Article New York Law Journal

New EU-Mexico Trade Agreement: What Lies Ahead for the Future of ISDS?

On April 21, 2018, the EU and Mexico announced an “agreement in principle” to update the terms of their 2000 Economic Partnership, Political Coordination and Cooperation Agreement. The new agreement advances the EU’s mission to transform the traditional investor-state arbitration in favor of a permanent bilateral investment court (BIC). It also follows similar treaties and free trade agreements between the EU and Canada, Vietnam, and Singapore. This article explores how this recent trend could affect international companies and individuals with investments in the EU.

Background on the Reforms

In today’s global economy, clients are investing and operating in markets that present heightened country risks such as the risk of nationalization, unfair taxes and discriminatory regulation. To offer foreign investors greater confidence in their ability to safely invest overseas, international investment treaties and free trade agreements (FTAs) provide valuable guarantees to foreign investors, and allow them to bring arbitration claims directly against host governments when those guarantees are violated. Today, there are over 3,000 international investment agreements worldwide, signed by over 150 countries.

While the scope of protection varies by instrument, most instruments contain similar protections. The fair and equitable treatment (FET) standard, for example, ensures that governments will refrain from discriminatory or arbitrary treatment of covered investors, and requires the governments to abide by terms promised to the investor. The treaties also prohibit uncompensated expropriations and create a level playing field for foreign and domestic investors.

A critical feature of the investor-state dispute settlement (ISDS) system is that disputes are submitted to a panel of neutral arbitrators appointed by the parties. In the event of a dispute, each party has equal power to appoint the arbitrator(s), who are private persons such as lawyers or academics. Once the tribunal renders its decision, the panel of arbitrators is dissolved.

To date, the 3,000 international agreements have yielded over 800 arbitrations against foreign governments. The large number of decisions produced by these tribunals has generated concerns regarding consistency. In extreme cases, two tribunals evaluating the exact same set of facts can arrive at wildly different conclusions regarding a State’s liability, without any appeal mechanism to reconcile those inconsistencies. Compare Iberdrola Energía S.A. v. Guatemala (ICSID Case No. ARB/09/5) with TECO Guatemala Holdings v. Guatemala (ICSID Case No. ARB/10/23). Critics also have taken issue with lack of transparency in investor-state arbitration given the public interest in the matters being determined, leading to the adoption of ICSID and UNCITRAL rules designed to enhance that transparency. Critics also have cited the “regulatory chill” that can arise from private arbitrators ruling on the legality of regulatory measures, leading to potentially significant state liability. Some feel that private investors ought not to be able to appoint decision-makers to render decisions involving sovereign rights behind closed doors.

These criticisms prompted the European Commission in 2015 to propose a new ISDS system in the form of a multilateral investment court. This past March, the EU’s highest court also decided that all intra-EU Bilateral Investment Treaties violate EU law by unduly ceding to tribunals the right to interpret EU law. Slovak Republic v. Achmea B.V. (Case C-284/16). Simultaneously, the EU has been working to negotiate FTAs and economic partnership agreements (EPAs) that provide for a BIC instead of arbitral panels.

The Transition From Arbitral Panels to BICs

Three agreements signed by the EU already provide for a BIC—the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU, the EU-Vietnam FTA, and the EU-Singapore Investment Protection Agreement. The EU-Mexico Agreement in Principle likewise contemplates the establishment of a BIC, although the agreement is not yet final. The following section describes the key reforms created by the four instruments.

Each agreement creates a permanent Tribunal and an Appellate Tribunal, replacing the traditional arbitration model. Depending on the agreement, the Tribunal is composed of nine to 15 members nominated by the states that signed the agreement. The Tribunal hears cases in divisions of three members appointed via a randomized selection process. The Appellate Tribunal reviews decisions of the Tribunal and can reverse or remand decisions back to the Tribunal. All decision-makers must possess the same qualifications required for the International Court of Justice. Depending on the agreement, the members will sit on the Tribunal for up to five years.

The agreements contain other important reforms, including an express reference to the right of governments to regulate in the public interest. Likewise, the agreements narrow the scope of investor protections. For example, the agreements contain a defined list of measures that could qualify as a violation of the FET standard. The agreements also limit situations in which a party can claim for an indirect expropriation. To address concerns about closed-door decision-making, the agreements introduce “full transparency in investment dispute settlement proceedings,” meaning that all documents will be publicly available online.

Some of the agreements may limit the right of particular investors to bring claims at all. CETA, for example, requires that an investor have a physical presence in a signatory state in order to gain protection in the other signatory State (i.e. mailbox companies can no longer invoke the protections). The agreements also may prohibit investors from seeking simultaneous remedies in domestic courts.

The recent changes affect only qualifying investors with investments in the EU who are from Canada, Vietnam, Singapore, and potentially Mexico. However, additional replacement treaties are likely on the horizon. For example, in a press release for a pending EU-Japan agreement, the EU Commission announced, “for the EU ISDS is dead.” All international companies and individuals with investments into the EU should therefore consider the potential implications of the recent reforms.

Potential Implications of the Reforms

Replacement of traditional arbitration for the BIC model could have important implications for non-EU investors in the EU, including:

Reduced investor protection. By narrowly defining the FET and indirect expropriation standards, the new agreements reduce investor protection. Notably, prior tribunals have found a violation of FET where an investor was treated “unfairly” or “inequitably,” encompassing a broader range of government conduct.

Improved consistency of jurisprudence. Because decisions will be rendered by a fixed roster of decision-makers (rather than ad hoc, privately appointed persons with potentially disparate views), investors can expect improved consistency of jurisprudence. The appeals panel, although still undefined, could also contribute to a stable body of jurisprudence by providing an opportunity for a second tribunal to correct earlier mistakes and reconcile inconsistencies across first-instance tribunals.

Decision-makers appointed by and accountable to the State. Traditional ISDS allows both the investor and the state to appoint arbitrators to decide a given dispute, which promotes neutrality because both parties have an equal opportunity to contribute to the formation of the tribunal. By contrast, the new agreements create tribunals appointed exclusively by the states. As a result, the judges are only accountable to the states, which could make them susceptible to bias in favor of states.

Enhanced transparency and reduced confidentiality. Increased transparency could encourage states to settle cases early where necessary to avoid airing the dispute publicly. However, public access could be problematic, particularly for companies that desire confidentiality for proceedings involving trade secrets or other confidential information. In addition, public access could lead to increased intervention from third parties such as public interest groups and NGOs.

It is difficult to predict how the BICs will affect investors’ rights and investment protection. What is clear is that this is a volatile period for international companies with investments in the EU. While the recent EU agreements only affect companies and nationals from Canada, Singapore, Vietnam, and potentially Mexico, more changes lie ahead. This month, the EU Commission was authorized to negotiate a multilateral investment court involving many more State parties, a process that will likely amend the treaties and FTAs available across the entire EU. Investors in the EU can expect that the EU will continue to replace investor-state arbitration in favor of a permanent court system. It is also possible that the new investment court model could gain traction beyond the EU. For example, some have suggested that the model be considered in the NAFTA negotiations. For those companies unfamiliar with ISDS, this is a good time to learn about the permanent court model and to evaluate its impact on investment protection in the EU and beyond.