Investment arbitration in the light of TTIP – a sensible instrument?

An opinion article from Jürgen Basedow

The campaign employed across Europe by the non-governmental organization attac that opposes globalisation, are rather more worldly. In its campaign against TTIP, it endeavours to enlist opposition to TTIP at many events and also on its website by making statements that are often only partially true or even false. A different subject is presented every few weeks to warn people of the decline of the western world. First it was the threat to national culture from trashy products from Hollywood, then came hormone-treated beef, chlorinated chicken meat and genetically modified maize. Social standards are also perceived as being under threat. The expression 'secret arbitration courts' gives rise to conspiracy fears, and recently TTIP was seen to pose a threat to democracy itself, with fears being expressed that democracy could be bypassed by reciprocal information on intended legislation provided by the countries concerned. 

What characterizes all these issues is a rather one-sidedly German or European view of the world. The fact that Americans, too, perceive threats to things that are dear to them, is never mentioned and of no interest to TTIP opponents. This mindset reminds one of the Biedermeier era, a private idyll of a prosperous Europe whose achievements are under pressure from all sides. The fact that prosperity is based to a large extent on free trade with other parts of the world and the movement of capital is at any rate not acknowledged. But we cannot overlook this constantly growing dependence: around 45 percent of Germany's GDP is based on exports, and 25 percent of all jobs in Germany are directly dependent on them. 

Legal experts are particularly interested in the subject of investment arbitration in this debate. Specifically, this is about the right of private investors to sue a foreign state for compensation in a court of arbitration if the investor has suffered damages as a result of sovereign actions by this state. We speak of Investor State Dispute Settlement or ISDS.

Origins

You can only understand the present and shape the future responsibly if you know the past. It is necessary, therefore, to look back. The protection of foreign investors has been seen as a major concern of international law for over a century: from a state's perspective as a necessary prerequisite of attracting foreign investors - and from the investor's perspective as an essential measure to contain the political risks of their commitment abroad. Customary international law does not recognize any general ban on discrimination, however, which means that states are free to conduct their economic policy specifically at the expense of foreign investors and to protect entrepreneurs in their own country. There is also a lack of effective protection from expropriations in customary law. After the 2nd World War, USA focused its efforts on enforcing the so-called Hull doctrine around the world. According to this doctrine, expropriations could only be reconciled with international law if “prompt, adequate and fair compensation“ is paid, i.e. the compensation is immediate, always comprises the full market value and is paid in a freely convertible currency. However, the Hull doctrine never attained the worldwide recognition required to become an opinio iuris (opinion of law). It was not accepted by socialist states nor by many developing countries which regarded the Hull doctrine in the period after the war as a restriction of the sovereignty they had only just acquired.

Against this backdrop, individual countries began agreeing investment protection in bilateral treaties. These Bilateral Investment Treaties or BITs generally govern several points: (1) the certification of investors from the other contracting state; (2) the duty of the state to treat the investment fairly and justly; (3) the right of the investor to repatriate his profits to the company's head office; (4) prerequisites for any expropriation, in particular the Hull formula; (5) a most favoured nation clause; and (6) an arbitration procedure which is the subject under discussion here. Germany became a pioneer in this movement with its investment protection agreement with Pakistan in 1959, and it has now signed 135 such BITs; worldwide there are around 3,000 of them. Germany's agreements were approved without exception by the German parliament by means of Acts of Consent as laid down in Art. 59 Para. 2 of the constitution. They are therefore democratically legitimized through and through. Not all states appreciate BITs, however; for example, Brazil rejects them as an instrument of policy.

In terms of the mechanisms for settling disputes, these were all arbitration cases under international law until well into the 1980s: At his instigation, the investor's home state can sue the state accepting the investment in a court of arbitration on the basis of the BIT. The background for introducing such arbitration courts is the fact that governments prefer diplomatic processes in their dealings with each other; legal actions between states bear the risk of unenvisaged political ramifications. The relevant ministries also often lack the human resources to satisfy all requests for litigation. That very quickly throws up the question of the equal treatment of different investors within any one country: why is my state pursuing the interests of investor A against a foreign country of investment but not those of investor B? BIT arbitration cases between states therefore seldom occur. For that reason, many BITs in the last few decades have also given the investors affected the right to bring their own actions, i.e. they have introduced ISDS. Naturally, the investor can also use the state courts in the country of investment; he is free to choose.

The investment arbitration procedure goes back to a second development strand which is closer to private law. For many decades, states have signed contracts for specific projects directly with investors, e.g. the construction of a port or the exploitation of natural resources. Here, too, there is a risk by the very nature of things that the state partner will intervene in the contract retrospectively by taking sovereign action such as passing laws. Legal protection is not necessarily to be expected from the courts in the country of investment; they are bound by the laws of their land. That is why, even before the 2nd World War, investors were pushing for arbitration courts to be agreed especially for concession contracts, for example contracts between local authorities and energy companies; the Permanent Court of Arbitration in The Hague has handled many such cases in which a private plaintiff sues a foreign state. However, there are also arbitration procedures within states; one only has to think of the case of "Toll Collect". In the contract between the government and the toll operator for trucks, this way of settling disputes was stipulated in the contract. In 2005, the state sued Toll Collect because the toll system was over two years late in working, and at the same time Toll Collect sued because the state held back some of the payments. Both cases are still running.

