May 17, 2016

May 17, 2016 | Issue Brief on Economic Freedom

Straight Talk on the ISDS Provisions in the Trans-Pacific Partnership

The Trans-Pacific Partnership (TPP), an investment and trade agreement signed last February between the U.S. and 11 other Pacific Rim nations, contains enforcement provisions, including an Investor-State Dispute Settlement (ISDS) mechanism, for resolving potential investment disputes related to the agreement.

Today, the ISDS system is used widely around the globe to help protect the investor and to secure for the signatory nation the foreign investment it seeks. But ISDS has become controversial, both as part of the TPP and because it may be included in the Transatlantic Trade and Investment Partnership (TTIP) presently being negotiated between the U.S. and the European Union.

The ISDS provisions are only one component of the TPP. The agreement must be assessed as a whole. The purpose of this Issue Brief is to assess the strengths and weaknesses of the ISDS provisions of the TPP, both as part of the agreement and as part of the broad agenda of American investment and trade diplomacy.

The ISDS System

The Index of Economic Freedom,[1] published annually by The Heritage Foundation and The Wall Street Journal, demonstrates time and again that a free and open investment environment provides maximum entrepreneurial opportunities and incentives for expanded economic activity, greater productivity, and job creation. As the Index also notes, protection of property rights is a central motivating force for workers and investors.

A key aspect of property rights protection is the enforcement of contracts. The voluntary undertaking of contractual obligations is the foundation of the market system and the basis for economic specialization, gains from commercial exchange, and trade among nations. Even-handed government enforcement of private contracts is essential to ensuring equity and integrity in the marketplace. In the case of foreign direct investment, ISDS provisions are vital ingredients of a good policy mix.

ISDS panels are created by trade and investment agreements between nations. The basis of the ISDS system is that nations should not discriminate against or among foreign investors, either by expropriating them or by discriminating against them through direct, gradual, or “creeping” regulations.

ISDS panels, which are composed of legal experts, can award compensation if nations engage in such discrimination. This is good for signatory nations and investors alike: Developing nations care about attracting investment, while developed nations care about protecting the private property and investment rights of their nationals residing or working abroad. ISDS panels are not permanent institutions: They help protect the rule of law, but avoid twisting that rule into a wooden, unyielding, bureaucratic apparatus.

An ISDS mechanism is created by a particular agreement, and it can be customized in many ways. The ISDS system as a whole is not perfect: One of the authors of this Issue Brief has set out comprehensive proposals for reform.[2] Similarly, ISDS panels cannot address every national deviation from free-market principles. But the essence of the ISDS system is that disputes about trade and investment agreements should be settled by arbitration in a mutually agreed forum designed to reflect the concerns of the agreement’s signatories.

Generalized Criticisms of ISDS Provisions in the TPP

ISDS opponents make a variety of claims about the ISDS provisions in the TPP. Only a few of these claims relate specifically to the TPP; most of them are generalized arguments against the entire ISDS system.[3] One claim commonly made about the TPP’s ISDS provisions is that, since the TPP includes six developed nations with mature legal systems, there is no reason why it should have an ISDS at all.[4]

But the TPP also includes a number of developing nations with less mature legal systems (such as Vietnam). Furthermore, ISDS claims have also been brought, sometimes successfully, against developed nations. Finally, if the TPP is to be a model for future investment and trade agreements, and to bring in additional nations (such as South Korea or Taiwan), it should create appropriate institutions from the outset.

Another common criticism is that ISDS panels, including those of the TPP, do not allow governments to sue corporations.[5] This ignores the fact that governments can, and do, charge corporations with civil or criminal violations in the domestic court system: ISDS panels exist precisely because governments can use the courts, and other means, to discriminate against foreign investors in ways that often are insidious. Indeed, it is a lack of trust, born of experience, in the fairness and probity of foreign governments, shared among investors of many nationalities, which led to the creation of the ISDS panels.

