investment Arbitration, a part of international law deals with foreign investors and host countries dispute, based on international treaties or treaties that preserve certain rights for investors and provides Investment intermediation. ISDS have been widely used in recent decades, as the number of investment treaties and agreements has increased significantly. According to United Nations Conference on Trade and Development( hereinafter UNCTAD ), the total number of ISDS cases was more than 1,257 by the end of 2022[1].

Still, the future of Investment Arbitration is uncertain and controversial, as there are many reform theories and alternatives to ISDS proposed by practitioners and organizations. Some of these theories aim to improve the existing ISDS system by addressing its perceived shortcomings and challenges. Others seek to replace ISDS with an alternative, such as the Multilateral Economic Court, the Permanent Court of Appeals, or domestic courts. These proposals and strategies have various implications for the role and function of Investment Arbitration in the global economy and governance[2].

We will discuss some of the key and relevant reform theories, the feasibility and desirability of these proposals and alternatives, taking into account the interests and perspectives of various stakeholders involved in financial intermediation and approaches to ISDS and assess their potential impact on the future of Investment Arbitration. We would argue that although some reforms and alternatives may provide some benefits and improvements over the current framework in ISDS, none of them can fully resolve the issues and concerns. We would therefore argue that a holistic and inclusive approach is needed to address the complex and multifaceted challenges facing financial intermediation in the 21st century.


Background

The history and development of Investment Arbitration can be traced back to ancient times, when arbitration was used as a means of settling disputes between different states or peoples. However, the second part of the 20th century saw the emergence of the current system of investment arbitration in reaction to the growth of foreign direct investment and the necessity for an efficient means of resolving investment disputes.[3]

A key component of Investment Arbitration is the ISDS process, which allows investors to initiate proceedings against states for alleged violations of their rights and protections under investment treaties or contract. They do not rely on domestic courts, which may be biased, ineffective, or inaccessible. ISDS aims to promote the rule of law, encourage foreign investment, and promote good governance at host state.[4]

However, ISDS has faced a lot of criticism from various stakeholders, such as states, civil society, academia, and even the mediators themselves.[5] Key issues and challenges outlined include: unspecified funding conflicts; imprecise and predictable mediation effects; the role and independence of mediators; the potential impact of ISDS on the right of the host state to legislate in the public interest; the high cost and length of ISDS proceedings; and inadequate compensation and remedies for investors[6].

This criticism has led to a debate about the need for reform or a different approach that would address its perceived shortcomings and challenges, while preserving its benefits and advantages. ISDS reform theories and strategies proposed by practitioners and organizations include: Improving existing ISDS systems by introducing transparency, diversity, accountability and efficiency with the replacement of ad hoc tribunals by multinational investment courts or permanent arbitration tribunals with the strengthening of domestic courts or regional mechanisms for the settlement of investment disputes; or complete abolition of ISDS[7].

To illustrate the scenario of investment Arbitration, here are some recent developments in important litigation involving India as a respondent state:

  • Vodafone v India (I): This case is about a conflict between a foreign investor's right to tax certainty and a host state's right to tax sovereignty. Vodafone was a British telecom company that had acquired a majority stake in an Indian telecom company, Hutchison Essar, from a Hong Kong-based company, Hutchison, in 2007. The transaction was done through a series of offshore entities, and Vodafone did not pay any capital gains tax in India, claiming that the deal was outside the jurisdiction of Indian tax authorities. However, in 2012, India passed a retrospective amendment to its Income Tax Act, which allowed it to tax such indirect transfers of Indian assets by foreign companies. India then issued a tax demand of US$2.2 billion to Vodafone, which Vodafone challenged under the India-Netherlands BIT, which protected its investment from expropriation, unfair treatment, and denial of justice. Vodafone initiated arbitration under the BIT in 2012, and in 2020, the arbitral tribunal ruled in its favour. The tribunal found that India had violated the BIT by imposing retrospective tax on Vodafone, and ordered India to refrain from pursuing the tax demand and to reimburse Vodafone's legal costs. India appealed the award in Singapore, but it was dismissed by the Singapore High Court. India also faced pressure from the UK and the Netherlands to honour the award and to settle the dispute amicably. India argued that the award was against its public policy and sovereignty, and that it had the right to tax its legitimate share of revenue from foreign transactions involving Indian assets. The case is still ongoing, and it shows the difficulties of balancing a foreign investor's right to tax certainty and a host state's right to tax sovereignty in investment arbitration. The challenge or dispute in this scenario is the conflict between the foreign investor's right to tax certainty and the host state's right to tax sovereignty. The foreign investor claims that it followed the existing tax laws and that the retrospective tax is arbitrary, discriminatory, and confiscatory. The host state claims that it has the sovereign right to tax its own resources and that the retrospective amendment was a result of correcting an error or a loophole. The arbitral tribunal has to decide whether the retrospective tax amounts to an expropriation or a breach of fair and equitable treatment under the BIT, and whether the host state has a valid justification for its measure. The arbitral award may also face challenges and resistance in its recognition and enforcement in different jurisdictions, depending on the public policy and sovereignty of the enforcing states.[8]

