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Does Investor-State Dispute Settlement (ISDS) threaten States’ regulatory autonomy? Fact-checking a commonplace of the TTIP debate

Filippo Fontanelli, University of Edinburgh

«That’s right: a company was able to sue a country over a public health measure, through an international court [sic]. How the **** is that possible? (laughs from the audience)»(from Last Week Tonight with John Oliver, 14 February 2015. See the video here, the bit in question starts at 8:21)

When the coolest US late-night satirical talk-show bashes investor-State dispute settlement (ISDS), it might be late to indulge in doctrinal sophistication.To be clear: I would consider it a success if this SIDIBlog focus attracts as much interest as the German metal song Anti TTIP (check the views counter). The clip from John Oliver’s show has been watched 4 million times, and counting.

The appropriateness of an ISDS system in the framework of the Trans-Atlantic Trade and Investment Partnership (TTIP) is contested. Pantaleo has summarised effectively the terms of the debate, and Nicola’s discussion of how increased transparency can backfire in the negotiation is an exemplary call to caution free of conspiracy undertones. I perform here a modest and narrower task: fact-checking and assessing some of the arguments invoked most often to criticise the ISDS, using a sample of oft-cited awards. Much of the debate is amateurish (or shamelessly partisan). It would be unfair to retain those views as a baseline, even if some of them are statistically representative of the anti-ISDS camp. To gauge the undercurrent protectionist and chauvinist sentiment of some of the most common attacks to the ISDS, just consider this passage (from here): «Grâce à ce mécanisme [the ISDS], les entreprises américaines pourraient attaquer nos règlements et nos Etats en justice s’ils se sentent injustement discriminés» (emphasis mine).

This is offered as a self-evident apocalypse. The authors of this statement failed to see that the logical alternative to this scenario is States’ unaccountability for ‘unfair discrimination’. Regardless of the minutiae (maybe they had in mind something more specific against arbitration), increased accountability of governments for arbitrary discrimination is presented as a dreadful notion. Hence, it is fair to say that the discussion has drifted away from level-headed moorings, carried offshore by ideology streams. The statement above betrays a worrisome implication: the rule of law, including the right to challenge public measures and invoke State liability, is reserved to ‘locals’.

To circumvent the heat of the debate and ideologies, I use as template two reports (here and here) that areclearly prepared to a high professional standard. Given the quality of the research and the overt one-sidedness of the reports, my assumption is that therein it is possible to find the best possible arguments against the ISDS as we know it. Several disputesare listed there, pending or concluded. These cases are selected to illustrate how investment protection can erode host States’ regulatory autonomy in matters of public interests (see thesis no. 6 of this ‘debunking’ effort). I will discuss the anti-sovereignty characterisation of each case (the pitch), and the minimum factual and legal matrix (the facts). I then add some remarks on its probative value towards the over-arching claim (ISDS ties the hands of responsible governments willing to pursue public interests). Although I am glad, and plan, to discuss all the cases mentioned (Vattenfall I and II, Eli Lilly, Ethyl, Chevron, etc), I have selected four for this first instalment, to minimise tedium. One is a settled case, two are pending, one is concluded. They are commonly presented among the most outrageous, and they are widely cited in public debates. I believe that the sample is representative.

Some general reflections will conclude. If you find the following analysis bleak, you can jump to the conclusions – you won’t be alone.

I) PieroForesti, Laura de Carli & Others v. The Republic of South Africa, ICSID Case No. ARB(AF)/07/01

The Pitch: Foreign investors sued the host state for passing non-discrimination measures.

The Facts: In line with the Broad-Based Black Economic Empowerment legislation,South Africa passed in 2002 the Mineral and Petroleum Resources Development Act (MPRDA, in effect on 1 May 2004), providing for the development of a Mining Charter (dated 13 August 2004). The Mining Charter required that 50% of mining companies belong to Historically Disadvantaged South Africans (HDSAs). To achieve the target, owners were obligated to sell their shares to black purchasers. Foresti and others brought in 2006 an investment claim against SouthAfrica under the Italy-South Africa and Benelux-South Africa BITs, claiming that this measure was tantamount to expropriation (and breached the fair and equitable treatment (FET) and national treatment (NT) guarantees). The case was discontinued (a settlement in disguise) in July 2010. Two months later, South Africa amended the Mining Charter, lowering the HDSA minimum ownership to 26%.

