Where trade agreements are a risk to sovereignty

December 24, 2014 12:00 am Published by Leave your thoughts

A nation’s sovereign right to determine matters within its borders is put at risk where its government signs a trade agreement which includes a dispute resolution clause known as an Investor State Dispute Settlement (‘ISDS’) clause. Sovereignty is at risk because where once an ISDS clause acted as a shield to protect a foreign corporation’s investment from the illegitimate act of a host nation, it has since morphed into a sword that a foreign corporation draws and waves demanding their self-interest prevails over the legitimate act of a host nation performed in the national interest. The ISDS clause needs to be replaced by a mutually beneficial mechanism which protects not only a foreign corporation’s interest against adverse acts of a host nation but also protects the sovereign right of a host nation to act in the national interest. 

ISDS clause

An ISDS clause is ostensibly a mechanism for resolving a dispute where two or more nations are bound by a trade agreement and a foreign corporation of one nation party to the agreement alleges that a host nation’s government, parliament or judiciary has acted in a manner which adversely affects the foreign corporation’s investment in the host nation. The clause yields a foreign corporation a legal right to sue the host nation for compensation. The right is not available to a domestic corporation to sue its home nation, however.

Typically, a dispute, in the first instance, is heard within the host nation’s legal system and if not satisfied with the outcome, then a foreign corporation, but not a host nation, can avail itself of the ISDS clause and refer the dispute to an arbitral tribunal. The decision of an arbitral tribunal is final and there is no right of appeal even where the decision is, on its face, manifestly wrong or unjust. 

A safeguard exemption can be negotiated between the nations and inserted in to the clause as a tactic to protect sovereign rights and that is the preferred tactic of the conservative UK government and recently a tactic adopted by the conservative Australian government. Whilst on the surface the tactic has merit, it is, however, inherently fragile because the reliability of the exemption is uncertain until tested in a court or arbitral tribunal – where the exemption might fail outright or provide insufficient comfort to a host nation.  

ISDS history and the trade agreement landscape

Although an ISDS clause can lead to a loss of sovereignty that outcome was unintended and beyond contemplation when the clause was introduced. The West German and Pakistan governments introduced the ISDS clause in their 1959 trade agreement, intending it to act as a shield to protect or compensate

foreign investors (foreign corporations) from a host nation (Germany or Pakistan) partaking in the illegitimate acts of discrimination or expropriation [1]. The clause has since been adopted and adapted by many nations and is now very common in trade agreements. However, over time, and particularly since 1998, the clause has morphed from a shield into a sword that has been drawn and waved by foreign corporations demanding their self-interest prevails over a host nation’s sovereign right to legitimately make law and policy in the national interest. 

The trade agreement landscape has become very adversarial. The risk to sovereignty posed by an ISDS clause in a trade agreement is not insubstantial and by 2013 there were about 2,750 active trade agreements [2] and alarmingly about 568 reported ISDS disputes [3]. The growth trend in disputes is now exponential having taken about 40 years to rise to a handful of disputes per year in 1998, it then leaped to about one new dispute per week, 15 years later, in 2013 [4]. Making a claim under an ISDS clause is typically worthwhile for a corporation. Thus far, claims made by corporations against nations range from USD 27 million to USD 1 billion [5] and the success rate is quite high. In 2013, for example, 57% of the ISDS claims achieved a result for the complainant corporations: 31% of the claims were settled and a further 26% of the claims were ruled in favour of corporations [6]. And yet, a high percentage of successful claims by corporations is not necessarily a poor reflection on a host nation or its judicial system, instead some commentators have pointed to the many flaws in the arbitral tribunal system which hears the disputes. 

Arbitral tribunal system

The arbitrary tribunal system which hears ISDS disputes essentially comprises four tribunals, each having its own rules and hearing about 95% of all disputes. The tribunals are: the International Centre for Settlement of Investment Disputes (‘ICSID’) which hears about 55% of disputes, the United Nations Commission on International Trade Law (‘UNCITRAL’) which hears about 35% of disputes and the Stockholm Chamber of Commerce (‘SCC’) which hears about 5% of disputes [7].

The proposition that a judgement of a supreme court or a superior court of an elite court system, for example the US Supreme Court or the Supreme Court of Canada or the High Court of Australia, can be called in to question or pushed to one side by an arbitral tribunal is deeply controversial and has attracted comments from judicial elders. Writing ex-judicially, Robert French, the Chief Justice of the High Court of Australia, explains the controversy: “[a]rbitral tribunals set up under ISDS provisions are not courts. Nor are they required to act like courts. Yet their decisions may include awards which significantly impact on national economies and on regulatory systems within nation states. Questions have been raised about the consistency, openness and impartiality of decisions made in ISDS arbitrations” [8]. Chief Justice French lists some of the factors that justify the questions: [9]

* provisions in treaties are vague and wide open to interpretation by arbitrators

* there are system loopholes enabling abuses where companies create subsidiaries in nations specifically to take advantage of trade agreements

* there are varying degrees of secrecy surrounding the arbitral processes

* the cases are expensive, about $US 8 million each 

* there is role swapping [an arbitrator will occasionally swap roles and appear before the tribunal as counsel]  

* tribunal decisions are inconsistent [or in other words, a tribunal is not bound to treat like cases alike]

* there is not an effective review or appeal process [whereby either party can appeal a tribunal’s decision]

ISDS disputes

The subject matter of some ISDS disputes clearly illustrate how an ISDS clause pits the self-interest of a foreign corporation against a host nation’s sovereign right to act in the national interest. In Quebec, Canada, the state government was concerned by the environmental impact and public objections to fracking. Acting legitimately and well within its sovereign rights, the Quebec government imposed a moratorium on fracking which in turn led to the revocation of the US’s Lone Pine Resource Inc’s (‘Lone Pine’) gas exploration permits. Lone Pine sued Canada for damages, claiming a breach of the North American Free Trade Agreement (‘NAFTA’). 

