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What is ISDS?
ISDS is a neutral, international arbitration procedure. Like other forms of commercial, labor, or judicial arbitration, ISDS seeks to provide an impartial, law-based approach to resolve conflicts. Various forms of ISDS are now a part of over 3,000 agreements worldwide, of which the United States is party to 50. Though ISDS is invoked as a catch all term, there are a wide variety of differences in scope and process. ISDS in U.S. trade agreements is significantly better defined and restricted than in other countries’ agreements.
Governments put ISDS in place for at least three reasons:
- To resolve investment conflicts without creating state-to-state conflict
- To protect citizens abroad
- To signal to potential investors that the rule of law will be respected
Because of the safeguards in U.S. agreements and because of the high standards of our legal system, foreign investors rarely pursue arbitration against the United States and have never been successful when they have done so.
What are the major criticisms of ISDS?
For some critics there is a discomfort that ISDS provides an additional channel for investors to sue governments, including a belief that all disputes (even international law disputes) should be resolved in domestic courts. Others believe that ISDS could put strains on national treasuries or that ISDS cases are frivolous. Based on our more than two decades of experience with ISDS under U.S. agreements, we do not share these views. We believe that providing a neutral international forum to resolve investment disputes under international law mitigates conflicts and protects our citizens.
The most significant concern that critics raise is about the potential impact of ISDS rulings on the ability of governments to regulate. Those concerns are why we have been at the leading edge of reforming and upgrading ISDS. The United States has taken important steps to ensure that our agreements are carefully crafted both to preserve governments’ right to regulate and minimize abuse of the ISDS process. Those steps are described in detail below.
What rights are protected by ISDS under U.S. agreements?
In U.S. agreements, the investment rules enforced by ISDS provide investors in foreign countries basic protections from foreign government actions such as:
- Freedom from discrimination: An assurance that Americans doing business abroad will face a level playing field and will not be treated less favorably than local investors or competitors from third countries.
- Protection against uncompensated expropriation of property: An assurance that the property of investors will not be seized by the government without the payment of just compensation.
- Protection against denial of justice: An assurance that investors will not be denied justice in criminal, civil, or administrative adjudicatory proceedings.
- Right to transfer capital: An assurance that investors will be able to move capital relating to their investments freely, subject to safeguards to provide governments flexibility, including to respond to financial crises and to ensure the integrity and stability of the financial system.
These investment rules mirror rights and protections in the United States and are designed to provide no greater substantive rights to foreign investors than are afforded under the Constitution and U.S. law. For example, the Fifth Amendment to the U.S. Constitution states that no person shall be “deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.” The Fourteenth Amendment states that no state shall “deny to any person within its jurisdiction the equal protection of the laws.” Several of these rights – such as those relating to expropriation and denial of justice – are also longstanding elements of customary international law protections for investors abroad.
Why aren’t local courts enough?
While ISDS does not provide additional substantive rights relative to U.S. law, it does provide an additional procedural right: the right for foreigners to choose impartial arbitration rather than domestic courts when alleging that the government itself has breached its international obligations, whether by discriminating against a foreign investor, expropriating the investor’s property, or violating the investor’s customary international law rights.
ISDS arbitration is needed because the potential for bias can be high in situations where a foreign investor is seeking to redress injury in a domestic court, especially against the government itself. While countries with weak legal institutions are frequent respondents in ISDS cases, American investors have also faced cases of bias or insufficient legal remedies in countries with well-developed legal institutions. Moreover, ISDS can be of particular benefit to small and medium-sized enterprises, which often lack the resources or expertise to navigate foreign legal systems and seek redress for injury at the hands of a foreign government. Indeed, SMEs and individuals have accounted for about half of all cases brought under international arbitration.
There is a long history of providing neutral forums for disputes that cross borders. Within the United States, for example, the rules of civil procedure allow for federal jurisdiction in cases involving citizens of foreign countries (or even citizens of different U.S. states) to eliminate biases that may occur within state courts. Internationally, there are a wide variety of judicial or arbitration mechanisms – including State-to-State dispute settlement and forums permitting direct actions by private parties – to create neutral means for resolving differences between parties from different countries; for example, the International Court of Justice, the World Trade Organization, and the Inter-American Court of Human Rights.
Where did ISDS come from?
Disputes between investors and foreign countries have required adjudication for as long as there has been cross-border investment. Prior to the evolution of the modern rules-based system, unlawful behavior by States targeting foreign investors tended either to go unaddressed or to escalate into conflict between States. Military interventions in the early years of U.S. history – gunboat diplomacy – were often in defense of private American commercial interests. As recently as 1974, a United Nations report found that in the previous decade and a half there had been 875 takings of the private property of foreigners by governments in 62 countries for which there was no international legal remedy. Though diplomatic solutions were possible, they were often ineffective and political in character, rather than judicial.