  • Cairn v. India: This case is about a conflict between a foreign investor's right to tax stability and a host state's right to tax fairness. Cairn was a British oil and gas company that had made a significant discovery of oil reserves in India in 2004. In 2006, Cairn restructured its Indian operations by transferring its shares in its Indian subsidiary, Cairn India, to a newly incorporated company, Cairn UK Holdings, which was based in Jersey, a tax haven. Cairn then sold part of its stake in Cairn India to another Indian company, Vedanta, in 2011, and made a capital gain of US$4.4 billion. However, in 2014, India passed a retrospective amendment to its Income Tax Act, which allowed it to tax such indirect transfers of Indian assets by foreign companies. India then issued a tax demand of US$1.6 billion to Cairn, which Cairn challenged under the India-UK BIT, which protected its investment from expropriation, unfair treatment, and denial of justice. Cairn initiated arbitration under the BIT in 2015, and in 2020, the arbitral tribunal ruled in its favour. The tribunal found that India had violated the BIT by imposing retrospective tax on Cairn, and ordered India to pay US$1.2 billion plus interest and costs to Cairn. India appealed the award in the Netherlands, but it was rejected by the Dutch court. India also faced enforcement actions by Cairn in several countries, including the UK, the US, Canada, France, and Singapore, where Cairn sought to seize India's assets and properties. India argued that the award was against its public policy and sovereignty, and that it had the right to tax its fair share of revenue from foreign transactions involving Indian assets. The case is still ongoing, and it shows the difficulties of balancing a foreign investor's right to tax stability and a host state's right to tax fairness in investment arbitration.The challenge or dispute in this scenario is the conflict between the foreign investor's right to tax stability and the host state's right to tax fairness. The foreign investor claims that it relied on the tax holiday as a legitimate expectation and that the retrospective tax is arbitrary, discriminatory, and confiscatory. The host state claims that it has the sovereign right to tax its own resources and that the tax holiday was a result of an error or a fraud. The arbitral tribunal has to decide whether the retrospective tax amounts to an expropriation or a breach of fair and equitable treatment under the BIT, and whether the host state has a valid justification for its measure. The arbitral award may also face challenges and resistance in its recognition and enforcement in different jurisdictions, depending on the public policy and sovereignty of the enforcing states.[9]

  • Devas vs. Devas India: This case is about a conflict between a private investor's right to a contract and a host state's interest in national security and public policy. Devas was an Indian company with foreign shareholders that had entered into a satellite spectrum lease agreement with Antrix, the commercial arm of the Indian Space Research Organization (ISRO), in 2005. The agreement was for 12 years, and it gave Devas the exclusive rights to use two satellites that Antrix would launch and operate for multimedia services. However, in 2011, the Indian government cancelled the agreement, citing national security concerns and the need to allocate the spectrum for strategic and social purposes. Devas claimed that this was a breach of the India-Mauritius BIT, which protected its investment from expropriation, unfair treatment, and denial of justice. Devas initiated arbitration under the BIT in 2011, and in 2015, the arbitral tribunal ruled in its favour. The tribunal found that India had violated the BIT by terminating the agreement without due process or compensation, and ordered India to pay US$672 million plus interest to Devas. India challenged the award in several jurisdictions, but it was upheld by courts in the UK, France, and the US. India also faced enforcement actions by Devas in several countries, including the US, where Devas sought to attach India's assets and properties. India argued that the award was against its public policy and sovereignty, and that it had the right to regulate its spectrum for national security and public interest. The case is still ongoing, and it shows the difficulties of balancing an investor's private rights and a host state's public interests in investment arbitration. The challenge or dispute in this scenario is the conflict between the private investor's right to a contract and the host state's interest in national security and public policy. The private investor claims that it relied on the contract as a legitimate expectation and that the cancellation of the contract is arbitrary, discriminatory, and confiscatory. The host state claims that it has the sovereign right to regulate its own resources and that the cancellation of the contract was a result of protecting its national security and public interest. The arbitral tribunal has to decide whether the cancellation of the contract amounts to an expropriation or a breach of fair and equitable treatment under the BIT, and whether the host state has a valid justification for its measure. The arbitral award may also face challenges and resistance in its recognition and enforcement in different jurisdictions, depending on the public policy and sovereignty of the enforcing states.


