Investor-state dispute settlement (ISDS) or investment court system (ICS) is a system through which countries can be sued by foreign investors for certain state actions affecting foreign direct investment (FDI). This system most often takes the form of international arbitration between a foreign investor and the nation receiving the FDI.
ISDS is a unique instrument of public international law, granting private parties (the foreign investors) the right to sue a sovereign nation in a forum other than that nation's domestic courts. Investors are granted this right through international investment agreements between the investor's home nation and the host nation. Such agreements can be found in bilateral investment treaties (BITs), certain international trade treaties (such as the USMCA), or other treaties like the Energy Charter Treaty.
To bring an ISDS claim before an arbitral tribunal, an investor from one country must have an investment in another country, both of these countries must have agreed to ISDS, and the foreign investor must claim that the state has violated one or more of the rights granted to the investor under the treaty.
ISDS claims are often brought under the rules of ICSID (the International Centre for Settlement of Investment Disputes of the World Bank), or one of several other international arbitral tribunals governed by different rules or institutions, such as the London Court of International Arbitration (LCIA), the International Chamber of Commerce (ICC), the Hong Kong International Arbitration Centre (HKIAC), or the UNCITRAL Arbitration Rules.
The ISDS system has been criticized by many its perceived failures, including investor bias, inconsistent rulings, inaccurate rulings, high damage awards, and high costs. There is widespread agreement that the ISDS system should be reformed. As of May, 2022, multiple reform efforts are underway.
Under customary international law, an investor-state can vindicate injury caused by the host state by exercising diplomatic protection, which may include retorsion and/or reprisals. In addition to diplomatic protection, states can and do establish ad hoc commissions and arbitral tribunals to adjudicate claims involving treatment of foreign nationals and their property by the host state ("state-state-dispute-settlement", SSDS), which can help avoid coercive resolutions and also protect against reneging. Notable examples of this practice are the Jay Treaty commissions, the Iran–United States Claims Tribunal and the American-Mexican Claims Commission. However, these treaties were limited to the treatment of foreign investors during a past period of time, whereas modern ISDS allows investors to make claims against states in general and on a prospective basis.
Currently, the legal protection of Foreign Direct Investment under public international law is guaranteed by a network of more than 2,750 bilateral investment treaties (BITs), Multilateral Investment Treaties, most notably the Energy Charter Treaty and number of Free Trade Agreements such as NAFTA containing a chapter on investment protection. Most of these treaties were signed in the late 1980s and early 1990s before the current explosion of investor claims under the treaties began in the late 1990s.
The majority of the treaties provides foreign investors with substantive legal protection (including the right to "fair and equitable treatment", "full protection and security", "free transfer of means" and the right not to be directly or indirectly expropriated without full compensation) and access to ISDS for redress against host states for breaches of such protection. Some of these standards are framed in vague terms, given extensive discretion to arbitrators in their interpretation and application. The overall number of known cases reached over 500 in 2012. Of these, 244 were concluded, of which approximately 42% were decided in favor of the host state and approximately 31% in favor of the investor. Approximately 27% of the cases were settled out of court.
Notably, only foreign investors can sue states under investment treaties, because states are the parties to the treaty, and only states can be held liable to pay damages for breach of the treaty. States have no corresponding right to bring an original claim against a foreign investor under the treaties, again because investors are not parties to the treaty and therefore cannot be in breach of it. Thus, a decision in favor of the state means that the state has not been ordered to pay compensation, not that it received any compensation from the investor (although costs can be awarded against the investor). A state cannot "win" in ISDS in the manner of a foreign investor - a state which wishes to sue a foreign investor does so through its own domestic courts, without the need for a treaty.
ISDS cannot overturn local laws (unlike the World Trade Organization) which violate trade agreements, but can grant monetary damages to investors adversely affected by such laws. According to the Office of the United States Trade Representative, ISDS requires specific treaty violations and does not allow corporations to sue solely for "lost profits". On the other hand, pundits opine that government violations may be difficult to foresee, and the threat of exorbitant fines may cause a chilling effect which halts regulation or legislation in the public interest (e.g. human health and environmental protection). Critics also state that treaties are written so that any legislation causing lost profits is by definition a treaty violation, rendering the argument null that only treaty violations are subject to ISDS.
