International investment dispute settlement: from ad hoc arbitration to a permanent courtSeptember 7, 2015 - nr.95
Summary, conclusions and recommendations
ISDS: history and debate
Since 1959 states have concluded between them more than 3,000 agreements containing provisions on the mutual protection of investments (referred to below as IPAs). The settlement of disputes between states and investors through international arbitration (investor-state dispute settlement or ISDS) gives investors the opportunity to invoke these agreements directly. ISDS is an instrument which protects investors in two situations: first, where an investor’s own government is unable or unwilling to provide effective assistance through diplomatic channels and, second, where the national legal system of the host country, for any reason whatever, provides insufficient protection for foreign investors. ISDS also has the advantage of being a fast and flexible procedure. As a result, ISDS is increasingly being used alongside domestic court proceedings and protection through diplomatic channels.
After leading an inconspicuous existence for many years, ISDS has evolved rapidly in recent decades. The provisions on ISDS in modern treaties, such as the free trade agreement between Canada and the EU (CETA) and also in the model bilateral investment treaty of the United States differ greatly from the provisions in the IPAs dating from the 1960s. The number of cases brought under these agreements has also increased greatly (at present a few dozen a year), as has the total volume of direct foreign investment worldwide.
The cumulative number of known ISDS disputes (including pending cases) by end-2014 was 608, of which 356 had been concluded. The arbitral award was in favour of the state in 37% of the cases and in favour of the investor in 25% of the cases. The dispute was settled before the tribunal made an award in 28% of the cases. The outcome remained undisclosed in the cases that were settled.
The majority (but by no means all) of the claimants are large corporations from Western countries. The OECD concludes from a survey of 95 cases that 22% of the claimants are either individuals or very small corporations with limited foreign operations.
Research into the size of claims and damages awarded is hampered by the lack of transparency. In many cases the amount claimed is not known and some awards remain secret, even if the existence of the dispute has been disclosed. Examination of the scarce data (see section II.4) shows that the claimed damages averaged USD 343 million and the average damages awarded were USD 10.4 million, but it is uncertain whether this picture is representative of all concluded disputes.
The total volume of foreign investment in the world amounted to over USD 25,000 billion in 2014. The United States and the EU were major investors in each other’s economies. Over half of direct foreign investment in the United States comes from the EU, and the reverse is also true.
IPAs provide benefits for both the contracting states and investors. Investors can thus rely on protection of their investments, even if the host country’s legal system is weak. For states, an IPA is an aspect of a favourable investment climate which enables them to attract foreign investment. This boosts economic growth, innovation and employment.
The existence of sufficient protection for foreign investment is of major importance to the Netherlands. This is because the Netherlands is among the world’s largest sources and recipients of foreign direct investment. Dutch companies make relatively frequent use of ISDS.
The EU has recently (since 1 December 2009 when the Treaty of Lisbon entered into force) obtained exclusive competence in the area of direct foreign investment, but not other forms of foreign investment. The EU is therefore empowered to conclude IPAs with third countries (a competence which it shares with the member states if the IPA has a broader scope).
Investment protection has recently become a topic of public and political debate, particularly as a result of the negotiations between the EU and the United States on the Transatlantic Trade and Investment Partnership (TTIP). This raises the question of the balance between the interests of free trade and investment on the one hand and the right to regulate of the United States, the EU and the EU member states on the other. This concerns legislation on such fundamental matters as environmental and climate protection, energy generation, health, working conditions, intellectual property rights, telecommunication, e-commerce and data protection. It is advocated in the debate that the right to regulate in such fields be clearly defined and recorded in TTIP, so that the scope for interpretation in the event of dispute settlement through ISDS or the domestic courts is limited.
The debate also focuses on whether ISDS meets the rule-of-law criteria, such as consistency of arbitral awards, the independence and impartiality of arbitrators and the transparency of international arbitration.
The content of investment protection rules
Chapter II describes the international ISDS system. The substantive law provisions of IPAs (the rules governing the substance of investment protection) are very similar in broad outline. Their aim is to ensure fair and equitable treatment, prevent discrimination and lay down conditions for expropriation. Concepts that occur in such agreements are national treatment, most-favoured-nation treatment (MFN) and/or fair and equitable treatment (FET). National treatment means that foreign investors have to be treated the same as national investors. MFN obliges states to treat foreign investors at least as well as an investor from the most favourably treated third country. Although FET has its origins in the standard of customary international law for the minimum protection to be afforded to aliens, it is usually interpreted nowadays as the requirement that a host state provides a fair procedure for the investor.
