Brexit: Implications for the EU Reform of Investor-State Dispute Settlement

Sophie Nappert, 3 Verulam Buildings

Nikos Lavranos, EFILA

“Reproduced from Practical Law with the permission of the publishers. For further information visit www.practicallaw.com or call 020 7542 6664.”

Investor-state dispute settlement (ISDS) is an international arbitration mechanism that allows an investor from one country to bring arbitral proceedings directly against the state in which it has invested, provided that the investor’s home country and the host country of the investment have so agreed by treaty (see box ISDSbelow). ISDS is currently found in most modern international trade and investment agreements.

In the period since the entry into force of the Treaty of Lisbon, conferring on the EU exclusive competence over foreign direct investment in the European space, the European Parliament and the trade ministers of key member states, such as Germany, France and the Netherlands, have perceived that ISDS presents a number of shortcomings. These concerns were crystallised in the responses to a public consultation on the Transatlantic Trade and Investment Partnership (TTIP), currently being negotiated between the EU and the US (see Transatlantic Trade and Investment Partnership (TTIP): tracker).

ISDS

Investor-state dispute settlement (ISDS) is a dispute resolution mechanism modelled on international arbitration, allowing an investor from one country to bring arbitral proceedings directly against the country in which it has invested, pursuant to the provisions of a treaty between the investor’s home state and the state hosting the investment.

ISDS provisions are contained in most modern international agreements including free trade agreements, bilateral investment treaties and multilateral investment agreements. If an investor from one country (the “home state”) invests in another country (the “host state”), both of which have agreed to ISDS, and the host state violates the rights granted to the investor under the international agreement between the home state and the host state (such as the right not to have property expropriated without prompt, adequate and effective compensation), then that investor may take the host state to international arbitration rather than sue in the domestic courts of the host state.

As a result, the European Commission has now tabled a proposal for a new dispute settlement system, the international court system (ICS), to be used in the EU’s future trade and investment treaties and, in the Commission’s words, “paving the way for a multilateral investment court” (see Legal update, European Commission proposes Investment Court System for EU trade agreements).

Instead of investor-state disputes being determined by an arbitral tribunal appointed by the parties, the Commission’s proposal is to create a judicial, two-tiered body consisting of a Tribunal of First Instance and an Appellate Tribunal. Party-appointed arbitrators would be replaced with “judges” unilaterally pre-selected by the state parties. As a result, the resolution of investor-state disputes by way a one-shot final arbitral award will be replaced with a two-instance procedure allowing for appeals on points of both fact and law.

The ICS proposal constitutes a strong push towards the institutionalisation and judicialisation of investor-state dispute settlement and is inspired by the WTO (World Trade Organisation) dispute settlement model applicable to state-to-state trade disputes. The important hallmarks of arbitration such as flexibility, finality and party autonomy will be essentially erased (see box ICS proposal: the concerns).

The EU’s seismic shift on its ISDS policy coincides with the UK’s consideration of its future as a member of the EU. If Brexit comes to pass, there will be legal repercussions on a number of levels as regards the UK’s trade and investment commitments at international law, and the protections currently enjoyed by UK investors abroad, including the ability to enforce arbitration awards worldwide pursuant to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). This is uncharted territory in many respects, and the opacity surrounding the progress of the current negotiations on the TTIP with the US adds to the uncertainty and lack of clarity.

ICS proposal: the concerns

While ISDS has been tested for decades and is a known quantity, it remains to be seen whether the benefits claimed by the proponents of the ICS will actually materialise. The EU’s proposal assumes that the ICS will not be declared by the Court of Justice of the European Union to be incompatible with EU law, as the CJEU has done consistently for other international tribunals, latterly the European Court of Human Rights).

For example, critics of ISDS claim that it has failed to take proper account of other relevant policy areas such as human rights, environmental law, intellectual property law and the “regulatory policy space” of states generally. The current ICS proposal does not specifically address those issues, and thus on its face provides little more credibility and legitimacy than does ISDS.

Another example concerns the qualifications required by the “judges” and the process of their selection by the contracting parties.

The proposal states that the only qualifications required of ICS “judges” for appointment to the Tribunal of First Instance is that they should be qualified for judicial office or a “recognised jurist”. For the Appeal Tribunal, the requirements are of qualification for the highest judicial office or being a “recognised jurist”. Interestingly, while the ICS proposal insists on expertise in public international law for its judges, expertise in investment law is deemed merely to be “desirable”. There is no requirement that (any of) the judges should demonstrate expertise in the policy areas that have fired up public debate and the anti-ISDS sentiment, such as human rights or environmental law.

The ICS proposal leaves the judge selection process entirely to the contracting parties. No transparency, public hearing or consultation with users or investors is currently envisaged. In addition, the “judges” are to be paid by the contracting parties and can be re-appointed by them. The anti-ISDS debate at the root of the ICS proposal claimed that the party selection and payment of arbitrators cast doubt as to the independence and impartiality of those arbitrators. The ICS proposal is open to precisely the same criticism.

