Investors are taking governments to global tribunals over policy shifts – could it help or harm efforts?
Climate change, Covid-19, human rights, corruption. Fundamental social issues of our time are increasingly triggering responses by governments around the world – but what happens when those responses negatively affect existing foreign investments?
In the past, claims for compensation by investors – which can amount to millions of dollars - have threatened to chill reform. More recently, they have held governments to account on green energy policy promises. Today, they could become a climate activism tool.
No country knows the sting of investment disputes in the climate space more than Spain.
The Mediterranean nation faced and is facing at least 50 claims in international tribunals after it watered down a renewable energy subsidy in 2013, affecting both new and existing projects. Many resulted in significant awards, including one amounting to €128 million. Spain ultimately reinstated incentives (albeit adjusted).
As global efforts to transition to a net zero economy surge, there is growing support for the possibility investors might take it one step further: from suing countries for reversing pro-climate policies, to suing them because the impacts of climate change (and a state’s inaction on climate) have hurt their investment opportunity.
This sits in stark contrast to an older trend: investors using the system, known as investor-state dispute settlements (ISDS), to fight policies which protect the environment but damage their investments.
As we look ahead to more ambitious net zero targets, we are also seeing:
A small city of fewer than 8000 people on the banks of Columbia River forms the backdrop for two fundamental rules in international environmental law: states have a duty to prevent harm to other states, and polluters must pay.
That small city – Trail, in Canada’s British Columbia – is also home to a lead and zinc smelter which has operated for more than a century.
From there, Columbia River winds its way across the border and into the US, where it flows by the Washington state town of Frontier. Trail is closer to Frontier – a 25-minute drive away - than to most other cities of BC, including Vancouver.
Wind generally travelled down the river valley, where plots of lands folded out from Boundary to Frontier, Doyle to Deep Creek.
In 1925, a farmer a “few miles south of the boundary line” – JH Stroh – became the first to complain to the Trail Smelter. Other downstream farmers and residents followed, claiming alleged sulphur dioxide fumes from the smelting plant had damaged their trees, soil and crops.
Alfalfa, clover, barley, oats and wheat were among general crops grown for feed. There was grazing land as well as forested areas where trees were harvested. In 1930, the daily level of sulphur emissions was roughly 300-350 tonnes.
The US sued Canada for damages.
In 1941, a specially formed tribunal (in its second decision – the first in 1938 awarded the US US$78,000, or US$1.5 million in today’s dollars) concluded “no State has the right to use or permit the use of its territory in such a manner as to cause injury by fumes in or to the territory of another or the properties or persons therein, when the case is of serious consequence and the injury is established by clear and convincing evidence”.
Foreign investors are increasingly bringing claims in relation to environmental matters
Despite the dramatic rise in support for climate action and surge in the number of decarbonisation pledges, there is no formal dispute resolution mechanism relating to climate change related state commitments under the Paris Agreement. This was a deliberate choice on the part of member states, but it does in part explain the dramatic escalation of investor disputes.
The ISDS fills a ‘governance gap’. The Energy Charter Treaty, which came into force in 1998 and has 53 signatories, has led to more claims than any other investment treaty by far: at least 145 of the more than 1100 treaty-based ISDS claims since 1987, or about 13%. The vast majority of these related to renewables - including the string of cases against Spain.
The Spanish arbitrations set a framework for copycat claims against other countries. Investors have not necessarily set out to use investment treaty dispute resolution mechanisms to force action on climate change, but the disputes send a powerful message to governments that investors can and will act if renewable energy incentives are wound back.
The cost of transitioning to a net zero environment by 2050 will require roughly US$4 trillion in clean energy investments each year from 2030, according to the International Energy Agency.
Could investors pursue climate activism?
The impacts of climate change have the potential to cause enormous harm to a broad range of investments including in fishing, agriculture and horticulture, food and beverage, coastal land, eco-tourism sites and wineries.
An investor could potentially claim against a country alleging breach of its obligations under a bilateral investment treaty for failing to take steps to reduce the impact of anthropogenic climate change on their investment.
