by Ioana Maria Bratu
States’ failure to meet the 2015 Paris Agreement targets has already had substantial impacts on the world of arbitration, including national courts imposing CO2 levels reduction on big oil companies, NGOs becoming much more involved in climate change disputes (see here para. 3.5), and recently culminating with Belgium, France, Spain and the Netherlands’ decisions to withdraw from the Energy Charter Treaty (‘ECT’), following Poland and Italy.
These impacts are hardly unproblematic. For instance, an investment environment without the ECT might paradoxically mean less protection for prospective investors in green energy compared to the protection offered to fossil fuel companies that were and will continue to be covered under the ECT. At least for a while, departing States would still be bound by the ECT indirectly, via the EU, on the one hand, and by the effect of the sunset clause, on the other hand.
The law evolves sluggishly, and this applies to the ECT modernisation, as well as to the wider implementation of Corporate Social Responsibility (‘CSR’) policies. However, the post here will focus on positive developments in the EU as regards CSR, some of which are already ongoing, and some of which are only being discussed now.
Investors will undoubtedly be affected by changes in this area, which are much broader than just the ECT modernisation. Therefore, they might consider becoming familiar with the legislative trends, as well as with tribunals’ reactions to these trends, in order to adapt gradually rather than be forced to comply. For theoreticians and those directly involved in the modernisation effort, be it at international, EU, or domestic level, the debate raises more elusive questions. These are questions around rebalancing rights and obligations, the legitimacy of international tribunals, transparency, access to justice, and competition for capital, just to name a few.
The New Corporate Sustainability Reporting Directive (‘CSRD’)
CSR generally refers to corporate conduct that complies with national and international standards in areas of human rights, international labour, environment, anti-corruption, and, collectively, in any sustainable development area.
In April 2021, the European Commission (‘EC’) tabled the EU Corporate Sustainability Reporting Directive (CSRD) proposal that amends the current Non-Financial Reporting Directive (2014/95/EU) (NFRD). Over June 2022, political agreement as to the directive was reached between the EU Parliament and the Council, with the letter inviting the EU Parliament to adopt the text at first reading, based on the final compromise text closely following.
The purpose of the CSRD is to encourage reliable sustainability reporting, and its scope is broader than the NFRD’s, so it will apply to a larger base of European and non-European companies operating in the EU-regulated markets.
The reporting standard will require its subjects to look both inside and outside of the company, a perspective known as ‘double materiality’. First, the reporting business will have to understand how its activities affect the business itself. Second, the same activities will be analysed by taking stock of the business’ impact on people, environment, and society. The sanctions for violations of reporting standards will be decided at state-level, along the Directive’s guidelines.
If successfully adopted, these new rules will expose investors not only to sanctions imposed by regulatory bodies or to disputes arising from misleading customers and shareholders, but also to a changed investment arbitration landscape.
The arbitration environment is transformed by such legislation in two major ways – first, by the effect it has on tribunals’ reasoning as applicable domestic legislation (see for example Hepburn pp. 137-138), and second, by the general expectation it creates for future investors.
Therefore, understanding the evolution of CSR concepts in investment arbitration will assist investors in better assessing risk in their respective sectors.
CSR standards and International Investment Agreements (‘IIAs’)
Even though, traditionally, the purpose of IIAs was to create a safe climate for foreign investments, non-economic objectives are steadily creating a new type of potential liability for companies that is seeping into the IIA framework. Over the last decade, efforts to rebalance the rights and responsibilities allocation in IIAs have gradually increased. These efforts, which are discussed below, were the adaptive reaction of the IIA system to the adverse response from the civil society, NGOs, politicians, and individual commentators.
As it has been observed many times before, one of the main forces driving the investment arbitration backlash is that investment treaties impose high standards on States, but do not offer means to hold corporations accountable for their impact on social, environmental, and economic matters. Arbitrations in which investors were compensated for the damage inflicted upon their business by state regulations in areas of important public policies were the springboard for this discussion. Such cases dealt with water management, hazardous chemicals regulation, and measures to address deep economic crises.
The paralysis of host States’ prerogative to regulate in the public interest, attributable to clusters of such investors’ rights in the network of IIAs, is known as the ‘regulatory chill’ (see for example here and here). Therefore, the criticism goes, the host State can neither seek redress against the investor in arbitration, as there is no specific right to base its claim on, nor can it better regulate for the future, as that would either affect existing investments and trigger disputes or it would put newer investors at a disadvantage, creating an unlevel playing field.