Moreover, ISDS has been recognised as providing flexibility and a dispute resolution process which engages both parties, the state and the investor, on an equal footing. By contrast, the ICS replaces this flexibility with a fixed set of rules, removing any participation from the investor claimant regarding for example the choice of arbitration rules and the selection of arbitrators.

These points highlight some of the concerns which call for further reflection and analysis regarding whether the ICS proposal is the improvement on the arbitration-modelled ISDS claimed by its proponents.

We set out below some of the potential implications, at both macro- and micro-levels.

Macro-level implications

The first macro-level issue is that Scotland and Northern Ireland have indicated that they may not wish to remain part of the UK post-Brexit. The prospect of a fragmented Britain (no longer the UK) raises the question of whether the EU or the US would consider it worthwhile to negotiate a trade and investment agreement with a dismembered Britain. It also raises the question of what leverage Britain in its new incarnation would have in such treaty negotiations, as opposed to that which it now enjoys as part of the EU.

Another question is Brexit’s potential impact on the existing 100 or so bilateral investment treaties (BITs) that the UK has with individual EU member states (intra-EU BITs), as well as with third states. A post-Brexit British state might be able to keep all these BITs containing the classic ISDS provisions assuming that its respective state counterparties agreed.

In this scenario, Britain would avoid the untested ICS proposal and its potential shortcomings, and become an interesting safe harbour for foreign investors who may find it attractive to structure their investments through it, thereby avoiding the current insecurity created by the ISDS reforms. If it considers it necessary and useful, post-Brexit Britain could seek to negotiate BITs with the EU (as a single entity), as well as those countries with which the EU has either signed or is negotiating trade and investment agreements, namely Canada, China, the US, Singapore and Vietnam.

The question arises, however, whether Britain, which currently appears to favour retaining ISDS over the ICS, would be able to impose ISDS provisions on potential counterparties given the EU’s push for the ICS to apply to future trade and investment treaties, and the willingness of at least some of the countries on this list to accept ICS.

Britain’s ability to do this is likely to be affected by which dispute settlement system ends up being included in the TTIP. If the ICS comes to feature in the TTIP, ISDS in its current, arbitration-based form faces an uncertain future.

One important aspect of post-Brexit Britain retaining ISDS in its arbitration form rests on the question whether Britain in its new incarnation has the ability to remain a party to the New York Convention, to which over 150 states are parties, and which is a significant part of the protection afforded to investors by ISDS.

Micro-level implications

At a micro-level, the international investment agreements (IIAs) that have recently been agreed by the EU and its relevant trading partners, but are still awaiting signature or ratification (namely, CETA (the Comprehensive Economic and Trade Agreement with Canada), the EU-Singapore Free Trade Agreement (FTA) and the EU-Vietnam FTA), would have to be amended to reflect Brexit.

Whether these trading partners would consider it attractive to negotiate new deals with Britain is an open question. The time and effort involved in the negotiation and conclusion of IIAs is not to be underestimated. The intervening period would be marked by legal uncertainty, to the detriment of UK investors abroad and Britain’s economy.

Another question is whether Brexit would have any impact on the ongoing TTIP negotiations, in particular with regard to the EU’s internal process of consulting with member states in adopting certain negotiating positions. Prime Minister David Cameron is said to be in favour of closing the TTIP as soon as possible because he considers it to have the potential of delivering huge benefits for the UK. At the same time, he appears generally untroubled by the anti-ISDS debate currently raging in many other EU member states.

A real and potentially significant impact

In conclusion, Brexit’s impact on the EU’s trade and investment policy would be real, as would its impact on post-Brexit Britain’s geo-political clout in the trade and investment arena. In contrast, it might offer interesting advantages, for both the UK as a host state and for investors who perceive the EU’s current investment policy as counter-productive. These advantages, however, are likely only to be felt after a significant period of uncertainty whilst post-Brexit Britain finds its footing, and in the short term are outweighed by that uncertainty.

Finally, the prospect of Brexit might cause the European Commission, the European Parliament and other member states to re-think the scope of their proposed “reforms” of investment treaties and ISDS.


Sophie Nappert is an arbitrator in independent practice at 3 Verulam Buildings, and Nikos Lavranos is Secretary General at EFILA.

GAR Awards 2016: The EFILA Lecture Has Been Shortlisted

EFILA is glad to announce that Ms. Sophie Nappert’s EFILA Lecture “Escaping from Freedom? The Dilemma of An Improved ISDS Mechanismhas been shortlisted for the 2016 GAR Awards for the best speech/lecture.

In the coming period, the voting process will begin. We would be grateful if Ms. Nappert’s outstanding lecture would receive your vote.

The 2015 EFILA Inaugural Lecture: Escaping from Freedom?

