New Frontiers in International Arbitration for the Asia-Pacific Region (5): Mediating Japan-Korea Trade and Investment Disputes

Written by: Prof James Claxton (Kobe University), Prof Luke Nottage (Sydney Law School) & Dr Brett Williams (Williams Trade Law & CAPLUS Associate)

[This is a compilation of our two-part postings for the Kluwer Arbitration Blog, on recent bilateral tensions with regional and even global ramifications. They could generate complicated and protracted disputes across various forums and so arguably could benefit from formal mediation. Our analysis builds on brief discussions at and after a July symposium at HKU as part of a joint research project with USydney, and a longer version can also be found on HKU’s “ADR in Asia” blog. It will be tabled also at the second joint symposium, on Friday 15 November at Sydney Law School.]

1. Complex Multi-faceted Tensions between Japan and Korea

A media and geopolitical storm recently erupted after Japan introduced measures affecting exports to the Republic of Korea (Korea). Thunder sounded with Japan’s imposition of certification requirements on three chemicals needed by South Korean companies to make semiconductors, memory chips and displays for consumer electronics (the 4 July Measure). This was followed by lightning and rain when Japan removed Korea from its “white list” of trusted trading partners (the 2 August Measure), then threats by Seoul to retaliate by reducing military-intelligence cooperation and imposing countermeasures on trade. The growing tempest has brought about the worst breakdown in cross-border bilateral relations in five decades, generating both regional and global ramifications.

Differing rationales for the geopolitical storm have been given. The Japanese government and media tend to emphasise security concerns, namely on-shipments of such chemicals with potential military applications to North Korea, violating multilateral sanctions. The South Korean government and media, as well as some international news outlets, have often placed more emphasis on the possibility of Japan “retaliating” for an October 2018 judgment of the Supreme Court of Korea. That decision upheld lower court judgments from 2014 finding major Japanese companies, such as Nippon Steel, liable to compensate claimants alleging that they were forced labourers for the Japanese companies during World War 2. The companies, and the Japanese government, have argued that such claims were precluded by a bilateral treaty signed in 1965 to restore diplomatic relations. (Similar claims and defences but under different bilateral instruments have been raised before Japanese courts by Chinese war-time labourers, generating a settlement with Nishimatsu group companies.) A few media reports also speculate that Japan introduced export restrictions affecting Korea to bolster the appeal of the Abe Administration in upper House of Councillor elections, but it secured another solid victory anyway. Some media sources suggest that populist Korean President Moon Jae-in may be “playing to the base” too in domestic politics.

Introducing trade-restrictive measures, however, raises the potential for Korea to complain before the World Trade Organization (WTO). It brings to mind the claim successfully brought by the Obama Administration against China over 2012-14, resulting in China removing export duties and quotas imposed on rare earths, for which it similarly controlled almost all world trade. However, the general exceptions China failed to establish in that case, under Article XX of the General Agreement on Tariffs and Trade (GATT), dealt with health and conservation of natural resources. By contrast, Japan here could be expected to raise national security exceptions under Article XXI. There are even greater differences from a procedural perspective, which we focus on below. If indeed Korea files a formal complaint and an ad hoc panel rules against Japan, this would only come by next year at the earliest. By then the Appellate Body will likely lack sufficient members (full-time “judges”), due to the Trump Administration blocking new appointments until its concerns about dispute resolution and other aspects of the WTO system are adequately addressed. Accordingly, Japan could appeal any panel decision allowing retaliation for any GATT violations found, and then never come under pressure to remove or adjust its measures against Korea.

The situation becomes even messier when we consider below other potential inter-state dispute resolution processes. Japan could seek arbitration under the 1965 treaty, but that effectively requires the counterparty to provide further consent, which Korea does not seem to want to do. Japan might also consider litigating the treaty before the International Court of Justice (ICJ). Another option is to invoke inter-state arbitration under the Japan-Korea bilateral investment treaty (BIT) in force since 2003, and/or a trilateral investment treaty including China in force from 2014, underpinning cross-border relations among Asia’s three largest FDI providers. However, it may be difficult to prove that the Korean court judgments involved a procedural defect or discrimination towards the Japanese companies creating a denial of justice, contrary to the relevant treaty.