ISDS represented a better way.
Though the modern form of ISDS did not emerge until the 1960s, the idea of using special purpose panels to resolve disputes between private citizens and foreign governments dates to the earliest days of the Republic. One of the forerunners of modern investor-State arbitration mechanisms, the Jay Treaty between the United States and Britain, was negotiated by our first Chief Justice and included a process for resolving property disputes that arose during the Revolutionary War to ensure that investors received “full compensation for [their] losses and damages” where those could not be obtained “in the ordinary course of justice.” Over the subsequent century, governments established more than 100 additional arbitration mechanisms, such as a series of U.S.-Mexican Claims Commissions, which heard thousands of private claims over the course of decades on issues ranging from cattle theft to denial of justice.
Opponents criticize ISDS for “elevating” corporations and investors to equal standing with countries by allowing corporations to “drag” sovereign governments to dispute settlement. But the right of private parties to challenge the actions of government is one of the oldest and most established legal principles (dating back 800 years to the Magna Carta): that “the king, too, is bound by law.”
Importantly, while it provides a venue for conflict resolution, ISDS protects the sovereign right of States to regulate. Under U.S. agreements, ISDS panels are explicitly limited to providing compensation for loss or damage to investments. They cannot overturn domestic laws or regulations.
How expensive is ISDS?
ISDS is a complex form of dispute resolution and is accompanied by similar legal costs to complex litigation in our courts. But ISDS represents just a fraction of the legal expenses governments incur defending lawsuits. Over the past 25 years, under the 50 agreements the U.S. has which include ISDS, the United States has faced only 17 ISDS cases, 13 of which were brought to conclusion. During that same time period, the United States government was sued in U.S. courts hundreds of thousands of times – more than 1,000 of those for alleged “takings”.
Though the U.S. government regularly loses cases in domestic court, we have never once lost an ISDS case and, in a number of instances, panels have awarded the United States attorneys’ fees after the United States successfully defended frivolous or otherwise non-meritorious claims. The U.S. federal government defends challenges to U.S. state or local government measures in ISDS disputes.
According to the most recent UNCTAD data, only a quarter of concluded ISDS cases worldwide have been decided in favor of investors. When investors win, the damages they are typically awarded are substantially less than the value they have claimed. Because of high arbitration costs, the low winning percentage, the potential for future retaliation against the investor by the government being sued, ISDS is typically a recourse of last resort.
Will ISDS affect the ability of TPP governments to regulate?
The United States already has international agreements containing ISDS in force with six of the eleven other countries participating in TPP (Canada, Chile, Mexico, Peru, Singapore, and Vietnam). The remaining five countries (Australia, Brunei, Japan, Malaysia and New Zealand) are party to a total of over 100 agreements containing ISDS. TPP will not newly introduce ISDS to any of the countries participating in the agreement. Rather, it presents an opportunity to establish agreement among the parties on a high-standard approach to resolving international investment disputes.
Much of the concern about ISDS is the risk of companies using the mechanism to challenge legitimate regulations. Philip Morris International, for example, has challenged Australia’s plain packaging regulation under a 1993 Hong Kong-Australia Bilateral Investment Treaty. Though that case has not yet been fully adjudicated and Australia has made no changes to their regulation, we nonetheless are working to ensure that TPP includes important safeguards that protect against ISDS being used to challenge legitimate regulation. That is why the United States has put in place several layers of defenses to minimize the risk that U.S. agreements could be exploited in the manner to which other agreements among other countries are susceptible.
In an effort to safeguard against potential abuses of ISDS, TPP will have state-of-the-art protections. It will recognize the inherent right to regulate and to preserve the flexibility of the TPP Parties to protect legitimate public welfare objectives, such as public health, safety, the environment, and the conservation of living or non-living exhaustible natural resources. The investment chapter will include carefully defined obligations and exceptions designed to ensure that nothing in the chapter impinges on legitimate regulation or provides foreign investors with greater substantive rights than those already available under U.S. law. It will also reaffirm the right of any TPP government to ensure that investment activity in its territory is undertaken in a manner sensitive to environmental, health, or other regulatory objectives.
TPP will also incorporate numerous safeguards to ensure that the investment obligations are interpreted carefully and in a manner consistent with governments’ intent, and that the ISDS process is not susceptible to abuse. These safeguards include:
- Full transparency in cases. Governments must make all pleadings, briefs, transcripts, decisions, and awards in ISDS cases publicly available, as well as open ISDS hearings to the public. One key objective of these provisions is to allow governments that are party to the agreement, as well as the public at large, to carefully monitor pending proceedings and more effectively make decisions about whether to intervene.