ISDS has existed for only a few decades and is an area of the law that is still evolving. This is one reason why older IPAs often contain fairly summary ISDS provisions, which leave arbitrators considerable scope for interpretation and the exercise of their discretion. The experience of ISDS in these older IPAs has shown that although ISDS is in itself a good way of settling international disputes, it is necessary to learn from the defects of the older agreements and take the next step in developing ISDS. A logical step would be to introduce more detailed ISDS provisions in the new agreements. In particular, it would be desirable to formulate the intentions of the contracting parties more clearly in the substantive law provisions of the agreement (rather than in the more generally worded preamble). If even concepts such as MFN and FET, which form the core of many IPAs, are not defined more clearly in these agreements, arbitrators will have to continue guessing at the intentions of the contracting parties. In these circumstances, other measures (such as promoting the independence and impartiality of arbitrators or establishing an appellate mechanism) will not provide the desired legal uniformity. There is also a risk that ISDS may lead to socially undesirable outcomes if more precise definitions are not included in IPAs.
Investment protection procedures
An international investor who is party to a dispute can often choose between different sets of procedural rules for ISDS. The most commonly used rules are those of the Washington Convention (1965). They provide for a procedure which is entirely separate from national judicial decision-making. Under these rules arbitration can be facilitated by the International Centre for Settlement of Investment Disputes (ICSID), which is part of the World Bank Group. Much use is also made of the rules of the United Nations Commission on International Trade Law (UNCITRAL). These provide for a procedure that is heavily reliant on domestic law and the domestic courts, for example in relation to the enforcement of arbitral awards. Usually the Permanent Court of Arbitration (PCA) provides for arbitration proceedings under these rules. The PCA also provides facilities for arbitration under all other procedural rules.
Establishment of a permanent international investment court
Chapter III shows that the ISDS system has failings. There is criticism of ISDS from the rule-of-law perspective (independence and impartiality of arbitrators and the transparency and coherence of arbitral awards), and there are concerns that it may compromise states’ right to regulate. This right to regulate is dealt with below.
The AIV believes that from the rule-of-law perspective a permanent international investment court, with tenured judges, would be better equipped than ad hoc arbitration tribunals to rule on disputes involving matters of major public interest. This is therefore the AIV´s preferred solution. Ideally, a permanent international investment court would have tenured judges, the substantive law would be the same for all states, all disputes would be dealt with in accordance with the same procedures, and a large number of states would be party to the founding treaty. However, establishing a permanent court for cases at first instance or possibly solely as an appellate body will take time. The AIV does not wish to underestimate its task and therefore makes suggestions below on how to achieve the best possible negotiating result on the ISDS provisions in TTIP and other future agreements containing such provisions. The AIV regards modernisation of the ISDS system as a second best option.
The establishment of a permanent international investment court with tenured judges will meet some of the rule-of-law criticisms of ISDS. The appointment of judges with a permanent and full-time position would provide more safeguards of independence and impartiality than the ad hoc appointment of (commercial) arbitrators. Arbitrators are accustomed to switching between the roles of arbitrator, state counsel and counsel for investors and may also hold other positions which could give rise to a conflict of interest. Unlike arbitration, where the parties to the dispute designate the arbitrators, the court would decide what judges hear a case.
The establishment of a permanent international investment court could also improve the consistency of rulings. Tenured judges would be more likely to consider themselves bound by precedent and, where there is reason to depart from an existing interpretation, to do so only if sufficient reasons can be given for the new interpretation. Coherence and consistency in the manner in which the dispute is concluded are ultimately in the interests of all parties to the dispute.
In practice, ISDS has proved itself a flexible and fast way of resolving disputes. Care should be taken not to lose this advantage if an international investment court is established.
Recommendation 1: the AIV recommends that the government examine whether the establishment of an international investment court would be possible in the context of TTIP. The establishment should preferably be arranged in such a way that other states can accede. The second best option would be to modernise the ISDS system.