Part II in a separate posting will analyse a further possibility: the Japanese companies might directly initiate investor-state dispute settlement (ISDS) claims, as provided by both investment treaties in lieu of inter-state arbitration. This could theoretically include an application to the ad hoc arbitration tribunal to issue interim measures preventing enforcement of the Korean Supreme Court ruling, until the tribunal had finally determined claims such as denial of justice. However, this dispute resolution option generates legal and practical problems for the Japanese companies themselves, and the Japanese government due to some renewed sensitivity recently over ISDS in general. Because of these multi-faceted potential disputes, involving various treaties and parties, we will end by urging formal mediation to assist achieving a global settlement.

2. Japan vs Korea Under the 1965 Treaty or Investment Agreements

Procedural as well as substantive law complications arise under the 1965 Japan and Korea Treaty on Basic Relations. It purports to settle and foreclose claims related to the treatment of Korean nationals during the period of Japanese colonial rule before World War 2 in exchange for a payment by Japan to Korea of USD 2.5 billion (in today’s terms) and an offer of favourable loans to Korea. Japan and Korea disagree about whether the treaty was meant to settle only state-level claims or to also extend to private claims by Korean labourers against Japanese businesses.

Article III provides that disputes over treaty interpretation can be settled in inter-state arbitration should diplomatic consultations fail. Although Japan invoked this provision on 20 May 2019, after consultations following Korean court execution orders against Japanese companies, Korea has not consented to arbitrate or selected an arbitrator under the terms of the treaty. This effectively closes the door on the possibility as there is no authority named in the treaty for default appointments of party arbitrators. While Korea’s non-compliance with the arbitration provision may raise the issue of good faith under general international law in principle, the practical consequence for now is that arbitration is stalled, although Japan still seems to hold out hope that the Korean government will change its course.

Japan has also said it is considering bringing the 1965 treaty dispute to the ICJ. Like arbitration, this option would require Korea’s consent because, unlike Japan, Korea has not made a declaration that the jurisdiction of the ICJ is compulsory or elsewhere consented to give the Court authority over the dispute. While proceedings before the ICJ raise a different set of procedural considerations – including relative efficiency, confidentiality, and access to provisional measures – it is unclear why Korea would be more open to this alternative than arbitration if Japan were to move to institute proceedings.

Japan could therefore instead make collateral claims under the 2002 Japan-Korea BIT or the 2012 trilateral investment agreement between China, Japan and Korea, although the Japanese government does not seem to have raised this possibility publicly. Both instruments were in force when the dispute arose and each provides for mandatory inter-state arbitration supported by appointing authorities to act for non-participating parties.

Article 14 of the BIT would allow Japan to commence UNCITRAL Rules (ad hoc) arbitration against Korea. It usefully adds an expedited procedure for submissions, hearings, and drafting of the arbitral award, but envisages first “consultations” without specifying any time limit beyond which arbitration can be commenced. Japan may also be disconcerted that there is no express elaboration of a “loser pays” principle, as has become more common (although far from uniform) in international commercial and even investor-state arbitration. The starting point under the BIT is instead that each state bears costs equally, whatever the outcome, subject to tribunal discretion.

Under the trilateral agreement, Article 17 provides that Japan can commence arbitration under the UNCITRAL Arbitration Rules after a mandatory consultation period of six months beginning with a written request for consultations. The scope of the written request, concerning “any dispute relating to the interpretation or application of [the trilateral agreement],” may not be broad enough to include Japan’s request for consultations under the 1965 treaty on 9 January 2019. Assuming notice is not a hurdle, the arbitration procedure mostly mirrors the expedited process and division of costs terms found in the BIT. The most significant difference is that China would be permitted to make submissions and attend hearings as a right.