- Public participation in cases. Tribunals have the clear authority to accept amicus curiae submissions. In U.S. cases, amicus briefs have been submitted by a variety of NGOs, including the Sierra Club, Friends of the Earth, and Center for International Environmental Law. (Documents in all investor-State cases filed against the United States are available on the State Department website.)
- Mechanism for expedited review and dismissal of frivolous claims and claims outside the tribunal’s jurisdiction. This mechanism enables respondent countries, on an extremely expedited basis, to move to dismiss (1) frivolous or otherwise unmeritorious claims (akin to provisions under the Federal Rules of Civil Procedure) and (2) claims the tribunal is not empowered to resolve.
- Denial of benefits for sham corporations. This provision prevents the use of shell companies to access ISDS.
- Restriction on parallel claims. This provision prevents a party from pursuing the same claims both in ISDS proceedings and domestic courts (i.e., restricting “forum shopping”).
- Statute of limitations. A three-year statute of limitations protects respondents against old claims, which are difficult for governments to defend in part because access to documents and witnesses becomes more difficult over time.
- Challenge of awards. Both parties to an arbitration have the option to challenge a tribunal award.
- Consolidation. On request, tribunals may consolidate claims raising common questions of fact and law, which may increase efficiency, reduce litigation costs, and prevent strategic initiation of duplicative litigation.
- Interim review of ISDS awards. Parties to the arbitration are permitted to review and comment on a draft of the tribunal’s award before it is made final.
- Prudential exception. This exception provides that nothing prevents countries from taking measures to safeguard the stability of their financial systems. If such measures are challenged, this provision allows the respondent country and investor’s home country to jointly agree that the prudential exception applies and that decision is binding on the tribunal.
- Tax exception. This exception defines and limits the coverage of government tax measures under the investment provisions. In addition, this provision provides that if the respondent country and investor’s home country agree that a challenged measure is not expropriatory, that decision is binding on the tribunal.
- Mechanism for treaty Parties to issue binding decisions on how to interpret treaty provisions. A binding interpretation mechanism enables TPP countries to confer after the agreement has entered into force and to issue joint decisions on questions of treaty interpretation that bind all tribunals in pending and future cases.
- Independent experts on environmental, health, or safety matters. In most ISDS cases, the disputing parties retain and appoint the experts. This provision provides arbitral tribunals with the power to appoint experts of their own choosing on environmental, health, and safety matters to ensure maximal objectivity in the evaluation of claims challenging such measures.
- Limitations on obligations: Clear limiting rules and definitions, including guidance on interpretation on the obligations frequently subject to litigation, to safeguard against subjective or overbroad interpretation – for example, the incorporation of U.S. Supreme Court standards on indirect expropriation and a clear tying of the “minimum standard of treatment” obligation to requirements under customary international law (i.e. the general and consistent practice of states that they follow from a sense of legal obligation).
The case record is instructive. Tribunals adjudicating ISDS cases under U.S. agreements have consistently affirmed that government actions designed and implemented to advance legitimate regulatory objectives do not violate investment obligations. In the Chemtura v. Canada case, for example, an ISDS panel rejected a claim that the Canadian government’s actions to ban the use of chemical product breached Canada’s NAFTA obligations. In rejecting the investor’s claim, the tribunal showed deference to the government’s scientific and environmental regulatory determinations. Similarly in the Methanex v. the United States case, an ISDS panel underscored the right of governments to regulate for public purposes, including regulation that imposes economic burdens on foreign investors, and stated that investors could not reasonably expect that environmental and health regulations would not change.
Some critics have argued that ISDS nonetheless “chills” regulation. But, far from inhibiting regulation, in the wake of U.S. trade agreements we typically see increases in public interest regulation. This is particularly true of recent U.S. agreements that have required trading partners to upgrade both their labor and environmental laws. But even under older agreements, there is strong evidence of countries making regulatory improvements subsequent to concluding trade agreements with the United States. For example, a recent study by the Organization of American States found that CAFTA-DR countries have improved over 150 existing environmental laws and regulations, and adopted 28 new laws and regulations related to wastewater, air pollution, and solid waste.
The evidence is equally clear in the United States. Despite having 50 ISDS agreements in place, the United States has never lost a case and nothing in our agreements has inhibited our response to the 2008 financial crisis, diluted the financial reforms we put in place, or has challenged signature reforms like the Affordable Care Act or any of the other new regulations that have been put in place over the last 30 years.