The right to regulate and regulatory chill
States have the right to regulate. This is a consequence of state sovereignty. In exercising this right they must not breach their international obligations. ISDS may not – and does not – undermine the right to regulate. However, if states exercise their right to regulate, situations may arise in which investors are entitled to compensation. International law on the right to compensation in the event of direct expropriation is clear: a state may expropriate foreign property provided that this is in the public interest, is carried out in a non-discriminatory manner, under due process of law and against the payment of compensation to the investor for the loss or damage suffered. Indirect expropriation may occur where a state takes measures that permanently destroy the economic value of property almost completely in which an owner has invested, for example because the owner is prevented from freely managing or using the property. To determine whether there is indirect expropriation (and hence a right to compensation), a tribunal must examine each individual case in the light of the facts, the precise wording of the IPA and other relevant law. Sometimes a state may also be able to invoke the right to take such measures out of necessity. Regulatory chill may occur where states forgo the right to regulate or retract legislation for fear that foreign investors will file large claims.
The AIV believes that IPAs must strike a balance between the investor’s right to protection of ownership and the state’s right to regulate in the public interest. Both are legitimate interests. The right of states to regulate can be protected in various ways, namely by mentioning the right to regulate in the provisions of the IPA, clearly specifying what is meant by indirect expropriation and defining the exceptions to investment protection under the IPA. The AIV therefore advocates inclusion of these elements in the provisions of IPAs. Reference to the right to regulate should be made in the definition of indirect expropriation. It is essential for it to be clear from the provisions of the agreement that in determining whether there is entitlement to compensation a tribunal takes into account not only the impact of the measure on the value of the investment (sole effect) but also the object and proportionality of the measure in relation to the intended objective. These measures can reduce the risk of regulatory chill. These elements can be found in the text of Annex X.11 to CETA, which contains binding provisions. This limits the scope for investors to successfully claim compensation in response to any non-discriminatory government measure designed to protect public welfare objectives. The AIV believes that these elements could greatly reduce the risk of limitation of the right to regulate and the risks of regulatory chill.
At national level the right to regulate is often restricted by the checks and balances that are an integral part of the rule of law in a democracy. And at international level the right to regulate may be limited by the obligations voluntarily entered into by states, for example in the context of the World Trade Organisation (WTO), IPAs or other treaties.
The establishment of a permanent investment court would not provide better protection for states’ right to regulate and would not reduce the risk of regulatory chill. These issues must be resolved by better drafting of the substantive provisions of IPAs.
Recommendation 2: the AIV recommends that the following elements be included in the provisions of IPAs: explicit mention of the right to regulate, a precise definition of indirect expropriation, and descriptions of exceptions to the protection of investments under the IPA.
Independence and impartiality of arbitrators
The AIV has expressed a preference above for the establishment of a permanent international investment court. However, it can be expected that such a project will take some considerable time. The AIV has therefore expressly decided to include in this advisory letter consideration of how the existing forms of international dispute settlement through arbitration could be improved. This includes ways of improving procedure and the establishment of an appellate mechanism. An appellate body could be the forerunner of a permanent international investment court, in which case it would make itself redundant in its original capacity.
Arbitrators must avoid any semblance of dependence or bias. This is of crucial importance to the legitimacy of ISDS. The existing ISDS procedures contain few safeguards for the independence and impartiality of arbitrators. The parties to a dispute may choose arbitrators, and the existing rules contain few requirements for arbitrators. Moreover, codes of conduct for arbitrators are not binding. Two improvements would be an obligation for the parties to a dispute to choose arbitrators from a permanent list of qualified candidates and the introduction of a binding code of conduct. The independence and impartiality of arbitrators could also be enhanced if their appointment could be challenged.
The AIV endorses the view of the Minister for Foreign Trade and Development Cooperation on the desirability of introducing an improved code of conduct for arbitrators and preparing a list of independent and qualified arbitrators.
Recommendation 3: the AIV recommends that provisions be included in IPAs to oblige parties to choose arbitrators from a permanent list and to introduce provisions in a code of conduct limiting the scope for arbitrators to take second jobs and swap professional roles. CETA’s provisions on this subject are an improvement on earlier IPAs.
