ISDS and Climate Change: What Happens Next?22 December 2022

Recently, ISDS has run into stiff headwinds. States are raising sovereignty concerns, complaining that their legislation is now subject to private challenge by foreign investors before “secretive” ad-hoc bodies. Institutional capacity is another threat – aggrieved investors are often large multinational corporations with extensive legal resources, facing down states who may lack the requisite institutional knowledge. Other criticisms include excessive costs and years-long proceedings, a seeming lack of consistency in awards, impartiality concerns and diversity issues within the investment arbitration community.ᶦᶦᶦ

ISDS and Climate Change

Climate change is posing some serious difficulties for the investment treaty system. The climate situation is getting worse by year. This year’s summer monsoons put a third of Pakistan – the world’s fifth-most-populated country – under water. Scorching heatwaves pummelled India, Europe and North America. While the world is making heartening progress in renewable energy, the climate crisis remains a danger to the planet and to global stability.

As the crisis deepens, countries are pushing for new solutions. The Paris Climate Agreement, signed in 2015, seeks to significantly reduce climate changes’ impact by capping the increase in global average temperature “to well below two degrees Celsius above pre-industrial levels” (preferably 1.5 degrees).ᶦᵛ The Agreement requires its 196 signatories to develop long-term plans to reduce greenhouse gas emissions, pushing them toward net-zero emissions status.ᵛ These “nationally determined contributions” are updated every five years and are composed of domestic mitigation measures, often laws enacted to support a country’s climate goals. In the years since the Agreement entered into force, many state signatories have overhauled their climate policies and worked to spur large-scale energy transitions.

Investment treaty law may set a few roadblocks. Most IIAs do not explicitly mention or regulate climate goals. Largely built in an era before widespread climate action, the investment treaty system is at best “climate neutral or climate blind”. As a result, commentators worry that it “both fails to advance and also hinders climate action.”ᵛᶦ

States advancing ambitious climate legislation may be targeted by disgruntled investors using existing investment treaties Climate policies that subsidise low-emission domestic investment while penalising high-emissions activities could run afoul of National Treatment or MFN clauses. Forced nationalisation of oil plants would likely generate expropriation claims, as would harsh regulatory measures designed to degrade the value of high-emissions activities as part of a shift to clean energy generation. Phasing out coal could spur fair and equitable treatment charges.

New-generation treaties are more generous to states. Many make a point of safeguarding states’ right to regulate and “generally contain more circumscribed and clarified substantive provisions, often accompanied by narrower access to ISDS”.ˣᶦᶦ They also incorporate specific provisions protecting the environment and encouraging climate action and sustainable development. These include:

• Treaty preambles: Treaty preambles establish the overall objective of an IIA. New treaties may reference promoting sustainable development and environmental protection, reaffirm states’ rights to regulate in the name of the environment and reiterate certain environmental commitments. They may also highlight commitments to mitigate climate change or directly reference climate action treaties like the Paris Agreement.ˣᶦᶦᶦ
• Substantive protections: Some treaties contain clauses imposing substantive environmental and climate obligations on the signing parties. These can range from specific treaty chapters on environmental protection to the promotion of climate-friendly investment;ˣᶦᵛ
• Carve-outs for environmental measures: Some new treaties carve out environmental protection from substantive treatment standards, making these measures more difficult to challenge and giving states more room to regulate. Carve-outs are often found in indirect expropriation and national treatment clauses, though not in fair and equitable treatment provisions;ˣᵛ
• Procedures for compliance and implementation of environmental protection: Some treaties explicitly require the contracting parties to effectively enforce their own environmental laws or to establish institutional mechanisms to promote climate cooperation;ˣᵛᶦ and
• Environmental protection as a general exception: Some new treaties include the environment as a public policy area where state flexibility needs to be preserved.ˣᵛᶦᶦ

According to UNCTAD, neither treaty generation is perfect. Neither type of treaty meaningfully distinguishes between low and high-carbon investments – and all “lack proactive provisions aimed at effectively supporting climate action”.ˣᵛᶦᶦᶦ Nevertheless, “as old-generation IIAs significantly outnumber new-generation ones, it is critical to address the problems and risks post by old-generation IIAs.”