Reform Proposals

The reform theory is a potential solution to the issues and challenges faced by both financial intermediation and ISDS. Recommendations for change vary from improving the existing ISDS system to replacing it with a new instrument. Key reform recommendations include:

  • Most Favoured Nation Treatment: MFN treatment refers to the treatment given by a granting state to a beneficiary state or those in a determined relationship with that state. Many countries, particularly developing ones, struggle with the scope and formulation of MFN treatment clauses in International Investment Agreements (IIAs). There are three reform options: applying MFN treatment to pre-establishment, applying it to post-establishment, or including country/sector-specific exceptions[10].

  • Code of Conduct for Arbitrators: UNCITRAL Working Group III has developed a draft code of conduct for arbitrators in investor-state disputes, addressing concerns about diversity, conflicts, and lack of common ethical standards[11].

  • Sustainable Development: Sustainable development reform in investment arbitration aims to balance investor rights and public interests. However, it faces challenges such as differing interpretations, varying investment treaties, lack of enforcement mechanisms, legal challenges, investor-state dispute resolution bias, treaty shopping, resource constraints, political influence, capacity building, and compliance and accountability. Reform efforts may not immediately impact legacy agreements, and powerful multinational corporations may oppose sustainable development reforms[12].

  • Improving the existing ISDS framework: The proposal proposes improvements to the ISDS framework, including increased transparency, diversity, accountability, and operational efficiency, through the development of a code of conduct, limitations on shareholder loss claims, and alternative dispute resolution methods..[13] The potential impact of these considerations on financial arbitration is to improve the quality and reliability of the arbitration process and outcomes, while preserving the flexibility and autonomy of the parties.

  • Establishment of a Multilateral Investment Court or Permanent Court of Appeal: The proposal proposes a permanent or semi-permanent institution to adjudicate economic disputes, including a multilateral investment court with preliminary and appeal proceedings, fixed judges, independence, uniform rules, and third-party involvement. The potential impact is to increase fairness, predictability, legality, and reduce litigation costs, but may face challenges.

  • Strengthening Domestic Court or Regional Systems: The proposal proposes resolving investment disputes through domestic court or regional mechanisms, requiring investors to exhaust local remedies before resorting to international arbitration. It includes establishing district courts for financial disputes and dividing sectors[14]. The proposal may raise national concerns.

  • Completely Eliminate ISDS: Proposals aim to remove ISDS from international financial law by terminating or renegotiating existing or new treaties. These include withdrawal from the ICSID Convention, challenging existing BITs or FTAs with ISDS provisions, adopting new models without ISDS, or rejecting ISDS in specific cases. Investment arbitration could end disputes, empower host states, but may negatively impact investors and countries.


Examination of Nations or Regions Enacting Reform Recommendations [15]:

  • Brazil: Brazil has never ratified any BIT with ISDS clauses. Instead, it has formulated its own Cooperation Facilitation Investment Agreement (CFIA), devoid of an ISDS provision. The CFIA prioritizes dispute prevention over resolution, establishing joint committees, public monitoring, focus areas, and action plans to enhance dialogue and collaboration between investors and countries.[16] The CFIA also promotes litigation through alternative dispute resolution mechanisms.

  • India: India has amended its Model BIT in 2015, which contains several amendment elements to improve the existing ISDS provisions. The revised Model BIT mandates a five-year adherence to local remedies before initiating legal action, omits tax provisions from judicial application, constrains denial of justice under the fair and equitable standard, eliminates claims of unfair dismissal, permits states to assert counterclaims, and introduces transparency and disclosure  regulations.[17]

  • European Union: The EU has pursued the establishment of a Multilateral Economic Court or Permanent Court of Appeal as its preferred amendment for ISDS. The EU has included provisions for a bilateral investment court system in its recent trade and investment agreements, such as the Comprehensive Economic and Trade Agreement (CETA) with Canada, the EU-Vietnam Bank Protection Agreement and the EU-Singapore Investment Protection Agreement.[18] The EU has also proposed the creation of a multilateral investment court during the UNCITRAL Working Group III discussions.

