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The US-EU trade treaty that could let corporations sue governments

Investor-state dispute settlement: US wants it, EU is trying to reform it, and 97 percent of EU citizens reject it

A proposed system between the United States and the European Union that would allow corporations to sue governments has Europeans up in arms. In the EU the system, investor-state dispute settlement (ISDS), was until two years ago understood by only a few — but that changed when a Swedish nuclear energy company sued Germany for $4.7 billion for deciding to phase out nuclear power in the wake of the Fukushima disaster in Japan.

“People felt very strongly that nuclear power should be phased out. They were shocked to see a company could actually challenge something that was approved at the constitutional level,” said Cecilia Olivet of the Transnational Institute, a Dutch social justice organization for scholars, activists and policymakers. This was the second time Germany was sued by the company — the first was over environmental restrictions on a coal-fired plant, which the country was forced to settle.

ISDS, a relatively obscure system of for-profit arbitration courts that has long been controversial in legal, corporate and policy circles, is catching public attention as it’s poised to become a lot more powerful. In these courts, such as the World Bank’s International Centre for the Settlement of Investment Disputes in Washington, D.C., foreign corporations sue governments over investment disagreements.

Proponents of ISDS argue that it helps establish the necessary conditions for successful investment, thus increasing global investment flows and the profit that accompanies them. Critics say it violates democracy and equality before the law and leads to a situation in which “corporate rights take precedence over human and environmental rights,” said Manuel Perez Rocha of the Institute on Policy Studies in Washington, D.C., a network of justice scholars and activists. 

Many free trade agreements — including one that the U.S. is negotiating with the EU, the Trans-Atlantic Trade and Investment Partnership (TTIP) — include clauses that require governments to accept the jurisdiction of ISDS courts. The Trans-Pacific Partnership, a trade agreement being negotiated among 12 Pacific Rim nations, also includes ISDS. The Office of the United States Trade Representative is pro-ISDS, describing it as a “neutral procedure” that “seeks to provide a law-based approach to resolve conflicts.” The deputy assistant U.S. trade representative for media and public affairs, Trevor Kincaid, declined to comment. Although governments can negotiate to exclude ISDS from trade agreements, high-level European officials, including EU Trade Commissioner Karel De Gucht have said that the U.S. has signaled it will abandon TTIP negotiations if the EU does not accept ISDS.

Cases like the one over nuclear power in Germany sparked protests so widespread in Europe that in June 2013, EU officials paused negotiations about ISDS with the U.S. to conduct a public consultation on whether and how to include it in the trade agreement. The consultation received 150,000 responses — more than any other in EU history — and 97 percent of those were opposed to ISDS.

EU officials understood this “as an expression of a strong feeling in European public opinion that these policies need to be deeply changed,” said Daniel Rosario, the European Commission representative for trade and agriculture, adding that the position of the EU is still that investment protection is necessary in all trade agreements. “The question for us is about how you make sure investments are protected but not at the expense of the right of member states to regulate. If we don’t have it, our investors in the U.S. will be at a disadvantage compared to investors in the U.S. from other parts of world who negotiated with ISDS.”

Last week the European commissioner for trade, Cecilia Malmstrom, released a series of reforms the EU will seek to make in the way that ISDS is implemented in the TTIP — which, she assured the public, would accomplish her goal of “the rule of law, not the rule of lawyers.” Because trade negotiations are conducted in secret, exactly how those reforms would accomplish this is unclear.

Some parts of the ISDS system are secret, but the U.N. Conference on Trade and Development has tabulated more than 300 cases since the system’s inception. (The United States has been sued 17 times in the past 25 years, according to the Office of the U.S. Trade Representative.) Most cases aren’t widely known, but two that are involve the tobacco company Phillip Morris, which sued the governments of Australia and Uruguay in 2010 and 2014, when they passed regulations to make smoking less appealing — Australia by forcing plain packaging for cigarettes and Uruguay by increasing the size of health warnings on packages from 50 percent to 80 percent. Olivet said the cases flabbergasted the European public. “People felt like, How come? This is for public health, it’s promoted by the World Health Organization, they’re following international guidelines, it’s working — and yet they’re still entitled to challenge such measures? The system has gone too far,” she said. In the United States, the case caught the attention of everyone from comedian John Oliver to Bill Gates and former New York Mayor Michael Bloomberg, who pledged $4 million toward the countries’ legal fees. The cases are still being decided in arbitration courts in Washington, D.C., and the Netherlands; meanwhile, other countries that wish to pass similar public health regulations, like New Zealand, cautiously await the decision to see if they can afford to.