In Australia, Philip Morris Asia, a Hong Kong subsidiary of Philip Morris Inc, the US tobacco giant, acquired Philip Morris Inc’s Australian subsidiary (Philip Morris Australia) and this apparently enables Philip Morris Asia to make use of an ISDS clause in an Australian-Hong Kong trade agreement. This corporate restructuring is seemingly a system loophole that overcomes the obstacle that the clause is not available to Philip Morris Australia, it not being a foreign corporation in Australia, to use against Australia [10] Philip Morris Asia alleges that Australia’s ‘plain packaging’ cigarette law – which denies the use of promotional insignia such as trademarks on cigarette packaging amongst other things – amounts to expropriation of the trademarks. In an earlier decision, Australia’s supreme court, the High Court of Australia, held that the law amounts to a deprivation of the use of the trademarks and does not, as claimed by Philip Morris Asia, amount to an acquisition of property in the trade marks by the Australian government and so does not attract payment under the Australian constitution [11]. And a Swedish company, Vattenfall, has sued Germany over Germany’s recent decision to phase-out nuclear power plants in light of growing public concern in Germany after the meltdown of Japan’s Fukushima nuclear power plant. 

Corrective action

The misuse of an ISDS clause as a sword to call into question a legitimate act of a nation’s parliament, government or judiciary is untenable and a mechanism is required to replace the ISDS clause. There are many flaws in the original design of the clause and the tribunal process that surrounds it. For example, the design of the clause does not recognise the right or obligation a host nation has to legitimately protect its national interest and nor does the tribunal process permit a host nation to refer a dispute to a tribunal or for either party to appeal the decision of a tribunal.   

Whilst corrective action is clearly required the mechanism of relying on a domestic court system, as proposed by Germany’s junior economy minister, Brigitte Zypries, [12] is obviously problematic. The proposal risks deterring foreign investment in Germany for the obvious reason that a foreign corporation would assess that it would be more probable than not that a German domestic court would not rule in favour of a foreign corporation where the matter in dispute is couched by the German government in terms of a matter of national interest. For example, on the matter of Germany’s decision to phase-out nuclear power stations, it is unlikely that a German court would have ruled against Germany and nor would have other domestic courts ruled against their national government.

A mechanism worth considering is to define and make adverse acts (illegitimate and legitimate) of a host nation an insurable risk. An insurance policy could be taken out by a foreign corporation and the cost passed on like any other business cost to the customer. Thus, the corporation has its shield and removed from a host nation are the burdens of a loss of sovereignty and the cost of compensation. Removing the burdens from a host nation need not open the floodgates to a host nation generating adverse acts because such acts by a host nation would attract a commensurate increase in the insurable risk and thereby reduce the likelihood of that host nation attracting foreign investment. And although, a rise in insurable risk might be viewed as a restraint on sovereignty, it is no more a restraint than that which is already imposed on a nation’s sovereignty through its membership of the international community.”


1 ‘Investor-State Dispute Settlement –  The arbitration game’, The Economist, 11 October, 2014, <http://www.economist.com/news/finance-and-economics/21623756-governments-are-souring-treaties-protect-foreign-investors-arbitration>, last viewed on 12 December 2014.

2 Wikipedia, <http://en.wikipedia.org/wiki/Investor-state_dispute_settlement>, last viewed on 10 December, 2014.

3 There is no authoritative number of disputes because reporting is voluntary.

4 UNCTAD, Recent Developments in Investor State Dispute Settlements (ISDS), No. 2, April 2014.

5 Ibid. 

6 Ibid.

7 Ibid.

8 R S French, ‘Investor-State Disputes Settlement – A Cut Above the Courts?’ (Paper presented at the Supreme and Federal Courts Judges’ Conference, Darwin, 9 July 2014), 1. Download from: <http://www.hcourt.gov.au/assets/publications/speeches/current-justices/frenchcj/frenchcj09jul14.pdf>, last viewed 14 December 2014.

9 Ibid.

10 This case is currently being heard by UNCITRAL.

11 The Commonwealth of Australia Constitution Act (1900) s 51(xxxi) requires acquisition of property by the federal government to be on “just terms” or in other words, the government must pay a person market value when it acquires a person’s property. Note: in law a corporation is considered to be a person.

12 Out-law.com, ‘Germany Plans to block ISDS clause in transatlantic deal’ <http://www.out-law.com/en/articles/2014/march/germany-plans-to-block-isds-clause-in-transatlantic-trade-deal/>, last viewed  on 14 December 2014.


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This post was written by Mark Horner

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