Role of Arbitration in Solving Investor-State Disputes: Advantages, Criticisms and Reforms

By Muhammad Faisal Hayat

The global economy now depends heavily on international trade and foreign investment for growth, which has increased the importance of investor-state disputes in both business and international relations. Typically, investor-state disputes arise when foreign investors, protected under treaties such as Bilateral Investment Treaties (BITs) or Multilateral investment Treaties (MITs), believe their rights have been violated by the host state and have disagreements over investment-related issues, resulting in economic losses or regulatory obstacles. This can include contract breaches, expropriation of assets, and discriminatory regulations by the host state. In order to establish a stable and predictable investment environment, it is crucial to resolve these disputes efficiently and fairly. Arbitration, a widely recognized method for resolving investor-state disputes as an alternative to traditional litigation in domestic courts. It provides a neutral and private forum in which parties can present their cases to an impartial tribunal. In this article, we will examine the role of arbitration in resolving investor-state disputes, its advantages, and its criticisms.

Role and Advantages

Figure 1: Network of Deep Trade Agreements

Image Source: Research Gate

Arbitration offers several distinct advantages over traditional litigation, making it an appealing choice for resolving disputes, particularly in an international context. Neutrality and impartiality constitute one of the most crucial aspects of arbitration. It provides a forum where both parties can present their cases to arbitrators who are exempt from any political influence or bias that may exist in domestic courts. Moreover, the flexibility of arbitration distinguishes it from the rigidity of court proceedings. The parties involved in arbitration are free to tailor the procedure to their particular needs. This adaptability is especially valuable in resolving complex international disputes that require unique approaches. The opportunity to select specialised arbitrators is a considerable advantage of investor-state arbitration. Parties can select arbitrators with expertise in disciplines such as international investment law, public international law, or particular industry sectors. This ensures that the decision-makers have the necessary knowledge and comprehension to effectively navigate the dispute’s complexities.

In addition, the enforceability of arbitral awards is a crucial factor that enhances their appeal. Generally speaking, international conventions, such as the New York Convention, simplify the enforcement of arbitral awards across different jurisdictions. This assurance of enforceability increases the efficiency of the arbitration process by ensuring that the final award will be recognized and upheld by courts worldwide. Therefore, the neutrality, adaptability, specialised expertise, and enforceability of arbitration make it an increasingly popular alternative to traditional litigation, particularly in international disputes. These benefits provide parties with the assurance that their cases will be heard in an impartial setting and that the final award will be enforceable and globally recognized.

Several tribunals have successfully arbitrated past disputes between investors and states and the following cases illustrate the importance of arbitration in resolving investor-state disputes and maintaining a balance between protecting the interests of foreign investors and respecting the regulatory sovereignty of host states.

Phillip Morris v. Uruguay: In 2010, Philip Morris International filed a claim against Uruguay with the International Centre for the Settlement of Investment Disputes (ICSID) of the World Bank. The dispute arose due to Uruguay’s strict tobacco control measures. The tribunal ruled in favour of Uruguay, upholding the state’s right to implement public health measures and establishing an important precedent for balancing investor rights and public policy goals.

Occidental v. Ecuador: In 2012, Occidental Petroleum filed a claim with the ICSID against Ecuador, alleging that Ecuador unlawfully expropriated its hydrocarbon investments. Indicating the significance of investor protection under international law, the tribunal ruled in favor of Occidental and awarded the company substantial compensation.

Unmasking the Flaws

However, the application of arbitration in this context is not free of criticisms and challenges. The absence of transparency in investor-state arbitration proceedings is one of the primary concerns. Due to the nature of the arbitration procedure, the details of the cases, including the arguments presented, the evidence submitted, and the ultimate awards, are frequently kept secret. While secrecy is necessary to safeguard sensitive business information, critics assert that excessive secrecy can hinder public oversight and accountability. When disputes involve matters of public interest, such as environmental regulations or public health measures, the lack of transparency raises questions regarding the legitimacy and impartiality of the process. Without public oversight, it may be impossible to determine if the arbitral tribunal acted impartially or if the parties influenced the decision.

The potential undermining of national sovereignty is a further significant criticism of investor-state dispute settlement clauses. It permits foreign investors to challenge domestic laws and regulations if they believe that their investments have been treated unfairly. While the intention is to provide an equitable and neutral process, opponents argue that this might limit a nation’s ability to regulate in the public interest. Governments may be hesitant to implement new regulations or enforce existing ones out of apprehension that foreign investors will file costly lawsuits. This may impair a country’s ability to implement policies that safeguard the environment, labour rights, or public health.