Detour: In parallel to the investment dispute, other provisions of the MPRDAwere challenged in domestic courts by South African investors. These norms modified existing mineral rights in the attempt to increase black people’s participation in the industry. Local claimants argued that the MPRDA expropriated their rights. The South African High Court ruled that the claimants’ mineral rights had indeed been «legislated out of existence» (Agri South Africa v Minister of Minerals and Energy 2012 (1) SA 171,para. 57). The Supreme Court of Appeal (Minister of Minerals and Energy v Agri South Africa 2012 (5) SA 1) reversed this decision, noting that mineral rights without right to mine cannot constitute property, therefore no expropriation could occur. The case reached the Constitutional Court (SACC). The SACC weighed the various interests involved (para. 64: «protect individual property rights as well as the facilitation of sustainable development, eradication of all forms of discriminatory practices in the mining industry and equitable access to the mineral and petroleum resources of this country, to all its people»). The inherently discriminatory nature of MPRD, which sought to compensate black people for past inequities, was also noted (para. 65). The SACC ruled that in the specific case there had been deprivation of rights without expropriation (i.e., acquisition by the State), but refrained from «decid[ing] definitely that expropriation is … incapable of ever being established» under the MPRDA (para. 75). Cameron J concurred with the judgment, but rejected the notion that State acquisition is a necessary component of expropriation (para. 78). Froneman J and Van der Westhuizen J also rejected this requirement and declared that expropriation had indeed occurred. They ultimately concurred with the SACC’s dismissal of the appeal, arguing that adequate compensation in kind had been offered to the expropriated claimants (para. 79).

Comment: It is impossible to draw rigorous assumptions from a settled case. South Africa resolvedto dilute the measures to avoid heavier liabilities: this might suggest that the State knew the unlawfulness of its conduct. That investment suits are a powerful negotiation tool is not surprising, nor is it troublesome as such. Whether this tool is used to bully governments or to restore compliance with the law is something that depends on the circumstances of each case. Incidentally, the challenged act was part of an affirmative action-type policy that has had doubtful effects (see the Economist, see also this account, in which «South African government’s efforts to engineer social and economic change by writ» are described as meritorious but poorly designed). The MPRDA generally relied on intrusive implementation measures, which could barely pass constitutional review in one case and are open to further challenges (see domestic proceedings). In sum: foreign investors impugned a certifiably intrusive and discriminatory measure which domestic companies also resented, then dropped the claim after its expropriatory effects were reduced.

II) Veolia Propreté v. Arab Republic of Egypt, ICSID Case No. ARB/12/15

The Pitch: The investor blackmails the host state’s government, wants the abolition of minimum wage legislation, disregards workers’ rights, tries to destroy a crucial social asset, tarnishes Europe’s image abroad.

The Facts:Veolia and the Governorate of Alexandria (Egypt) had run together since 2001 a private-public partnership for the provision of waste-management services. After the concession was terminated in 2011 (four years before the natural term), Veolia launched in 2012 an ICSID suit against Egypt. It claimed that the Governorate of Alexandria (whose acts are attributable to Egypt) unjustly terminated the contract and previously failed to discharge its obligations thereunder. In particular, the concession allegedly included contractual guarantees whereby Alexandria committed to «buffer the concessionaire from the financial implications of any … legal changes» such as new labour laws (from here). In 2011, in the wake of the revolution, Egypt passed an act raising minimum wage (from circa 55$ to 100$ per month). In short, Veolia claimed that Alexandria arbitrarily failed to fulfil its contractual obligations to compensate Veolia for costs entailed by the new legislation. The ensuing termination of the contract caused Veolia considerable losses (see 2011 annual financial report).

Comment: This case is 1) confidential and 2) pending. As such, nobody should reasonably use it as evidence for anything, because, respectively, i) nobody can claim to know exactly what the terms of the dispute are and ii) the outcome is unknown. Yet, it is widely cited as proof of multinationals’ threat to responsible governments. This is perhaps a stretch, given that Veolia presents itself as a good corporate citizen (it is a member of the UN Global Compact since 2002 and has adopted internal codes of conduct supporting basic labour rights and ILO principles). Also, Egypt is currently struggling with multiple investment suits, in the wake of a re-nationalisation strategy that seeks to contain and redress the damages caused by past governmental corruption and mismanagement of public resources. If there is one usual suspect in this dispute, it is the defendant.

