ISDS in EU FTIAs. Yes, No, Maybe? A Domestic Enforcement Perspective

by  Szilárd Gáspár-Szilágyi

I. SETTING THE STAGE

In recent years ISDS has been on the lips of many politicians, academics, NGOs and even laymen, some of whom have recently ‘discovered’ that there is a mechanism through which foreign investors (often large multinationals, but not always) can bring claims against host-states before an international arbitral tribunal. The arguments in favour and against ISDS are plentiful, but one always catches my eyes. According to this argument (page 3), the EU does not need ISDS in its new free trade and investment agreements (FTIAs) with developed states, because the original rationale of this mechanism was to protect foreign investors from host‑state jurisdictions where basic tenets of the rule of law were not observed. However, trading partners such as the US or Canada have well‑functioning judicial systems that protect foreign investors; therefore, ISDS is not needed.

As a novice to the field of EU investment law, I must confess I am not yet fully convinced by the benefits of ISDS. Nevertheless, the afore-mentioned argument resonates with my previous field of research, concerned with the domestic enforcement of EU and US international agreements, and once again illustrates that there is often a disconnect between the international and the domestic enforcement of treaties.

I will not advocate for the ‘greater’ protection of foreign investors. Instead, I want to shed some critical light on the argument according to which foreign investors already enjoy high levels of protection in advanced domestic judicial systems. I will argue that the domestic protection of foreign investors is more complex. On the one hand, foreign investors can bring a claim before a domestic court against the host-state, invoking domestic standards of protection. On the other hand, they could also potentially bring a claim before the same domestic courts, relying on international standards of investment protection. As I will illustrate, the international and domestic levels of enforcement should not be treated as worlds apart and the interplay between the two can shape the strategies of the treaty negotiators and of the investors.

II. SOME CURSORY EXPLANATIONS

Some cursory explanations are needed before proceeding.

First, with regard to the judicial avenues foreign investors have against host-states, three come to mind: (a) bringing a claim before an investor-state tribunal; (b) bringing a claim before a domestic court, based on domestic and/or international standards of protection; and (c) private commercial arbitration based on a contract between the investor and the host‑State.

Second, the recent EU FTIAs with Canada, Vietnam, Singapore and the TTIP proposal all include investment chapters that are made up of three parts: (a) an initial part on what constitutes an investment and who qualifies as an investor; (b) a part on standards of investment protection and principles the host-state must ensure (MFN, FET, prohibition of all types of expropriation, etc.); and (c) the ISDS mechanism.

Third, as Semertzi has noted in 2014, recently concluded EU free trade agreements in some form or another are precluded from having ‘direct effect’ in the domestic (EU and MS) legal orders. The recent EU FTIAs are not any different and they all include a clause according to which the FTIAs do not grant rights to private parties and/or that they cannot be directly invoked before domestic courts (Article 30.6 CETA; Article X.19, Chapter 17, EU-Vietnam; Article 17.15, Chapter 17, EU-Singapore). Without going into a debate on what is meant by ‘direct effect’ (see here and here), for the purposes of this short piece the afore-mentioned clause shall be dubbed as a ‘no direct effect’ clause. This clause is very important since it prescribes the domestic effects of FTIAs vis-à-vis private parties. According to the CJEU, it shall only decide on the internal/domestic effects of EU international agreements, if the contracting parties have not done so (Air Transport Assoc. of America, para. 49). Since this has already been settled by the treaty parties in the recent FTIAs, it follows that foreign investors cannot rely on EU FTIAs before EU or MS courts to challenge EU or MS measures which are inconsistent with the FTIAs.

