As two major international trade agreements are being negotiated, an increasingly contentious debate is taking place on the need to include an Investor-State Dispute Settlement (ISDS) mechanism. This mechanism enables companies to sue governments and challenge legislation in arbitration courts (outside of domestic judicial systems).

In the EU, a growing debate is taking place around the inclusion of a chapter on ISDS in the Transatlantic Trade and Investment Partnership (TTIP) agreement, which is currently being negotiated with the US. While the European Commission is considering introducing changes in the ISDS mechanism to fix some of its flaws, major concerns remain on the reasons and the need for including such a mechanism in the agreement as ISDS could provide a way for US companies to undermine and circumvent EU legislation on data protection or intellectual property, for instance.

Some governments have started to reject this mechanism. For instance, Australia abstained from including an ISDS mechanism in the free trade agreement it negotiated with the US back in 2004. Recently the Australian government concluded that ISDS is not in its national interest and thus refused to be subjected to it under the Trans-Pacific Partnership (TPP), currently being negotiated between the United States and several countries of the Pacific Rim.

In this post, we’ll explain how ISDS does (and does not) work.

What is ISDS?

ISDS is a dispute resolution mechanism that originated in the 1950s to protect investors from arbitrary government actions and weak court systems in developing countries. For example, imagine that your company came to an agreement with a foreign state and decided to invest there by building a factory. Unfortunately, a few years later, once you have made your investment, the host country’s government decides to seize the factory. To claim economic compensation against this arbitrary measure and avoid the weak judiciary system of this country, you could file a complaint under the ISDS mechanism.

Over the years, the scope of the ISDS mechanism has moved away from simply providing investor protection and has been introduced into several free trade agreements between countries with functioning judicial systems. Problematically, ISDS now operates as an arbitration system with an increased scope, loose rules, and little accountability to the public.

How does ISDS work?

ISDS undermines state competence and operates in secret courts

Through ISDS, foreign investors are empowered to sue governments if changes in law affect their profits — or at least, the profits they “expected” — on a particular project. By giving companies equal standing with governments, ISDS empowers corporations to directly enforce a trade agreement, undermining the balance of power between the state and the private sector. While states are the ones negotiating and ratifying a treaty, through ISDS, companies have the ability to interpret and enforce it.

Disputes under ISDS take place in secretive tribunals with no institutional independence, enabling corporations to skirt domestic courts. Specifically, most of the disputes brought under ISDS are heard in the World Bank’s International Center for Settlement of Investment Disputes (ICSID) or the United Nations Commission on International Trade Law (UNCITRAL). Both international arbitration bodies dedicated to only hearing ISDS complaints operate with similar rules and procedures which exclude the public and do not allow human rights or consumer advocates to intervene. Disputes are heard and interpreted by three private sector attorneys designated as arbitrators. The nomination of arbitrators by both parties involved in a claim result in a lack independence and impartiality as arbitrators tend to focus more on pleasing the nominating parties in order to ensure that they are re-appointed in future cases. This situation has lead to a growth in the number of challenges to arbitrators, as they have been often perceived as “biased or predisposed.”

The scope and use of ISDS is constantly growing

The ISDS mechanism was ostensibly created to offer foreign investors protection against national governments confiscating private property. However, over the past decades, with the increase of foreign investments and through provisions included in NAFTA, the scope of ISDS has significantly expanded and now enables investors to sue governments over a wide range of vaguely worded provisions. However, the fact that these mechanisms are becoming more commonplace in trade agreements does not mean that they are legitimate or fair.

For instance, in November 2012, Eli Lilly & Co. initiated a dispute under NAFTA to attack Canada’s standards for granting drug patents, claiming that the invalidation of a patent undermined the company’s “expected future profits” demanding a compensation of $500 million. While the resolution of this dispute is yet to be known, the Canadian government is already starting to rethink its patent legislation in order to avoid paying this amount.

Under ISDS, not only can investors challenge governments when their property have been confiscated or their “expected future profits” have been undermined, but also when vague clauses pointing to a “minimum standard of treatment” or “fair and equitable treatment” have been allegedly violated. Those two clauses set up norms that governments agree to respect in order not to discriminate investing foreign companies. However, arbitrators are left with the task to interpret what constitutes “fair and equitable” treatment or what is the “minimum standard” of treatment. As a result, the number of disputes under ISDS has grown from fewer than 50 cases between 1950s and 2000 to 514 known cases between 2000 and 2012.

Through ISDS, companies can become lawmakers

While international arbitration tribunals cannot force a state to repeal or modify law, Investor-State dispute resolution can influence regulatory changes. For instance, in already two occasions, the threat of investors filing a dispute under the NAFTA agreement led the Canadian government to abandon its insurance regime and change its regulation on gasoline in order to avoid massive economic damages.

Through ISDS, deep-pocketed and influential firms have successfully challenged and undermined several environmental and consumer protections. A current dispute between Australia and the Tobacco company, Philip Morris Asia, under the 1993 Bilateral Investment Treaty between Australia and Hong Kong, might lead Australia to review its cigarette plain packaging legislation which is aimed at curtailing the harmful effects of smoking and improving the health of its citizens.

In the past, we have already witnessed companies’ intense lobbying activities trying to modify legislation in their interests. For example, following heavy lobbying by Microsoft and IBM, the US Government is pushing New Zealand to change its recently adopted regulation outlawing software patents, during the negotiation process of the TPP agreement. While it is already difficult to restrain this level of lobbying, through ISDS, companies would gain the ability to challenge this and any other type of legislation in secret court.

Negotiations on ISDS in the TTIP

The European Commission is now negotiating with the US authorities to include a chapter on ISDS in the future free trade agreement, TTIP. As this mechanism empowers large firms and endangers public policies, the European Commission faces opposition from citizens and civil society.

However, the Commission seems to be ignoring these concerns, as evidenced by the launch of its public consultation on ISDS. For instance, the exclusion of ISDS in the agreement does not seem to be an option as the Commission is only asking for comments on which type of ISDS people would prefer: an ISDS with a lot of loopholes or one with fewer.

Submission to this flawed consultation will be accepted until July 6. Access Now will be responding and encourage citizens to share their views on this mechanism and help limit companies influence in the lawmaking process.

Stay tuned for more information!