ISDS can take place in secrecy. This is at odds with the duty of accountability of democratically elected governments. The secrecy of such proceedings could make it impossible for governments to render account for matters in the public interest such as health or the environment, on which democratic decisions have been taken. This is unacceptable. Enhancing transparency is an important way of increasing the legitimacy of ISDS.
Recommendation 4: the AIV recommends that transparency should be the rule. Grounds for limiting transparency are state security and the confidentiality of business information. The AIV also recommends that the subject of transparency be regulated in an IPA, which should specify in what cases the requirement of a public hearing can be waived. The Minister for Foreign Trade and Development Cooperation has already stated her preference for greater transparency.
Coherence, consistency and legal certainty
A few cases are known in which tribunals have given conflicting rulings in comparable cases. The main causes of inconsistency are the defective wording of provisions and inadequate definitions of terms in IPAs, as well as the varying ways in which they are interpreted by arbitrators. The best-known examples of inconsistency are the ISDS cases in response to the measures taken by the Argentine government in combating the economic crisis in 2001 and 2002. Sometimes it is even hard to determine whether inconsistencies have actually occurred, since the applicable substantive standards and facts differ from case to case.
One important way of preventing inconsistency in arbitral awards is to ensure that the text of IPAs is drafted unambiguously. This is already being done more and more in modern IPAs. In addition, the contracting parties can provide clarity about the correct interpretation of the IPA by publishing joint declarations. This responsibility can also be entrusted to a committee established by the IPA and consisting of representatives of the contracting parties.
Recommendation 5: the AIV recommends that the consistency of arbitral awards should be increased by drafting future IPAs better and, where necessary, issuing interpretative declarations about an existing IPA together with the other contracting parties. As regards TTIP, a committee of the contracting parties should be established to issue binding declarations about the interpretation of the agreement.
Recommendation 6: the AIV endorses the view of the Minister for Foreign Trade and Development Cooperation that the concept of MFN should be applied only to substantive standards, not to procedures, and recommends that this be recorded in IPAs (including TTIP). The AIV also recommends that the concept of FET should be defined more precisely in order to limit the scope for interpretation by tribunals.
Arbitral awards must give clear reasons and be accessible. Awards that differ from the commonly held view should be properly reasoned. The establishment of an appellate mechanism would be one way of correcting awards that differ markedly from the consensus view. The Minister for Foreign Trade and Development Cooperation has already stated her support for the establishment of an appellate body.
Recommendation 7: the AIV recommends the establishment of an appellate body to which states and investors could apply on limited grounds for review of an award. This would benefit the consistency of awards. The AIV recommends that the grounds for appeal be limited to cases in which it has been established that the arbitrators concerned were insufficiently independent of the parties, that the decision taken at first instance was manifestly arbitrary, that there was clearly no proper consideration of the relevant facts, that the assessment was demonstrably contrary to what is usual in international arbitration or that procedural standards were flagrantly violated. An appellate body should preferably consist of tenured judges since the risk of inconsistency is greater in the case of a court of fluctuating composition. However, the judges could be available on call on an ad hoc basis.
CETA and TTIP
The AIV considers that it would be desirable to include a form of ISDS in TTIP. It is doubtful whether domestic courts in the United States and the various EU member states are always able (or willing) to provide sufficient legal protection for foreign investors. It appears, for example, that preferential treatment for local investors is not prohibited in the United States. Similarly, international treaty obligations do not have direct effect in all legal systems of the contracting states. Moreover, there are still significant differences in how the judicial system functions in the different EU countries. ISDS should therefore be in a form which addresses the shortcomings described above.
In the AIV’s opinion, the concerns expressed above about states’ right to regulate, regulatory chill and the rule-of-law failings of ISDS are already addressed much more effectively in the free trade agreement between the EU and Canada (the Comprehensive Economic and Trade Agreement / CETA) than in the first generation IPAs. For example, CETA contains better definitions of the terms indirect expropriation and FET, thereby protecting states’ right to regulate more effectively than in older IPAs. CETA provides an opening for the establishment of an appellate body. It also makes it compulsory for arbitrators to comply with an existing code of conduct. Arbitrators are chosen from a permanent list. On the subject of transparency, CETA follows the UNCITRAL rules. This means that the parties to the dispute determine the desired degree of transparency. The AIV regards CETA as a big step in the right direction and a good model for TTIP, although transparency could still be improved. Transparency should be the rule; confidentiality should be the exception.