Main article: North American Free Trade Agreement
A notable example of ISDS, which has been in existence for two decades now, is Chapter 11 of the North American Free Trade Agreement (NAFTA). NAFTA Chapter 11 allows investors of one NAFTA party (Canada, United States or Mexico) to bring claims directly against the government of another NAFTA party before an international arbitral tribunal. Because NAFTA Article 1121 waives the 'local remedies' rule, investors are not required to exhaust local remedies before filing Chapter 11 claims. While this fact has been amply criticized in public, proponents of ISDS point out that speedy dispute resolution through ISDS is critical in modern economic environments and would be defeated by adding several steps of local remedies. On the other hand, there is no other situation in international law where a private party can sue a state without showing that the state's domestic courts are not independent or reliable. The removal of the customary duty to exhaust local remedies, where reasonably available, may have been a factor in the explosion of investment treaty claims since the late 1990s, although a more obvious explanation is the explosion in the number of bilateral free trade agreements since the breakdown of the multilateral WTO Doha round in the mid-2000s.
Investors may initiate an arbitration against the NAFTA Party under the Arbitration Rules of the United Nations Commission on International Trade Law ("UNCITRAL Rules") or under the Rules of the International Centre for Settlement of Investment Disputes ("ICSID Rules"). NAFTA Chapter 11 was the first instance of an ISDS provision receiving widespread public attention, especially in the United States in the wake of the Methanex case.
Resistance from the EU side to the US proposal to include an ISDS clause in the draft Transatlantic Trade and Investment Partnership treaty was such as to cause this element to be abandoned in September 2015. In its place, the European Commission proposed an investment court system (ICS). Not long afterwards, ICS was declared illegal by the German Association of Magistrates, though the Commission dismissed the magistrates' judgement as based on a misunderstanding. For its part, the United States wants ISDS reinstated.
According to a 2019 study, opposition to ISDS is the single most important factor motivating opposition to TTIP among Germans.
If you wanted to convince the public that international trade agreements are a way to let multinational companies get rich at the expense of ordinary people, this is what you would do: give foreign firms a special right to apply to a secretive tribunal of highly paid corporate lawyers for compensation whenever a government passes a law to, say, discourage smoking, protect the environment or prevent a nuclear catastrophe. Yet that is precisely what thousands of trade and investment treaties over the past half century have done, through a process known as 'investor-state dispute settlement', or ISDS.
—The Economist, October 2014
Much debate and criticism has arisen concerning the impact of ISDS on the capacity of governments to implement reforms and legislative programs related to public health, environmental protection, and human rights.
Opponents argue that ISDS threatens democracy and the rule of law, in part because investor state claims (or the threat of them) inhibit the ability of domestic governments to pass legislation addressing perfectly legitimate public concerns, such as health and environmental protection, labor rights or human rights.
Proponents of ISDS argue that governments retain their regulatory ability if the agreements in question specify that regulations protecting health, the environment, labor rights, and human rights are allowed. The Office of the United States Trade Representative challenges the notion that ISDS challenges "the sovereign ability of governments impose any measure they wish to protect labor rights, the environment, or other issues of public welfare". The International Bar Association (IBA) mirrors these sentiments, noting that "while investment treaties limit states’ ability to inflict arbitrary or discriminatory treatment, they do not limit (and, in fact, expressly safeguard) a state's sovereign right to regulate in the public interest in a fair, reasonable, and non-discriminatory manner." The White House notes that investment protections are a component of more than 3,000 trade agreements, the vast majority of which have some form of neutral arbitration. The United States is party to at least 50 such agreements, has only faced 13 ISDS cases and never lost an ISDS case.
In a February 2016 op-ed against the TPP, Senator Elizabeth Warren used the example of a French company suing Egypt because Egypt raised its minimum wage as an argument against the ISDS provisions of the TPP. The editorial board of The Washington Post has, however, challenged this characterization of the case, noting that "Veolia of France, a waste management company, invoked ISDS to enforce a contract with the government of Alexandria, Egypt, that it says required compensation if costs increased; the company maintains that the wage increases triggered this provision. The case — which would result, at most, in a monetary award to Veolia, not the overthrow of the minimum wage — remains in litigation."
According to the International Bar Association (IBA), states have won a higher percentage of ISDS cases than investors, and that around one-third of all cases end in settlement. Claimant investors, when successful, recover on average less than half of the amounts claimed. IBA notes that "only 8 per cent of ISDS proceedings are commenced by very large multinational corporations." IBA challenges the notion that ISDS is biased against developing countries, noting that there is "no correlation between the success rates of claims against states and their income levels or development status." IBA notes that ISDS is necessary even in countries with sophisticated domestic legal systems because those domestic courts rule according to domestic laws, not international law. IBA notes that "increasingly, awards require the losing party to pay arbitration costs and legal fees to the winning party", which deters investors from initiating unmeritorious cases.
