Investor-State Dispute Settlement: The Net-Zero Obstacle No One is Talking About

ByAlex Foulger-Fort (2L)Vasily Kandinsky, Improvisation No. 30 (Cannons), 1913. Credit: Arthur Jerome Eddy Memorial Collection, Art Institute of ChicagoPhoto: Charlie Riedel / AP file

Why are governments around the world failing to enact climate change legislation? For many  governments, one reason is that they worry about the prospect of lawsuits from transnational corporations and foreign investors. Under the investor-state dispute settlement (ISDS) mechanisms contained in most of the world’s free-trade agreements (FTAs) and bilateral investment treaties (BITs), transnational investors can sue national governments in private arbitral tribunals over policies and legislation that they believe reduce the value of their investments in that country. This has become a hotly contested issue in trade and investment circles, but the issue must now become part of the public discourse surrounding climate change.  

FTAs and BITs generally contain a number of protections for foreign direct investment to encourage the inflow of foreign capital. These protections generally seek to ensure the equitable treatment of different investors and a certain degree of stability in the host country’s regulatory environment. When foreign investors believe that a host government has enacted legislation or taken certain regulatory action that jeopardizes the value of their investment (like canceling a mining permit, for example), they may be entitled to trigger the ISDS clause and compel the host nation to participate in investor state arbitration, bypassing the domestic court system. Some commentators argue that the threat of ISDS proceedings has imposed a ‘regulatory chill’ upon many national governments, stultifying domestic climate action and preventing states from meeting their climate obligations under the Paris Agreement.  

In fact, many recent suits commenced under the ISDS mechanism have been about climate action. A 2021 report from the International Institute for  Sustainable Development (IISD) found that the fossil fuel industry is “the most litigious industry in the ISDS system,” responsible for almost 20% of all known ISDS cases. But the problem runs across industries. The United Nations Conference on Trade and Development (UNCTAD) estimates that between 1987 and 2021, investors brought 175 claims in relation to measures governments had taken for the protection of the environment. These are high numbers relative to the number of ISDS claims submitted per year. The 2021 IISD report found that the number of arbitration cases per year has risen from an average of 4.1 between 1972 and 1999, to an average of 53 per year between 2000 and 2020.  

The growing prevalence of these cases is the tip of the iceberg. Investors frequently demand billions in compensation, amounts which would cripple many nations. Based on available data from UNCTAD and the International Centre for the Settlement of Investment Disputes (ICSID), since 1995 investors have “brought claims demanding at least $195 billion and won awards totalling at least $73.2 billion.” The average award in fossil fuel cases is over USD $600 million, almost five times the average amount awarded in non-fossil fuel cases. To make matters worse for states, investors have succeeded in 72% of cases at the merits stage. 

In adjudicating these matters, it appears as though arbitral tribunals have consistently failed to adequately incorporate climate-related considerations into their decision-making. For example, in a dispute arising out of Costa Rica’s expropriation of an investor’s biodiversity-rich land for the purposes of conservation, the tribunal held that “the purpose of protecting the environment for which the Property was taken does not alter the legal character of the taking for which adequate compensation must be paid.” 

Investor-state tribunals are creatures of the international investment law (IIL) regime. They are designed specifically to address investment-related issues and disputes which arise under the terms of FTAs and BITs. As a result, arbitrators are often not equipped to handle ‘external’ issues relating to the environment, human rights, or sustainable development.

From a legal perspective, the ISDS system is riddled with controversy. First, the system allows private parties to bring an action against a state without first exhausting local remedies (i.e., the national justice system), a customary rule of international law. It is unclear why foreign investors should be exempt from this rule. Moreover, international tribunals often work on a confidential basis (many decisions and awards are not published), escape public attention, and usually refuse to allow third parties such as NGOs from intervening to provide a neutral or specialized perspective.  

Second, arbitrators often employ very strict interpretations of contractual/treaty provisions in line with the principles of IIL. From an international law perspective, IIL is seen as a ‘self-contained’ regime. That is, the regime largely operates according to its own principles and rules, with little influence from other international regimes (such as international environmental law), or even international legal norms and customary rules. This often leads to myopic interpretations of treaty provisions, even where the language is more explicitly designed to protect the regulatory power of states. Yet, this conflicts with the push against self-contained (or ‘fragmented’) regimes in the international law sphere. The argument goes that in an age of concurrent global crises which require coordinated solutions, legal regimes ought to collaborate and be subject to international norms relating to environmental protection and human rights.  

Third, many ISDS decisions can be read as showing blatant disregard for state sovereignty and states’ right to  regulate within their jurisdiction. Can treaty-based investment protections trump the right of a state to legislate within its own public policy arena? The apparent bias in favour of investment protection may be partially attributable to the myopic interpretations described above, but the treaties themselves may also be to blame. Many FTAs and BITs provide little explicit protection for states’ right to regulate, tilting the scales in investors’ favour.  

On this view, ISDS clearly poses a problem. To the extent that the system imposes a regulatory chill upon states, it does so with questionable legal legitimacy. The question then becomes, what should we do? There are a number of calls for reform. The majority of these proposals call for new treaty language with more explicit protections for states. One commentator, Gus Van Harten of Osgoode Hall Law School, has also proposed incorporating an environmental ‘carveout’ in such treaties, meaning that ISDS cannot be applied to environmental disputes. Others have focused on the fragmentation issue, and discussed ways in which arbitrators could incorporate environmental considerations into their interpretive analysis. 

However, we should also be asking: is it even desirable for investor-state tribunals to resolve climate change disputes? Should these creatures of the IIL regime have jurisdiction over issues which are clearly beyond their mandate and expertise? Perhaps these disputes should be resolved by an international tribunal dedicated to climate change issues. Such an institution would itself raise a number of concerns, but it seems unlikely that environmental considerations will ever be given equal footing with investment considerations while the latter has home field advantage.  

Bottom line: ISDS is rarely cited in mainstream discussions as a major barrier to climate action, but that must change. Revisiting the current arbitration model is imperative to thaw the regulatory chill.