Changing the ISDS system will take time. New IPAs can be framed to take account of the latest thinking, but incorporating such thinking into the three thousand-odd existing IPAs is another matter altogether. The Netherlands has concluded some 90 bilateral IPAs, the oldest of which dates from 1966. The IPAs which the EU will conclude with third countries in the next few years will replace some bilateral IPAs between the Netherlands and these third countries. This will make it unnecessary to modernize these existing IPAs. However, the EU will not conclude an IPA within the foreseeable future with all countries with which the Netherlands has a bilateral IPA. In such cases it is necessary to consider amending the IPAs since the concerns about and criticism of ISDS may otherwise continue to exist in relation to them. Sometimes it may be possible to issue a declaration, together with the other contracting party, about the desirable interpretation of the agreement if a dispute arises between an investor and one of the contracting parties. This would enable pressing questions to be resolved quickly.
Government response to the AIV’s advisory report ‘International Investment Dispute Settlement: from ad hoc arbitration to a permanent court’
On 18 May 2015 the Advisory Council on International Affairs (AIV), acting on its own initiative, published an advisory report entitled ‘International Investment Dispute Settlement: from ad hoc arbitration to a permanent court’ (advisory report no. 95). The preparation of this report was prompted by the current political and public debate on the investment protection mechanism and investor-state dispute settlement (ISDS) through international arbitration. This debate is being conducted above all in the context of the negotiations on the Transatlantic Trade and Investment Partnership (TTIP). The subject of this debate is whether the conditions of ISDS still meet the rule-of-law requirements and whether the possibility of ISDS proceedings may make states reluctant to exercise their ‘right to regulate’ out of fear of receiving claims for damages from investors. The design of investment protection and ISDS is currently under review both in the Netherlands and elsewhere. In its advisory report the AIV considers this form of international arbitration from a rule-of-law perspective and makes a number of recommendations. Below is the government’s response to this advisory report.
The Netherlands is among the world’s biggest sources and recipients of foreign direct investment (FDI). International investment protection agreements (IPAs) are therefore of great importance to the Netherlands and to Dutch companies. They provide basic rules to protect foreign investors from unlawful government action. The rules are intended to ensure fair and equitable treatment, prevent discrimination and regulate conditions for expropriation. As such, they constitute an integral part of the Dutch legal system. Compensation is payable only if these basic rules have been breached. As the quality of national court proceedings or a fair trial abroad is not guaranteed everywhere, the ISDS alternative remains important. Other alternatives for dispute settlement, for example through diplomatic intervention or state-state dispute settlement, are not always suitable for specific disputes between an investor and a state, and entail the risk of the dispute becoming politicised.
The government acknowledges the concerns that exist about the current structure of investment protection, as regulated, for example, in the IPAs concluded by the Netherlands, and wishes to modernise these provisions. At present, this is the subject of a careful process of reflection in Europe. The Netherlands is making every effort to address the existing concerns and modernise the present mechanism. In view of the findings of a study on the benefits and risks of the investment protection mechanism in TTIP, commissioned by the Minister for Foreign Trade and Development Cooperation at the request of the House of Representatives, the Netherlands considers that improvements to the present system are essential (see Parliamentary Paper 21501-02-1397). Together with a number of other EU member states, the Netherlands has submitted further proposals to prevent improper use of arbitration, avoid conflict with normal legal proceedings and guarantee the right to regulate (see Parliamentary Paper 21501-02-1465). The Netherlands considers that improvements must be made in four areas:
- restricting the improper use of arbitration;
- ensuring the right to regulate, without the risk of arbitration claims;
- defining and clarifying investment protection standards;
- modernising ISDS (including greater transparency, improved selection of qualified and independent arbitrators, an appeal mechanism and the establishment of a permanent authority).
These proposals have been well received within the EU. The Dutch contribution was acknowledged in the proposals of Commissioner Malmström for investment protection and ISDS in TTIP and other trade and investment agreements, as presented on 6 May 2015 and discussed in the Foreign Affairs Council on trade on 7 May 2015 (see Parliamentary Papers 21501-02, no. 1499).