Outside the realm of IIAs, the debate has materialized in soft law instruments, such as guidelines, principles, and frameworks. In contrast to these, the new CSR Directive represents much more than guidelines; it will result in actionable national legislation.
IIAs themselves rarely contain CSR provisions, and when they do, the said provisions are drafted to be vague and usually only impose obligations on Contracting Parties (i.e., States) to create, encourage or strengthen CSR standards, while companies/investors do not bear any responsibility. This reflects a wider asymmetry in IIAs, whereby the investor is afforded a considerable number of protections, and very few, if any, obligations.
Indirect CSR provisions place the burden on the host State to further CSR goals, through internal regulations and advancement of CSR policies, coupled with oversight of potential transgression. This is where the Directive Proposal might be grouped. Even though the Directive Proposal’s terms are manifest, its effect in investment arbitration under IIAs can only be indirect, and dependent upon the IIA’s text. The IIA’s text is necessary to identify the point of entry for such a piece of legislation.
When they do make an unexpected appearance, substantive CSR obligations on investors in IIAs are either located in the treaty’s preamble or in a dedicated provision or chapter in the body of the text (see analysis here). Even so, the obligations are still expressed in ambiguous terms. The looseness of these terms even led some scholars to wonder whether the CSR treaty provisions could be translated into legally binding effects.
A roundabout way to insulate the host State’s regulatory power in areas that overlap with CSR initiatives’ focus is a treaty carve-out. In this way, CSR regulatory measures are made exempt from the indirect expropriation standard in the IIA or even from the ISDS tribunal’s jurisdiction, thus protecting the State’s regulatory autonomy with regard to vital public interests. Yet another obliquitous way of considering CSR implementation is providing for extraterritorial jurisdiction relating to civil liability of foreign investors’ conduct abroad. This is exemplified by Article 17.2 of the South African Development Community’s (SADC’s) Model Bilateral Investment Treaty, which is intended to protect against a potential forum non conveniens defence. One might think that a clause stipulating that the investor can be pursued in their home court for CSR violations would restore some balance to the uneven allocation of rights and obligations between investors and States. However, as Levashova argues, domestic home courts might still be inclined to decline jurisdiction to arbitration, out of deference or for lack of resources or expertise.
All the same, unequivocal express CSR obligations placed on the investor are the exception, not the rule. Therefore, the soft law aspect of most CSR standards can only be imposed vis-à-vis investors by the use of the courts’ interpretative power.
The issues of admissibility and jurisdiction
Many IIAs expressly or impliedly require investors to comply with the domestic law of the host State, which would include domestic regulations relating to CSR. Nevertheless, this typically acts as a pre-condition for investor protection and not as a substantive obligation that the investor owes to the host State.
Therefore, this would be an issue of admissibility of the investor’s claim. In this regard, Monebhurrun suggests that a ‘minimum standard of corporate social diligence’ is slowly building, which would call for meeting a threshold of (social) due diligence before the investor is able to access the IIA’s protections.
The investor not abiding by the CSR standards of the host State could also fall under the scope of a jurisdictional objection, regardless of whether CSR measures are outside the mandate of the tribunal or not. That is to say, in some instances, the IIA itself might exclude defined CSR measures from the scope of the tribunal. In other instances, where the IIA is silent, the tribunal can take into account a lack of CSR compliance when deciding on its jurisdiction.
For example, the tribunal in Phoenix Action Ltd v. the Czech Republic held that “nobody would suggest that ICSID protection should be granted to investments made in violation of the most fundamental rules of protection of human rights, like investments made in pursuance of torture or genocide or in support of slavery or trafficking of human organs.” Whether other types of CSR requirements, such as those targeting environmental goals, will meet the necessary level of ‘fundamental rules’ is a development to be observed.
State Counterclaims and Objections
ISDS traditionally involves an investor making a claim against a host State, stemming from a violation of a guaranteed protection that resulted in a loss of value for the investor. The ISDS system is designed to assuage the investor, so most IIAs do not present the State with the option to initiate proceedings.
However, States can sometimes counterclaim if the dispute resolution provision in the IIA allows, and they can always object to the claims raised by the investor.
As to the objections, depending on how they are framed by the Respondent State, the tribunal can make the infringement of CSR standards part of its assessment of treaty obligations, including the FET standard, the non-discrimination requirement, or the prohibition of unlawful indirect expropriation (for analysis see here and here). Raising counterarguments in the objections can also contribute to an unfavourable perspective as to the investor when determining the compensation amount, as for example in Bear Creak v. Peru or Copper Mesa v. Ecuador. Therefore, breaking CSR rules will affect the investor’s case if the State raises the point, albeit in an indirect manner.
