Australia’s free trade agreement with China, the highly debated Trans-Pacific Partnership Agreement and Australia’s recent dispute with big tobacco in Singapore have drawn public and political attention to Investor State Dispute Settlement, or ISDS. Characterisations of ISDS have included it being an attack on democracy, a threat to national sovereignty or a panacea that protects all international investment. In commercial reality, ISDS is a useful tool that can provide valuable protection for investors and should be part of all international investment planning. While ISDS is not an insurance policy for international investment it can be used to minimise sovereign risk, especially on investments into higher risk and volatile countries.

Australian businesses have severely lagged behind other countries when it comes to the utilisation of ISDS to protect international investment. However, Australians are starting to wake up to the value of ISDS and its role in investment decisions. In this litigation monitor, Moulis Legal Partner Christopher Hewitt and Senior Lawyer Emily Murphy examine the role of ISDS in international investment and how it can support and protect investment projects.

ISDS and Australia

ISDS is a dispute resolution mechanism that allows foreign investors to initiate a legal claim directly against the State through international arbitration. Claims can be brought if the State has breached its investment obligations under the relevant treaty or trade agreement. Those investment obligations vary between each treaty and trade agreement, although they commonly include rules relating to expropriation, non-discrimination, minimum standards of treatment and the free movement of capital.

The subject matter of ISDS disputes includes a range of issues such as claims of wrongful revocation of permits and licences, unreasonable tax assessments and breaches of contract by the State. The rationale of ISDS is that it allows businesses to protect their investment from unjustifiable State intrusion without having recourse through potentially biased local courts and without requiring contractual rights against the State.

Australia currently has 27 agreements that allow for ISDS (not including the Trans-Pacific Partnership Agreement):

  • Australian has 6 Free Trade Agreements with ISDS provisions with China, Korea, Chile, Singapore, Thailand and ASEAN (Indonesia, Malaysia, Philippines, Singapore, Thailand, Brunei Darussalam, Vietnam, Laos, Myanmar and Cambodia); and
  • Australia has 21 Investment Protection and Promotion Agreements or Bilateral Investment Treaties with ISDS provisions with Argentina, China, Czech Republic, Egypt, Hong Kong, Hungary, India, Indonesia, Laos, Lithuania, Mexico, Pakistan, Papua New Guinea, Peru, Philippines, Poland, Romania, Sri Lanka, Turkey, Uruguay and Vietnam.

The Trans-Pacific Partnership Agreement – if passed by the lawmakers in the various member States – will add to the countries where Australian investors may seek ISDS arbitration, including the United States of America.

Interestingly, among the countries that have ISDS provisions with Australia are some of the countries that have been most frequently subject to ISDS claims:

  • Argentina is the most prolific with 56 cases;
  • Czech Republic is third with 29 cases; and
  • Egypt is fourth with 24 cases.[1]

While this is anecdotal, these numbers suggest that Australian investors in these countries may have had reason and opportunity to initiate an ISDS claim at some stage in the past but have not done so. Despite the right to seek investor state dispute arbitration against a large number of States, Australian investors have been reluctant to take advantage of ISDS. Undoubtedly the cost of the dispute process has been a factor, although costs have not necessarily prevented Australian businesses from litigating through the courts. There are other reasons that have prevented or held back potential Australian ISDS claims – many of those reasons are based on misconceptions or myths.

Dispelling some myths about ISDS

The common misconceptions by Australian businesses are that ISDS claims are rare, the exclusive domain of big business and do not produce real results. In reality, ISDS is used commonly in global investment disputes (though not in Australia or by Australians), claims are frequently initiated by smaller investors and the success rate of ISDS claims by investors is impressive.

ISDS is more common than you may think

ISDS accounts for a substantial proportion of global legal disputes relating to international investment. By the end of 2014, there had been a total of 608 known ISDS claims with 356 of those claims concluded. The European Union has been, by far, the most active in using ISDS to protect investments with over half of all ISDS claims being initiated by European investors. European businesses have been especially active in using ISDS to protect investments into higher risk investment regions, such as Africa and South America.

