Abandoning all Investor-State Dispute Settlement Mechanisms Also Not Supported by the Facts (updated 17 August)

I am glad the High Court of Australia rejected today the argument by major tobacco companies that Australia’s plain packaging legislation is an unconstitutional “acquisition” of their rights. I dislike those companies’ products, their marketing and their litigation strategies, and I support the plain packaging legislation. I’ve also made numerous submissions to the Australian government since 2005 seeking to improve safety regulation for general consumer goods – partially achieved in the 2010 “Australian Consumer Law”.
But I hope that the ongoing arbitration claim of “expropriation”, initiated by Philip Morris Asia under the 1993 Hong Kong – Australia bilateral investment treaty, does not feed into blanket rejection of any forms of investor-state dispute settlement (ISDS) in investment treaties. Although that system has flaws, it also has benefits, and there is ample scope to draft treaties to provide clear and appropriate mechanisms to balancing private and public interests. With others familiar with international investment law, I provide further examples of the most promising substantive and procedural law reforms in an Open Letter dated 28 July 2012, in response to a recent OECD Public Consultation on ISDS.
My comment will therefore address points made recently on The Conversation blog by Dr Kyla Tienhaara, who remains completely opposed to any form of ISDS. In fact, she urges the Gillard Government to try to excise ISDS from all Australia’s existing FTAs and investment treaties (dating back to 1988), in addition to eschewing them for future treaties – as the Government seems to be attempting, pursuant to its policy shift on ISDS announced in the 2011 Trade Policy Statement (TPS). An alternative is for the Government to approach Hong Kong authorities to seek agreement on amending the 1993 treaty to suspend PMA’s pending claim. More generally, Australia should consider including ISDS provisions in future treaties but expressly reserve its right to agree with the treaty partner to suspend particular types of claims, for example regarding public health issues. This compromise approach is already essentially found in investment treaty practice where the claim involves allegations of “expropriatory taxation”.