We are pleased to offer you the full text of the 2015 EFILA Inaugural Lecture by Sophie Nappert, “Escaping from Freedom? The Dilemma of An Improved ISDS Mechanism“, delivered on 26 November 2015 in London.

In times such as ours, when freedom is often abandoned for security to be gained, Sophie Nappert’s lecture is a vindication of freedom endorsed by law.

Executive Summary

ISDS in its current international arbitration format has attracted criticism. In response, the EU proposal for ISDS in the TTIP consists of a two-tiered court system, comprising an appeal mechanism empowered to review first-instance decisions on both factual and legal grounds and, the EU says, paving the way for a “multilateral investment court”.

The EU proposal envisages that the courts of first instance and appeal be composed of pre-ordained, semi-permanent judges randomly assigned to cases and subject to compliance with a Code of Conduct worded in general terms.

As it stands the EU proposal walks away from the international arbitration format, and consequently the application of the New York Convention.

The Lecture expresses surprise at the EU proposal of a court mechanism given the CJEU’s unambiguous, historical unease with other similar, parallel international court systems, as most recently expressed in its Opinion 2/13 of 18 December 2014 on the draft Accession Agreement to the
European Convention on Human Rights.

The Lecture examines whether, and how, the EU proposal might provide solutions to critical issues presented in two recent cases taken as illustrations – the Awards in the cases of the Yukos shareholders against the Russian Federation, as well as the case of Croatia v Slovenia currently pending in the PCA.

The Lecture remarks that appeal mechanisms are not free from difficulty, not least of which the real risk of inconsistent decisions between the first and appeal instances, due to different, equally valid approaches to a developing area of international law.

The Lecture also notes that the proposed Code of Conduct provides no practical sanctions to deal with instances of arbitrator misconduct such as that featured in the Croatia v Slovenia matter, and expresses surprise that ethical challenges are to be decided by fellow Judges – probably one of the most problematic features of the current ICSID system.

The Lecture proposes a third way, aimed at addressing these concerns, whereby a Committee – stroke – Interpretive Body, informed by the intentions of the TTIP Parties, would take over the development of TTIP jurisprudence in a more linear and consistent manner, with a longer-term view, whilst ad hoc arbitration tribunals in their current form would focus on the settlement of the discrete factual dispute.

Dissociating the settlement of the factual dispute from the broader interpretive exercise would create a repository of the TTIP jurisprudential function, allowing for a more harmonious and authoritative development of TTIP interpretation and law and alleviating the phenomenon of “overreaching” currently burdening ad hoc tribunals – arguably the real source of the criticism aimed at ISDS.

The Committee/Interpretive Body could also more credibly act as decision-maker in ethical challenges than would fellow Judges, provided the Code of Conduct is reviewed to allow for realistic standards and practical sanctions.

This proposed “third way” retains the arbitration features necessary for the application of the New York Convention, and is not inconsistent with the EU’s own proposal, building as it does on Article 13(5) which contemplates an overseeing Committee that would be well-placed to take over the above role.

See the full text of the Lecture here.

UPDATE: EFILA Annual Lecture 2015 – Sophie Nappert

Due to the present situation in Brussels, the EFILA annual lecture will be transferred to London. The date and time of the lecture will be maintained, i.e. 26 November, 5.00 o’clock PM.

More precisely, the new venue of the lecture delivered by Sophie Nappert will be:

Allen & Overy LLP
One Bishops Square
London
E1 6AD Telephone Number+44 20 3088 0000

Please register for the event at the following e-mail address: Laura.Weston@allenovery.com

EFILA Annual Lecture 2015 – Sophie Nappert

In the wake of the release of the European Commission’s proposal for a new investment chapter in the Transatlantic Trade and Investment Partnership, EFILA is pleased to announce a launch of its Annual Lecture series.

The inaugural Annual Lecture of EFILA entitled: “Escaping from Freedom? The Dilemma of an Improved ISDS Mechanism” will take place on 26 November 2015 from 16.30 until 19.30 at the Brussels Press Club Europe (Rue Froissart 95, 1000 Bruxelles).

The inaugural Annual Lecture of EFILA will be delivered by Sophie Nappert, a highly regarded, experienced arbitrator and peer-nominated Moderator of OGEMID.

As stated by Sophie, the purpose of her speech is not to make the apology of ISDS in its current form, or to sing its eulogy.  Rather than clinging to a model that is showing cracks, she is far more interested in the challenging proposition of making investor-to-State, and most relevantly investor-to-EU, dispute resolution in the 21st century legitimate and authoritative at this fascinating intersection between EU law and international law, whilst remaining loyal to core values common to both the EU and international dispute settlement. For the abstract of Sophie’s lecture please click here.

Please register by sending an email with your name, affiliation and phone number to Ms Senta Marenz, s.marenz@efila.org.

We look forward to welcoming you to the Annual Lecture of EFILA.

Sponsors of the Annual Lecture 2015