TPP trade pact still needs improvements to protect governments from foreign suits

Earlier this month, a dozen Asia Pacific countries including Australia, Canada, Japan and the U.S. signed the Trans-Pacific Partnership (TPP) Agreement in Auckland, New Zealand.

Despite the fanfare, the agreement will actually not take effect until at least six countries have ratified it. The U.S., for one, is unlikely to do so until at least after the November elections.

The run-up to the congressional vote will give us time to think more deeply about the controversy surrounding investor-state dispute settlement (ISDS). This mechanism allows foreign investors to sue governments over discriminatory and abusive practices, such as unreasonable government seizure of assets.

Why is ISDS so controversial? What safeguards has the TPP installed to address the wide public concerns? Can further improvements still be made?

How ISDS works

Thus far, ISDS has attracted criticisms from policymakers, law professors and human rights experts.

Senator Elizabeth Warren is among the most vociferous critics of ISDS. As she laments, the mechanism gives large corporations “the right to challenge laws they don’t like – not in court, but in front of industry-friendly arbitration panels that sit outside any court system.”

To make things worse, ISDS allows these corporations to redo their legal matches in more friendly turfs. A case in point is Eli Lilly’s US$500 million complaint against Canada, which was filed after Canadian courts invalidated two of its patents.

The drug manufacturer claimed that such invalidations violated the North American Free Trade Agreement by indirectly expropriating its investments. Yet, critics lambast Eli Lilly for using ISDS as “an oversized public insurance scheme.”

Four major criticisms of ISDS

More specifically, ISDS has been criticized in four general directions.

First, it erodes national sovereignty and regulatory space by allowing private investors to challenge legitimate regulations, such as those concerning labor and the environment. An oft-cited example is tobacco giant Philip Morris' recent failed attempt to use ISDS to challenge Australian plain packaging regulations, which severely limit the display of cigarette brands.

Second, ISDS can impose heavy burdens on governments, especially those in the developing world. Arbitral awards can be significantly large. For example, the compensation for Russia’s wrongful expropriation of the now-defunct Yukos Oil was over $50 billion; Russia is currently appealing the ruling in the Netherlands. Because private investors initiate the arbitration, they may also file more complaints than governments would have under the WTO.

Third, ISDS arbitrations are costly and procedurally flawed. OECD estimated the costs to average over $8 million and to be as high as $30 million. In addition, arbitration tribunals may be filled with biased lawyers who have strong ties to major corporations. Critics of ISDS have also complained about a lack of transparent proceedings and a potential for frivolous claims.

Fourth, ISDS arbitrators may have tunnel vision. They may focus narrowly on only one side of the investment bargain – for instance, intellectual property protection instead of land grants or tax breaks. They may also ignore the important safeguards and flexibility provided by international agreements.

Even worse, unlike court cases, ISDS arbitrations are not subject to appeal within the dispute settlement process. They also do not follow precedents, as in common law jurisdictions. As a result, arbitration rulings can vary according to party, tribunal or subject matter.

Improvements in the TPP

To respond to these criticisms, the TPP has built some new substantive and procedural safeguards into its investment and related chapters.

Regarding sovereignty and regulatory space, the agreement reserves to each country the ability to regulate in the public interest, such as to ensure financial stability and to achieve “environmental, health or other regulatory objectives.” The agreement also explicitly recognizes the health authorities’ ability to introduce tobacco control measures.

To address the ISDS' procedural flaws, arbitration tribunals are now empowered to review and dismiss frivolous claims and to award costs and attorneys’ fees. The TPP also imposes on investors the burden to prove all elements of their claims. The agreement further limits claims to those that occurred within three and a half years and that involve more than mere expectations of profits.

Concerning transparency, arbitral proceedings under the TPP will be open and publicly accessible. According to the Office of the U.S. Trade Representative, the State Department’s website will contain all submissions, hearing transcripts and other key documents regarding TPP-based investment cases against the U.S.

In addition, TPP countries will establish a code of conduct for ISDS arbitrators to ensure impartiality. Before any final rulings, disputing parties will also have the opportunity to review and comment on proposed arbitral awards. TPP parties can further agree on interpretations that will bind arbitration tribunals.

Finally, to avoid tunnel vision, civil society organizations, environmental groups, labor unions and other interested stakeholders can file “friend of the court” briefs. Nondisputing parties, such as the investors’ home governments, will also be able to make submissions to arbitration tribunals.

Need for further improvements

Notwithstanding the improvements in the TPP, additional efforts will still be needed to address the remaining public concerns about ISDS. Fortunately, many of these efforts can be taken without amending the agreement.

To begin with, arbitration tribunals should avoid automatically equating legal rights with investments. For example, commentators have questioned whether intellectual property rights constitute investments when copyrighted materials have been merely circulated on the Internet or when patents have been reregistered. After all, in both situations, the investments involved were made outside the host countries.

Arbitration tribunals should also consider taking into account the relationship between the TPP and other international agreements, such as those within the WTO. Such consideration would greatly allay the concern about how ISDS cases could rewrite the hard-earned bargains made through the WTO negotiations.

Furthermore, TPP countries may want to establish an advisory center to support small and medium-sized enterprises (SMEs) and developing country governments. A potential model is the Advisory Centre on WTO Law, which trains government officials and provides legal advice and support on WTO matters.

If TPP countries are open to amending the agreement – as allowed in its amendment process – two additional changes can be considered.

First, these countries could institute a small claims procedure that would drastically lower arbitration costs. With ISDS costs averaging over $8 million, many SMEs will simply be unable to afford ISDS.

Second, TPP countries could develop an appellate process or tribunal that would feature individuals with expertise in relevant international agreements. One such process could involve WTO panelists and Appellate Body members.

Only the beginning

The ISDS mechanism in the TPP contains many new and constructive safeguards. Yet, these safeguards should only be the beginning.

If the wide public concerns about ISDS are to be alleviated, policymakers should consider additional complementary reforms.

Peter K. Yu does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.