A 2017 study found that the success rate of investors in investor-state disputes has sharply fallen over time because most legal challenges today seek compensation for regulation implemented by democracies, not expropriation by non-democracies. The author of the study argues that the likely goal of investors is not to obtain compensation through ISDS, but to impose costs on governments contemplating regulations and therefore deter the regulatory ambitions of governments.
The Peterson Institute for International Economics (PIIE) claims that ISDS provisions are necessary, as they boost investment: "empirical evidence has shown that treaties including these provisions have a positive effect on foreign direct investment (FDI) flows between signatory countries.". On the other hand, Hallward-Driemeier (2003)  analyzed the impact of Bilateral Investment Treaties (BITs) and, after conducting several tests with different dependent variables – absolute amount of FDI, the ratio of FDI to host country's GDP and the share of host country's FDI in total FDI outflows of a home country – concluded that BITs do not serve to attract additional FDI. Additionally, Emma Aisbett (2007)  found "no evidence for the claim that BITs signal a safe investment climate". Yackee also concluded that "the apparently positive effect of BITs on FDI largely (and in some cases entirely) falls from significance", which is consistent with the empirical findings that "potential investors seem to have little awareness or appreciation of specific BITs".
The impact of FDI on the GDP of developing economies is, itself, a matter of research. While some research (Olofsdotter, 1998; Reisen and Soto, 2001) finds a positive impact on developing countries, other authors (Mencinger, 2003; Carkovic and Levine, 2005; Johnson, 2006; Türkcan, Duman, and Yetkiner, 2008; Herzer, 2012) find a negative impact, and some (De Mello, 1999) find the data to be inconclusive. A fourth conclusion was proposed by others (Alfaro et al., 2004; Li and Liu, 2005; Batten and Vo, 2009): FDI may have a positive or negative impact on the GDP of developing economies depending on the existence of adequate policies to "filter" speculative or predatory investment. Thus, opponents of ISDS warn that these systems may harm the government's ability to filter FDI more favorable to development, and therefore harm GDP. The Cato institute warns that the creation of a two-tier justice system, by which foreign investors are subject to a set of rules different from domestic investors, apart from being contrary to the principle of the Rule of Law, is itself a market distortion prone to inefficiencies that are bound to harm GDP.
Finally, opponents of ISDS also argue that these systems increase inequalities, harm public services, threaten labor and consumer protections, threaten financial stability and the environment, all of which have perilous economic consequences.
PIIE challenges the claim that ISDS "arbitrators lack integrity", noting that arbitrators take an oath of impartiality and both sides of a case choose arbitrators.
Opponents of ISDS argue that, although the system lacks safeguards regarding individual abuse, the most important problem is systemic. Opponents of ISDS note that arbitrators are paid on a case-by-case basis, and therefore they are personally benefited with an increase in claims. Because governments may not use the ISDS system to sue investors, if arbitrators have any bias toward companies of investors, they will encourage further claims and be personally benefited by that increase. The vague terms of most BITs ease this kind of "drift" on the interpretation of treaties by arbitrators. This drift, fueled by the conflict of interest in the core of the system (that need not assume any lack of integrity on a personal level on the arbitrators side, but solely the cognitive difficulty in overcoming a bias when one's personal interest is at stake) may help explain the explosive growth on the number of known ISDS cases in the last few decades.
Opponents of ISDS argue that arbitrations are sometimes carried out in secret by trade lawyers who do not enjoy the typical safeguards of judicial independence and procedural fairness, who earn income only if a case is brought and proceeds, and who are not accountable to the public or required to take into account broader constitutional and international law human rights norms. The Peterson Institute for International Economics agrees "that secrecy has gone too far" in many ISDS cases, but notes that agreements such as the Trans-Pacific Partnership did ensure greater transparency in ISDS. Proponents of ISDS point out that confidentiality is a standard feature of all arbitration and one that enables a constructive, de-politicized and fact-oriented atmosphere of dispute resolution. On the other hand, such traditional confidentiality is limited to disputes that affect the parties in question and not the broader public. Also, most ICSID awards, although confidential, are de facto published by consent of the parties. However, many awards under other arbitration rules are not public and, in the case of investor-arbitration at the International Chamber of Commerce, there is a requirement for blanket confidentiality for all aspects of a case.
