International commercial arbitration is an alternative method of resolving disputes between private parties arising out of commercial transactions conducted across national boundaries that allow the parties to avoid adjudication in national courts. Over the years, it has become a very popular method, as most parties do not want to get into the ravages of litigation with regard to any issue, more so when the litigation would be in an alien country. The arbitration clause is usually a part of the contracts signed between the two parties. Therefore, arbitration as an alternative dispute settlement mechanism has gained fervour.
Investor-State dispute settlement mechanism (or the ISDS mechanism) is a kind of commercial international arbitration. It is an instrument of public international law and forms a part of a numerous number of Bilateral Investment Treaties (BITs). It is a system, wherein an investor from one country (home country) invests in another country (host state), both of whom have a bilateral investment treaty in place (with an ISDS clause), and the investor can bring an arbitration against the host country before an independent arbitration tribunal, in case the home state violates the rights granted by it under the BIT, to the investor.
A Bilateral Investment Treaty (BIT) is an agreement establishing the terms and conditions for private investment by nationals and companies of one state in another state. This type of investment is called a foreign direct investment (FDI). BITs are established through trade pacts. Most trade agreements encounter disputes that affect a particular class of goods or services and do not usually impact the workings of a single firm. However, BITs provide protection that extends to an individual private investor (firm or a corporation), in case of a breach of treaty obligations that affects an individual enterprise. And these individual foreign investors can initiate an arbitration claim against the state, hence the name, investor-state dispute settlement.
Analysis of the mechanism
ISDS has been a polarizing topic for years now. A usual ISDS clause in a BIT is meant to provide/afford to the private foreign investors, a set of rights, so as to provide them an environment that is conducive for them to invest in the said home state. Such an investment can be a win-win situation for both the parties, the home state getting a boost in its economy by the FDI, and the investors getting a wider market to expand their business. It is to this end that they are extended the said set of rights in the bilateral investment treaties, a breach of any of which on the part of the state, would be grounds for bringing on an ISDS claim. These rights extended to the investors aren’t always identical in all BITs, but they generally include-
Fair and equitable treatment
Prompt and adequate compensation in case of an expropriation
Permission to easily move capital (for various purposes) in and out of the country with considerable ease
no imposition of any performance requirements
no discrimination by the government in favour of a local or a third country investor, etc.
On the surface, it looks like the best possible solution for both the parties involved in case of a dispute, but it has got its detractors as well.
The detractors of the ISDS system have come forth with a number of arguments. Many believe that the ISDS affects the sovereignty of nations, by causing ‘regulatory chilling’, wherein this mechanism acts as a means for the investors to intimidate the governments into not implementing the regulatory policies that they wish to implement, against the fear of having to pay huge amounts as compensation and the growing number of ISDS cases. Lori Wallach, the director of Public Citizen’s Global Trade Watch, says that BITs “allow companies to challenge public interest regulations outside the domestic court systems, before a tribunal of three private sector trade attorneys operating with minimal to no conflict of interest rules. These arbitrators can order governments to pay corporations unlimited taxpayer-funded compensation for having to comply with policies that comprise their future expected profits, and with which domestic investors have to comply.”
This apparent undermining of domestic laws by prioritizing investor preferences over government’s regulatory policies is the biggest cause of concern among the opponents of the system. The rapidly increasing number of cases and the lack of transparency of the proceedings instil among some, the feeling that the ISDS is a secretive procedure, with little accountability, that allows multinational firms to arm-twist governments into getting richer at the expense of the public (taxpayers) and impedes the government’s ability to implement public interest regulations.
However, not every nation is willing to let go of the system with just as much readiness.
A proper research into all the ISDS claims that have ever arisen in the world shows that about 90 percent of all the BITs in the world run smoothly, without any disputes. Research also shows that the rise in the number of ISDS claims over the past few years has been proportional to the rise in foreign-invested capital stock.
The office of the United States Trade Representative (USTR) asserts that the rights conferred on the investors (see above) are consistent with the universal civil rights at the core of most democracies, and are same as the rights provided to the domestic investors. The rights conferred in the BITs in place by the USA (and the general model of BIT propagated in the world) guarantee that the foreign investors will receive, what are essentially universal rights, and follows the general universal principle of reciprocity. They insist that ISDS agreements are expressions of national policies, in the same way as statutes, regulations and other measures are approved by the government.
Proponents of the system argue that the success of BITs and ISDS in creating a predictable environment for investors has contributed to prosperity in a number of ways, and should not be abandoned without serious consideration of the alternatives. They claim that it doesn’t come in the way of the implementation of regulatory legislation, and that it, in fact, works towards both, protecting the investors and safeguarding the public interests. After some initial criticism, the process has been made as transparent as it can be possibly made, by making the records of all the proceedings of the ISDS cases public.
Empirical data on the subject
The data present, with regard to the 1023 cases that have arisen in the world till date, show that, about 37 percent of all the cases that have reached a conclusion, have been in favour of the states, 21 percent have been settled before any conclusion could be reached, and about 20 percent have gone in favour of the investor (the rest being discontinued). Moreover, on an average, the investors get an amount less than half of what they initially claim, the average duration of the arbitration proceedings is 3.5 years, and the entire process is significantly expensive. The remedies given to the investors are retrospective monetary compensations, and the ISDS system cannot directly require the states to change their laws and regulations.