Apart from these procedural issues, arbitration under an investment treaty may not be attractive to Japan as it could narrow the scope of possible claims. Rather than deal directly with the questions of interpretation of the 1965 treaty, the arbitration would concern whether the Korean judiciary breached standards of treatment in the investment treaty by holding Japanese companies liable for forced labour. The standards for resolving this question are expressed differently in the instruments. The BIT promises state treatment that is fair and equitable without qualification while the trilateral agreement links fair and equitable treatment of investors to “generally accepted rules of international law” and goes on to stipulate that “a determination that there has been a breach of… a separate international agreement, does not ipso facto establish that there has been a breach [of the investment treaty].” Based on the broader treatment standard and indefinite consultation period, the BIT may offer a better option for Japan.

To prevail under either investment treaty, Japan would likely have to demonstrate serious procedural irregularities or prove that the Korean Supreme Court’s ruling was discriminatory and not merely that the court misinterpreted the terms of the 1965 treaty in reaching its judgment. There are a few public examples of investors challenging court judgments successfully on the basis of protections in investment treaties. Chevron notably convinced an investment tribunal to stay a 9.5 billion USD Ecuadorian court judgement against the company and ultimately recovered damages for denial of justice under the Ecuador-U.S. BIT and violations of customary international law. Yet the fit with the dispute between Japan and Korea is far from perfect. While the Chevron tribunal found that the court judgment was written by a third party in exchange for payment to the judge, there have been no such allegations of corruption against the Korean courts.

Even if Japan were to convince a tribunal that its nationals were denied justice by the Korean courts, the tribunal would not necessarily have to interpret the 1965 treaty to resolve the claims. Absent a ruling on the meaning of the treaty, the root cause of the dispute would remain unsettled.

3. Korea vs Japan in the WTO

So far, Korea has not filed any formal complaint under the WTO’s Dispute Settlement Understanding (DSU). In force from 1995, that allows an affected member state first to seek bilateral consultations, then request formation of panel of three ad hoc decision-makers, and then appeal any adverse ruling to the Appellate Body for review by a minimum of three “judges”. However, Korea instead has so far raised its concerns in this case to the WTO General Council, the WTO’s highest decision-making body comprising representatives of all member states. Korea may be seeking to raise wider awareness among them about the bilateral tension and thereby prompt an informal diplomatic solution, but raising matters in this forum could entrench positions. If Korea does file a formal complaint through the DSU, issues anyway are complicated in terms of substantive WTO law and especially under the current WTO dispute settlement regime.

We elaborate elsewhere the substantive issues. In short, Korea will claim that Japan’s 4 July Measure violates the Most-Favoured-Nation rule in GATT Article I because exports to other WTO Members of the three chemicals receive an advantage in the form of the expedited export facilitated by the bulk licences and that advantage is not extended to exports to Korea. It could similarly complain about the 2 August Measure, removing Korea from the white list of countries receiving less onerous treatment from Japan in relation to controls over exports of a broad range of goods.

Japan might then claim justification for both measures under GATT Article XXI, allowing a state to take “any action which it considers necessary for the protection of its essential security interests”. A recent WTO panel decision in one of several disputes between Russia and Ukraine, found that this exception is not completely “self-judging” (as asserted by Russia, as well as generally the USA,) so it had jurisdiction to examine the measures that Russia claimed were to protect its security. But the panel nonetheless found them justifiable, applying a two-step test.

If Korea does bring a WTO claim and Japan raises this particular security exception, a new ad hoc panel formed may not follow such legal reasoning and factual determinations may be difficult. There is further uncertainty because although the Russia-Ukraine panel decision was appealed, the Appellate Body is understaffed and cannot deal with it this year.

That understaffing points to an ever bigger, procedural problem for Korea. Even if it prevails on the merits before a WTO panel, this is unlikely to occur before next year. By then, however, another of the three remaining Appellate Body judges will have reached mandatory retirement. If the USA keeps objecting to any new appointments because of various objections to the DSU procedures and the wider WTO system, the Body will lack a quorum to decide any appeals, including for example by Japan if unhappy with the earlier ad hoc Panel. In other words, Korea will have achieved only a pyrrhic victory.

Various WTO members are trying to resolve the DSU breakdown. For example, the EU proposed amendments to the DSU in late 2018 that attracted support from Australia and Korea, but the USA was not persuaded. The EU and China apparently criticised April 2019 proposals by Australia and Japan as being too soft on the USA. China’s views towards the WTO dispute settlement system are unclear, after recently withdrawing from panel proceedings against the EU’s anti-dumping duties.