Clearly, UNCTAD wants to see treaty reform – and fast. In the Note, they suggest two broad approaches:

1. making individual treaties climate-responsive by ensuring that only low-carbon and sustainable investments are covered, by safeguarding state regulatory power and by adding provisions aimed at promoting sustainable investment; and
2. reconceptualising the scope, purpose and design of the IIA regime at the multilateral, regional, bilateral and national levels.ˣᶦˣ

Nonetheless, UNCTAD is still worried. They single out two cases suggesting that ISDS mechanisms are being used to directly challenge important environmental policies:

• Eco Oro Minerals Corp. v. Republic of Colombia:ˣˣᵛᶦ The Eco Oro dispute involved a Canadian mining company extracting gold and silver deposits in the Colombian mountains, per a mining concession from the Colombian government. This concession was later eroded through successive environmental bans, causing Eco Oro to lose over 50% of its mining rights. The company filed for arbitration against Colombia under the Colombia-Canada FTA (2008). The tribunal found Colombia’s bans violated the treaty’s minimum standard of treatment, inflicting damage on “Eco Oro without serving any apparent legitimate purpose.”ˣˣᵛᶦᶦ The tribunal also held that the FTA’s general environmental exception did not preclude payment of compensation. According to UNCTAD, Eco Oro “signals that measures taken for the protection of the environment can be challenged and deemed a violation of IIAs” and “sheds doubt on” the effectiveness of “explicit safeguards and exceptions” included to protect a state’s climate regulation;ˣˣᵛᶦᶦᶦ and
• RWE v. the Netherlands:ˣˣᶦˣ In the first-ever investment treaty case filed against the Netherlands, RWE (a German energy company) attacked a measure phasing out coal-fired electricity generation by 2030. RWE argues that the measure – an attempt to address the Netherlands’ Paris Agreement commitments – was tantamount to an expropriation of its investments in the Netherlands. RWE is also arguing that the Dutch government failed to grant enough time and resources for the company to shift away from coal production without losing an immense amount of money. The case is ongoing, though parallel German court proceedings may halt it.ˣˣˣ Uniper, another German energy company, was recently forced to drop a similar lawsuit as a condition for receiving a bailout from the German government.ˣˣˣᶦ To UNCTAD, RWE “demonstrates countries’ risk when implementing regulations for phasing out fossil fuels”.

Other cases (unmentioned in the UNCTAD report) suggest investors do indeed use treaties to challenge states’ climate actions, though without much success. In Westmoreland Holdings v. Canada, a U.S. investor attacked Alberta Province’s attempt to phase out coal-generated electricity, arguing that the ban violated its legitimate expectations and constituted unfair discrimination. The case, filed under the old North American Free Trade Agreement (NAFTA) was dismissed on jurisdiction without a ruling on the merits.ˣˣˣᶦᶦ In Lone Pine v. Canada, a U.S. investor challenged Quebec’s suspension of oil and gas exploration permits as part of an anti-fracking initiative (the claim was dismissed last month, with two of three arbitrators finding no NAFTA violation).ˣˣˣᶦᶦᶦ Outside the climate sphere, companies like Philip Morris have used investment treaties to challenge anti-smoking public health measures in Uruguay and Australia (though all were unsuccessful).ˣˣˣᶦᵛ

Litigation strategies are getting ever more creative. In 2008, the Alaskan village of Kivalina – located on low-lying coastline – sued more than 20 energy companies for the proceeds needed to move the whole town inland.ˣˡᶦ Other U.S. cities, including San Francisco and Oakland, have filed similar suits. The doctrine of fractional culpability is also expanding. As attributive science advances, litigants are delineating private roles in climate activities with ever greater precision. An indigenous Peruvian farmer is suing a German energy company, alleging proportionate responsibility for estimated future repair costs for home flooding generated by melting glaciers.ˣˡᶦᶦ On climate law’s very frontier, lawsuits are exploring the legal personhood of animals, trees and lakes.ˣˡᶦᶦᶦ

There is even some talk that environmental protection is now a fundamental norm of international law. Fundamental norms – also known as peremptory or jus cogens norms – are widely recognised by the international community. They cannot be derogated from (devalued, diminished, reduced) and can only be modified by a subsequent norm of international law – one that is just as strong, with the same character.ˣˡᶦᵛ The International Court of Justice has already labelled environmental protection as an essential interest of the state,ˣˡᵛ suggesting it is a clear customary international law principle set forth in state practice and instruments like the Paris Agreement, the Rio Declaration and the UNFCC. If future cases uphold this trend, the consequences could be immense.

Investor-state arbitration is not immune to these developments. Increasingly, investors may be using treaties to force states to adopt suitable environmental protection measures. In Allard v. Barbados, an eco-tourism operator claimed that Barbados had failed to institute “reasonable and necessary environmental protection measures” and “directly contributed” to contaminating the environment, destroying the value of the investment. These failures amounted to indirect expropriation of the operator’s investment and breached the standard of fair and equitable treatment under the Canada-Barbados BIT. The claim was unsuccessful, but the Allard tribunal recognised that states may have treaty-based obligations to protect investments against environmental damage.ˣˡᵛᶦ Tribunals have also recognised treaty-based environmental defenses to investor claims. In Burlington Resources v. Ecuador, Ecuador counterclaimed for compensation for an investor’s breach of domestic environmental laws, eventually winning US$41m.ˣˡᵛᶦᶦ In Cortec Mining v. Kenya, a tribunal declined jurisdiction over a mining concession dispute because the investor’s activities failed to substantially comply with local environmental law. The Cortec tribunal noted that Kenya’s environmental obligations were of “fundamental importance” and the claimant’s failure to abide by related environmental regulations eliminated its claimed “investment” as a matter of treaty law.ˣˡᵛᶦᶦᶦ

These questions go far beyond investment treaties and investor-state dispute settlement. But UNCTAD’s policy notes hold some sharp lessons for investors and states seeking to navigate uncertain times.