It is further pointed out that judges are not elected in most countries outside the US, so that "public accountability of judges" may not be considered a standard of public international law. In any event, they say, the qualification of ISDS arbitrators matches or exceeds the qualification of most court judges. In response, critics make the point that any judge, whether domestic or international, who is part of a legal system not shown to be systematically biased or unreliable, has a greater claim to independence than an arbitrator because they are insulated from conflicts of interest that arise when arbitrators work on the side as lawyers, and is assigned cases in an objective manner rather than by the discretion of a disputing party or an executive official. Arbitrators are appointed by both parties at dispute, so such conflicts of interest may arise on both sides.
While ISDS has traditionally been confidential as any other arbitration, the general trend in the last decade has been to allow for more openness and transparency. On the other hand, there is still widespread confidentiality in the system.
Under Art. 29 of the U.S. Model-BIT of 2004, all documents pertaining to ISDS have to be made public and amicus curiae briefs are allowed. However, no investment treaty allows other parties who have an interest in the dispute, other than the claimant investor and respondent government, to obtain standing in the adjudicative process.
Under the Trans-Pacific Strategic Economic Partnership, the tribunals shall, subject to the consent of the disputing parties, conduct hearings open to the public. The tribunal will make available to the public documents relating to the dispute such as the notice of intent, the notice of arbitration, pleadings, memorials, minutes or transcripts of the hearings of the tribunal, where available; orders, awards and decisions of the tribunal. In addition, third parties can and increasingly do participate in investor-state arbitration by submitting amicus curiae petitions.
The World Bank's International Centre for the Settlement of Investment Disputes (ICSID) is required by ICSID Administrative and Financial Regulation 22 to make public, information on the registration of all requests for arbitration and to indicate in due course the date and method of the termination of each proceeding. It also publishes the vast majority of awards with the consent of the parties. If the parties do not consent, ICSID publishes excerpts showing the tribunal's reasoning. The ICSID website has published awards for most completed arbitrations, and decisions in investor-state arbitrations outside of ICSID are also publicly available online.
On 1 April 2014, the UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration entered into force. Article 3 foresees a general duty to publish all documents pertaining to an ISDS-procedure under UNCITRAL Rules, where the treaty establishing the ISDS-mechanism has been concluded after 1 April 2014 or where the parties so consent, subject to certain overwhelming confidentiality interests listed in Article 7. Original proposals to make all UNCITRAL arbitration under investment treaties public were not adopted after opposition by some states and by representatives of the arbitration industry who participated in the UNCITRAL working group negotiations as state representatives.
On 17 March 2015, the United Nations Convention on Transparency in Treaty-based Investor-State Arbitration ('Mauritius Convention') was opened for signatures in Port Louis, Mauritius. The Mauritius Convention will render the UNCITRAL Rules on Transparency in Treaty-based Investor State Arbitration also applicable to disputes arising out of investment treaties that were concluded prior to 1 April 2014 if both parties to the investment treaty are also party to the Mauritius Convention. The convention has not yet entered into force since the three required ratifications have not yet been submitted. 10 States have signed the Mauritius Convention so far.
See also: Bilateral investment treaty § Criticism
Development under the draft Pan-African Investment Code, envisaged strengthening the role of defending states by allowing them to initiate counter-claims against investors.
A counter-claim may be a way of rebalancing investment law, by allowing states to file claims against investors, as a means to sanction investor misconduct.
Investment disputes can be initiated by corporations and natural persons and in almost all cases, investment tribunals are composed of three arbitrators (unless otherwise agreed by the parties). As in most arbitrations, one is appointed by the investor, one by the state, and the third is usually chosen by agreement between the parties or their appointed arbitrators or selected by the appointing authority, depending on the procedural rules applicable to the dispute. If the parties do not agree who to appoint, this power is assigned to executive officials usually at the World Bank, the International Bureau of the Permanent Court of Arbitration, or a private chamber of commerce.
Other individuals cannot initiate a claim against a state under an investment treaty. Also, no individual or state can initiate a claim against a foreign investor under an investment treaty. This has led to criticisms that investor-state arbitration is not balanced and that it favours the "haves" over the "have nots" by giving foreign investors, especially major companies, access to a special tribunal outside any court. While the arbitration process itself does not provide explicitly privileged access for larger investors over individuals or SMEs, the costs of ISDS, as in any court or arbitration system, tend to be off-putting for smaller claimants.
According to a 2011 paper, "In terms of wins and losses, [the] U.S. has never lost a case as the respondent country. U.S. investors have won 15 cases, lost 22 cases and settled 14 cases. In terms of performance with respect to developing countries, U.S. investors have won 14 cases and lost 17."