Other critics assert that the TPP’s ISDS panels replace the U.S. legal system.[6] It seems reasonable to require investors to exhaust domestic remedies first. But the U.S. has—unsuccessfully—tried this in a variety of public international law fora. Among other difficulties, signatories will not accept a one-sided deal whereby only U.S. courts get the first bite of the apple—and the U.S. will not accept many foreign courts’ exhaustion prerogatives because U.S. investors in those nations have been subjected to adverse bias, interminable delays, corruption, or classic denials of justice due to insufficiently developed procedural and substantive law. The way to resolve this dilemma is to allow all parties access to ISDS panels.

Even more fundamentally, because these trade and investment disputes are international to the core, and often are generated by the clashing interpretations of an international agreement, it is reasonable to subject them to international arbitration through a carefully designed and limited forum, and one that has been mutually agreed, such as an ISDS panel.

These critics also maintain that ISDS panels are bad for American sovereignty. Ironically, many of these critics are on the left, which is not normally noted for its concern with protecting U.S. sovereignty. These critics might first consider that a government that uses its power (especially its administrative power) to discriminate against a particular group of foreigners is in practice likely to have fewer scruples about discriminating against one group of Americans in favor of another. Whether this is described as corporatism, discrimination, or cronyism is less important than securing the correct remedy, which is equal protection under the law for all.

More broadly, the ISDS system, if carefully designed, does not endanger U.S. sovereignty. What would endanger U.S. sovereignty is a situation in which the U.S. binds itself to uphold the provisions of an agreement while lacking the means to require other signatories to live up to their own commitments under that agreement. ISDS panels provide some of these means. The ISDS system helps protect U.S. sovereignty by making it harder for a trade agreement to become a one-sided deal that limits the U.S. but does nothing to constrain the official conduct of other signatories.

The TPP’s ISDS Provisions

The TPP’s ISDS provisions are contained primarily in Chapter 9, Section B, of the agreement.[7] At their core, these provisions adhere to the approach of similar treaties: Parties to the dispute each select one arbitrator, and they together select the third and presiding arbitrator. But the TPP’s provisions also contain innovations and arrangements unique to the TPP. These provisions include:

  • Parties must consult and negotiate during a six-month “cooling-off” period before submitting a claim for arbitration (Articles 9.19-20);
  • Claimants must choose their arbitration forum at the start of proceedings, and cannot initiate parallel proceedings (Article 9.20.4);
  • Claimants must agree in writing to the appointment of each individual member of the panel, which allows arbitrators to be nationals of states that are signatories to the agreement and party to the dispute. (Article 9.22.4(a-c));
  • Arbitrators must comply with the code of conduct created by Article 28 of the TPP, as modified by the parties to ensure relevance to ISDS proceedings (Article 9.22.6);
  • The panel may accept and consider amicus curiae submissions, and submissions from non-disputing parties (Article 9.23.3);
  • Documents relevant to arbitration proceedings must be made public (Article 9.24);
  • There are a variety of penalties for frivolous claims (including Article 9.29.4);
  • Expropriation is defined, and is generally not actionable with respect to regulations that do not discriminate on the basis of nationality, and which pertain to “legitimate public welfare objectives, such as public health, safety and the environment” (Annex 9-B);
  • Investors who lose money on public debt purchases may not bring a claim unless they have been expropriated, or, in in the context of a negotiated debt restructuring, have been subject to discrimination on the grounds of nationality (Annex 9-G);
  • A wide variety of measures related to the expropriation of land (Singapore and Vietnam, Annex 9-C), currency transfers (Chile, Annex 9-E), foreign investments (Chile, Annex 9-F, and Australia, Canada, Mexico, and New Zealand, Annex 9-H), non-conforming measures (Vietnam, Annex 9-I), government contracts (Malaysia, Annex 9-K), and investment agreements (Peru, Mexico, and Canada, Annex 9-L) are treated specially;
  • Chile, Mexico, Peru, and Vietnam require claimants to choose at the fork in the road: They may select either a domestic court, or proceed to arbitration through an ISDS panel (Annex 9-J); and
  • The agreement exempts “tobacco control measures” from arbitration (Article 29.5).