More to the point, though, it seems that Veolia based its claim on the guarantees contained in the concession contract, whose description recalls the standard function of “stabilisation clauses”. These clauses are a common feature in long-term governmental concessions, as they guarantee the maintenance of an economic equilibrium between the parties. Their function is to defuse the unfair effects of unexpected contingencies «including fluctuations in the exchange rate between France and Egypt, changes in Alexandria’s population levels, or increased labour costs» (from here). It is worth mentioning that the 1974 France-Egypt BIT does not contain a proper umbrella clause. Therefore, the dispute will turn around the characterisation of Veolia’s claim as a treaty-based one, and/or its attempts to use the most-favored nation (MFN) clause to reach out to another Egyptian BIT’s umbrella clause (see for instance Art. 12(2) of the Egypt-Finland BIT). Alternatively, the claim could hinge on the breach of the investor’s legitimate expectations, induced bythe State authorities’ agreement to include the alleged stabilisation clause in the concession.

Perhaps the claim is really based on an “economic equilibrium” stabilisation clause, whereby the city of Alexandria pledged to compensate the financial impact of new labour legislation. If so, the suit would not be the consequence of the investor’s proneness to fabricate vexatious treaty claims out of open-ended clauses, in the hope that pro-investor arbitrators validate the claimant’s construction. The suit would be the direct consequence of Alexandria’s disastrous and specific commitments, which tried to monetise the comparatively poor labour standards prevailing at the time. The clause sought to attract the investment and guarantee its long-term financial viability, by entrenching the factors ensuring cheap labour. Similar clauses are a common legal device to provide insurance against the host state’s political risk. According to Veolia, Egyptian authorities reneged on their contractual obligations once the triggering conditions were met (the passing of new legislation affecting the investment’s profitability). Invoking labour standards to escape liabilities under an economic equilibrium stabilisation clause is like killing the parents and then plead at the murder trial «mercy, I’m an orphan» (credits to J.H.H.Weiler, who loves this joke). If the accounts I base these comments on are inaccurate, the commentary might be as well.

III) Philip Morris Asia Limited v. The Commonwealth of Australia,UNCITRAL, PCA Case No. 2012-12

The Pitch: the investor is suing the host state over public health measures.

The Facts: Australia passed in 2011 a law requiring cigarettes to be marketed using “plain-packaging”. Namely, cigarettes packs cannot bear any brand logo or trademark (they must be “plain”). Besides gruesome pictures displaying the effects of smoke on human health, the unadorned pack must have a default colour and size, and bear the name of the brand in a default typeface. Plain packaging is, according to Australian authorities, a method to remove the appeal that brand image of tobacco manufacturers has on smokers, especially younger ones. The measure is therefore aimed at «improv[ing] public health» (Art. 12). Philip Morris Asia challenged this measure under the Hong Kong-Australia 1993 BIT. The investor claimed that the 2011 act constitutes expropriation of its intellectual property (IP) rights (trademarks, copyrights, designs), and more generally amounted to a breach of the BIT standards of fair and equitable treatment and full protection and security. The arbitration is under way. Australia’s request for bifurcate proceedings was upheld by the tribunal (constituted under the UNCITRAL rules, in proceedings administered by the Permanent Court of Arbitration). Therefore, a decision on jurisdiction will precede the possible phase on the merits. According to Procedural Order no. 9, the hearing for the jurisdictional phase should have just taken place in Singapore (mid-February 2015). We are, presumably, several months (maybe years) away from a potential award on the merits, even if the tribunal’s president’s practice of impeccable anticipation and planning has earned him the title of the “timely arbitrator”. A parallel WTO dispute has been launched by several tobacco-exporting countries (plus Ukraine, not a major exporter; plausible speculations have emerged regarding a quid pro quo deal with Big Tobacco). The gist of the claim is the same as Philip Morris’s one. Under the TRIPS, WTO members must abide by certain standards of IP protection. The claimants argue that the Plain Packaging Act breaches the TRIPS. I cannot expand on this dispute, but its relevance to the ISDS debate is incidental.