Fourth, whenever looking at domestic cases that involve international agreements, several factors are important to look at: the type of international agreement that is invoked, the party bringing a claim under the agreement, the measure against which the claim is brought and the court where the case is launched. Thus, claims can be brought to challenge both EU and MS measures before the CJEU or MS courts for their compatibility with various international agreements. Nevertheless, as Mendez has concluded, the CJEU resorts to ‘avoidance’ techniques when EU measures are challenged for their compatibility with international agreements and tries to shield EU law from international obligations, compared to a more lenient approach when MS measures are concerned. Furthermore, since foreign direct investment (FDI) falls under exclusive EU competence (Article 207(1) TFEU), the CJEU has the power to decide on the domestic effects of the investment protection provisions of EU international agreements (Slovak Brown Bear, paras. 30-32; but we need to wait also for Opinion 2/15, EU-Singapore), even if a case is brought against a Member State measure before a Member State court.

Fifth, private claims before MS courts are launched according to MS procedures, while before the CJEU a private party can bring a case directly as an action for annulment (Article 263 TFEU), an action for failure to act (Article 265 TFEU) and an action for damages (Article 268 & 340 TFEU), or indirectly via the preliminary reference procedure (Article 267 TFEU).

Sixth, in the following sections four options are derived from the interplay between the international and domestic enforcement of EU FTIAs. When presenting the four options the following issues are discussed: (i) the optimal scenarios for investors and civil society. The Public Consultation on TTIP’s ISDS conducted by the EU Commission indicates a clear split between civil society’s rejection of ISDS and the business world’s approval of it. The optimal outcome for investors is if they have the possibility to bring a claim based on an EU FTIA before an investor‑state tribunal and before domestic courts, while the optimal outcome for civil society is if investors cannot bring an FTIA claim before any of the two judicial avenues; (ii) problems facing the domestic enforcement of ISDS awards; (iii) the need to keep the investment protection standards in the agreements or not.

This blogpost focuses on the domestic avenues of enforcement. This is in order to critically assess the argument that investors are provided high levels of domestic protection in the host entities.

III. FOUR DESIGN OPTIONS

EU negotiators have the following four options to choose from, depending on whether they would like to include or exclude ISDS (international enforcement) and ‘no direct effect’ clauses (domestic enforcement) in/from EU FTIAs.

Options ISDS ‘No D.E.’ Clause
Option 1 Yes Yes
Option 2 Yes No
Option 3 No Yes
Option 4 No No

Option 1: Both ISDS and the ‘no direct effect’ clause are included

i. This option is not optimal for either the investors or for civil society, but would please the investors. It is preferred in the new EU FTIAs: ISDS is possible but private parties are precluded by the agreements from relying on them before domestic courts. Therefore, if the foreign investor chooses to bring a claim before the CJEU or MS courts in order to challenge MS or EU measures for their incompatibility with the investment protection standards laid down in the EU FTIAs, it will be denied the possibility to do so due to the ‘no direct effect’ clause.

The investor would thus need to change strategy before the domestic courts. The domestic courts might resort to consistent interpretation of the domestic measure with the international provisions but in case of a clear conflict between the domestic measure and the international agreement, consistent interpretation reaches its limits (AMS, para. 39). Furthermore, as I have previously argued, the application of the Fediol and Nakajima exceptions outside the field of WTO law was all but closed by the CJEU. Therefore, domestic courts are not an option for investors if they want to directly invoke the investment protection standards of the FTIAs. The investors could still rely on MS and EU law provisions on the prohibition of discrimination, expropriation without compensation etc. However, standards such as FET are hard to find in domestic law.

In light of the above, the investor would probably prefer to resort to ISDS or private commercial arbitration.

ii. Another consequence of the ‘no direct effect’ clause is that it might hamper the enforcement of future ISDS awards. According to the CJEU (FIAMM and Fedon, paras 128-129), the decisions of an international body, which concern the compatibility of a domestic measure with an international agreement, which does not grant privately enforceable rights, shall also not be able to grant such rights to private parties. This is an area in which scholarship has recently commenced and more research is needed on the interplay between the domestic enforcement of ISDS awards in the EU legal order, the domestic enforcement provisions under the New York Convention and the ICSID Convention.

iii. In this scenario the FTIA’s investment protection standards need to be kept because they form the basis of the claim brought before the investor-state tribunal.

