Very few aspects of international law cause as much consternation as Investor-State Dispute Settlement (ISDS). It is probably one of the very few features of Free Trade Agreement (FTA) negotiations that generate media headlines which capture the attention of the general public; often sensationalising the ‘secret courts’ entrenching the advantages of greed-driven multinational corporations. 

Despite the widespread ‘backlash’ against ISDS, originating primarily in academia, ISDS offers important procedural protections for foreign investors and should be retained in Free FTAs. On balance, it is an advantageous system that is conducive to foreign investment.

Simply put, ISDS enables legal claims to be brought by foreign firms against the states in which they do business. Such claims are typically based on rights created through international investment treaties (or the investment chapters of FTAs), such as guarantees against discrimination or full compensation in the event that the host state expropriates the investors’ assets. 

The availability of ISDS remains central to many firms’ decisions to invest in particular countries, particularly those where the rule of law is, or is perceived to be, weak or where courts lack independence.

What is ISDS?

• ISDS allows foreign firms to bring legal claims against host states in which they do business,
• Claims are based on rights established in international investment treaties or investment chapters of Free Trade Agreements (FTAs),
• ISDS provides procedural protections for rights such as guarantees against discrimination and compensation for the expropriation of investors’ assets.
• Modelled on international commercial arbitration, with arbitrators chosen by the parties and rendering legally binding decisions,
• ISDS offers advantages such as neutrality, cost-effectiveness, and faster resolution compared to traditional court procedures.
• It also provides confidentiality, allowing firms and states to avoid unwanted media attention.
• Awards are enforceable in courts around the world, enabling investors to use local legal systems to seize assets in the event of non-payment

Modelled on international commercial arbitration, ISDS rests on the consent of the parties who choose arbitrators who render legally binding decisions. This is in contrast to conventional national courts where judges are appointed by states, in some cases lacking independence or sufficient expertise in international commerce.

ISDS has been around for more than fifty years, originally created as a tool of economic development to mitigate risks of economic activity in politically unstable countries. It gained momentum in the late 1990s and by the first decades of this century, several hundred claims had been brought against host states by investors. ISDS appears in most of the many thousand investment treaties, although this trend appears to be reversing. Unfortunately, ISDS is now being extricated from FTAs. 

Why use ISDS?

In addition to its neutrality, as with most forms of arbitration, ISDS is usually cheaper and faster than normal civil court procedures. It also offers confidentiality, enabling firms (and states) to escape some of the harsh consequences of unwanted media attention.

The arbitration awards are enforceable in courts around the world, which is not always the case for civil judgments, many of which have no legal significance in foreign courts. It is no surprise that ISDS has become so popular for internationally mobile firms.

Critics of ISDS point to the high value of awards issued by tribunals, in some cases, placing burdens on host governments which must pay them. They further assert that the legal costs of ISDS are too high, often because of the long time frames of the cases, foreclosing the ability of smaller firms to use the system. The system is regularly accused of lacking transparency, essential due to the public nature of the claims brought as a consequence of government decisions. 

This backlash against ISDS is often grounded in broader criticisms of international investment treaties themselves. These instruments historically granted rights to investors with no corresponding obligations.

Protections have been based on vague standards, limiting governments’ capacity to regulate in the public interest for fear of claims adjudicated by international tribunals without any role for their own domestic courts. Many accuse ISDS tribunals of being biased against states, particularly those in the developing world.

While these assessments have some merit, many of these problems are exaggerated, or are manageable. Reforms to ISDS, instigated by UNCITRAL, ICSID and other bodies, have augmented the transparency and streamlined procedural rules with a view to reducing time frames and costs.      

New codes of conduct for arbitrators should help ensure that ISDS adjudicators are impartial, helping contribute to legally sound and consistent awards. Statistically, there is no evidence that arbitrators are biased in favour of investors. On the substantial elements of investment treaties, modern instruments have pulled back on protections for investors and enlarged the policy space of host states. 

Perhaps the greatest indictment of ISDS has been its one-sided nature – it is traditionally only available to investors who bring claims against states, not vice-versa. This appears to represent an inherent flaw in the system – reinforcing its illegitimacy as a forum of international law. 

It is important to point out that the availability of counter-claims by host states is increasing. New treaties have the capacity to impose environmental and social governance (ESG) obligations on firms which could be actionable through ISDS. 

More crucially, though, is the reality that host states are already in a position of dominance over foreign investors. For many businesses, it can take decades of costly investment before profits begin to appear. This is especially true in the extractive sector where mineral resources may not become profitable for twenty years or more, with sunk costs representing huge financial exposure. 

During this time, investors are incredibly vulnerable, subject to the whims of often volatile local governments where corruption or worse, political upheaval are endemic. While ISDS’s are admittedly unequal, they are designed precisely to rectify this imbalance.

ISDS in developing and developed countries

While these risks are not as prevalent in developed countries because of a more stable political environment and robust independent court systems, the risks still exist.

Investors may be as vulnerable to the vagaries of municipal or regional courts and governments in developed states, which may lack the rigour or integrity of their federal equivalents. Moreover, the time and expense of civil courts, particularly in advanced Western countries with a strong culture of combative litigation, can be prohibitive for smaller firms seeking to gain a foothold against larger market incumbents. ISDS, particularly with its recent reforms designed to lower costs, is well-suited to address these challenges, levelling the playing field and encouraging risk-taking enterprise.

Time and again investors have indicated that they value ISDS, especially in unsafe countries with untapped resources. Removing it from new FTAs, as has been the case for example in the USMCA, is likely to be a mistake.      

Moving forward, it would be advantageous that countries revisit the recent antipathy towards ISDS, and instead listen to the needs of the business community upon which the economy, and by extension society at large, relies for continued prosperity.