ISDS first showed up in the context of decolonization, in a 1959 investment treaty between Germany and Pakistan. The logic behind it then was to create a favorable climate for investors in potentially volatile countries. “The underlying theory of ISDS is that investors should have a neutral forum in which to seek recourse against improper government conduct. This is based on the idea that governments have a power over foreign investors and their investments — a government has the sovereign power to, either through direct seizure or through regulations, take the investor’s investment away,” said Philippe Cavalieros, a Paris-based partner at Winston and Strawn, a global law firm that represents states and investors in ISDS arbitration. “However, in reality, governments are not necessarily stronger, because they can be subject to immense pressure from foreign investors and/or the foreign investors’ governments.”

Whether ISDS leads to more investment is hotly debated. A decade of investigation by Gus Van Harten, an ISDS expert at Osgoode Hall Law School in Canada, showed “no clear evidence that ISDS makes any systematic difference” in investment flows. Cavalieros said that while ISDS is not “absolutely necessary in order for trade and investment to be conducted in a mutually beneficial way” and the “ISDS system still definitely has room for improvement,” it’s useful in “counterbalancing the risk of having to face state courts that are not necessarily able to render unbiased decisions. Some investors rely on the existence of ISDS when making their decision to invest.” EU officials agree, according to Rosario, who said “practice shows that investors feel more comfortable having these assurances that their investments are protected.”

But the Philip Morris case exemplifies some of the driving factors for the public outcry over the system — for example, that ISDS “enables corporations to bypass human rights and a large number of regulatory measures that governments make for the public interest,” Rocha said. Citizen groups like his point out a host of ways in which they say ISDS arbitration courts rig the game in favor of investors.

First, only investors may sue governments in ISDS tribunals; the reverse is not possible. (If Australia wanted to sue Phillip Morris for public health expenses due to smoking-related cancer, for instance, it wouldn’t be able to do so in ISDS courts.) “ISDS sets up a parallel judicial system available only to foreign corporations,” said John Hilary, the executive director of War on Want, a British anti-poverty organization.

This amounts to special rights for investors, according to Scott Sinclair of the Canadian Center for Policy Alternatives, who studies ISDS cases brought under the North American Free Trade Agreement (NAFTA). “Why should foreign investors have the right to bypass ordinary courts, which have been evolving for hundreds of years as part of our democratic system of justice?” he said. “Investors can win, but the best that governments can do is avoid paying damages.” (Sinclair found that the majority of ISDS claims against Canada under NAFTA have been over environmental protection regulations.)

ISDS courts, unlike normal courts in most democracies worldwide, are for-profit institutions in which practicing lawyers and industry experts, not professional judges, sit as arbitrators. This means “for-profit arbitrators decide whether public policies implemented by democratically elected governments are right or wrong,” said Olivet.

According to Van Harten, ISDS arbitration thus “lacks all safeguards of independence and impartiality … The penalty could cripple a country economically. That a government would face so much unpredictability with so much public money — you have to understand the power of it.” 

Government tabs are ultimately paid by taxpayers, he said, describing ISDS as a “public insurance program for foreign investors against the risks that come from democracy, politics and judicial decision-making in countries all over the world.” His research shows a “huge transfer of public money from taxpayers worldwide to wealthy individuals and companies in North America and Western Europe” — about $6.5 billion through early last year, 65 percent of which went to corporations with annual revenues of over $10 billion.

Proponents of ISDS dismiss such resistance as alarmism drawn from a few egregious examples and point out that statistically, most cases are either settled or won by governments. But even if governments don’t lose, “lawyers’ and arbitrators’ bills will still run into the millions, and that has to be paid nonetheless,” said Olivet. “So the moment that investors sue, the bill starts to run.”

The threat of expensive lawsuits can leave governments afraid to pass laws in citizens’ favor, a phenomenon known as regulatory chill. Van Harten said this is true “especially for big companies and individuals with deep pockets who can credibly threaten to bring a lawsuit. ISDS helps them by shifting the institutions of government decision-making in their favor. Now whenever governments make a decision that will affect one of those actors, those actors have a special right to say, ‘If you do this, we can sue you. Even if there’s a small risk of losing, it has to be a powerful tool in getting governments to do what they want.”