Dr Tienhaara’s recent posting, entitled “ACCI’s right to sue compaign not supported by the facts”, responds to a 13 July 2012 letter to Prime Minister Gillard in which the Australian Chamber of Commerce and Industry joined with others to urge reconsideration of the TPS policy shift. The ACCI’s succinct letter urges Australia to return to allowing some forms of ISDS in appropriate cases, particularly in treaties with countries with less developed court systems and protections for property and other rights.
I was a co-signatory to that letter, but out of intellectual interest and in order to contribute to a rational public policy “conversation” – one that also remains open to exploring a “middle way” regarding ISDS. I am certainly not within the signatories decried by Dr Tienhaara as “lawyers and arbitrators that have a strong vested interest: they profit greatly from the system of international investment arbitration that they are seeking to preserve”. I am neither (practising) lawyer nor arbitrator and do not provide consultancy services in this field – nor do I expect to do so. If anything, I would gain financially if ISDS were indeed abandoned altogether. I have particular expertise in cross-border contract law and commercial arbitration (one alternative to ISDS, suggested by Dr Tienhaara), and I have already assisted various governments in “legal technical assistance” programs aimed at improving their domestic legal systems (another alternative favoured by the Gillard Government, but a costly one that takes time).
In her blog posting, Dr Tienhaara also remarks that the 2010 Report of the Productivity Commission (PC), which succinctly analysed ISDS before recommending that Australia seek not to include treaty protections for foreign investors greater than those offered to local investors, did not find a clear economic problem requiring such protections. The PC did canvass the argument that foreign investors encounter greater discrimination from some host states compared to local investors. But it pointed to an econometric study based on World Bank surveys from 1999-2000, which noted that foreign firms instead enjoyed regulatory advantages not shared by their domestic equivalents.
Yet that study also found that such relative advantages disappeared when foreign investors were benchmarked against politically-connected domestic firms; there was even evidence that foreign investors were then disadvantaged. Further, comparing foreign investors versus all domestic firms, a related World Bank study found that any “foreign privilege” phenomenon was stronger in Eastern Europe and South America compared to East Asia. For a more contemporary specific example of discrimination against foreign investors in our region, consider Indonesia’s new regulations requiring divestment of majority interests in mining investments. Such concerns on the part of Australian investors abroad appear to be the driving force behind the ACCI’s present campaign to bring back the possibility of ISDS in some future treaties.
Dr Tienhaara also highlights the PC’s other major finding, that econometric evidence does not clearly show that offering treaty-based ISDS protections significantly increases inbound investment. But the PC relied primarily on a Working Paper published in 2010 by the WTO, containing data only through to 2004, which in fact found a significant increase on one regression analysis regarding regional investment treaties. Some estimations and studies find significant effects, although others don’t. Econometrics is not an exact science, especially in the field of FDI, as I noted in a response last year. Anyway, econometrics only deals in aggregates. Australian policy-makers should concentrate, for example, on the links between ISDS protections and investment flows in the subset of Australia’s major existing and likely partners, particularly in Asia. As well as future quantitative analysis, qualitative evidence should be relevant – including views expressed by Australian industry groups on whether and how ISDS protections may impact on investments into Australia.
Thus, the evidentiary base provided by the PC is a weak foundation for Australia to “go it alone” in the Asia-Pacific region – altering our two-decade-long treaty practice by refusing now to countenance any forms of ISDS. Instead, while acknowledging that the benefits of ISDS may be less apparent or harder to prove than many had assumed, we should look for ways at minimizing risks and disadvantages that may be associated with ISDS. For example, concerns about “regulatory chill” from expropriation claims can be limited by tightly defining the scope of that protection, along the lines found in one Annex on ISDS (among several) in the Australia-Chile FTA signed in 2009. Indeed, if Australia caps treaty protections at its domestic law levels (such as “acquisition” under our Constitution), this obviates concerns about extra compensation payouts at taxpayers’ expense – yet Australian outbound investors could “take abroad” such protections, probably higher that those available in many developing countries.
Dr Tienhaara remains rightly concerned about delays and costs involved in ISDS proceedings. Indeed, more recent data from the OECD’s Scoping Paper (at p19) suggests that average legal and arbitration costs (in a subset of publically available cases) are around US$8 million. But that Paper also points out efforts recently to control costs by redrafting treaties and Arbitration Rules, and several Public Comments note that costs anyway must be assessed relative to complexity and the amounts in dispute. Other Comments indicate various ways to control costs more effectively, as further explored by me and Dr Kate Miles in 2009. Anyway, inter-state dispute resolution (not excluded under the TPS) is often costly and time-consuming, as WTO proceedings show. Domestic court proceedings, typically involving multiple appeals, can often be too.
There are also hidden costs in moving to a regime without any form of treaty-based ISDS. Dr Tienhaara suggests that investors can and should negotiate individual contracts with each host state. But often those would include an arbitration clause anyway, and ironically this risks diminishing transparency of any arbitral proceedings compared to contemporary investment arbitration. Anyway, individual negotiations will significantly increase drafting and negotiating costs both for investors and host states, adding for example to the Australian government’s growing bill for legal services. It also disfavours small- to medium-sized investors, as do inter-state dispute resolution processes, and the OECD Paper indicates that such investors (not just big bad tobacco companies) are significant users of treaty-based ISDS (pp 17-18).
Dr Tienhaara argues that investors can turn to investment (political risks) insurance. But such policies are often for shorter terms and cover more limited risks than contemporary treaties. Political risks insurers also often piggy-back on treaties providing for ISDS, and can be state-supported anyway. Private insurance is less readily available too, after the Global Financial Crisis.
Foreign investors have another, but very unpalatable “alternative” to ISDS, which is not considered by Dr Tienhaara or the PC: bribery of officials (and others) in the host state. Recently I co-authored a partly empirical analysis of why Asian host states and especially claimants appear relatively under-represented in investment arbitrations. One factor that has been highlighted to me in follow-up interview-based research is that Asian-based companies are perceived as more likely to bribe, particularly in some sectors (such as resources). That seems to be corroborated in the 2011 Transparency International survey of bribe-payers. If we want to reduce incentives for such egregious “investment risk management”, then ISDS can be an attractive measure. Anti-bribery conventions and legislation are not proving sufficient, as shown by the recent debacle in South East Asia involving a subsidiary of the Reserve Bank of Australia.
In sum, it is time to engage in fuller debate over Australia’s policy position on ISDS, including its theoretical and empirical foundations. More research is needed to justify the unusual shift, for a developed country, of completely eschewing any forms of ISDS. It may not completely stymie pending negotiations over important FTAs, such as the Trans-Pacific Partnership Agreement, but it will surely complicate negotiations as all other actual and potential parties (including Japan) have treaty practice now supportive of ISDS. There is a real risk that at the final stage of negotiations, Australia will either have to compromise its position, or give up a major trade or other concession, without an adequate “back-up plan” or full assessment of the real pros and cons involved in retaining some forms of ISDS.
Postscript (17 August 2012)
Dr Tienhaara has since posted a further blog entitled “Government wins first battle in plain packaging war”, which reiterates objections to all forms of ISDS. She concludes by urging other countries to follow Australia’s lead in “rejecting systems of international arbitration that enhance corporate power at the expense of democracy”, remarking that “The Philip Morris case perfectly highlights the many problems with investment arbitration, while the purported benefits of the system remain unproven”. Yet, as indicated above, there do appear still to be some significant benefits for states like Australia to maintain the widespread practice of providing for ISDS in appropriate situations, limiting disadvantages uncertainties (inherent in any form of legal dispute resolution) through careful treaty negotiation and drafting.
Further, the PMA arbitration is far from representative of ISDS proceedings. Out of 450 known investment claims identified by UNCTAD recently, brought under thousands of treaties over many decades, I am only aware of one brought by a tobacco company (against Uruguay, ICSID case ARB/10/7). Other ISDS claims are frequently initiated by SMEs, as shown by the recent OECD study. That also only identifies one other case involving alleged “post-dispute treaty shopping” (at p57: Yukos v Russia). The issue also arose in an ICSID claim against El Salvador (ARB/09/12), but in June 2012 the tribunal decided on the facts that there had been no abuse of process – while ruling against the investor on other grounds. Again, a better solution for now is to (re)draft investment treaties – ensuring there are clear rules on when investors can pursue ISDS claims, as well as appropriate exceptions for non-discriminatory public health measures.
[A shorter revised version of this comment is forthcoming on the “East Asia Forum”. It draws on research for my project on “Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific“, supported by the Commonwealth through the Australia-Japan Foundation which is part of the Department of Foreign Affairs and Trade. The views expressed are obviously my own, and do not represent Australian government policy.]

Author: Luke Nottage

Prof Luke Nottage (BCA, LLB, PhD VUW, LLM LLD Kyoto) is founding co-director of the Australian Network for Japanese Law (ANJeL), Associate Director (Japan) of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS), and Professor of Comparative and Transnational Business Law at Sydney Law School. He specialises in international dispute resolution, foreign investment law, contract and consumer (product safety) law.