Comment: The echo of this investment dispute is disconcerting. This case has not yet even reached a determination on the jurisdiction of the tribunal, and it has already made it on John Oliver’s show (see above). Whereas heightened attention on this case is very welcome and healthy, I am puzzled by all the statements regarding what this dispute epitomises, or the systemic implications it should have. As of today, this claim only shows that an investor believes that Australia unfairly took away its rights, and is convinced enough to invest a fortune in legal fees. This is not unprecedented: a similar challenge was brought before domestic courts (see the High Court of Australia’s judgment of 5 October 2012) and failed. The judges found that no acquisition of property had taken place.

This is a textbook case of alleged regulatory expropriation. There is no direct taking, but there is an obvious restriction of the claimant’s right, based on public policy purposes. Whereas expropriation for public policy purpose is never unlawful per se, it requires compensation (not just under the BIT, but also, for instance, under Protocol 1 of the European Convention of Human Rights). The case will therefore hinge on whether the effects of the plain packaging act are expropriatory (under Art. 6 of the BIT). I can reasonably predict that the tribunal would consider, if the case reaches the merits phase, the non-discriminatory character of the impugned legislation and its statutory goals. Presumably the effectiveness of the measure would be under crossfire: the investor would try to prove that plain packaging does not work, or even harms public health (e.g., because cigarettes of all brands will look identical, consumers’ preferences will be driven by price alone, encouraging manufacturers to compete by lowering the product’s quality). If the investor were to succeed, then the challenged legislation would be considered unnecessary or even harmful, and it might follow that its expropriatory effects warrant compensation. In this hypothetical scenario, Australia would be happy to learn that its policy had been poorly designed and would thank the tribunal for the advice. If, however, the investor did not prove conclusively that plain packaging does not work, as many observers predict, no harm would hit Australia; the investor might even be ordered to pay legal fees (this happened in the domestic proceedings). That’s the most that can be said.

A final word on the standard for expropriation. Whereas Art. 6 of the applicable BIT is remarkably concise, new generation agreements have several carve outs for public policies. For instance, the corresponding provision in the CETA (Canada-EU) Agreement is complemented by Annex X.9.1, guaranteeing that «[e]xcept in rare circumstances, 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». In other words, even if Australian measures are somewhat considered expropriatory in the current investment proceedings (a very big if), a similar claim under the CETA or the TTIP would probably be rejected outright (we explain here why the CETA was drafted like this, and why the TTIP will be similar). In sum, this is a pending dispute the outcome of which might please the anti-ISDS camp after all. In any case, this is not a dispute which could be replicated lock-stock-and-barrel under the upcoming CETA and TTIP. It makes little sense to invoke it as a sign of how dangerous the TTIP would be to health policies.

IV) Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka, ICSIDCase No. ARB/09/2

The PitchThe award granted investment protection to a financial instrument, paving the way for claims by investors that have no physical business in the host state.

The Facts: Deutsche Bank and Sri Lanka’s national oil corporation, CPC, fully owned by the government, concluded an oil hedging agreement in July 2008. Through this derivative transaction, essentially an oil future contract, CPC sought to offset the financial risk deriving from the expected increase of oil price. The parties agreed that the contract was governed by English law and would be submitted to the jurisdiction of English courts. The agreed strike price (the watershed threshold used to determine whetherparty should compensate the other for flotation in the price) was 112.5$ per barrel, at a time when the price on the market was comfortably higher (137$). After July 2008, oil price dropped spectacularly by roughly 60%. Accordingly, CPC was bound to make massive payments to the investor, and sought to restructure the agreement in fall 2008.

In November 2008, individual petitioners had seized the Sri Lanka’s Supreme Court. In their claim against CPC and government officials, they claimed that CPC had no authority to conclude the hedge agreement and that the latter was «prima facie iniquitous». The Supreme Court issued an emergency order enjoining CPC to suspend all payments to Deutsche Bank. The Chief Justice later confirmed that the decision was politically motivated and deprived of legal foundation. He also predicted huge liabilities at the international level, for which Sri Lanka would have «no defense» (see para. 434). In December 2008, Deutsche Bank availed itself of the power to terminate the contract for non-performance and presented a bill of approximately 60m$.