Assessing the TPP’s ISDS Provisions

The Good Provisions. Many of the TPP’s ISDS provisions are sensible. In particular, the ban on parallel proceedings, the transparency requirement, the penalties for frivolous claims, and the careful definition of expropriation are welcome. So is the limitation on claims related to public debt: Investors in the state should have to bear their own losses, provided such losses are not the result of expropriation or discrimination.

Other provisions may have negative effects over time, but these effects will likely be minor and the provisions are not inherently malignant. The requirement to conform to the code of conduct wrongly implies that ISDS arbitrators have in the past acted unethically. The value of the code in practice will depend on its contents and interpretation down the line.

Similarly, while it is likely that the submission of amicus curiae briefs will be hotly contested in controversial cases, there is no reason why panels should not have the power to receive these briefs. These briefs may be particularly useful in cases involving scientific, technical, demographic, or other specialized information about which the tribunals generally lack expertise, but upon which the outcome of the awards might turn.

The Bad Provisions. On the other hand, some of the TPP’s ISDS provisions are undesirable, or may have undesirable effects. The special treatment for various national measures decreases the scope of ISDS coverage. The requirement for a claimant’s consent is neither new nor unreasonable, but it enhances the ability of respondent nations to select their own nationals. This tends to pull the ISDS system toward viewing arbitrators not as impartial experts, but as de facto national representatives.

The fork-in-the-road provision that covers Chile, Mexico, Peru, and Vietnam is troubling. Vietnam, in particular, does not have a legal system known for being honest, trustworthy, and efficient. This provision was included because in these four nations (unlike in the U.S.), investors have direct access to local courts on the basis of the TPP. (In the U.S., investors can file a takings claim based on the Constitution, not the TPP.) This provision prevents Vietnam from being placed in double jeopardy by a case filed in both its domestic courts and an ISDS panel. While this is reasonable in itself, it cuts against the general tendency of the ISDS to move away from involving domestic courts in international investment disputes.

The exemption of “tobacco control measures” is controversial. It is unclear why this provision was included, since Annex 9-B, concerning expropriation and public health, seems to make it unnecessary. It appears to be a response to cases against “plain packaging” brought by a major tobacco firm against Australia (which was dismissed in December 2015) and Uruguay, as well as a political concession to anti-tobacco lobbyists. By carving out tobacco, the TPP sets a bad precedent: The next agreement might carve out trans fats, alcohol, or anything to which public health, sustainable development, or other activists might object.

Independent as each agreement theoretically is of another, in reality, certain agreements (such as the TPP) acquire a de facto super-agreement status that lends them, and the ISDS cases that stem from them, special influence in the ISDS universe. The tobacco carve-out legitimates the idea that some products that are legally sold can and should nevertheless be accorded a lower level of protection under the law. More broadly, this approach of playing favorites with special interests takes a toll on the respect attached to the ISDS, and indeed to trade and investment treaties as a whole.

What the U.S. Should Do

The ISDS measures contained in the TPP are valuable partly because they make it clear that the U.S. is committed to securing ISDS protections in its investment and trade agreements. In other words, the most significant feature of the TPP’s ISDS provisions may be what they say about the broad agenda of American investment and trade diplomacy, and about the commitment of the United States to advancing economic freedom for all countries. The European Commission has proposed an undesirable Investment Court System as an alternative to an ISDS in the proposed TTIP: On these grounds alone, the ISDS provisions in TPP are welcome.[8]

On their merits, the ISDS measures in the TPP are largely sensible. Criticisms that these measures damage American sovereignty, or are unnecessary, are wide off the mark. Several of the ISDS provisions in the TPP may have adverse effects, but these effects are likely to be minor, and the provisions themselves are reasonable. Less desirably, the various special treatments, the fork-in-the-road provision (especially as it relates to Vietnam), and the effects of the requirement for claimant consent can all be justified—but all are moves away from a comprehensive and impartial ISDS system. The most dubious provision is the tobacco carve-out, which is unnecessary and sets a dangerous precedent.

