Sovereign risk: first ISDS dispute won, but it won't be the last

By Stephen Easton

December 23, 2015

Australia may have swatted away the first case ever brought against it under an investor-state dispute settlement clause in a trade agreement, but it’s unlikely to be the last.

Originally designed to prevent grossly unfair treatment of foreign investors like expropriation of private assets, ISDS mechanisms can go too far the other way, giving the biggest investors legal means to throw their considerable weight against the legitimate decisions of sovereign governments.

Last week, Commonwealth lawyers successfully defended Australia’s world-leading plain packaging regulations against a challenge from Philip Morris under the ISDS provision of a 1993 agreement with Hong Kong. The court of arbitration hearing the case in Singapore ruled the matter out of its jurisdiction.

The company is trying to play down the significance of the decision as a mere technicality through a derisive global press release that chided the Commonwealth’s advocates for arguing a “procedural issue … instead of confronting head on the merits of whether plain packaging is legal or even works”.

On the contrary, international trade law expert Tania Voon sees it as a “significant win” for Australia’s regulatory sovereignty and an encouraging sign for other nations contemplating similar restrictions.

“I think it’s misleading to say it’s a narrow technical issue; I think it’s a significant procedural issue,” the University of Melbourne law professor and former World Trade Organisation official told The Mandarin.

“I think it’s misleading to say it’s a narrow technical issue; I think it’s a significant procedural issue.”

“The arguments that Australia was putting forward were that this is an existing dispute that was repackaged as an investment claim [and] that it was an abuse of right under the investment treaty.”

The Asian arm of the global business, based in Hong Kong, bought out the Australian subsidiary months after the federal government’s intention to regulate became clear. The cigarette company thought this gave it access to ISDS under the Hong Kong agreement, but the Commonwealth successfully argued it did not because the company made an investment knowing the new legislation was likely to proceed, with the express purpose of challenging it.

Australia also accused Philip Morris Asia of a criminal offence: misleading the government about why it was buying into Phillip Morris Australia and whether the deal could affect Australian interests. The final argument was that one Phillip Morris subsidiary buying another did not even constitute a true “investment” under the treaty.

Even so, in picking the little-known Hong Kong investment promotion and protection agreement, Voon thinks “Philip Morris chose one of the worst treaties they could from Australia’s perspective, because it doesn’t have exceptions and nuances that the newer kinds of treaties have”.

Voon thinks other countries will be slightly encouraged to move ahead with tighter restrictions against the notoriously litigious tobacco industry heavyweights as a result of the decision. While it would obviously have sent a “stronger signal” to win a case fought on the merits of plain packaging itself, she points out this would also have cost the Australian taxpayer even more time and money.

If it had come to it, the Commonwealth’s team was ready to argue strongly that plain packaging was a legitimate exercise of its regulatory powers to protect the health of its citizens.

Valid concerns about ISDS

It’s only the first case brought against Australia under an ISDS provision and such cases are still fairly uncommon worldwide — but the number has been rising. The Trans-Pacific Partnership could increase the risk, if it goes ahead. Still, ISDS rules also give protection to Australian investors in some risky overseas markets.

The fear of ISDS can be unwarranted; Voon says most of the ISDS rulings she has examined have been “reasonable”. But there are still widespread and legitimate concerns with how the system generally operates.

“Nearly everyone in the system — even people that benefit from the system — would accept that there are significant problems with ISDS,” she told The Mandarin.

There’s the potential for conflicts of interest, with the same pool of international lawyers acting as arbitrators in some cases and advocates in others. Sometimes the parties challenge the appointment of certain arbitrators, or they excuse themselves voluntarily. Voon believes the issue still needs to be resolved.

Professor Tania Voon
Professor Tania Voon

She approves of a European Commission proposal to establish a more permanent appellate court system to hear ISDS cases. “It’s more like a court rather than an arbitration system,” she said.

“If there were judges who had security of tenure, then you wouldn’t have the same concerns about arbitrators being worried about whether they’re going to be appointed again and who they should side with on that basis.”

