By Karthik Konath, Senior Editor
Before the official terms of the Trans-Pacific Partnership were even finalized, large outcries from the Sanders/Warren wing of the left had already began to ring. In February, Senator Elizabeth Warren penned an op-ed in the Washington Post in which she declared that a system of Investor-State Dispute Settlement, known as ISDS, would “undermine U.S. sovereignty,” suggesting that ISDS could be used to prevent the United States from raising the minimum wage and regulating businesses in the name of public interest.
In a statement following the release of the finalized text, fellow Senator Bernie Sanders upped the ante, saying, "The TPP would allow foreign corporations to sue federal, state, and local governments in an international tribunal for passing an increase in the minimum wage or any other law that could hurt expected future profits.”
The strong denouncement of ISDS by two public leaders of the progressive wing of the Democratic Party paints a dark picture of a world in which a trade deal such as the TPP were to pass with ISDS provisions. Before examining why the picture they paint is inaccurate, it would help to know what ISDS actually is.
What is ISDS?
Investor-state dispute settlement is a process that allows investors to seek redress before an international arbitration tribunal for abuses committed by a government. Examples of abuse include discrimination in favor of domestic corporations and interests, uncompensated expropriation of property, prevention of the free movement of capital, and denial of equal access and treatment in a court of law.
These tribunals provide both sides of international suits a neutral setting to prevent the bias that may arise in legal proceedings in the domestic court systems of the governments being sued. While instantiations of ISDS across thousands of investment treaties may vary in scope and procedure, the general principles remain consistent.
The process of initiating ISDS can generally be defined as follows:
If state A and state B are engaged in a trade deal that allows investor-state dispute settlement and state B violates the rights of an investor from state A that has invested in state B, the investor may submit to arbitration a claim that state B has breached an obligation.
These claims are submitted under the United Nations Commission on International Trade Law, or UNCITRAL, Arbitration Rules, the International Centre for Settlement of Investment Disputes, or ICSID, Convention, the Additional Facility Rules of ICSID, or less frequently, under other arbitration rules.
After the arbitration panel is established per the chosen rules, the case is argued until resolution is reached through either a settlement or a decision by the tribunal.
Generally, the tribunals only award compensatory damages, though on occasion they may order an injunction, a specific performance, or restitution; however, such non-pecuniary remedies are rare, and their enforcement even rarer.
Critiques of ISDS and the Trans Pacific Partnership
Potential for Biased Tribunals
In her opinion piece, Elizabeth Warren begins her criticism by claiming that ISDS tribunal judges would be highly paid corporate lawyers biased in favor of their corporate clients. This demonstrates a misunderstanding of the appointment of arbitrators and a lack of awareness of the results of past ISDS proceedings. As the International Bar Association points out, states and investors have the same rights with respect to appointing arbitrators. In a typical three-members tribunal, both the state and investor will appoint one arbitrator each. Those two arbitrators will then select a chairperson. If the two arbitrators cannot mutually agree on a chairperson, under ICSID rules – the most common rules for ISDS proceedings – the chairperson will be selected from a panel of arbitrators appointed by states.
A report from the United Nations’ Conference on Trade and Development notes that only twenty-five percent of all cases are decided in favor of the investor. To date, the United States has yet to lose an ISDS case brought against it. In fact, the United States has had its legal fees paid for by multiple complainants who brought frivolous suits. The fairness of the process governing the selection of arbitrators and the track record of current ISDS tribunals disproves Warren’s unfounded claims of bias in favor of investors in ISDS proceedings.
The Necessity of ISDS
Warren continues her attack with the claim that while ISDS may have been needed in the past to encourage and protect investment in countries that offer investors weak legal protections, TPP signatories are “hardly emerging economies with weak legal systems” and that in absence of ISDS, market competition would solve for countries’ political risk by incentivizing them to offer stronger legal protections in order to retain foreign investment. This argument doesn’t hold up to scrutiny for two reasons.
First, developed countries with strong legal systems are not immune to all of the problems ISDS seeks to remedy. The International Bar Association notes that investment agreements create international legal standards independent from a country’s domestic legal standards. Actions that are legally permissible in a given country may violate international trade law, which can leave domestic courts incapable of enforcing trade agreements. ISDS tribunals, however, have no such problem. The IBA further warns that “a national legislature may remove remedies under domestic law, which would leave the court unable to remedy even a violation of domestic law.” Therefore, ISDS provisions are necessary even in agreements between two developed countries to protect investors from abuse.
Second, removing ISDS protections and hoping “market competition” prevents poor legal protections does not resolve the issue of investors being denied justice from the legal system of the country in which they invested. Instead, it leaves investors with zero recourse outside of the country’s domestic legal system that, as discussed previously, may have few protections for investors.
Worse still, it introduces two new problems: Warren’s call for action to remove ISDS protections from treaties and let market competition handle everything would dry up foreign direct investment in developing countries where it is needed the most and leave investors hanging if reactionary leaders in countries that are normally less risky choose not to abide by existing contracts. For someone who recognizes that issues of injustice are best solved not by free markets but government intervention, Warren’s claim that market competition can solve these issues rings hollow.