This Issue Brief considers only the ISDS provisions of the TPP agreement. In any trade and investment agreement there will be some less-attractive elements. While these should not be glossed over, their significance should not be exaggerated. In considering the TPP, Congress must weigh the importance of a few undesirable ISDS measures against the broader merits of most of the ISDS provisions. Assessing the ISDS chapter is, in turn, only part of the consideration that Congress must give to this complex and important agreement.

—Ted R. Bromund, PhD, is Senior Research Fellow in Anglo–American Relations in the Margaret Thatcher Center for Freedom, of the Kathryn and Shelby Cullom Davis Institute for National Security and Foreign Policy, at The Heritage Foundation. James M. Roberts is Research Fellow for Economic Freedom and Growth in the Center for Trade and Economics, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation. Riddhi Dasgupta, PhD, is an expert on international dispute settlement. He earned his PhD at the University of Cambridge, and his JD at the University of California at Berkeley.

About the Author

Theodore R. Bromund, Ph.D. Senior Research Fellow in Anglo-American Relations
The Margaret Thatcher Center for Freedom

James M. Roberts Research Fellow For Economic Freedom and Growth
Center for Trade and Economics (CTE)

Show references in this report

[1] Terry Miller and Anthony B. Kim, 2016 Index of Economic Freedom (Washington, DC: The Heritage Foundation and Dow Jones & Company, Inc., 2016), pp. 22–24, http://www.heritage.org/index/book/chapter-2.

[2] Riddhi Dasgupta, International Interplay: The Future of Expropriation Across International Dispute Settlement (Cambridge, UK: Cambridge Scholars Publishing, 2013), pp. 86–87.

[3] For a broader assessment of the value of ISDS mechanisms, see Ted R. Bromund, James M. Roberts, and Riddhi Dasgupta, “Investor-State Dispute Settlement (ISDS) Mechanisms: An Important Feature of High-Quality Trade Agreements,” Heritage Foundation Issue Brief No. 4351, February 20, 2016, http://www.heritage.org/research/reports/2015/02/investor-state-dispute-settlement-isds-mechanisms-an-important-feature-of-high-quality-trade-agreements.

[4] Todd Tucker, “The TPP Has a Provision Many Will Love to Hate: ISDS. What Is It, and Why Does It Matter?” The Washington Post, October 6, 2015, https://www.washingtonpost.com/blogs/monkey-cage/wp/2015/10/06/the-tpp-has-a-provision-many-will-love-to-hate-isds-what-is-it-and-why-does-it-matter/ (accessed April 27, 2016).

[5] Ryan Cooper, “How the TPP Boosts Corporate Power at the Expense of National Sovereignty,” The Week, October 7, 2015, http://theweek.com/articles/581609/how-tpp-boosts-corporate-power-expense-national-sovereignty (accessed May 13, 2016).

[6] Elizabeth Warren, “The Trans-Pacific Partnership Clause Everyone Should Oppose,” The Washington Post, February 25, 2015, https://www.washingtonpost.com/opinions/kill-the-dispute-settlement-language-in-the-trans-pacific-partnership/2015/02/25/ec7705a2-bd1e-11e4-b274-e5209a3bc9a9_story.html (accessed May 5, 2016).

[7] Office of the United States Trade Representative, “2016, TPP Full Text,” https://ustr.gov/trade-agreements/free-trade-agreements/trans-pacific-partnership/tpp-full-text (accessed April 27, 2016). These provisions, in turn, implement the provisions contained in Chapter 9, Section A, of the agreement, which define the relevant standards of treatment to be accorded to investors. As the purpose of this Issue Brief is to examine the TPP’s ISDS system, not its underlying standards of investor protection, it does not systemically consider Section A.

[8] Ted R. Bromund, James M. Roberts, and Riddhi Dasgupta, “The U.S. Should Reject the European Commission’s Proposed Investment Court,” Heritage Foundation Issue Brief No. 4485, November 13, 2015, http://www.heritage.org/research/reports/2015/11/the-us-should-reject-the-european-commissions-proposed-investment-court.