Australian businesses have traditionally not taken advantage of ISDS claims in investment disputes with States. Australian investors have only initiated 3 ISDS claims against foreign governments plus a handful of claims initiated by foreign subsidiaries of Australian businesses. This is despite Australian investors actively investing in more volatile investment destinations that are party to investment agreements with Australia, such as Argentina, Egypt and India.

ISDS is an option for large and small investors

ISDS is available to all investors – large and small – that satisfy the requirement of being from a country that has an applicable investment agreement or trade agreement with the investment host State. Whether an investor is defined as being from a particular country varies between ISDS provisions and has been subject to many contentious disputes. Recently, the Government of the Republic of Guinea successfully argued that real estate company Société Civile Immobilière de Gaëta could not access the arbitration provisions in an investment treaty between Guinea and France because the company was actually domiciled in Guinea. Notwithstanding legal arguments around the domicile of a business, ISDS is available to investors and businesses of all sizes and types of international investment.

Statistics from the United Nations show that ISDS is frequently used by medium and small businesses, with a quarter of all claims being initiated by individuals or very small businesses with limited international operations.[2] Surprisingly, only 8% of claims have been initiated by very large multinationals. Again, only 3 of these claims were initiated by Australians and there has been a lack of uptake by Australian businesses – both large and small – of the opportunities afforded by ISDS and Australia’s investment agreements around the world.

Investors have decent success and settlement rates

As with many dispute resolution mechanisms, many international investment arbitrations are settled by agreement between the parties prior to the final decision. Settlement is often the strategic goal of a party initiating a dispute because the formal arbitration process affords greater leverage to negotiate a favourable outcome. Taking that into account, investors have an impressive success rate in concluded ISDS arbitrations:

  • 28% of arbitrations had been settled by agreement of the parties;
  • 37% had been decided in favour of the State; and
  • 27% of arbitrations were decided in favour of the investor.[3]

Despite these encouraging statistics, investors considering initiating an international arbitration should consider that the compensation awarded or agreed by parties is commonly significantly less than the original amount claimed by the investor – a 2014 study found that:

… the average inflation-adjusted damage claimed … was around $622.6 million

and

… the average amount awarded (including settlements and discontinuances where public records reflected a State transferred funds to the claimants) was around $16.6 million.[4]

When a new investment treaty or trade agreement containing an ISDS provision is signed the media will often fixate on the dramatic cases where global companies have been awarded billions. For instance, in October 2012, an international investment arbitration awarded Occidental Petroleum USD1.8 billion, plus interest and tribunal costs, against Ecuador after the State annulled a contract. The arbiters found that the actions of Ecuador breached the fair and equity provisions of the investment treaty.[5]

However, decisions such as Occidental Petroleum v Ecuador are exceptional and in most instances the monetary award for a successful claimant is substantially less than the original amount claimed. As with most dispute resolution mechanisms, the formal dispute is part of the negotiating and resolution process, and the goal is not to get rich from an arbitration or court decision.

The protective hard hat in the international investment toolkit

Governments around the world go to great lengths to entice international businesses to invest in their economy, preaching of legal and economic stability and promising tax incentives, free trade zones and investment support. Businesses rely on these promises and benefits when making investment decisions. ISDS allows businesses some degree of confidence that a host state will be held accountable for breaches of its investment obligations and commitments.

ISDS does not provide absolute protection for international investors. However, there is substantial precedent for ISDS being used to protect investment and minimise unreasonable sovereign risk. Australian businesses investing overseas should become familiar with the investment treaties or trade agreements that provide ISDS protection to their investment. Where Australia does not have an investment treaty or trade agreement with a country, investors may consider means of structuring their investment to maximise investment protection through the treaties and investment agreements of other countries and trading blocs.

ISDS works and Australian businesses need to take a fresh look at ISDS as a key element in investment planning and protection.