Option 2: ISDS is included but the ‘no direct effect’ clause is not

i. This is the optimal scenario for investors and the worst one for civil society. In this scenario ISDS is included, but the contracting parties have not decided on the domestic effects of the agreement (as has been the EU practice until very recently). Therefore, it will be up to the CJEU to decide on the effects of the investment protection provisions of the FTIAs, because FDI is an area of exclusive EU competence. However, as explained, the CJEU will be more eager to allow for private party enforcement of international agreement against MS measures but will resort to ‘avoidance’ techniques when EU measures are concerned.

Thus, the chances of successfully invoking the FTIA provisions before domestic courts against MS measures are higher than doing so against EU measures. This means that in case of EU measures the investor might prefer to resort to ISDS instead of EU judicial remedies. In case of MS measures or if the CJEU has a more open approach when EU measures are concerned, the investor will be able to invoke the FTIA protection standards against the domestic measures. Nevertheless, the question arises whether certain domestic courts, which might have never been confronted with international investment law, will possess the relevant know-how to interpret international investment provisions. As is well known, such terms as FET have caused heated debates among investment lawyers and investors might doubt whether domestic fora are capable of properly understanding how these terms should be interpreted.

ii. With regard to ISDS awards, the chances of their domestic invocation are quite high if the FTIAs are deemed to have ‘direct effect’.

iii. In this scenario the FTIA’s investment protection standards need to be kept because they form the basis of both the ISDS and the domestic claim.

Option 3: ISDS is not included but the ‘no direct effect’ clause is

i. This would be the optimal scenario for civil society, NGOs and parts of academia. Nevertheless, this is the worst scenario for investors. In this case ISDS is lacking and investors are precluded from relying on the FTIAs before domestic courts.

This scenario is similar to Option 1, with the difference that the investor cannot resort to ISDS. Thus, the investor would most probably resort to the less transparent commercial arbitration.

ii. In this scenario the domestic effects of ISDS awards do not arise.

iii. The investment protection standards included in the FTIAs are unenforceable via ISDS or domestic courts. Therefore, negotiators should simply not include them, unless state-to-state arbitration remains a possibility.

Option 4: Neither the ISDS clause, nor the ‘no direct effect’ clause are included  

i. This option is not optimal for either the investors or for civil society, but would please civil society. This scenario is similar to Option 2, without the possibility to resort to ISDS. Thus, the reliance on the investment protection standards of the FTIAs before domestic courts is conditioned by the tactics employed by the CJEU, depending on whether a MS or an EU measure is challenged.

ii. In this scenario the domestic effects of ISDS awards do not arise.

iii. The FTIA’s investment protection standards can be kept because investors have the chance to invoke them before the domestic courts. Nevertheless, the issue of whether some domestic courts have the know-how to interpret these standards arises.

 IV. SOME FOOD FOR THOUGHT

In this short exposé it is impossible to account for all factors (length of proceedings, amount of obtainable compensation, etc.) influencing an investor’s choice of forum for adjudication or the choice of treaty negotiators to include international and/or domestic enforcement mechanisms. Nevertheless, it shows that the argument, according to which the investors are sufficiently well protected domestically in developed entities, needs to be more nuanced. The domestic protection of foreign investors covers a more complex situation that involves not only reliance on domestic standards before domestic courts, but also the possibility or not to rely on international investment protection standards before the same courts and the option to use other available avenues. These considerations can in turn influence the choices of treaty negotiators and of foreign investors.

If the EU insists on including investment protection standards in its FTIAs, but is willing to give up ISDS, then the question arises whether there is still a need to spend time negotiating complex standards of investment protection. In case the lack of ISDS is coupled with a ‘no direct effect’ clause, then the inclusion of such international standards is a redundant exercise. Investors will have to choose between relying on domestic law before domestic courts, lobbying their home-state to launch state-to-state dispute settlement or to use the less transparent private commercial arbitration. Given the length of domestic proceedings coupled with the impossibility of invoking international standards, and the difficulty to convince the home-state to further their case, the likelihood is high that the investors will choose commercial arbitration.