After ISDS claims by investors sharply increased starting in the late 1990s, ISDS came under greater public attention and criticism. This was true for the NAFTA claims against the United States in the late 1990s, for Germany in the wake of the Vattenfall claims in the late 2000s and also for Australia in 2011, when confronted with the Philip Morris claim.
In 2011, the Australian government announced that it would discontinue the practice of seeking inclusion of investor-state dispute settlement provisions in trade agreements with developing countries. It stated that it:
"...supports the principle of national treatment — that foreign and domestic businesses are treated equally under the law. However, the Government does not support provisions that would confer greater legal rights on foreign businesses than those available to domestic businesses. Nor will the Government support provisions that would constrain the ability of Australian governments to make laws on social, environmental and economic matters in circumstances where those laws do not discriminate between domestic and foreign businesses. The Government has not and will not accept provisions that limit its capacity to put health warnings or plain packaging requirements on tobacco products or its ability to continue the Pharmaceutical Benefits Scheme... In the past, Australian Governments have sought the inclusion of investor-state dispute resolution procedures in trade agreements with developing countries at the behest of Australian businesses. The Gillard Government will discontinue this practice. If Australian businesses are concerned about sovereign risk in Australian trading partner countries, they will need to make their own assessments about whether they want to commit to investing in those countries... Foreign businesses investing in Australia will be entitled to the same legal protections as domestic businesses but the Gillard Government will not confer greater rights on foreign businesses through investor-state dispute resolution provisions."
This statement is a reaction to Philip Morris' ISDS claim under UNCITRAL rules to challenge Australian tobacco Advertising Restrictions. By 2013,[needs update] Australia had not terminated any bilateral investment treaties allowing for ISDS. Even if it were to do so, most such treaties foresee post-termination-protection for many years after the termination has become effective. In any event, since the election of the conservative Coalition Government in 2013, the Government has entered into free trade agreements (such as the China-Australia Free Trade Agreement, Ch 9 section B) that include ISDS.
An alternative way ahead may be the preservation of investor protection under public international law, including ISDS, but with more concern for transparency and the balancing of economic and non-economic interests. As noted above, the European Commission proposed September 2015 an 'Investment Court System' to replace ISDS clauses (notably in the draft TTIP), with the scope for investor challenge much reduced and with 'highly skilled judges' rather than arbitrators used to determine cases.
In this vein, Karel De Gucht, the EU commissioner in charge of negotiating International Investment Agreements declared on 18 December 2014 that future agreements shall become more transparent, shall "fully enshrine democratic prerogatives" and "explicitly state that legitimate government public policy decisions – on issues such as the balance between public and private provision of healthcare or "the European ban on chicken carcasses washed with chlorine" – cannot be over-ridden". He announced to "crack down on companies using legal technicalities to build frivolous cases against governments", to "open up investment tribunals to public scrutiny – documents will be public and interested parties, including NGOs, will be able to make submissions". Also, he said, the EU "will eliminate any conflicts of interest – the arbitrators who decide on EU cases must be above suspicion". However, insisting equally on the advantages of such investment protection agreements, he states along that [they] "protect job-creating investment from discrimination and unfair treatment" and that "the task here is to find the right balance between preventing abuse and protecting investments".
Current controversies over ISDS appear driven by attempts to expand its scope to new countries and, especially, to relations between developed countries with mature court systems and democratic governments.
In 2014, several members of the United States House of Representatives expressed opposition to the inclusion of ISDS in the proposed Transatlantic Trade and Investment Partnership (TTIP) between the United States and the European Union. In 2015, faced with opposition to ISDS in several European countries, the European Parliament adopted a resolution requiring any new dispute settlement scheme included in TTIP "must be replaced by a new public and transparent system of investment protection, in which private interests cannot undermine public policy and which is subject to public law". (The commission's 2015 proposal in response is noted above).
South Africa has stated it will withdraw from treaties with ISDS clauses, and India is also considering such a position. Indonesia plans to let treaties with ISDS clauses lapse when they need renewal. Brazil has refused any treaty with ISDS clauses.
In 2018, the Court of Justice of the European Union ruled that "The arbitration clause in the Agreement between The Netherlands and Slovakia on the protection of investments is not compatible with EU law". This ruling could imply that any similar arbitration tribunal considering corporate sovereignty cases would also be illegal under EU law.
The process of the UK leaving the EU (known as Brexit) may generate ISDS cases against the UK. For example, non-EU financial firms, that based themselves in the City of London in the expectation of continued participation in the European Single Market and subsequently having suffered adverse consequences of the loss of such access under different arrangements, may have an actionable case against the UK Government.