Therefore, it would be safe to conclude that it is a process which requires a significant effort in terms of time and money, on the part of the investors, that too with a statistically low chance and rate of returns. Even when they run into certain troubles, the first instinct of the investors usually is to reach an understanding with the host nation, in order to allow their operations to continue. They choose to opt for process like the ISDS, only when it is the only option they are left with. Key factors in their decision-making process (to seek an arbitration) usually include a large scale expropriation by the government, affecting their expected revenues, or some other government mistreatment.
Usage of mechanism by different countries
Even though the empirical data doesn’t really favour either party (when it comes to ISDS results), some countries seek to shy away from the mechanism, stating that their domestic laws are sufficient to render the ISDS mechanism redundant, and then there are some other countries which seek to incorporate it in every bilateral investment treaty of theirs.
Let’s take the example of two prominent nations of the world, India (for it is the country that we live in) and the USA (for it alone is responsible for 24 percent of the outward FDI stock, and the US investors alone filed for 22 percent of all the ISDS claims).
Investors from economies that are large capital exporters are the most frequent advocates of dispute claims. The USA is the single largest country source of the outward FDI, providing 24 percent of the capital export stock of the world, and the US investors are also responsible for the largest individual share of ISDS claims – 22 percent. This is irrefutable evidence to show that the USA is one the foremost proponents of the mechanism, and has claimed, through multiple sources, that the ISDS cases brought against it have never managed to have even a semblance of a chilling effect, when it comes to any kind of regulation or legislation, and that the mechanism has proven to be to the satisfaction of both, the investors and the state.
India, on the other hand, came very late to the fray. It signed its first BIT with the UK in 1994 (the first BIT of the world was signed in 1959) and did not have model BIT before 2003. And while 9 ISDS cases were brought against India from 2003 to 2009, it wasn’t until White Industries, an investor from Australia, brought a case against India, which was decided against India, that the Indian government decided to step up its efforts to put such legislations in place, that would give primacy to the policy objectives of the state, over the rights of the investors.
India has worked towards making itself a favourable destination for inbound FDI, currently sitting among the top 10 nations in the world for the same. Over the last two years, India has abundantly improved its FDI policies by widening the sectors as well as the limits on investment through the automatic route, and growing ease of doing business. However, the ISDS mechanism seems to be a thorn in its side, as it keeps on finding ways to avert any of its implications. The White Industries verdict, delivered against India in 2011, was a cause of embarrassment for the government and sparked a debate about the protections being granted to foreign investors, as opposed to the regulatory powers of the state.
Therefore, when Vodafone got a Supreme Court ruling in its favour back in 2012, with regard to a retrospective taxation demand of the government, the government came up with a new finance bill, with amendments specifically designed to by-pass, what was the basis of the Supreme Court judgement. The (then opposition) new government criticized the move, which surely sent out a negative message to the investors abroad about the safeguards that would be afforded to them in the country, but did nothing to change it when the political dispensation changed in their favour. In fact, the government came up with a new model BIT in 2016, with provisions that went on to legitimise, what was being perceived to be a protectionist attitude towards the entire system. The ITA (Investment Treaty Arbitration) clause in the model BIT is much more restrictive and precise in its articulation, so as to minimize the scope of unanticipated interpretations by independent arbitration tribunals.
Significant cases like White Industries v India, and Vodafone v India, went in the favour of the investors, and have seemingly turned India into one of those countries that believe that the likely goal of investors is not to obtain compensation through ISDS, but to impose costs on governments contemplating regulations and therefore deter the regulatory ambitions of governments. In the past 4 years, India has revoked a 58 of the 83 BITs it had signed over the years and has signed only 3 new ones. However, even the BITs which India has already terminated continue to protect the foreign investors for the next 10-15 years.
In the past 40 years or so, ISDS has emerged a prominent and frequently used mechanism to safeguard the rights of investors in a foreign state. Evidently, it has divided opinions the world over. The data available on the subject tells the world that statistically and monetarily, it is a useful method to make foreign investors feel secure about investing in the alien countries, and for the host countries to be able to encourage FDI and provide a boost to their economies, as the numbers (see above) do not show any party having a significant advantage over the other in these proceedings. However, a number of countries are sceptical and wary of encroachment on their sovereignty by the means of exorbitant fines and chilling effects that they inevitably bring along with them, when it comes regulation formation and legislations, and of the rapidly rising number of ISDS claims, which has led them to adopt a protectionist attitude, when it comes to guaranteeing rights to the investors in their BITs.
Some countries, like the USA, have been able to make productive use of the system. Although they too have been wary of the overreaching effects that it could have on the government’s power to regulate on public welfare, in favour of granting rights to investors, accounting even for the loss of their expected future profits out of taxpayers’ money, a stance which has been strongly echoed by countries like India (and Australia and many others, explicitly or implicitly). Calls have been made by various Civil Society Organizations of multiple countries, including European nations, South American nations, along with India and USA as well, to stop trying to improve the procedural flaws of a system that provides ‘excessive rights to the foreign investors…to challenge public interest laws (in alien countries) outside the domestic of the domestic courts’, and move completely away from the system, to explore other alternatives like a ‘multilateral investment court’.
The flaws of the system are never far behind the advantages of the same, when it comes to a discussion of the mechanism, which has led to it being labelled as a ’predicament’ in the field of international commercial arbitration. The author is of the opinion that the ISDS mechanism is/has the potential to be a positive change in the world, and step away from a world filled with retorsions and reprisals in what could be characterised as vindictive and reactionary diplomacy, provided the countries are proactive in the formulation of their BITs, keeping in mind their own interests, as well as that of the investors.