There is arguably a precedent for this: in 2009 Peter Allard, a Canadian eco-tourist operator who owned a wildlife sanctuary on the south coast of Barbados, sued the country for indirect expropriation in violation of the Canada–Barbados Bilateral Investment Treaty (BIT).
Allard argued the government failed to take ‘reasonable and necessary environmental protection measures’ and ‘destroyed’ the site, after a state-operated sewage treatment plant failed. He ultimately lost, but in its 2016 award the tribunal found that states could, under the right circumstances, be under an obligation to protect investments against environmental damage.
Climate disputes in domestic courts are increasingly successful, despite their novel nature. Whether foreign investment disputes can replicate this to force countries or companies to take action on climate change is an open question.
Could investor disputes in fact ‘chill’ climate reform?
As ISDS claimants are typically from high-income states, this may lead to an uncomfortable situation wherein investors from the wealthiest states challenge policies of low-income states designed to alleviate the impacts of climate change on that state.
Some investors are rumoured to have applied informal pressure against change using the threat of an investment treaty dispute. Governments may fail to regulate in the public interest because of that threat.
This means poor quality environmental protection regulations remain, to the disadvantage of people and the environment. Low-income countries may lack the resources to hire the highest quality legal representation to defend such claims. They may also hold concerns about the prospect of paying not only an award for damages but also legal costs, which in ISDS proceedings can be high: Australia paid an estimated AU$24 million (at least) to defend claims brought by Philip Morris relating to plain packaging laws. Uruguay had its costs in a similar claim covered by the Bloomberg Foundation.
The effect is difficult to prove.
Examples of cases that both support and undermine the possible existence of a chilling effect:
- Australia went ahead with plain packaging reforms despite the action by Philip Morris
- Germany (Hamburg) by contrast, eased water-use permit restrictions for a coal-fired plant as part of a settlement deal
- Canada reversed a ban against a petrol additive
- Canada (Alberta) pledged to phase out coal-fired power by 2030, which triggered a compensation claim for US$470 million from a US company with coal interests in Alberta. The case is ongoing but the sheer quantum of the amount claimed may be a deterrent to other jurisdictions from decarbonisation efforts.
In 2021 two coal power plant owners filed ICSID arbitrations against the Netherlands in reaction to 2019 legislation which prohibits the use of coal to generate electricity from 1 January 2030. Both companies made their views clear in the public consultation process prior to legislation being passed but the Netherlands proceeded regardless. The Netherlands has stated that its legislation meets its international and European law obligations and that plant owners should not have expected that the government would not impose measures to reduce carbon emissions.
Spain was an early mover in the renewable energy space but its scheme was a victim of its own success. Among those attracted to the scheme were foreign investors. Following a series of multi-million dollar claims, Spain ultimately reintroduced measures to support affected projects.
1990s introduced policies to incentivise the take-up of renewables
2006-08 installed solar PV capacity in MW increased by almost 27-fold*
2007 introduced generous feed-in-tariffs (FITs): payback to providers feeding electricity from renewables to the grid
2009 electricity system over-burdened and costs rocketed, reaching €2.6 billion per annum**
2009 global financial crisis deepened in Europe, fiscal imbalance followed and Spain wound back incentives to rescue its bottom line
2012 cut support for new projects
2013 retroactively cut the FIT level for existing projects, making many unviable.
The investors argued Spain’s actions were in breach of its obligations under the Energy Charter Treaty and effectively amounted to expropriation, or Spain had otherwise violated its duty to afford the investors fair and equitable treatment by undermining their legitimate expectations.
In response to the awards against it, at the end of 2019 Spain reintroduced some incentives for affected projects provided investors abandoned their claims or didn’t make claims.
Italy (13 cases) and the Czech Republic (6 cases) were similarly state party defendants after changing renewable incentives. Canada also attracted claims under the North America Free Trade Agreement, after the state of Ontario gave one company priority access to wind and solar transmission capacity.