There are ongoing discussions for back-up plans whereby member states agree not to appeal or to substitute the usual two-tier DSU process with inter-state arbitration under DSU Article 25, rarely used since 1995 (as discussed on this blog here). But these plans are complicated and involve states opting in to a new dispute settlement regime. Such deep uncertainties over inter-state dispute resolution procedures further cloud the picture regarding a potential WTO claim by Korea against Japan.

To conclude so far, Japan can probably fend off WTO claims by Korea. However, on substantive and/or procedural grounds, Korea probably has a good chance of fending off claims brought by Japan under the two applicable investment agreements and the 1965 treaty. This leaves questions over potential investment agreement claims by affected Japanese companies, creating further complications and enhancing the need to try formal mediation, as we explain [below …].

4. Japanese Companies vs Korea Through ISDS

Apart from the difficulties outlined in our previous posting over proving a denial of justice, a major problem for the Japanese companies if they initiate ISDS arbitration is that they would have to fork out tribunal, lawyer and expert witness fees. Empirical evidence confirms those are often hefty, even if the claim ultimately succeeds, which is one major reason why investors try to mobilise and involve their home states even if relevant treaties allow them to “go it alone” by providing the option of ISDS as well as inter-state arbitration.

A major problem for the Japanese government, in turn, is that any ISDS claims brought by the companies would likely further incense not only the current Korean government, but also some groups within Korean society (including an association of judges). They and the then opposition party first became critical of ISDS especially as it was negotiated into the Korea-US Free Trade Agreement (KORUS) and their presidential candidate ran on a platform that was critical of ISDS. However, that candidate lost resoundingly, which practically ended the debate, and KORUS was brought into effect from March 2012. Nonetheless, ISDS also remained on the radar as the first-ever treaty-based claim was brought against Korea from late 2012 by a Belgian subsidiary of US-based Lone Star. The claim is still pending, despite some expectations it would be resolved by March 2019.

One Australian NGO now even interprets a recent Korean newspaper report of current Prime Minister Lee Nak-Yeon as suggesting that Korea may “abolish” ISDS. More likely he was expressing his personal views because Korea’s investment treaty policy and practice largely remain unchanged. This is evident from the recent Korea-Armenia BIT and Korea-Central America FTA, which both contain ISDS, although wider policy and practice have been evolving somewhat (e.g., regarding transparency in ISDS). Nonetheless, an ISDS claim by Japanese companies and/or an award favouring Lone Star would further inflame simmering political tensions. This potential is heightened as this year another US investor (Gale) has filed a notice to initiate ISDS regarding a development in Incheon, while Chinese and now Malaysian investors have filed notices regarding projects on Jeju Island.

Despite such practical difficulties, as early as 2014 (in the wake of the first-instance Korean court judgments against Japanese companies like Nippon Steel) Investment Arbitration Reporter commentators had reported that Japanese companies could be preparing ISDS claims against Korea. Apart from questions over the substantive grounds under the relevant treaties, outlined in our previous posting, another threshold issue to consider is: how likely are Japanese investors generally to bring ISDS claims anyway?

Japanese investors were initially very “reluctant claimants”, with an analogy potentially with Japan’s “reluctant litigants” as measured by comparatively few per capita civil suits filed in Japanese courts. In contrast to home countries with much higher ISDS claiming per capita (such as Canada, more so say than the US), there had been only a few indirect treaty-based claims from companies linked to Japan, notably Nomura via its Saluka Investments subsidiary against the Czech Republic (settled in 2007), and Bridgestone via a US subsidiary against Panama (with public hearings over the internet, 29 July – 2 August 2019, illustrating incidentally the growing transparency of ISDS proceedings). At least one other threatened ISDS claim was seemingly based on consent to arbitration administered by the International Centre for the Settlement of Investment Disputes (ICSID) contained not in a treaty but an investment contract, namely between an aluminium smelter consortium and Indonesia. However, this also settled (in 2013) so no arbitration was commenced by the Japanese investors.