The government welcomes the AIV’s advisory report, which makes a useful contribution to the debate and formulation of investment protection policy. The report gives a good insight into the history and operation of investment protection, including such aspects as substantive law, procedures and the most common dispute settlement fora as well as the relationship between the dispute settlement procedure through international arbitration and national legal proceedings. The report also discusses recent developments and clearly explains the concerns about and criticism of the mechanism from a rule-of-law perspective. The AIV notes in this connection that the existing criticism often fails to distinguish between provisions from the first generation of IPAs and those from more recent treaty texts, such as the treaty between the EU and Canada – the Comprehensive Economic Trade Agreement (CETA).
The AIV notes that the dispute settlement mechanism between investors and states is a relatively new phenomenon which has been actively used only in recent decades. International arbitration law is therefore still very much in the development stage and some issues have not yet crystallised. Although the AIV regards the mechanism as a good way of international dispute settlement, it says that it is now necessary to address the mechanism’s failings, and makes seven recommendations for this purpose. Many of them support the proposals made by the Netherlands for improving the mechanism. The AIV also states that the regulation of investment protection and ISDS within CETA is a big step in the right direction. The AIV has a clear preference for the establishment of a permanent international investment court, but as it recognises that this may be a lengthy process it also expressly considers ways of improving existing forms of international dispute settlement through arbitration.
The government welcomes these recommendations, which are in keeping with the efforts made by the Netherlands to modernise the existing investment protection mechanism. The recommendations are also in line with the 14 points for improvement previously put forward by the government, following the findings of the study on the benefits and risks of the investment protection mechanism in TTIP, and elaborated in follow-up proposals.1 These proposals are in keeping with the four general areas for improvement set out above. The response to each individual recommendation is given below.
Response to recommendations
Establishment of a permanent international investment court
Recommendation 1: the AIV recommends that the government examine whether the establishment of an international investment court would be possible in the context of TTIP. This should preferably be arranged in such a way that other states can accede.
The AIV considers that, from a rule-of-law perspective, a permanent international investment court with tenured judges would be better equipped than ad hoc arbitral tribunals to rule on disputes involving matters of public interest. This solution could address some of the rule-of-law criticisms of the present dispute settlement mechanism. The appointment of judges with permanent, full-time positions would provide more safeguards of independence and impartiality than the ad hoc appointment of (commercial) arbitrators and may reduce the risk of conflicts of interest. Unlike arbitration, where the parties to the dispute designate the arbitrators, the court would decide which judges hear a case. The establishment of a permanent international investment court could also promote the consistency of rulings. A permanent international investment court would need to have a sufficient workload to justify the appointment of full-time judges. However, the AIV also warns that care should be taken to ensure that the advantage of ISDS through arbitration, which has proved itself a flexible and fast way of resolving disputes, is not lost if an international investment court is established. The AIV also recommends that the existing structures, for example the Permanent Court of Arbitration (PCA) and the International Centre for Settlement of Investment Disputes (ICSID), should serve as the basis for the establishment of a permanent court.
Although the AIV is in favour of establishing a permanent investment court, it believes that this may prove to be lengthy process. It notes that a treaty would be necessary to provide a legal basis for such a court and adequately regulate the legal status of the judges. Although the AIV does not believe this can be achieved in the short term, since it will be no simple matter to reach agreement at international level, it could be a long-term objective. The AIV also sees opportunities to establish a permanent court within the EU, initially on a bilateral basis, with an opt-in possibility for other states.
The AIV recommends that in the meantime the system of ISDS should modernised. The AIV makes suggestions on how to achieve the best possible negotiating result on the ISDS provisions in TTIP and other future agreements, including the establishment of an appellate body (see also recommendation 7).
If there is to be a modernised system of investment protection and a legitimate dispute settlement mechanism, it is important to set high standards for the quality and independence of arbitral tribunals. The recommendation that a permanent court should be established in order to put in place an improved and modern mechanism for investment protection is therefore in keeping with the proposals for improvements made by the Netherlands in this context, and the AIV report makes a useful contribution to the formulation of ideas on a permanent court. On this point the Netherlands supports the proposals of Commissioner Malmström. Her proposals, which would be in addition to the improvements already made to the system, concern the selection of arbitrators from a permanent list, the possibility of third-party interventions and a bilateral appellate mechanism to which other partners could accede. These proposals focus on TTIP as well as other future EU trade and investment agreements. The TTIP negotiations can help to introduce a new standard for investment agreements that incorporate the desired improvements. The Commissioner also proposes to work in parallel on the creation of a multilateral permanent court that has jurisdiction under the various agreements concluded between different trade partners (see also Parliamentary Paper 21501-02, no. 1499). This is a complex process that will have to be defined in detail. In the short term, it is important to establish a bilateral appellate mechanism between parties to a bilateral agreement.