On the other hand, if the EU insists on including investment protection standards in its FTIAs, but keeps ISDS, then the incentives of the investor not to rely on domestic courts are fairly high; especially, if the presence of ISDS is couple with a ‘no direct effect’ clause.

This short piece will form the basis for further research into the necessity or not for investment protection standards and ISDS in EU FTIAs, by thoroughly taking into account the domestic avenues of enforcement and their influence on the choices of treaty negotiators and investors.

5 comments

  1. Laurens Ankersmit

    Dear Szilárd, when you say that ‘the likelihood is high that the investors will choose commercial arbitration’ (in the conclusion), what is your basis for such a claim? You are presuming that there is a contract between the investor and the state, which is certainly not always the case. Second question: could you please clarify whether you think that the domestic levels of protection in the EU legal order are sufficient or not sufficient for Canadian investors, and if not, why not. This really seems to be the basis for your claim that ISDS might be needed, because recourse to international standards is necessary and denial of direct effect prevents this. Thirdly, if there is an explicit choice to deny direct effect by the Treaty makers, isn’t that because they choose to leave the implementation of the Treaty obligations up to the executive and the legislature, instead of the judiciary? So shouldn’t you be advocating implementation of these obligations in the EU legal order instead?

  2. Szilard Gaspar-Szilagyi

    Thank you for the comments Laurens.
    1. From what I gather from my colleagues who deal with investment law either as academics or as practitioners, the ‘anecdotal’ evidence points in the direction of investors choosing commercial arbitration if the ISDS or domestic courts option becomes too long and burdensome. Clear empirical analysis is lacking but it is also very difficult to gather since most of the commercial arbitration is unfortunately private and for many no records exist. There is a lack of evidence for example to indicate what are the benefits of commercial arbitration over ISDS (more expedited proceedings? more compensation awarded? more secrecy? clearer substantive legal bases?, etc). You are right of course to say that commercial arbitration is available only if there is a contract between the investor and the host-State. However, nowadays investors will almost always conclude a contract with the State if it concerns public services, works, etc. furthermore, a lot of the cases that go before ISDS could also be brought under commercial arbitration because they often concern the revocation of some form of license, subsidy, etc, that formed the basis of the investment. As I have explained, in a short blogpost it is difficult to account for all the factors that influence the choice of forum by investors.
    2. When it comes to the domestic levels of protection I wanted to emphasize the various ways that domestic protection can occur in the enforcement phase. That is why I say that the often circulated argument mentioned in the post needs a more nuanced discussion given the complexity of these issues. Domestic protection via judicial enforcement can be done either by allowing the investor to invoke only national norms or/also international standards if they exist. I do believe that in the EU, Canadian or US investors will face equal protection. I do not believe some of the anecdotal examples always mentioned, of biased Romanian and Bulgarian courts or biased Mississippi courts in the US. So I would be ok if ISDS didn’t exist. But as an academic I am trying to be neutral and always discuss both sides of the story.
    Without ISDS these agreements would take much less time to negotiate (look at Joost Pauwelyn’s argument on the World Trade blog). Nevertheless, Europeans tend to forget the other aspect of the discussion. The European investors in the US or Canada. Should they get then extra protection or not in the US or Canada? What about EU investors in certain Asian or African countries? I think politically it is difficult to get rid of ISDS for several reasons a) for the Commission it is hard to ‘sell’ a trade agreement based on differential treatment, telling for e.g. Vietnam that ISDS is needed with them (because we don’t trust their courts), but not with Canada because they are the good guys. Then we either include it with everyone or with no one b) there was a very good article in the last issue of the JWIT by Robert Basedow on how foreign direct investment got into the TFEU. Turns out it was the Commission that pushed for it all along during the Constitutional Convention and they sneaked in the 3 words of FDI via the backdoor when politicians were not attentive. So it cannot be argued that in 2001-2 when these negotiations were undergoing the business world pushed for it. At that point in time most investors didn’t even know about BITs or ISDS. Of course, now they do. C) Countries such as Germany, the Netherlands, who have invented the whole system of BITs and ISDS, cannot make their own BITs anymore due to the EU taking over such competences. So then someone has to take up their agenda, and this will be the Commission. What I do not agree with in the European discourse is the often fairly hypocritical attitude according to which we think that all of a sudden US companies will exploit poor European countries and they will impose lower standards on us. In many areas, such as car safety, toys, electronics the US often has higher standards than the EU. Furthermore, EU countries invented this system and EU firms are the biggest users of it, even in intra-EU contexts against countries such as Romania, Czech Republic, Hungary, Slovakia, etc.