The history of trade liberalisation includes quite a few high-profile ISDS decisions, mostly under the North American Free Trade Agreement, which sparked public anger and were seen as going too far in contesting the mandate of an elected government.

One recent “problematic” decision of many that Voon believes have gone “too far into regulatory sovereignty” was a NAFTA tribunal ruling in favour of Bilcon, a company from the United States that had been blocked from building a new quarry in Canada. “It was quite shocking and I think it … went further than you would normally expect one of these tribunals to go,” she said.

One of the three NAFTA arbitrators, Donald McRae, dissented from the decision, and lots of Canadians agreed. He said it was a “remarkable step backwards” that would weaken the ability of governments to protect the environment and a “significant intrusion” into Canada’s regulatory sovereignty. Coincidentally, McRae was also Australia’s pick to hear the dispute brought by Phillip Morris.

Voon thinks arbitrators are generally starting to tread more carefully around the right of nations to regulate to protect human health or the environment, compared to the earlier days of trade liberalisation. She says there is a growing recognition within the system that it can’t continue as it is.

“I think arbitrators are increasingly aware of [public concern] and maybe that can help to stem these sorts of decisions where they’re really going against legitimate regulatory responses in a way that was never intended under this system,” she said.

ISDS refined under TPP — if it happens at all

Voon doesn’t think the TPP’s ISDS clause will be a “huge disaster” for Australia’s sovereignty, as some think. Still, she holds serious concerns about the looming treaty.

One of those is that it will vastly increase the number of companies that can challenge Australia’s laws by giving investors from two major trading partners, the US and Japan, access to an ISDS mechanism for the first time. North American investors have a lot of experience using NAFTA to challenge member states, she points out, again increasing the likelihood of more cases for Australia to defend.

The second reason to agree to an ISDS clause — to attract more investment — is less important to Australia as it is already seen as a low-risk jurisdiction. That’s one reason Australian negotiators felt comfortable refusing to have one in our FTA with the US, and why the ISDS in the TPP does not apply between Australia and New Zealand.

“The basis for that is we recognise each other’s judicial systems as well established and fair,” Voon explained.

“So you could easily say the same thing as between Australia and the US — that we have sophisticated judicial systems and there are domestic protections, so … why does a foreign investor need more protection than a domestic investor? A foreign investor can bring claims in Australian courts under Australian law, and there are plenty of protections.”

“You might not be able to see the decision or it can be heavily redacted so you can’t makes sense of it.”

Philip Morris and other tobacco companies did just that, and the High Court ruled against them. Several members of the WTO are also taking on Australian plain packaging on behalf of the tobacco industry, a pivotal case with implications for all 162 members of the organisation, and one Voon thinks they will lose.

The TPP has a special clause preventing tobacco companies making use of its ISDS provision, but other extremely large, long-established industries that are beginning to see governments turn against them — like fossil fuel companies — could begin to use similar tactics, fighting a losing battle to prolong their demise.

Voon says the “unusual” exclusion is broadly worthwhile but also a kind of “red herring” because “there are many other policy areas where we want to maintain regulatory autonomy” besides tobacco control.

On the plus side, the TPP does address some problems of earlier free-trade agreements. “For example,” Voon said, “requiring that documents be revealed to the public and that hearings be open — whereas normally another problem with the system is that it’s so closed that often you’ll never know that a dispute exists, and even if you know that it exists, you can’t get access to the documents.

“You might not be able to see the decision or it can be heavily redacted so you can’t makes sense of it. Even in this tobacco case, Australia didn’t release its own submissions.”

She also believes large, multilateral agreements like the TPP do more to create a level playing field between investors and states compared with the bilateral agreements they are slowly superseding all over the world.

These newer treaties negotiated between groups of nations, she explains, generally end up with “more nuanced language to make clear that non-discriminatory regulatory actions for a legitimate policy objective, such as health or the environment, are not intended to be caught by these provisions against expropriation”.

The free-trade genie won’t go back in its bottle as some hope. But Voon can see the lessons of the past both informing the wording of newer ISDS mechanisms and putting the brakes on “arbitrators’ excesses” so that regulatory sovereignty and investment protection can coexist more harmoniously.

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