A bilateral appellate mechanism could provide a way of correcting awards made by arbitral tribunals, provide a better safeguard of consistency in awards and increase legitimacy in terms of both substance and institutional design by providing better guarantees for independence, impartiality and predictability. These are major improvements that could be made in the short term and would be in keeping with the AIV’s recommendation. The government therefore regards this recommendation as support for its existing policy.
The right to regulate and regulatory chill
Recommendation 2: the AIV recommends that the following elements be included in the provisions of IPAs: explicit mention of the right to regulate, a precise definition of indirect expropriation, and descriptions of exceptions to the protection of investments under the IPA. It explicitly refers to the CETA text on indirect expropriation, which limits the scope for investors to successfully claim compensation in response to any non-discriminatory government measure designed to protect public welfare objectives. The AIV also points out that better drafting of the substantive provisions of IPAs would limit still further improper use of investment protection. At the same time, it is important for investors to be entitled to damages in the event of unlawful government intervention.
This recommendation is in keeping with the Dutch aim of clearly formulating and delineating the standards for investment protection so that the meaning of the provisions is clear. The government considers that the risk of regulatory chill would be reduced if the standards were defined more precisely in IPAs. The Netherlands seeks, above all, to arrive at an explicit provision confirming the right of states to regulate in the public interest. Other aims are to define the scope of investment protection more narrowly and introduce clear criteria on when a right to damages exists in the event of indirect expropriation, as included in CETA. A narrower definition should ensure that states are able to take justified measures (e.g. in relation to the financial services sector) and that proportionate measures taken in the public interest cannot be classified as indirect expropriation.
Independence and impartiality of arbitrators
Recommendation 3: although the AIV would prefer the establishment of a permanent court, it recognises that this may prove to be a lengthy process and therefore also expressly addresses the issue of how existing forms of ISDS through arbitration could be improved. The AIV makes proposals for modernising the procedure (safeguards for the independence and impartiality of arbitrators) and for the establishment of an appellate body. In doing so, it explicitly supports the Dutch position on introducing a new code of conduct for arbitrators and preparing a list of independent and qualified arbitrators.
The AIV recommends that provisions be included in IPAs to oblige parties to choose arbitrators from a permanent list and to introduce provisions in a code of conduct limiting the scope for arbitrators to take second jobs and swap professional roles. The AIVD regards CETA’s provisions on this subject as an improvement on earlier IPAs, which contained no such specific rules.
The government views this recommendation as backing the current Dutch approach, which is in keeping with the position taken by the European Commission.
Recommendation 4: the AIV considers that the present ISDS system in which proceedings are conducted in secrecy is at odds with the duty of accountability of democratically elected governments. The AIV recommends that transparency should be the rule. The AIV notes that transparency may be limited on the grounds of state security and confidentiality of business information. It also explicitly refers to the position already advocated by the Netherlands that there should be greater transparency and recommends that the subject of transparency be regulated in IPAs, which should specify in what cases exceptions to the principle of transparency can be made.
The government considers that transparency is of major importance in the dispute procedure for the legitimacy of the investment protection mechanism, but that there may be good reasons for limiting transparency, such as state security and the confidentiality of sensitive business information. If it is decided to limit transparency, reasons should be given.
Coherence, consistency and legal certainty
Recommendation 5: the AIV notes that in a few cases tribunals are known to have given conflicting rulings in comparable cases. The main causes of inconsistency are the defective wording of provisions and inadequate definitions of terms in IPAs, as well as the varying ways in which they are interpreted by arbitrators.
The AIV therefore recommends that future IPAs should be better drafted and, where necessary, interpretative declarations issued about an existing IPA together with the other contracting parties. As regards TTIP, the AIV recommends that a committee of the contracting parties should be established to issue binding declarations about the interpretation of the agreement. This has already occurred in the case of CETA.
