Investor-State Dispute Settlement

As the Trans-Pacific Partnership edges closer to completion, the debate over trade and investment policy is reaching a crescendo in Washington. Prominent in the debate is “investor-state dispute settlement” (ISDS), a mechanism used to resolve claims made by a trading partner’s investors.

Critics charge that ISDS grants corporations special rights that allow firms to overturn laws that cut into profits and circumvent the judicial system. We answer some of the most frequent questions about ISDS below, based on our empirical research on the development and operation of ISDS, Investor-State Dispute Settlement: A Reality Check.

Some background: All modern trade agreements include rules to settle disputes among parties. Most are general commitments concerning treatment of a class of good or service and are settled at the “state-to-state” level while disputes over investment are handled through arbitration between the investor that claims harm and the government. This form of treaty-based arbitration has been adopted by every major economy worldwide—there are over 2400 bilateral investment treaties (BITs) in force, while 159 nations are signatories to a treaty that sets rules for dispute settlement.

Q1: Does ISDS gives corporations special rights?

A1: BITs and investment chapters of trade agreements require governments to: not discriminate in favor of home-country or third-country investors; afford investments fair and equitable treatment; provide effective compensation in the event of an expropriation; allow investors to move their capital into and out of the country; not impose performance requirements; and allow for neutral dispute arbitration if treaty obligations are breached (ISDS). Such provisions are consistent with (and often informed by) the U.S. Constitution and the UN Universal Declaration of Human Rights which states that “Everyone is entitled in full equality to a fair and public hearing by an independent and impartial tribunal, in the determination of his rights.”

Q2: Can ISDS force states to overturn legislation?

A2: ISDS tribunals do not have the authority to overturn national legislation or regulations. The U.S. Model BIT is explicit about the available remedies for investors, and limit panels to monetary damages or restitution of property in the event of a treaty breach.

The vast majority of investor claims do not challenge the government’s power to legislate or regulate but rather challenge the administration of law and regulation, such as the government’s treatment of an individual investor. In almost all cases, the investor’s claim arises from a government action which is claimed to be corrupt, arbitrary, or discriminatory.

Some claim that ISDS creates a “regulatory chill” where governments hesitate to create laws from fear that investors may claim damages. A careful review by two Dutch scholars found no evidence that any government has changed a policy position or refrained from action for fear of potential claims. To the contrary, many agreements (including all U.S. agreements since 2004) stipulate that “except in rare circumstances, nondiscriminatory regulatory actions that are designed and applied to protect legitimate public welfare objectives . . . do not constitute an indirect expropriation.”

Q3: Is ISDS a tool for big corporations to bully national governments?

A3: Not according to the evidence. Of the 105 disputes filed by U.S. investors, two-thirds of the claimants were individual investors or small-or-medium-size enterprises (SMEs) as defined by the U.S. Small Business Administration (individuals or firms with fewer than 500 employees).

As for governments being “bullied,” states usually prevail in ISDS. About one-third of disputes are settled before arbitrators reach a decision and for those that reach a decision, investors win only about one-third of the time and awards are generally pennies on the dollar claimed. Firms seem well aware of the low winning percentage, and the fact that arbitration is expensive and time-consuming. When combined with the risk to a going concern of a challenge to a host government, filing an arbitration claim is often an investor’s “last resort.”

Q4: Is ISDS necessary when the treaty partner has a well-developed legal system?

A4: It’s true that many investment disputes arise in host economies with poor rule-of-law records. However, many claims occur in sectors with high levels of state intervention, regardless of the legal system. Europe is a useful case study. Since Europe is perceived to have “high-quality” legal institutions, one would expect European investors to use ISDS relatively rarely. In fact, the opposite is true: According to the United National Conference on Trade and Development (UNCTAD), 75 percent of all ISDS claims brought by EU investors are filed against EU member states.

Q5: Are ISDS tribunals secret? Who decides the cases?

A5: Thanks to transparency reforms in the 2004 U.S. Model BIT, both of the key facilities whose rules govern ISDS—the UN’s UNCITRAL, and the World Bank’s ICSID—require that awards and documents are made available to the public and allow for the filing of amicus briefs by any party. Further, ICSID provides live webcasts of its arbitral proceedings, giving the public greater access to ISDS arbitrations than they have to many national courts.

Each ICSID member government creates the roster of qualified arbitrators. When a dispute moves to arbitration, one arbitrator is selected by the investor, one by the state, and the third is agreed upon by both. Each party may reject a selected arbitrator for perceived conflict of interest. It is true that arbitrators frequently alternate between representing clients and deciding cases, but each arbitration is sui generis.

Conclusion: Overall, treaty-based investor protection represents a major advance in the fair treatment of aliens and has helped de-politicize dispute settlement. Importantly, withdrawal from international investment agreements and ISDS—the logical conclusion of the critics’ position—would likely have far more negative consequences for economic growth and the rule of law.

Scott Miller holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C. Greg Hicks is a State Department fellow at CSIS. Paul Nadeau is a research assistant with the Scholl Chair at CSIS. The views expressed herein are those of the authors and do not necessarily reflect the views of the U.S. Department of State or the U.S. government.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS Does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2015 by the Center for Strategic and International Studies. All rights reserved.