Nonetheless, Japanese firms have filed three Energy Charter Treaty claims arbitrations against Spain since 2015. This follows the lead of investors from many other states, also impacted by Spain’s abrupt changes in renewable energy policy. Their precedents allow Japanese companies and their legal advisors to reduce costs and other “institutional barriers” to pursuing formal dispute resolution procedures. Nissan’s UNCITRAL Arbitration Rules claim in 2017 under the India-Japan FTA is even bolder, as few of the many ISDS claims brought against India (since a 2011 award for Australia’s White Industries) have involved investments in manufacturing. This claim may indicate a changing mindset among the leaders of at least larger Japanese companies, towards more active engagement in international arbitration. However, Nissan is quite unusual given its alliance with French shareholder Renault (although that relationship is itself now impacted by securities law prosecutions against CEO Carlos Ghosn).

Tracing the emergence of claims by Japanese investors generally, the possibility of ISDS claims against Korea now by Nippon Steel and other affected companies cannot be excluded simply on the basis say of some general “cultural” aversion to formal dispute resolution processes. As for those who still favour instead the “elite management” theory put forward for such aversion to explain low levels of civil litigation within Japan, whereby government and business elites divert cases away from formal dispute resolution, it is noticeable that peak business associations (especially the Keidanren) have long pressed for ISDS-backed investment treaty protections. And the Abe Administration since 2012 has signed 16 standalone BITs (all with ISDS), albeit still far fewer than Korea, as well several FTAs. This sends the message that investment treaties are important and to be used, paralleling more active engagement with ISDS in other parts of Asia especially as various “institutional barriers” slowly start to come down. However, in highly politicised cases such as this they are probably best used as part of a multi-level negotiation and an overall dispute resolution as elaborated in the concluding section below.

Article 15 of the 2002 BIT envisages the investor seeking “consultations or negotiation” with the host state for up to 3 months, then a notice of intent triggering a cooling-off period of at least another 3 months, before being able to commence arbitration under the ICSID Convention (as both Japan and Korea are parties), with its more favourable enforcement regime, or any other separately agreed Arbitration Rules. (Articles 17-18 exclude ISDS for disputes over prudential measures concerning financial services and temporary safeguards for cross-border capital transactions, which are inapplicable here.)

Article 15 of the trilateral agreement requires more details in the investor’s request for consultations so the dispute can be “solved amicably”, but if no settlement is reached after four months the investor can seek arbitration under the ICSID Convention, UNCITRAL Rules or any other separately agreed Arbitration Rules. The host state can require the investor to first seek administrative review under any local requirements, but only for up to four months before arbitration is commenced. (ISDS exclusions regarding certain intellectual property rights or temporary safeguards are again inapplicable here.)

Nonetheless, filings would mean investors incurring significant arbitration expenses up-front, with empirical studies on ISDS costs showing claimants are often unable to recover all lawyer and expert witness expenses even if successful. More importantly, filings by Nippon Steel and others would likely inflame the underlying tension, resulting in boycotts, protests or even strikes around their affiliated companies in Korea. Perhaps for such practical reasons, this point has not been raised by general media, relevant companies or the Keidanren, although the Investment Arbitration Reporter has reiterated the possibility of ISDS claims since the Korean Supreme Court judgment late last year.

5. Mediation to Assist a Negotiated Settlement

In light of this complex and delicate situation, how could a global settlement be reached? One possibility is for one or more affected Japanese companies to seek direct consultations with Korea, but include a request for mediation to help reach a negotiated outcome. Neither the BIT or the trilateral agreement mention mediation or conciliation, unlikely some investment treaties that refer to it as an option, but mediation can be agreed separately as neither treaty’s “fork in the road” provision preclude this possibility.

Recent empirical research highlights the pervasiveness of settlements even after arbitration is filed, contrary to some commentators’ scepticism. This therefore demonstrates the potential for even more settlements through greater use of investor-state mediation.