The Usefulness to Small Corporations
Warren makes yet another obviously false claim when she says that only big corporations would be able to sue governments in ISDS tribunals. An OECD Working Paper titled “Investor-State Dispute Settlement: A Scoping Paper for the Investment Policy Community” found that “twenty-two percent of the claimants in both ICSID and UNCITRAL cases are either individuals or very small corporations” and that less than ten percent of claimants in both ICSID and UNCITRAL cases are major multinationals. Contrary to Warren’s claim, ISDS acts as a valuable protection for individuals as well as small and medium-sized companies against arbitrary and discriminatory actions by powerful governments where protections against direct and indirect expropriation are weak or non-existent.
The Risk to the US
Warren goes on to express her alarm at the increase in the number of ISDS cases from fewer than one hundred from 1959 to 2002 to fifty-eight in 2012 alone. The lack of ISDS cases from 1959 to 2002 can easily be explained by the lack of bilateral investment treaties with ISDS provisions, of which there were fewer than one hundred during the middle of the twentieth century. Today, there are over 3000 such treaties. Furthermore, the Center for Strategic and International Studies shows that the growth in ISDS cases tracks nearly perfectly with the growth in global FDI stock. The increase is not due to some nefarious corporate plot or wanton abuse, but rather a result of more states being eligible for such cases being brought against them.
She continues on to say that this explosion in the number of ISDS cases is likely to do “serious damage” to the United States. This claim isn’t particularly persuasive either, as the United States’ success rate in ISDS defenses is significantly higher than its success rate in defenses of similar cases in domestic courts and the damages awarded in ISDS are almost always solely compensatory, and as such do not cause serious damage.
The “Flawed” ISDS Cases
Warren then brings up a series of ISDS cases that she believes are flawed. She alleges a French company sued Egypt because Egypt raised the minimum wage, but the case she described, Veolia v. Egypt, was not a case over the minimum wage. The Washington Post Editorial Board said as much in their response to Senator Warren’s op-ed, writing that, “Critics trumpet ISDS horror stories, but upon closer inspection they generally turn out not to be so horrible,” and added that this case “would result, at most, in a monetary award to Veolia, not the overthrow of the minimum wage.” In summary, Veolia had a contract which provided that they would be compensated for any increases in operating costs they incurred during their creation of a greenhouse gas reduction program for Egypt. The minimum wage increase caused an increase of costs incurred during the project, so Veolia sued for compensation; the minimum wage increase was never in legal danger.
Vattenfall v. Germany, another case to which the Senator refers, was a Swedish state-owned company that sued for compensation because the German government violated their contract by shutting down a nuclear power plant owned by Vattenfall years ahead of schedule. Warren implies that Vattenfall attempted to prevent Germany’s objective to eliminate its use of nuclear power by 2022, Vattenfall is only using ISDS to sue for compensation of damages as a result of breach of contract.
In the case of Saluka v. Czech Republic, there was a clearly discrimination; the Czech government bailed out the three large Czech banks that did not have any foreign investors with a large minority share and did not bail out the only one that did. Instead, it took over that bank and sold it to another bank for about 4 cents. The tribunal correctly found that the Czech Republic clearly did not treat the bank with minority foreign ownership equally. While Warren was clearly wrong on the merits of the case, her criticism is further rendered moot since the TPP expressly prevents such a case from winning with its prudential exception clause.
Warren then tries to use Philip Morris v. Uruguay, a case that had not been decided at the time, to prove that ISDS prevents governments from regulating in the public interest. Many analysts said Philip Morris would likely lose, and lo and behold, they did roughly a year and a half after she penned the article, proving that government’s ability to regulate fairly in a non-discriminatory fashion will not be hampered. With consideration to current information, it is clear that none of the cases Warren named were poorly decided. Proper analysis and the passage of time vindicate the sobering claim of The Washington Post that the horror stories provided by critics of ISDS are inaccurate.
The “Future Profits” Criticism
Sanders, like many TPP opponents, claims that “The TPP would allow foreign corporations to sue federal, state, and local governments in an international tribunal for passing an increase in the minimum wage or any other law that could hurt expected future profits.” He, too, likely based his minimum wage claim on the common misunderstanding of Veolia. An increase in minimum wage alone would not allow anyone to sue successfully for compensation, so long as it is not discriminatory against foreign corporations.
Sanders also misunderstands how ISDS proceedings work by asserting that any corporation whose expected future profits are hurt by a government policy would be owed compensation. A plaintiff must prove that the law violated the trade deal by being discriminatory, violated some pre-existing contract, or prevented the government from meeting an obligation it had. As the TPP states plainly, “the mere fact that a Party takes or fails to take an action that may be inconsistent with an investor’s expectations does not constitute a breach of this Article, even if there is loss or damage to the covered investment as a result.”
Warren and Sanders are Wrong on Everything
In essence, ISDS acts as a check against arbitrary and discriminatory acts passed by a government under the guise of public interest in an attempt to exclude foreign investors. And despite claims to the contrary, it does not prevent governments from passing laws in the public interest, as demonstrated by the recent ruling in Philip Morris v. Uruguay.
Sanders’s and Warren’s criticisms of the TPP’s ISDS clauses are not borne out by the facts. The ISDS system set forth in the TPP is the product of a series of lessons learned after watching over a hundred countries enter thousands of trade agreements with ISDS systems within. New provisions that ward off frivolous claims, increase transparency in cases, deny benefits to sham corporations, and restrict forum shopping all create an ISDS system that protects the interests of all parties involved. There is a reasonable case that can be made against entering into ISDS agreements, but the Sanders/Warren one certainly is not it.