New investor state dispute settlement mechanism following Canada – European Union trade agreement

The agreement by the two trading partners over the new approach towards investment protection and investment dispute settlement clears the path towards ratification of the European Union-Canada Comprehensive Economic and Trade Agreement (CETA) by the end of this year, and is expected to come into force in 2017.

A controversial investment protection clause that gives investors the right to seek compensation from states through international tribunals if government policies damaged their business interests had become a sticking point in negotiations between the two parties since an agreement in principle was reached over the free trade deal in 2013. Canada had originally asked for the inclusion of the investor-state dispute settlement (ISDS) in CETA as it sought to preserve the system that operates under North American Free Trade Agreement. An agreement was ultimately reached at the end of this February after the European Union, under pressure by critics who focused on ISDS in their opposition to CETA and the planned EU-U.S. trade deal (TTIP), quietly convinced Canada to include a new way of settling investor claims in their trade deal.

The new approach, negotiated during the legal scrubbing or revision of the CETA deal, represents a clear break from the traditional ad hoc ISDS system where three arbitrators sat on the tribunal, one of whom was appointed by investors, another by the defending government, and a third usually by agreement of the two disputing parties, explained Dan Hohnstein, an Ottawa international trade lawyer with Borden Ladner Gervais LLP. Decisions reached by the arbitral tribunal under the traditional ISDS are shown a high level of deference, and are “very difficult to challenge” unless it could be shown that it acted in manifest excess of its powers, added Hohnstein.

“A main criticism of the traditional ISDS system is a lack of certainty and predictability in the interpretation and application of investment protection provisions,” said Hohnstein. “There is a perception out there in the international investment law community that in some cases there may be bias and inconsistency in the traditional ISDS system.”

Even more contentiously, the traditional ISDS system was often perceived as handing over to panels of investment lawyers the determination of whether states violated treaty norms that protect foreign investors, pointed out David Schneiderman, a law professor at the University of Toronto and a senior fellow with the Centre for International Governance Innovation. “One of the problems with this regime of investor rights is that it confers enormous discretion on an elite corps of lawyers,” said Schneiderman.

The establishment of a permanent multilateral investment court attempts to address these concerns by changing the way that arbitrators are nominated and by creating an appellate tribunal that is modelled to a large degree on the World Trade Organization Appellate Body. While the new arbitral tribunal will still be composed of three arbitrators, the arbitrators will be chosen from a roster of 15 people created by Canadian and the EU. It will comprise of five members who are Canadian nationals, five members from the EU, and five members who are not Canadians or EU nationals. The member from the third country will chair the arbitral tribunal. Under the CETA agreement, the president of the tribunal will appoint members on a rotation basis so that the composition of the hearing panel is random.

“We need to move away from a purely ad hoc system to one that has an institutional framework,” said Riyaz Dattu, a Toronto investment and international trade lawyer with Osler, Hoskin & Harcourt LLP. “This is necessarily a progression from viewing disputes as being purely commercial because they are not. They impact in a very significant way the workings of a government. So it is arguably correct to have the two governments who set up this panel, who set up this process, to have a say as to who the panellists will be.”

The new system will also help circumvent conflicts of interest that has at times arisen under the traditional ISDS system, according to international trade experts. The days when some arbitrators could act as lawyers in other disputes seems to have been put to an end with the new approach. So too has the incentive to broadly read into treaties to “encourage more disputes going forward” in order to ensure steady clientele for their legal services, said Schneiderman. “It does solve a handful of problems associated with the traditional system where there was a revolving door between advisors, arbitrators and lawyers,” added Schneiderman.

But other international trade lawyers are concerned that the new composition of the arbitral tribunal will do a disservice to investors involved in a dispute with a state. By preventing investors from nominating at least one arbitrator and handing that power to governments, there is a risk that the new arbitral tribunal will narrowly interpret investor rights in favour of governments, said John Boscariol, head of the international trade and investment law group at McCarthy Tétrault LLP in Toronto. “We are now moving towards the creation of a bureaucratic institution that is going to introduce a bias in favour of governments,” said Boscariol. “Governments will be controlling the process in terms of administering the dispute settlement process and the selection of arbitrators who could be viewed as government friendly. It doesn’t bode well for investors but I can certainly see why governments are moving in this direction.”

Boscariol is also concerned that following the legal scrubbing the CETA agreement provides for stronger language on a government’s right to regulate in the “public interest within their territories.” The “mere fact” that a government modifies its laws in a manner that might negatively impact an investment or “interferes with an investor’s expectation,” including its expectations of profits, no longer amounts to a breach, according to the agreement. “It’s going to be very interesting to see how the tribunal is going to deal with that,” remarked Boscariol.

The introduction of an appellate tribunal however is largely viewed as a welcome development by international trade lawyers as it is expected to provide a much-needed uniform body of law. One of the concerns with the traditional ISDS system is the absence of stare decisis, said Dattu. In other words arbitration panels are not bound to follow a decision made by another panel on a question of law. “The appellate body is needed because it will result in the formulation of legal principles that will provide uniformity and predictability,”  said Dattu.

But according to Schneiderman, the entire new regime is flawed as it confers “a broad set of rights” on investors whose interpretation will decided by arbitrators who will be on retainer. “They are not judges, have no independence and no security of tenure,” said Schneiderman, who is calling for empirical studies to be conducted so that decisions are based on “real evidence rather than fears or power or influence by a particular cadre of people.”

It remains though that the new approach might prove to be a template used in other free trade agreements, noted Jennifer Radford, an Ottawa international trade lawyer with Borden Ladner Gervais LLP. Much of it will hinge on the planned EU-U.S trade deal, and whether the U.S. decides to adopt this new process. “It can’t be stressed enough that these provision are novel, and they are more likely than not to have an impact on ongoing negotiations in other investor-state disputes,” said Radford. “This could be sort of the coming of a new age.”