How long is too long to wait for a change?
The CSR debate has already changed the arbitration process and will clearly continue to re-shape it further. Nevertheless, recent advances in treaty practice and interpretation might be of little consolation to those who wish to see a more rapid arrival of climate and social justice.
But any reform, be it at international, EU or state level, will have to be embedded into the greater network of economic and social factors that make up our global economy. For example, there are hurdles yet to overcome in switching to greener energy, many of which are physical and scientific barriers rather than legal or political.
One can find that very often practical and technical concerns are ignored in these negotiations, when they should be at the forefront of any decision. For example, energy experts report that, as long as we do not find another reliable, as opposed to seasonal/intermittent energy source, there will always be need for carbon-based fuel for backing up renewable energy infrastructure and heavy-duty transportation like trains and planes. Renewables are highly climate dependent. As climate events are often surprising, one cannot plan too much in advance based on renewables without having a back-up source of energy. Therefore, the intermittency and scale issues will have to be resolved before any switch can realistically happen. Until renewables become our main source of energy and non-renewables are only used as a back-up, there is still need for non-renewable sources (fossil-fuel based or nuclear) to carry us through the transition. In the meantime, investment in renewables will have to be greatly encouraged, as well as investment in carbon capture technologies. Similarly, CSR issues such as communities’ access to resources or a population’s public health interests are rarely just a regulation issue.
For example, the SARS-Cov-2 pandemic has demonstrated that even public health initiatives can cut across the CSR core and create divides between the right to health and the right to work, the right to education and the right to a safe working environment, the right of free movement and the right to social security etc. A comparably thorny example is that regarding the resource impact of one of the most renowned brands in sustainability, Tesla, and its factory in Germany. In that case, locals are claiming that the factory is exhausting the area’s water supply.
There is an argument to be made that it is better to improve a tried and tested regime that works instead of burning it to the ground without a plan in place.
Having said that, as Cutler and Lark remark, the worry remains that, if executed with no understanding of the grander scheme, these treaty reforms will only “further legitimize and lock-in states to neoliberal disciplines while obscuring and deepening the costs associated with the expansion of transnational capitalism”.
Ioana Bratu, M.CIArb is a study grant recipient and fellow researcher (PhD) in Law and Legal Orders at The Open University, UK. ↑
However, caution should be urged as to definitive conclusions at this point. For instance, according to ministerial communications, as it stands now, the Netherlands is not withdrawing immediately from the ECT and would rather wait to see the end of the reform first. ↑
As a retort to this hurdle, it has been suggested that EU Members States may try to terminate the sunset clause inter se. However, this possibility is not as legally straightforward as its supporters might propose. ↑
The companies to whom these changes will apply are: (a) large companies who meet at least two of the criteria: having a balance sheet total of €20m; having a net turnover of €40m; employing an average number of 250 employees during the financial year; (b) non-EU companies with substantial operations in the EU regulated markets, represented by €150m in annual turnover in the EU, and having at least one subsidiary or branch in the EU; (c) SMEs with securities admitted to trading on a EU regulated market. ↑
The framework of the EU-UK Trade and Cooperation Agreement, ‘TCA’, the Austrian Model BIT (2010) or the Dutch Model BIT (2019) are among the notable exceptions.
Some examples are those of: Brazil–Malawi Investment Cooperation and Facilitation Agreement, Article 9, 2017 Intra-Mercosur Investment Facilitation Protocol, 2016 Pan-African Investment Code, 2016 Argentina-Qatar BIT; 2016 Morocco-Nigeria BIT, 2012 South African Development Community (SADC) Model BIT. ↑
See, for example, the Trans-Pacific Partnership (‘TTP’), The Canada-European Union (EU) Comprehensive Economic and Trade Agreement (‘CETA’), China-Korea Free Trade Agreement, the China-Australia Free Trade Agreement (‘ChAFTA’). ↑
One notable exception to this is the Draft Pan-African Investment Code in its Art. 43. ↑
However, it is difficult to meet the test for a counterclaim. Cases such as Urbaser v. Argentina, ICSID Case No. ARB/07/26 or Burlington Resources v. Ecuador, ICSID Case No. ARB/08/5 are demonstrations of how the argument can be made and how the tribunal can reason through such an argument in order to allow the State to counterclaim, but as there is no recognition of precedent in international investment arbitration, these could remain isolated occurrences. ↑