In 2021, Japan was subjected to its first ever investment treaty claim; reportedly filed by a Hong Kong investor under the Hong Kong-Japan Bilateral Investment Treaty in relation to changes to Japan's renewable energy subsidies. This is likely to be a precursor to more renewable energy disputes across the region.
In total, investment treaty tribunals have awarded approximately €1.2 billion in damages in the renewables sector.
* Source: IISD, from 103 to 2708
** Source: IISD
How countries are protecting their power to act on climate
1. Environment ‘carve-out’ clauses in treaties
Countries are increasingly inserting carve-outs for environment preservation into investment treaties – in essence to shield regulatory action to protect their environment from claims. For example:
- The Netherlands Model Investment Agreement refers to the Paris Agreement and reaffirms that parties to Dutch investment treaties commit to their obligations under international environmental law
- The Morocco–Nigeria Bilateral Investment Treaty contains binding provisions requiring parties to ‘apply the precautionary principle’.
Whether these provisions will work as an effective shield against ISDS disputes is unclear, leaving a ‘grey zone’ at the intersection of international environmental law and international investment law. The need for clarity in relation to climate change measures may lead to renewed efforts to form an international agreement at the intersection of these two bodies of law.
For the moment, most claims are under ‘old generation’ treaties which don’t include this new language, and even those with it haven’t had a smooth run. In one dispute between Colombia and Eco Oro Minerals, the tribunal held the carve-out allowed Colombia to enforce an environmental protection measure but didn’t stop an investor from claiming compensation where affected.
Whether more general provisions – like those allowing a state to take measures to protect the public interest or its essential security interests – could extend to protection of the environment is an open question.
2. COUNTRIES FIGHTING BACK WITH COUNTER-CLAIMS
Some countries are hitting back when investors make claims by seeking compensation for any environmental damage caused by the investment.
In the past tribunals haven’t admitted counterclaims against investors who bought the original claim. But claims over the past five years have upended this tradition.
In 2017 Ecuador successfully counter-claimed US$2.8 billion in compensation from an investor for a breach of its environmental laws. Ecuador successfully counterclaimed again two years later and was awarded US$54 million (although it is important to note that this matter was complicated – it did not begin as an environmental claim but one relating to tax and the company affected by Ecuador’s takeover of oil extraction activities was awarded US$448 million).
They reflect a growing willingness of investment treaty tribunals to allow states to use the ISDS process as a sword for seeking compensation for and mitigation of the environmental harm caused, or contributed to, by investors.
There are only limited examples of environmental counterclaims, especially compared to the growing body of cases in other international forums relating to questions involving the environment, such as the International Court of Justice. Leaving open questions as to what constitutes ‘environmental damage’ and threshold questions of liability.
3. AN EMERGING “NORM” REQUIRING ENVIRONMENTAL PROTECTION?
In international law, some rights and obligations are of such widespread importance that they are owed by a country to the international community as a whole. They are erga omnes: a Latin phrase meaning ‘towards all’ or ‘in relation to everyone’.
There are very few recognised rights and obligations owed to all, since the concept first gained traction in 1970: prohibitions against aggression, genocide, slavery, racial discrimination, crimes against humanity and torture, and the right to self-determination.
Some have argued there is a new emerging obligation to all: environmental protection. Whether or not this is the case is arguable, but you can read an interesting discussion of it here and decide where you stand.
The upshot? Climate change-related disputes are likely to grow in number, complexity and size as the impacts of the climate crisis become more pronounced, raising thorny questions for investment treaty tribunals.
- Want the in-depth take? Our experts have published a piece on this topic in the esteemed Global Arbitration Review, featuring as a chapter in its first investment treaty protection and enforcement guide. You can read it in full here.
- Although we refer to ‘countries’, the technical term is ‘states’ under international law. We refer to ‘countries’ to align with commercial lexicon but acknowledge not all countries are recognised as legal states. Only those meeting certain criteria are – in brief, a permanent and stable population, a defined undisputed territory, and an effective and independent government.
Thanks to Jack McNally for assistance and KWM School of Opportunity student Olivia Stewart for research on arbitration cases.