In February 2009, Deutsche Bank filed an ICSID claim. Sri Lanka advanced several jurisdictional objections, variously related to the illegality or invalidity of the hedge agreement, and to the impossibility to consider it an investment under the applicable BIT. The majority of the tribunal found that the transaction had a sufficient territorial nexus with Sri Lanka (para. 292) and qualified as investment. It ordered Sri Lanka to pay the full amount claimed (para. 573: the quantum was not disputed by the respondent) plus interest and legal costs.

Comment: I do not suppose that the outcome on the merits is suspicious: Sri Lanka’s authorities appear to have made a very poor financial decision, in hindsight, and were ultimately held accountable for their debt. Standard Chartered Bank brought an identical claim before UK courts (and succeeded); Citibank did the same in a London-based international commercial tribunal (and failed). The different outcome turned on the different qualification of the contracts as hedging (risk-limiting) or speculative (increasing the exposure to risk in view of a benefit). Because the banks had agreed that speculative transactions were outside CPC’s competence, their claim’s success depended on the agreements being considered hedging rather than speculative. UK courts took the same view of the ICSID tribunal’s majority, whereas the LCIA tribunal followed the opposite pathway. This distinction, besides being devilishly elusive, is ultimately irrelevant for the purpose of this post.

I understand the dangerous bit of the reasoning being the finding that financial contracts are investments made “in the territory” of the host state. It is worth noting that the Sri-Lanka-appointed dissenting arbitrator, who contested virtually every finding of the majority, did not object the reasoning onthe territorial link. He insisted rather on the thorny issue of the «economic contribution», linked to the speculation/hedging distinction, and argued that the debt was still recoverable in English courts (hence arbitration was premature).

The treatment of (intangible) contractual rights as property is commonplace in human rights law. To determine the territoriality of the investment, in a case of purely financial transactions, the identification of the beneficiary State as the locus contractus seems at least plausible. Note that this determination did not affect the applicable law to the agreement (the parties selected English law). It only supported the finding that Deutsche Bank is investing (i.e., carrying out a long-term expenditure of resources entailing entrepreneurial risk, for an expected profit) in Sri Lanka. The only legal consequence of upholding this territorial nexus is the application of the BIT and, in turn, the jurisdiction of ICSID. In the absence of a better explanation as to whether this finding is mistaken or unfair, I must assume that this award is on the black-list for the simple reason that it confirms ICSID’s competence over a category of investment disputes. In other words, if ICSID’s activity is inherently bad, everytime its exerciseis not hindered is a bad time. This is a petitio principii: I do not think this case can be styled as a “policy space”-adverse precedent.

Interim conclusions

I apologise for the bleakness of this report. I am only partially responsible, because I did not select the cases. Public discourse fed these cases and many more into a narrative that reaches out to millions of people. Somebody grabbed them and classified them, eager to build a dossier which could provide a façade of technicality to a bias; I simply sought to perform a due diligence check. Do these cases really stand for what they are used for in the debate? It would be pretentious to demand that everyone who wants to weigh in in the debate about ISDS should have read and understood all these cases. At a certain level of abstractness, everyone is able to formulate genuine views on public policies. And the views of everyone should count towards deciding how to manage public goods, according to which priorities.

However, this is my feeling: many fewer people know anything about these cases than those who talk about them. There is a powerful vulgata about their detrimental impact, but a closer scrutiny makes you wonder whether it was spread in good faith. To those who are interested in knowing more about the pros and cons of ISDS, and ponder on its possible reform: do you want this debate to be conducted by somebody invoking Veolia and Philip Morris in such a twisted and self-serving way? A final word: I do not take position on whether ISDS is good overall, and I believe in the need for its reform. I certainly agree with Alemanno, who noted that the disproportionate emphasis on the ISDS is affecting the possibility of a proper discussion about the TTIP, whose crucial features lie elsewhere.

I would warn against poor arguments which verge on bad faith. Certainly, investment protection instruments do limit States’ autonomy. All international obligations do precisely that, after all: the very notion of obligation implicates a reduction in one’s autonomy. If TTIP and CETA’s substantive obligations were too wide (I would doubt it), it would be appropriate to reduce their reach.

Claiming that the system of dispute resolution, in and of itself, can reduce States’ autonomy is a counterintuitive suggestion, which requires corroboration. I believe that the precedents used to support this claim are sometimes inconclusive, sometimes contrary to it, often clearly not precedents at all (settlements and pending disputes).

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Filippo Fontanelli

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