Furthermore, ISDS critics point out, arbitrators decide cases considering only the terms of the business contract, even if human rights abuses may have happened. This is the case with the government of El Salvador, which refused a Canadian mining company permission to operate because of irreversible pollution it would cause to the country’s largest freshwater source and currently faces a $301 million suit for that decision.

“It’s a license to be unfair,” said Van Harten. “You get to make certain decisions that affect people without hearing from them. Those who are hurt by the misconduct don’t even get to participate. Why should anyone get these extensive rights backed by large amounts of public money without responsibilities?”

The Philip Morris cases also show a legal hopscotch that deepens the divide between corporate and human rights. Philip Morris is legally a U.S. company, but it was able to use its foreign subsidiaries to choose which trade agreements it preferred to use to sue Australia and Uruguay — a practice known as forum shopping. (It used Australia–Hong Kong and Uruguay-Switzerland agreements, both of which recognize ISDS jurisdiction.) Yet when human rights practitioners have tried to sue multinational corporations in U.S. courts for alleged human rights abuses abroad, the U.S. legal system has said that multinationals are defined by only one home country, as in the 2013 case Kiobel v. Royal Dutch Shell, which the U.S. Supreme Court said could not be tried in the U.S. because Shell is a Dutch company and the case did not “sufficiently touch and concern the territory of the United States.”

“In a way, everyone accepts this culture of impunity, which has grown up because of handing over so many powers to multinational corporations without any channels of redress or ways to rein in their power … Everyone knows that’s the problem,” but there isn’t widespread agreement on how to fix it, he said.

The past 40 years have seen myriad attempts at the United Nations to balance corporate and human rights in a legally enforceable way. Through the decades, Hilary said, these attempts have “failed as a result of dogged resistance from Western nations.” The U.N. has the Ruggie Principles, guidelines that establish that corporations must respect human rights, but they’re not enforceable. Some companies are signatories to a voluntary agreement to do so, the Global Compact, but companies cannot be forced to follow through.

The most recent such attempt at the U.N. is from Ecuador, which lost a $1.7 billion ISDS lawsuit to the U.S. company Occidental Petroleum. In August 2013 the country proposed that the U.N. Human Rights Commission write a treaty setting binding human rights obligations for transnational companies. The measure passed in June 2014, despite resistance from the U.S. and the EU. The commission is drafting a treaty.  

Another increasingly popular idea is to create an international court, like the criminal court in The Hague, that would be “accessible for everyone that faces problems around global investment flows,” said Pia Eberhardt of the Corporate Europe Observatory, a lobbying watchdog group. “This should be a court where investors could also be taken for violations of human rights and where all affected parties could participate — not only investors and governments but also civil society and communities,” said Perez Rocha.

The idea is supported by many EU officials, according to Rosario, who said, “We think this is a very good idea and it would be useful to start working on it now so that it becomes a reality in a medium-long term.” In fact, in early May, EU officials presented to the U.S. a proposal for ISDS reform — including beginning the process of creating an international court. The U.S. rejected it and called concerns about ISDS “misguided,” according to the U.S. undersecretary for international trade at the Commerce Department, Stefan Selig.

But the question remains about what to do with ISDS in the TTIP. According to Van Harten, if it remains in, the amount of U.S. investment flows covered by ISDS would rise from approximately 15 percent to 50 percent, and if it stays in all the free trade agreements being negotiated around the globe, total worldwide investment flows subject to ISDS would hover near 90 percent.   

U.S. and EU trade officials insist that reforms to ISDS would correct problems with the system. “We had a meeting a couple of months ago with the economics attaché of the US embassy in the Netherlands to tell her our concerns,” said Olivet. “Her response was, ‘You have to trust us.’ But based on experience, we just can’t do that.” 

As ISDS is poised to skyrocket in influence, public opinion is increasingly turning against it — not least because to many, it’s not obvious why it’s necessary. Most trade and investment around the world happens without ISDS, and some countries simply refuse to sign agreements that include it, like Brazil.

And in the case of the TTIP, a strong trading relationship between the U.S. and the EU already exists. “We have strong private property laws, efficient and reliable courts, trillions of investment dollars flowing back and forth. What’s the problem they’re trying to address?” said Eberhardt. “The alternative to ISDS is no ISDS. The alternative to a headache is no headache.”

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