KWM Explainers - Investor-state dispute settlement - KWM

Foreign investors are increasingly using international arbitration to make claims when investments go wrong – so, what is ISDS?

One option for investors negatively affected by a government’s decision is to take legal action under treaties designed to protect foreign investment. Investor-State Dispute Settlement (ISDS) is an option increasingly understood and used in Asia. Most cases are in the energy sector, cases can last for years, and compensation awarded can reach into the billions.

In this explainer, we share our insights on this ever-important area of international arbitration - and make the complex simple.

The number of cases started has risen exponentially since ISDS began in the ’80s, with mixed results

Investors have brought more than 1200 treaty-based ISDS cases since 1987, of which 343 were pending at the end of 2022. Of the 890 cases concluded in that timeframe, most were decided in favour of a state, yet a relatively high number were decided for the investor or settled.

These are the matters known about. Others are decided in secret, by closed tribunals.

Source: The United Nations Conference on Trade and Development (UNCTAD) Investment Policy Hub

By far, the Energy Charter Treaty has attracted the most actions – almost double that of the next in line, NAFTA

The majority of International Centre for Settlement of Investment Disputes (ICSID) proceedings initiated between 1987 and the end of 2022 were brought on the basis of the Energy Charter Treaty (157) followed by NAFTA (79).

The amounts claimed are substantial and can reach into the billions

Across all cases between 1987 and 2022 where the amount claimed is known (all bar 382 cases):

Source: UNCTAD Investment Policy Hub

Awards are generally lower than the amount claimed, but some are substantial: the highest award to date is US$40 billion

Awards of compensation have steadily increased from tens of millions of US dollars in the early 2000s to billions today. The largest award of compensation in an investment treaty arbitration was US$40 billion awarded in Hulley v Russia. This was awarded in 2005 to a shareholder in the nationalised Yukos Oil company against the Russian Federation for indirect expropriation.

Compensation awarded in ISDS proceedings will vary depending on the type of compensation sought, be it for expropriation or breach of other investment provisions. Investment treaties often include provisions for the timely payment of compensation and the requirement that interest be paid in the event of delay ^[1].

Suing using the ISDS can take time and money – but there are efforts under way to address that

A study of 635 cases found that the average duration of proceedings was just under 3.5 years (1,263 days) and the average duration of decided cases was nearly 3.75 years (1,361 days) ^[2].

The time and cost involved in pursuing ISDS proceedings has been raised as a concern in the UN’s Working Group (WG) III current review of the process but is difficult to resolve.

• The duration of ISDS proceedings is heavily dependent on individual fact scenarios and a short proceeding doesn’t necessarily translate to a better proceeding.
• The duration of proceedings is most often prolonged because of procedural events such as bifurcation and arbitrator challenges or replacements.

The difference between the costs incurred by investors and respondent States is significant but costs for both parties have been dropping in recent years. Costs incurred by the Tribunal have remained fairly steady in recent years ^[3].

There is a push for permanent courts

In 2017 UNCITRAL assigned its WG III to consider possible reform of ISDS mechanisms amid criticism that the system was inconsistent, lacked transparency and was unfair.

Interest in the work of WG III among member states, non-member states, and other observers is intense and the review process has been delayed due to the impact of the COVID-19 pandemic. WG III has identified several topics for discussion including:

• the duration and cost of ISDS proceedings
• the lack of transparency
• the lack of an early dismissal mechanism for meritless claims
• the lack of a counterclaim mechanism for respondent states
• the lack of consistency in ISDS decisions.

During its discussions in 2020, WG III considered the establishment of a multi-national investment court or court of appeal^[4].

They started centuries ago to give investors into emerging economies security and confidence

Early systems for investor-State dispute settlements were first developed in 1795 with the Treaty of Amity, Commerce and Navigation between Great Britain and the United States. It provided for the establishment of a commission from which panels of 3 commissioners could be drawn to settle claims by merchants of one country for compensation against the other country following American independence. But it was not until the 1960s that provisions for investor dispute settlement mechanisms, as we know them today, began to appear in bilateral investment treaties (BITs).

In 1966 the ICSID Convention (also known as the Washington Convention) entered into force and today 160 nations are signatories. 

Additionally, BITs and international investment agreements may stipulate use of other dispute settlement mechanisms such as the Permanent Court of Arbitration or the Arbitration Institute of the Stockholm Chamber of Commerce^[5].

There are typically three arbitrators on a tribunal panel, one chosen by each party

ISDS proceedings are decided by panels of three arbitrators appointed and paid for by both parties to the proceedings. ICSID’s Panel of Arbitrators and Panel of Conciliators are drawn from nominations made by member states and the Chair of the ICSID Administrative Council.

• Detractors from the system argue that arbitrators are drawn from a small pool and have faced questions as to their independence.^[6]
• ICSID is actively working to improve the diversity of its arbitrator pool.

The ICSID secretariat provides administrative services for each case it administers, including legal counsel assisted by paralegals and legal assistants.^[7]

YouTube is among channels Tribunals are using to improve the transparency of proceedings

ICSID has made efforts to improve the transparency of its proceedings in recent years:

• publishing information about cases on its website
• improving awareness of international investment dispute settlement more broadly
• live web-casting proceedings since 2008
• recordings of proceedings are posted on its dedicated YouTube channel.^[8]

ICSID publishes its rulings on its website with the consent of the parties involved. Where consent is withheld excerpts of the legal reasoning are published.

UNCITRAL adopted Rules on Transparency in Treaty-based Investor-State Arbitration in 2013. The rules enable public access to documents and hearings as well as the ability for third parties to make submissions^[9].

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