Another concern is the absence of a centralised international court for investor-state disputes. Consequently, various arbitral tribunals can construe investment treaties differently, resulting in inconsistent and unpredictable outcomes in similar cases. This lack of legal coherence and predictability can discourage foreign investment and generate uncertainty for investors and host states alike. Investors may be hesitant to invest in regions with an uncertain legal framework, and nations may be doubtful of the potential liabilities that could result from their policies or actions.

In addition, the lack of an appeal process in many investor-state arbitration cases raises concerns about the arbitrators’ accountability. Appeals provide a system of checks and balances in traditional judicial systems, where decisions are subject to review. However, in investor-state arbitration, arbitrators’ decisions are final and cannot be challenged effectively. Even though the majority of arbitrators are knowledgeable and impartial, the absence of an appeals process could lead to arbitrators exercising unrestricted authority.

The above concerns have been addressed by reforming investor-state arbitration systems. Some trade agreements such as United States-Mexico-Canada Agreement (USMCA) and Trans-Pacific Partnership (TPP) now include provisions for increased transparency, granting the public access to particular documents and proceedings. Moreover, there have been discussions regarding the establishment of a permanent international investment court to assure more uniform rulings and increase arbitrator accountability.

Thus, even though investor-state arbitration has benefits in resolving disputes between investors and host nations, it is not devoid of criticisms and obstacles. Concerns include the lack of transparency, the potential degradation of national sovereignty, inconsistent rulings, and the arbitrators’ lack of accountability. Striking an equilibrium between investor protection and public interest protection remains a difficult and ongoing challenge in international investment law.

Directing The Way Forward

In 2013, the United Nations Conference on Trade and Development (UNCAD) introduced five broad paths for reforming the international investment dispute settlement  (ISDS) system. They are as follows:

1. Promoting Alternative Dispute Resolution (ADR): This approach suggests using non-binding alternative methods like conciliation and mediation to resolve disputes instead of traditional arbitration. ADR focuses on finding fair solutions rather than strictly applying legal rights. It can save time and money and help maintain relationships between disputing parties. However, it might not always lead to resolution and may not be suitable for certain types of disputes.
2. Tailoring the Existing System: This path involves making individual modifications to the ISDS system within specific investment treaties. Procedural changes, transparency enhancements, and clarifications of substantive provisions could be applied based on each country’s preferences. While this allows tailored solutions, it does not comprehensively address all ISDS concerns.
3. Limiting Investor Access to ISDS: This approach aims to restrict the situations in which investors can use ISDS. It could involve reducing the scope of claims, restricting the type of investors eligible for treaty protection, or requiring the exhaustion of local remedies before resorting to arbitration. This approach could slow down the rise of ISDS cases and save resources.
4. Introducing an Appeals Facility: This option suggests creating a standing body to review arbitral awards. This facility would ensure consistency among awards and correct errors made by initial tribunals. It could provide authoritative interpretations of legal issues, making the system more predictable. However, it would require significant coordination among countries to establish and operate effectively.
5. Creating a Standing International Investment Court: This path involves replacing ad hoc arbitral tribunals with a permanent international court for investment disputes. Judges would be appointed or elected by states, ensuring impartiality and independence. This option offers consistency, transparency, and legitimacy but requires a complete overhaul of the current system and broad international agreement.

Arbitration: A Flawed Solution? The dependence of the global economy on international trade and foreign investment has increased the importance of investor-state conflicts. Due to its neutrality, flexibility, specialized expertise, and enforceability, arbitration has emerged as a crucial means of resolving such disputes. Notable cases, such as Philip Morris v. Uruguay and Occidental v. Ecuador, demonstrate the effectiveness of arbitration in achieving a balance between investor rights and public policy objectives. However, the arbitration system has been criticized for its lack of transparency, potential erosion of national sovereignty, inconsistent rulings, and absence of an appeals procedure. Reform alternatives include fostering alternative dispute resolution, tailoring the existing system, limiting investor access to arbitration, introducing an appeals mechanism, and establishing a permanent international investment court. In international investment law, striking an equilibrium between investor protection and public interest remains an ongoing challenge.

The views and opinions expressed in articles submitted to the Comparative Advantage Blog are those of the author and do not necessarily reflect the views of The Moot Court Bench.