This recommendation supports Dutch policy and the approach already being adopted within the EU. Careful elaboration of the modernisation plans is important in this connection.
Recommendation 6: the AIV explicitly endorses the Dutch view that the Most Favoured Nation (MFN) concept should be applied only to substantive standards, not to procedures, and recommends that the concept of Fair and Equitable Treatment (FET) should be defined more precisely in order to limit the scope for interpretation by tribunals. The AIV also considers that arbitral awards must give clear reasons and be accessible. Awards that differ from the commonly held view should be properly reasoned. The establishment of an appellate body would be one way of correcting awards that differ markedly from the consensus view.
Here too the recommendation explicitly endorses the Dutch position. As in the case of recommendation 4 above, account should be taken of good reasons for limiting the transparency of awards, such as state security and the confidentiality of sensitive business information.
Recommendation 7: the AIV recommends the establishment of an appellate body to which states and investors could apply on limited grounds for review of an award. This would benefit the consistency of awards. The AIV recommends that the grounds for appeal be limited to cases in which it has been established that the arbitrators concerned were insufficiently independent of the parties, that the decision taken at first instance was manifestly arbitrary, that there was clearly no proper consideration of the relevant facts, that the assessment was demonstrably contrary to what is usual in international arbitration or that procedural standards were flagrantly violated. In the AIV’s view, an appellate body should preferably consist of tenured judges since this reduces the risk of inconsistency. However, the judges could be available on call on an ad hoc basis.
The government welcomes the specific solutions suggested by the AIV for the establishment of an appellate body. This is a goal that needs to be developed further and is also a matter of debate within the EU. The AIV advisory report, which also deals with the obstacles to the creation of an appellate body capable of being set up only by treaty, is viewed by the government as contributing to the further development of this goal.
CETA and TTIP
Finally, the AIV considers that it would be desirable to include a form of ISDS in TTIP. It indicates that it is doubtful whether domestic courts in the United States and the various EU member states are always able (or willing) to provide sufficient legal protection for foreign investors. Nor do international treaty obligations have direct effect in all legal systems of the contracting states. Moreover, there are still significant differences in how the judicial system functions in the different EU countries. ISDS should therefore be in a form which addresses these concerns.
The government shares this view and therefore considers that incorporating a form of ISDS in TTIP would have added value. It would also provide an opportunity to introduce a new modern and global standard, which would be important for any future trade and investment agreements with other strategic trade partners.
The AIV also indicates that CETA addresses the concerns about states’ right to regulate, regulatory chill and the rule-of-law failings of the present dispute resolution mechanism. The AIV regards CETA as a step in the right direction and a good model for TTIP, although transparency could still be improved.
The government endorses this view and regards CETA as a good agreement that contains major improvements in terms of investment protection and ISDS. In response to the present debate on modernisation of the investment protection mechanism, steps are presently being taken to ascertain whether further technical modifications should be made to CETA. It is important, however, that the negotiations should not be reopened, thereby jeopardising the balance nature of the final result.
The Netherlands’ bilateral investment protection agreements
The AIV also indicates that changing the system of dispute settlement between investors and states will take time, particularly the process of updating the 90-odd existing Dutch IPAs. Some of them will be replaced in due course by EU agreements concluded with third countries. The AIV recommends that it is necessary to consider amending the others. Sometimes it may be possible to issue a declaration, together with the other contracting party, about the desirable interpretation of the agreement if a dispute arises between an investor and one of the contracting parties. According to the AIV, this would enable pressing questions to be resolved quickly.
The government has previously stated that it is in favour of revising the existing IPAs to which the Netherlands is party. However, various matters should be taken into account in this connection, including the need to obtain the consent of the European Commission and of the counterparty and the risk of counterproposals. Care must be taken to safeguard the legal position of the parties concerned in the renegotiating process.
The Netherlands will adopt the EU investment protection standard currently being developed. The AIV’s recommendation that pressing issues about a specific dispute under an IPA should be dealt with by issuing interpretative declarations is an option which the government will consider. It is important, however, that this should not jeopardise legal certainty. Moreover, the process by which parties to an IPA reach agreement on a joint declaration will not be simple and may well turn out to be protracted.