The Investor-State Dispute Settlement Mechanism : Where To Go In The 21st Century ?

I. Introduction

Traditionally, investment disputes between foreign investors and host countries were resolved in the local court of host countries since many developing countries insisted on Calvo Doctrine. However, developed countries tried to protect their overseas investors by resolving investor-state investment disputes in the international arena through diplomatic protection or international arbitration. They insisted investor-state dispute settlement provisions, such as international arbitration by the International Center for the Settlement of Investment Dispute (ICSID), be inserted into investment treaties, including bilateral investment treaties (BITs) and free trade agreements (FTAs) signed with developing countries. Since the 1980’s, more and more developing countries have deviated from their traditional conservative position and have increasingly accepted highly protective investor-state dispute settlement mechanism (ISDSM) in the BITs or FTAs with both developed and developing countries.

The highest protective ISDSM is that of North America Free Trade Agreement (NAFTA). In the last decade, some developing countries -- such as Argentina and Mexico -- were confronted by a number of investment law suits filed by foreign investors and thus realized the serious problems arising from highly protective ISDSMs. Therefore, developing countries began restricting or withdrawing from jurisdiction by ICSID. At the same time, the United States, the leading country of developed countries, after being challenged by several NAFTA investment cases, also changed its attitude toward NAFTA-style ISDSMs. The US made several improvements to some of its 1994 Model BIT provisions concerning ISDSM and created a new indirect mechanism excluding the ISDSMs in the recently signed Australia-US Free Trade Agreement (AUSFTA). After a thorough review of these changes, the author concludes that both the improvements and the new mechanism echo the four “safety valves” once insisted on by many developing countries. The author opines that the new trends in both developed and developing countries reflect the emerging consensus between them and thus recommends ISDSM not be covered in any future investment rules, either in the WTO or in UNCTAD in the 21st Century.

II. New trend in developing countries towards investor-state dispute settlement mechanisms

Regarding ISDSMs, the positions of developing countries may be described in four stages: Before the 1960’s, the traditional attitude was that investor-state disputes should be resolved by local remedies. From the 1960s through the 1980s, the still conservative attitude was insisting on four “safety valves” in ICSID arbitration. Almost full acceptance of ICSID jurisdiction and other arbitration occurred from the late 1980s to early 21st Century. And, the new trend in the early 21st Century reverted back to the traditional and conservative attitudes.

1. Developing countries’ traditional attitude towards ISDSMs

In the 20th Century, transnational capital gradually started to flow to developing countries, in addition to flowing among developed countries. The flow was a “one-way street”, for there was almost no investment from developing countries to developed countries. The investment issue was touched upon in the Treaty of Friendship, Commerce, and Navigation (FNC Treaty) between developed and developing countries, without mentioning the resolution of investor-state disputes. The reasons included that investment issues were not a key issue in the treaty, and that the Calvo Doctrine was insisted on by Latin American countries which were the main body of developing countries at that time.

After World War II, many newly independent developing countries exercised economic sovereignty to nationalize some foreign investments in order to further develop their national economy. As a result, tensions between foreign investors and host countries were created and gradually intensified. Under such circumstances, developed countries -- as home countries -- started to sign new types of treaties with developing countries so as to protect the interests of their overseas investors. The new types of treaties included the Investment Guarantee Agreement (IGA) by the United States with developing countries, and the Investment Protection Agreement (IPA) by Germany and other West European countries with developing countries. The focus of IGA is about investment insurance and subrogation, while the focus of IPA is investment protection. Therefore, the IGA did not touch upon the settlement of investor-state dispute, while the IPA did.

The above FCT Treaty, IPA and IGA are collectively called BIT which was created as a treaty between developed and developing countries from the very beginning. Developed countries hoped to set the rights and obligations of developing countries toward foreign investors from developed countries through a binding international treaty. Therefore, when signing BIT, developed countries were standing in the position of capital-exporting countries for the purpose of protecting their overseas investors and their investments. The first IPA in the world was signed between Germany and Pakistan in 1959. The Germany-style BIT was a model for many developed countries, except for the US, for many years.

No ISDSM provision was contained in the Germany-style BITs or other BITs before the creation of ICSID (i.e. the middle of 1960s). The main reason was that the newly independent developing countries cherished very much their hard-won state sovereignty and thus insisted on the traditional Calvo Doctrine. The Calvo Doctrine requested disputes be resolved by the domestic administrative tribunal or court according to domestic law in the host country.

However, foreign investors regarded the domestic legal systems of developing countries as incomplete and lacking of just and un-biased expertise who could fairly and effectively settle the investor-state disputes. Therefore, they did not want to be subject to the exclusive jurisdiction of the host country. Instead, they relied on their home country to exercise diplomatic protection. According to customary international law, the pre-requisite that a country exercised diplomatic protection is the exhaustion of available local remedies without satisfactory result. This is to provide host country a chance to redress foreign victims, to reduce the number of international claims, and to avoid the involvement by the home country that might affect the political relations between the two countries. However, some developed countries started to exercise diplomatic protection before the exhaustion of local remedies by exerting political pressure,

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