An advantage of such ad hoc mediation is that skilled mediators could also bring in the host states, and come up with a resolution of the disputes under the 1965 treaty and the WTO as well. Mediation has not been so popular in inter-state dispute resolution, but a recent successful settlement of a maritime boundary dispute between Australia and Timor-Leste has highlighted its wider potential for large-scale international disputes nowadays.

There are otherwise few signs that Japan and Korea will be able to work out the dispute on their own at the moment. President Moon has warned of a “prolonged” conflict and has committed that Korea “won’t be defeated again”, while Japan initially resisted engaging in negotiations after Korea refused to arbitrate under the 1965 treaty and is now ratcheting up pressure on Korea in the trade dispute. This suggests that the states’ positions have hardened as public sentiment on both sides has soured amidst protests, product bans, disruptions to business and tourism, and even self-immolation by Korean nationals in protest against Japan.

High-level officials from the US have tried to extricate the parties from their entrenched positions. An early offer by Donald Trump to mediate did not get traction, but the US has continued to try to play a role in resolving the dispute including calls for a “standstill agreement” to prevent further escalation of tensions. Yet the US suffers from a credibility problem, as the Trump Administration has itself been using trade policy in a more confrontational way, evidenced by the WTO Appellate Body problem and bilateral trade war with China. Some see that approach as having spread now to Japan’s dealings with Korea. Others urge the US to keep exploring ways to “quietly nudge” both nations to resolve their disputes, but acknowledge the limited scope for informal interventions even for a superpower.

Australian (former) officials or politicians from Australia may have a role to play, or from another influential state (such as Singapore) in current negotiations around the WTO DSU as well as a Regional Comprehensive Economic Partnership (RCEP, or ASEAN+6 FTA). Furthermore, Singapore is actively positioning itself as a proponent of international mediation, not least by hosting last week the diplomatic conference for a new UN Convention on cross-border enforcement of mediated settlement agreements – signing up along with 45 others (including Korea, China and the USA, but not Australia or Japan), attracting widespread commentary. Although the new treaty is designed to promote commercial and potentially investor-state mediation, it could heighten interest also in inter-state mediation.

It would further delay RCEP negotiations if there were a collapse in trust and values shared between Korea and Japan, including generally regarding ISDS and investment commitments. Already, some have suggested that this bilateral tension is behind Korea getting cold feet about seeking to join the regional CPTPP now partly in force, which Japan (with Australia and Singapore) pushed to bring into force after the Trump Administration withdrew US signature of the earlier Trans-Pacific Partnership FTA.

However, even Australia or Singapore could be seen as having their own interests in the bilateral spat. Better candidates as neutral mediators – especially for a more structured and sustained mediation process – could be senior figures (formerly) within the United Nations, such as UNCTAD, or another international organisation such as:

  • the OECD, although it is more policy – than practice – oriented;
  • the International Bar Association, which produced investor-state mediation rules in 2012, although those are hardly used so far and the Association’s leaders tend now to be full-time practitioners especially from larger law firms; and
  • the International Law Association, instead comprising mostly professors specialising in international law.

Both ICSID  and the Centre for Effective Dispute Resolution (CEDR) have started to promote investor-state mediation recently, including running courses with the International Energy Charter and International Mediation Institute to train up mediators for investment disputes. They too could be consulted for possible mediators, with experience also preferably in WTO law and broader international relations, especially in Asia.

Overall, successful mediation and negotiated settlements tend to arise in two ways. One is where the litigation behind the mediation, including likely costs and delays, has a predictable outcome. (This is one reason sometimes given for low levels of civil litigation in Japan, epitomised by traffic accident data.) But another is where the dispute becomes very complicated, allowing skilled mediators to help parties find novel ways to perceive and develop shared interests. This would not be possible before an adjudicatory forum, like the ICJ or an arbitral tribunal, with a limited mandate to decide claims. An imposed solution, with a perceived winner and loser, might also fail to calm the tide of nationalism, public unrest, and deteriorating relations between the countries. These circumstances offer both a unique opportunity for mediation as well as a challenge for international dispute resolution.

This analysis derives from a project on Asia-Pacific international business dispute resolution funded jointly over 2019 by the University of Hong Kong and the University of Sydney. It will be tabled at a second symposium on 15 November.

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.