We make the following recommendations:

For investors

• Invest sustainably. Where possible, prioritise investments that contribute to the green transition and avoid those that may run afoul of changing climate legislation. Many governments offer attractive incentives to promote sustainable growth – identify and capitalise on the ones that are right for you. WFW is a key player in the global sustainable transition and can advise you on accessing capital markets, completing mergers and acquisitions, financing your investment and planning your dispute resolution strategies;
• Do your treaty due diligence. Understand your host country’s investment treaty landscape. When you set up in-country operations, make sure you are covered by one or more investment treaties with generous procedural and substantive protections. Be sure to do this before a dispute arises, or your claim may be denied on jurisdictional grounds. WFW can assist with your investment planning needs, helping you address urgent issues ranging from the type of local corporate presence you need to the duration and character of the protections you will receive;
• Know your host country’s climate policy. Monitor domestic politics and stay abreast of climate-based initiatives, particularly in energy (a hugely important political issue). Know the country’s Paris commitments and its domestic climate goals. Track upcoming legislation to ensure you understand how your activities fit within it;
• Know your host country’s treaty plans. Consider your host state’s current attitudes on investment treaties and monitor their upcoming trade deals. New treaties may look very different from existing ones. India, for example, has terminated most of its old investment treaties in favour of extremely limited new agreements that abolish traditional ISDS entirely. Thailand is currently pursuing an FTA with the European Union, which will likely resemble the EU’s deals with Vietnam and Singapore (more room to regulate on the climate front, restructured dispute resolution systems).ˡᶦᶦᶦ WFW tracks treaty developments regularly and can assist you here;
• Communicate and advocate. Cultivate good relationships with your host state’s regulators and other government officials. Keep your licenses and permits up to date and follow all relevant laws and procedures. Join commerce groups and work with other companies on areas of common interest. If your investment makes use of host country incentives (like feed-in tariffs for power generation or special custom levies for green manufacturing), advocate for their protection and extension. Publicise your role locally and focus on the benefits of green investments; and
• Prepare a legal strategy for future disputes. Identify key challenges for your investment and have a dispute strategy ready if the state relationship turns sour. Know your rights under domestic and international law. If a dispute does arise, consult sophisticated outside counsel early in the process and get an honest read on your chances. If arbitration is not feasible for you, consider active talks with the relevant host state officials to resolve the dispute early.

For states

• Create good policy. Above all, states should have clear national policies to promote low-carbon investment. Facilitate new market entrants who can jumpstart green investments and enact market creation policies to foster demand for low-carbon products. Vietnam is a great recent example, as the nation heavily incentivised investment in solar and wind generation to become one of the world’s clean energy leaders;ˡᶦᵛ
• Review your treaties and plan your defense. Conduct a thorough review of existing IIAs. Know the treaties you are party to and understand how they may or may not protect you in the event you pass new environmental regulation. Be aware of your regulatory authority under these treaties – do they provide leeway to regulate in defense of the environment? Do they contain generous investment protection standards that may make your regulatory job difficult? Create a good legal strategy – if you are sued in arbitration, don’t be afraid to try novel or unique legal arguments while presenting a thorough defense;
• Consider compensation. Climate change legislation is often drastic (necessarily so). Consider the investment interests at play when you are drafting legislation. If you have the fiscal room, consider fair compensation or monetary incentives as an alternative to measures that may land you in arbitration;
• Incorporate climate protection into new treaties. Consider negotiating new treaties where appropriate. As opportunities for new trade deals arrive, make sure to preserve your regulatory authority on the climate and environment. Creating and agreeing new investment treaties is a complicated process. Nonetheless, parties drafting new treaties with an eye to climate protection should focus on the following:
  • preamble: referencing the importance of climate action, incorporating relevant climate law principles and treaties, committing to uphold environmental standards and promising cooperation on climate change mitigation and sustainable development;
  • treaty scope: distinguish between climate-friendly and climate-harmful investments via lists, schedules and annexes as well as classification mechanisms and treaty definitions of sustainable investments;
  • climate action regulation: carve out climate action measures from some investment standards, include general climate law exceptions and clarify compensation mechanisms;
  • investor obligations and responsibilities: incorporate CSR codes and sustainable investment requirements;
  • climate change and investment governance: commit to institutional cooperation on climate action, including implementing important climate treaties; and
  • promote sustainable investment: encourage development and transfer of low-carbon technologies, provide preferential treatment for qualifying investments.

Bangkok Trainee Teresa McGillivray also contributed to this article.