Safeguard for foreign investors

A practical approach: investment protection and TTIP

By Dr. Markus Burianski, Hansel T. Pham and Dr. Sonja Dünnwald
White & Case, Frankfurt am Main / Washington

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The last several months have seen an animated public debate about the merits and disadvantages of international trade and investment protection. The trigger for the debate has been the Transatlantic Trade and Investment Partnership (TTIP), which is being negotiated between the EU and the U.S. TTIP is a combined free trade and investment agreement, which aims to reduce tariff and nontariff barriers to trade and protect foreign direct investment. While some of the concerns voiced regard the nontransparent conduct of the negotiations and the free-trade elements of the proposed agreement, the discussion has served as a catalyst for fear and frustration with the current system of investment protection. The main points of criticism relate to the system of investor-state dispute settlement (ISDS): This system allows a private party to bring a claim against a sovereign state, that is heard by a tribunal made up of three private individuals with the capacity to grant billions in damages in an allegedly nontransparent process, and there is no possibility to appeal a wrong decision. Furthermore, there are concerns that legitimate public policy decisions made by the state could result in damages, stifling the ability of states to regulate in the public interest.

Overview: investment treaties

Foreign investment is not a recent phenomenon. For centuries, business professionals have sought opportunities to invest and make money in economies other than their home country. The protection of these early foreign investors practically depended on their power both within the host state and—should the host state interfere with their business—on the amount of pressure they could exert on their home government to force the host state to discontinue the interference. International relations, like international law, were strictly a state-to-state matter. This approach started to shift in the early 1960s, when states began to conclude bilateral investment treaties with each other. Bilateral investment treaties proved to be a very appealing instrument, which saw an incredible proliferation in the following decades: Today, there are more than 3,000 investment treaties in force, most of them bilateral treaties. The majority have been concluded between developing and developed states; however, more recently, states with a similar degree of economic development have also entered into investment treaties. Furthermore, there has been a trend to conclude multilateral investment treaties as part of free-trade agreements, such as the American NAFTA and CAFTA. TTIP is based on a similar concept.

Substantive protection

At the substantive level, most investment treaties set forth a core set of protection standards, which each contracting state guarantees to honor when in the position of the host state. The most traditional core standard is the restriction of lawful expropriation: This standard prevents states from expropriating property unless for a public purpose and accompanied by the payment of compensation. This protection extends to indirect expropriatory measures. The second standard is the prohibition of discrimination. Being a relative standard, it protects foreign investors from being treated less favorably than comparable investors in the host state or investors from a third country. >> If contained in TTIP, investment protection standards will make it difficult for a state to alter regulation affecting a foreign investor more than it affects its own nationals << The third and most important standard is the standard of fair and equitable treatment. This objective standard sets a minimum floor for the treatment of foreign investors. While the exact level of protection differs from treaty to treaty, it seems uncontentious that the standard protects the legitimate expectations of the investor, the stability and predictability of the legal and business framework, and the notion of due process. Since the standard has not been defined by prior international public law, its content has been mostly shaped by arbitral tribunals. Most investment treaties contain additional, more specific guarantees, which, however, mainly fall within the broader tenets of the core standards. If contained in TTIP, these standards could secure a European investor abroad: In the past, the substantive standards have resulted in compensation for medium-sized investors, for example, when permits were retroactively restricted or further regulation of their economic activity was enacted. In the context of TTIP, a European investor can bring a claim if, for example, a U.S. state introduces a measure that covertly discriminates against the business of the investor by not impacting similar business owned by a U.S. citizen. TTIP thus will make it difficult for a state to alter regulation affecting a foreign investor more than it affects its own nationals. The critics of TTIP fear that a state could possibly be taken to arbitration over changes in its law that have been adopted for a public purpose, but reduce the profits made by an investor. As a consequence, this could lead to governments not legislating in the public interest in view of looming damage claims. While it is true that the interpretation, especially of the standard of fair and equitable treatment, has in the past often been wider than the state parties had originally anticipated, investment tribunals generally respect the deference owed to the state in adopting measures of public policy. Investment decisions normally find no violation in nondiscriminatory measures adopted for a public purpose in line with due process. In the case of TTIP, it is in the hands of the drafters to control the content of the future agreement and to ensure the necessary leeway for future legislation.

Procedural mechanisms

At the procedural level, most modern investment treaties allow for ISDS. In renunciation of the earlier dogma that such disputes are effectively disputes between the home state and the host state of the investor, they allow foreign investors to personally and directly commence arbitration proceedings against the host state. No involvement of the home state is required. In the arbitration proceedings, the investor and the host state are treated on equal terms. The system involves both parties in choosing the arbitrators: Generally, the investor nominates one arbitrator, the host state nominates another and the third arbitrator, the chairperson, is chosen by these two arbitrators. Finally, the arbitral tribunal produces a binding and enforceable award. While investment treaties have been in place for a considerable time, the last 20 years have seen a significant influx of investment treaty claims. ISDS is currently foreseen in TTIP, even though the negotiation mandate of the EU directly states that its implementation “will depend on whether a satisfactory solution [for all EU interests] is achieved.” Opponents articulate discomfort with the ability of foreign investors, at times large corporate entities, to drag a sovereign state before a tribunal composed of three individuals, who have the ability to order the state to pay unlimited damages. It is true that there is a lack of symmetry due to the fact that the investor alone can commence investment arbitration proceedings. The host state can bring proceedings against the investor only in its national courts. This, however, lies in the nature of the underlying agreements, which foresee obligations only for the states involved, not for individuals. Investment arbitration was first introduced in treaties between states of largely different degrees of development. The developing states considered them helpful to encourage investments from foreign investors distrusting the host state’s legal system. What was necessary in such a relationship to create a level playing field may not be necessary in TTIP, an agreement between the EU and the U.S.—all of which have functioning legal systems. But even in a functioning legal system, investors may be uncomfortable and, potentially, disadvantaged and seeking significant damages in the home courts of the host state. Skepticism has also been voiced regarding the fact that arbitrators form a small set of private practitioners and academics and that they typically represent either the investor or the host state. The development of a group of specialized arbitrators is not surprising. It similarly occurred in commercial arbitration, meaning disputes between commercial entities located in different states, where the arbitrators’ specialization is thought to yield more satisfactory results than national court proceedings. Also, both parties, including the states, are entirely free to appoint whom they think fit and thereby enlarge the pool of suitable candidates. Finally, biased arbitrators can be challenged as a result of conflicts of interests. Investment arbitration does not have to be characterized by “secretive proceedings.” While it is true that certain proceedings in past investment disputes have not been public, overall investment arbitration is more publicly accessible than national court proceedings in most states. Not only is the judgment often publicly accessible, but so are the submissions of the parties and sometimes even the oral proceedings, notwithstanding specific redactions for confidentiality. Investment arbitration also embraces elements of public participation, like the possibility for nongovernmental organizations to act as amici curiae. Transparency is also furthered by the recent UNCITRAL Rules on Transparency in Treatybased Investor-State Arbitration. All these elements demonstrate that a lack of transparency is not an inherent aspect of investment arbitration and that it is up to the negotiators of TTIP to implement respective rules.

Conclusion

Investment arbitration (and TTIP) constitutes a safeguard for foreign investors in case the host state hinders an investment. While the debate around TTIP raises valid considerations, the procedural or material tenets of investment protection are not set in stone: States can make sure that the policy space they need is adequately addressed in the negotiation stage of the agreement.

mburianski@whitecase.com

hpham@whitecase.com

sduennwald@whitecase.com