    3. The whole question of direct effect is more complex than this. I recommend you this paper of mine from the European Law Review – https://www.academia.edu/6976354/A_Look_at_EU_International_Agreements_through_a_US_Lens_-_Different_methods_of_interpretation_tests_and_the_issue_of_rights- There are 3 distinct issues: direct incorporation into the EU legal order (that is always the case according to the EU for EU agreements). Direct judicial application (should the judiciary apply it or does it need extra implementation by the executive or legislative?). Private rights/narrow direct effect (can private parties invoke international provisions and obtain domestic remedies). Unfortunately, the choice for ‘no direct effect’ in my opinion goes against the EU’s self-bloating idea that we are the defenders of international law and obligations. The true watchdogs are always the private citizens, who right now cannot even bring a claim directly under these agreements. This was a very clear political choice influenced by past experiences of the EU political bodies and the Member States in having their domestic measures challenged for non-conformity with international obligations. ‘Implementation’ is an often misunderstood term. If by it, you mean ‘copy pasting’ an agreement into an EU regulation, then I don’t see the point. Furthermore, this type of transposing via copy pasting is not an EU practice. The only domestic act is the Council decision by which it adopts the agreement. Implementation of course can also mean enacting further legislative, executive, administrative rules and in some cases those are needed. But this boils down to what the treaty provisions say. If you have a provision clearly stating that contracting parties shall afford investors treatment no less favourable than to their own nationals, there is nothing to implement. If the provisions says contracting parties shall endeavor to set up some kind of authority to deal with this, then of course that provisions needs further implementation. I am not a big fan of the ‘monist/dualist’ distinction because in practice it does not really work.

    • Laurens Ankersmit

      Thanks for the detailed reply I appreciate it.

      On 2) I appreciate the anecdote on the revised art. 207 TFEU, and yes I agree on the real reason this stuff is included is to make it easier to sell to developing countries which in my opinion does little to actually improve the standards of living in those countries (it is often sold as a way to attract investment there).

      On 3) Thanks for the reference. I agree private enforcement is the most effective way of enforcement, which also makes it politically contentious (take the WTO as an example). And this is the reason why direct effect can be denied by the Treaty makers, its a political choice. So you might have a preference for direct effect, but you can hardly make a legal case IMO on that TEU reference. No direct effect, in whatever form, is quite commonplace in international law.

      On 1) this is why States should never agree to commercial arbitration in a contract with an undertaking but always opt for the use of public courts. It’s public money after all. That being said, I’m not sure all your examples hold up as being something that can be subject of commercial arbitration, as generally these are public law measures.

  3. Jean F. Delile

    Very interesting analysis. A major advantage of domestic enforcement that could also be mentioned is the smaller costs of trials beforce a domestic courts. From a SME’s point of view, an action before an ISDS seems to be madness as “the costs of arbitration should be borne by the unsuccessful disputing party”. As the Ecosoc pointed out, average costs of USD 4m per party must act as a major deterrent to SMEs.

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