  • South Africa: South Africa excluded ISDS from its domestic and international investment laws, repealed its existing BITs, and enacted a new law called the Protection of Investment Act in 2015[19]. The new law states financial disputes Resolution shall be by domestic court or arbitration, and arbitration shall be permitted only with the consent of the government. The new law also gives the government the power to expropriate investments for public purposes, with domestic courts setting the amount of compensation


Alternatives to the ISDS Mechanism

Many scholars, practitioners, and civil society groups have proposed various alternatives to ISDS aimed at addressing these issues and better aligning with the Sustainable Development Goals A brief suggestion of these alternatives includes here is what it means in terms of Investment Arbitration:

  • Strengthening Domestic Legal System: Foreign investors should use host country courts and laws for dispute resolution, ensuring domestic regulatory systems' capacity, independence, and impartiality. This approach respects sovereignty, promotes rule of law, reduces litigation costs, and reduces risks. However, challenges include trust issues and difficulty in accessing domestic regulatory frameworks[20].

  • Political Risk Insurance System: Foreign investors must obtain insurance coverage from public and private providers to protect against political risks like labor expulsions, treaty violations, and civil unrest in host countries. This shifts the burden of compensation from the host country to the insurer, allowing them to pursue immigration claims through ISDS or other means. This approach reduces host countries' exposure to court claims, encourages due diligence and risk assessments, and promotes dialogue between insurers and host countries to prevent disputes and resolve adverse selection problems[21].

  • State-to-State Dispute Settlement: This approach implies that disputes arising out of investment treaties should be resolved through diplomatic channels or through international arbitration between the country of residence and the investor country rather than through investor country intermediaries. This would involve amending or modifying existing investment treaties that give investors direct access to ISDS. The main advantages of this approach include balancing rights and responsibilities between states and investors, increasing legality and transparency of dispute resolution, greater consideration of public interests and policy objectives, which is difficult to ensure adequate and full participation before third including parties[22].

  • Human Rights Mechanisms: The approach suggests that foreign investors who experience human rights violations by host states should seek redress through existing human rights mechanisms at the national, regional, or international level, rather than through financial intermediation. This involves ensuring human rights provisions are accessible, effective, and responsive to investor issues, consistent with investment treaties and ISDS. However, challenges include the potential lack of capacity to address complex economic conflicts, potential conflicts between human rights and economic norms, and difficulty in enforcing human rights judgments against insurgent states.

  • Permanent Investment Tribunal: This approach implies the creation of a permanent judicial body to adjudicate disputes arising out of investment contracts rather than relying on ad hoc tribunals on. This will require the creation of a new multilateral body or the amendment of existing ones to accommodate such arbitration, and broader support and participation from states and investors In the future, appeals will be offered to correct wrongs or inconsistencies but some difficulties include possible opposition or resistance from those already involved in the litigation process, the potential difficulties and costs of setting up and administering such litigation, coupled with legal systems and cultures that are difficult to ensure consistency and authenticity

  • Corporate Social Responsibility: This approach encourages responsible business practices by investors and companies, focusing on human rights, labour rights, environmental protection, anti-corruption, and good governance. However, it may have limitations such as binding powers and inconsistent standards. Some countries have already implemented or tried these mechanisms, such as the EU's replacement of ISDS in trade with investment treaties and domestic legislation for foreign investment regulation. These approaches face legal, political, and practical constraints and uncertainties, requiring further research and discussion among stakeholders to ensure their feasibility and desirability. Other modifications can be added to improve the current system of settling investment disputes.


Exploring ISDS Mechanism Alternatives: Case Studies in Implementation

  • Indonesia: Indonesia has decided not to renew or extend 20 of its BITs that have expired or will expire soon, and has announced its intention to terminate or renegotiate the remaining ones. Indonesia has also developed a new model BIT, which limits the scope of protected investments, excludes taxation measures, and requires investors to exhaust local remedies for at least four years before initiating arbitration.

  • Bolivia: Bolivia denounced the ICSID Convention in 2007, and terminated or denounced several of its BITs. Bolivia also adopted a new Constitution in 2009, which prohibits the use of ISDS and requires foreign investors to respect the sovereignty, laws, and public policies of the state. Bolivia has also joined the Union of South American Nations (UNASUR), which is working on a regional arbitration center based on principles of cooperation, complementarity, and solidarity.

  • Ecuador: Ecuador has begun to rethink its investment policies and practices in light of its constitutional principles and human rights obligations. Ecuador challenged the ICSID Convention in 2009, terminated or amended existing BITs with several countries, and joined the Bolivian Association of Our American People (ALBA) in 2010. Ecuador also proposed a new regional approach to economic dispute resolution under ALBA, based on human rights, social justice and solidarity.


Conclusion

In conclusion, Investment Arbitration especially ISDS challenges and proposed reforms mark. Criticisms of ISDS with issues of sovereignty, public policy and policy flaws includes a range of change theories and case studies of various nation reveal different pathways. The future of financial intermediation depends on balancing the interests of investors, countries, and global governance in a holistic and inclusive manner.