ISDS in practice

These are the two roots, therefore, which have given rise to the investment arbitration procedures in today's bilateral state treaties. They are a widely used way of settling disputes. Depending on the definitive BIT clause, cases are referred to a court of arbitration convened ad hoc which often bases its procedure on the (Arbitration Rules) developed by the United Nations Commission on International Trade Law UNCITRAL, or to an arbitration court of the International Center for the Settlement of Investment Disputes (ICSID), an institution which was set up through a multilateral state treaty at the World Bank in Washington. The plaintiff often has the choice. Around 560 cases against states around the world have now been heard, among them only two are known of against EU states. The amounts in dispute are all very high. Not all but many rulings have been published; one can hardly talk of secretiveness.

There are three new aspects to TTIP: firstly, investment protection has been transferred to the sole authority of the European Union by EU member states through the Lisbon Treaty. In future, BITs can only be concluded by the EU and no longer by member states. Secondly, USA as a contractual partner is a constitutional country with a functioning judiciary; there is without doubt less need for ISDS here than in many third world countries. Admittedly Germany also maintains BITs with 13 EU states and so when concluding these treaties in the past, it did not restrict itself to developing countries. Thirdly, we are seeing a gradual change in capital flows. Whereas earlier it was purely a question of protecting western investments in developing and emerging countries, more and more companies from these countries, e.g. China or India, are now investing in western Europe. The BITs were always symmetrically formulated and should therefore apply equally for investors from both contractual states. However, in practice they have been asymmetrically applied because people in developing or emerging countries did not invest in Germany or western Europe. The signs are that they will now be applied on a more equal footing and this is what has aroused the resistance described at the beginning of this article.

Nothing new

It should have become clear by now that TTIP will not change much with regard to the settlement of disputes. Not even in the direct relationship between USA and Europe. Investors who prefer an arbitration court to state jurisdiction, can already have one. A US entrepreneur only has to process his investment in Germany through a subsidiary in Mexico, off the cushion, as it were. Then, if he feels unfairly treated by German legislation, he can initiate an arbitration case against Germany through the Mexican subsidiary under the German-Mexican BIT. This kind of treaty shopping is unavoidable in a purely bilateral system; it certainly happens but not too frequently.

One of the main points of criticism concerns the vague substantive standard of investment protection: Even if it is fleshed out with examples, the expression, "fair and just treatment", must necessarily remain indeterminate. The line on interventions by the country of investment which must be compensated as "indirect expropriation", is also not clearly drawn anywhere, not even in the latest agreements such as the one between Canada and the EU which goes by the name of CETA.

But is this so much different from German law? Under Art. 14 of the constitution, restrictions in the use of property must be accepted without compensation but expropriation is only permitted in return for compensation; there has to be a law to cover it. Over 30 years ago, the Federal Constitutional Court rejected compensation without a law purely on the basis of the severity of the intervention in the so-called wet gravel extraction ruling. Under German constitutional law, therefore, there is no (or no longer any) case law concept of an intervention equivalent to expropriation - the indirect expropriation of the BITs. Of course, this does not prevent the legislature by means of a simple law from granting compensation for interventions that constitute mere boundary definitions. This has happened in many places in the legal system, for example in the right of emergency way under § 917 BGB or with preservation orders under state law. The consent laws for the BITs are also to be put in this category.

It is not possible to draw the line for an intervention requiring compensation on qualitative criteria, but it can be assessed according to the intensity of the intervention and the residual opportunities for using the property in question. The regulatory aims of the country of the investment also have to be taken into account, as the Institut de droit international underlines in its 2013 Tokyo Resolution. The boundaries are very unclear, therefore, but the constitution does not demand that such compensation circumstances be specifically defined.

Due process

The process comes in for further criticism when it questions democratically legitimized regulations - such as tighter environmental specifications. In view of this, is there not a need for greater transparency in the arbitration procedure and stronger participation by political forces? Is it enough just to publish an arbitration ruling? Or should the initiation of proceedings not be announced and important documents published? How can we ensure that the arbitrators nominated by the parties are free of conflicts of interest, neutral and reach their decision in good faith? And should there not be an appeals process available to ensure that rogue decisions can be revised?

These are serious and justified questions that do not permit hasty responses. They demand the refinement of ISDS in a constitutional sense. Of course it must always be borne in mind that even in cases before state authorities and courts, transparency ends as soon as confidential information is involved. And exhausting the legal process may correct some mistakes; but it extends cases and makes them more expensive when they already take years and are very expensive due to their complexity.

This shows the direction that future legislation must take. The first steps have already been taken. In 2013, for example, UNCITRAL adopted rules for the transparency of arbitration cases between investors and host states based on agreements; in future they are to complement the UNCITRAL Arbitration Rules in ISDS cases. The CETA agreement between the EU and Canada provides for the inclusion of these principles, and contains a raft of further rules which refine the arbitration procedure in a constitutional sense. No appeals procedure is planned; however, a special committee is to examine the need for one in the coming years.

The Federal Minister of Economics has taken the largest step forwards with his proposal to set up a kind of international trade and investment court. Similar to the way in which the European Court of Human Rights (ECtHR) works, a state could be sued there by a private plaintiff, in this case an investor. The judges would presumably be full-time. But unlike the ECtHR, a court of this nature would not have to wait until the plaintiff had exhausted all the internal legal remedies in the country of the investment. This requirement which applies to the European Convention on Human Rights would be the kiss of death for investment protection. How quickly these ideas can become a reality, is anybody's guess. At least the European Commission and the European Parliament have adopted the proposal. However, in a world with 3,000 BITs, fundamental changes will not be achieved overnight. But that should not be a reason to lose hope. An international jurisdiction which gives private individuals the opportunity to sue states, is an appropriate response from the legal system to the challenges of globalisation. Initially it could be achieved in the relationship between USA and the EU. If it satisfies constitutional principles, this will be the way forward in the future.