ENDNOTES

[1] Investment Dispute Settlement Navigator | UNCTAD Investment Policy Hub. (n.d.). https://investmentpolicy.unctad.org/investment-dispute-settlement

[2] Mohanty, G. (2021, September 21). APPEAL MECHANISM IN INVESTMENT ARBITRATION: TIME TO REVISIT ICSID CONVENTION. Arbitration Workshop. https://www.thearbitrationworkshop.com/post/conceptualizing-appeals-mechanism-in-icsid-through-the-lens-of-multilateral-investment-court

[3] India and Investment Treaty Arbitrations: A Chequered Past and Uncertain Future | SCC Blog. (2021, September 29). SCC Blog. https://www.scconline.com/blog/post/2021/09/29/india-and-investment-treaty-arbitrations/

[4] Origins of Investment Arbitration. (n.d.). American University Washington College of Law. https://www.wcl.american.edu/impact/initiatives-programs/international/news/origins-of-investment-arbitration/

[6] Brown, C., & Miles, K. (2011, November 17). Evolution in Investment Treaty Law and Arbitration. Cambridge University Press eBooks. https://doi.org/10.1017/cbo9781139043809.

[7] T. K., & T. K. (2023, July 21). 30 Important Judgments on Arbitration by Indian Courts [January – June 2023]. Bar And Bench - Indian Legal News. https://www.barandbench.com/columns/30-important-judgments-on-arbitration-by-indian-courts-january-june-2023.In-Text Citation: (2023)

[8] Rajasekaran, V. (2021, December 30). Indian Arbitration Yearly Roundup: 25 Important Arbitration Judgments Of 2021. Arbitration & Dispute Resolution - India. https://www.mondaq.com/india/arbitration--dispute-resolution/1146106/indian-arbitration-yearly-roundup-25-important-arbitration-judgments-of-2021.

[9] Rajasekaran, V. (2021, December 30). Indian Arbitration Yearly Roundup: 25 Important Arbitration Judgments Of 2021. Arbitration & Dispute Resolution - India. https://www.mondaq.com/india/arbitration--dispute-resolution/1146106/indian-arbitration-yearly-roundup-25-important-arbitration-judgments-of-2021

[10] MOST-FAVOUREDNATION TREATMENT, UNCTAD Series on Issues in International Investment Agreements II.

[11] Draft code of conduct for arbitrators in international investment dispute resolution and commentary, United Nations Commission on International Trade Law,Fifty-sixth session, Vienna, 3–21 July 2023.

[12] Schill, S. W. (2015). Reforming Investor-State Dispute Settlement (ISDS): Conceptual Framework and Options for the Way Forward. (E15Initiative). International Centre for Trade and Sustainable Development/World Economic Forum. http://e15initiative.org/publications/reforming-investor-state-dispute-settlement-isdsconceptual- framework-and-options-for-the-way-forward/

[13] Giorgetti, C., Létourneau-Tremblay, L., Behn, D., & Langford, M. (2020, February 7). Reforming International Investment Arbitration: an Introduction. The Law and Practice of International Courts and Tribunals; Brill. https://doi.org/10.1163/15718034-12341406 

[15] CORE – Aggregating the world’s open access research papers, https://core.ac.uk/download/pdf/161809857.pdf (last visited Jan. 30, 2024).

[16] Brazil’s Cooperation and Facilitation Investment Agreements (CFIA) and Recent Developments – Investment Treaty NewsInternational Institute for Sustainable Development, https://www.iisd.org/itn/en/2017/06/12/brazils-cooperation-facilitation-investment-agreements-cfia-recent-developments-jose-henrique-vieira-martins/ (last visited Jan. 30, 2024).

[17] OECD (2004), “Fair and Equitable Treatment Standard in International Investment Law”, OECD Working Papers on International Investment, 2004/03, OECD Publishing. http://dx.doi.org/10.1787/675702255435

[18] Multilateral Investment Court project, Trade, https://policy.trade.ec.europa.eu/enforcement-and-protection/multilateral-investment-court-project_en (last visited Jan 30, 2024).

[19]  Challenges of investment treaties on policy areas of concern ... Available at: https://www.g24.org/wp-content/uploads/2019/03/Challenges_for_developing_countries_in_IIAs.pdf (Accessed: 30 January 2024).

[20] Exploring Alternatives to ISDS | Columbia Center on Sustainable Investment. (n.d.). https://ccsi.columbia.edu/content/exploring-alternatives-isds

[21] Ibid.

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