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‘Investor-State Dispute Settlement’ as a new avenue for climate change litigation

LSE | 2 June 2021

‘Investor-State Dispute Settlement’ as a new avenue for climate change litigation

Matteo Fermeglia, Catherine Higham, Korey Silverman-Roati and Joana Setzer present the international investment law scenario in which climate-related ‘Investor-State Dispute Settlement’, or ISDS, cases are emerging, identify the main types of ISDS cases, and consider some reasons why ISDS is relevant for climate litigation and climate policies.

Climate litigation is now established as a critical part of domestic climate governance regimes. While domestic climate litigation is still the most notorious form of climate-related dispute resolution, arbitration and mediation are becoming important means of resolving climate-related disputes. However, the confidential nature of such processes means they are difficult to examine and quantify.

In 2021 the Sabin Center for Climate Change Law (Sabin Center) at Columbia University and the Grantham Research Institute on Climate Change and the Environment partnered with the Centre for Government and Law (CORe) at Hasselt University, to identify climate-related Investor-State Dispute Settlement (ISDS) cases for inclusion in Sabin Center’s Climate Litigation database and the Grantham’s Research Institute’s Climate Change Laws of the World database. At least 13 climate-related ISDS cases filed between 2012 and the present were identified. While these cases do not always contain explicit references to climate change, they all relate directly to the introduction, withdrawal or amendment of a policy measure explicitly developed to meet a country’s climate goals.

International investment law and ISDS

International investment law is gaining increasing attention as a forum for climate change litigation. The international investment legal regime comprises more than 3,000 bilateral and multilateral International Investment Agreements (IIAs). In principle, IIAs aim to promote foreign investment and thereby stimulate domestic economies in capital-importing countries. By becoming party to an IIA, a State reciprocally commits itself to afford protection to foreign nationals in other IIA party States that invest in their territory.

IIAs typically include a set of obligations upon host States. Such obligations include the prohibition on expropriating foreign investors’ assets directly (i.e. by seizing the investments) or indirectly (i.e. by a substantive deprivation of the value of an investment through one or a series of actions or inactions). IIAs also include the obligation to provide investors fair and equitable treatment, understood as an obligation to provide due process, to adopt proportionate measures, and to avoid actions that frustrate the legitimate expectations of investors. Importantly, IIAs require the obligation to avoid discrimination against foreign investors on the basis of their nationality, both against investors from third countries and from the host States’ nationals.

Furthermore, IIAs often include provisions known as an ‘umbrella clause’. Umbrella clauses oblige host States to honour any commitment or agreement they undertake with foreign investors of their IIA’s counterparty, thus essentially elevating any contractual breach by host States as a violation of their IIA’s treaty obligations.

In case of an asserted breach of these IIA standards of protection, foreign investors may sue host States directly to seek pecuniary compensation. These cases are filed before ad hoc international arbitral tribunals under the Investor-State Dispute Settlement (ISDS) regime. ISDS tribunals are mostly established within the World Bank International Centre for Settlement of Investment Disputes
(ICSID), the Permanent Court of Arbitration (PCA), the International Chamber of Commerce (ICC) and the Stockholm Chamber of Commerce (SCC). ISDS tribunals are composed of one arbitrator (nominated by each the claimant investor and defendant host States) and a third arbitrator jointly nominated by both other arbitrators. ISDS tribunals render international awards which, if favorable to investors, can be directly enforced against host States.

Foreign investors can challenge a broad array of domestic measures adopted by host States’ public authorities before ISDS tribunals. Such measures include, among others: direct seizure or nationalisation of investments, alleged breach, non-fulfilment or interference with contracts, termination, non-renewal or revocation of licences, permits or concessions, legislative reforms on subsidies to specific activities, tax-related measures such as the imposition of a capital gains tax, bans on import/exports of certain products, and so on.

Total ISDS cases had reached 1,023 by the end of 2019. Although the majority of ISDS cases have been decided in favour of host States, those decided in favour of investors have resulted in substantial damages paid to the claimants from public budgets. According to the United Nations Conference on Trade and Development (UNCTAD), up to the end of 2017 the average amount awarded to foreign investors was US$504 million, with an increase in extremely high value cases (such as the over $4 billion award in Tethyan Copper v. Pakistan in 2019). Furthermore, and importantly, around 17% of the ISDS cases as of January 2020 (at least 173 cases) stemmed from investments in or related to the fossil fuel sector. Indeed, the ICC, in its recently issued Report of its Task Force on Arbitration of Climate Change-related Disputes, concluded that the ICC’s procedures, including its arbitration rules, can be used for resolving such climate-related disputes.

ISDS claims as climate litigation

The increase in ISDS cases over the course of the last decade represents an important trend in global climate change litigation. We have identified at least 13 climate-related ISDS cases filed between 2012 and the present. While these cases do not always contain explicit references to climate change, they all relate directly to the introduction, withdrawal or amendment of a policy measure explicitly developed to meet a country’s climate goals. Such cases can be classified into three distinct groups.

1. Compensation claims

Firstly, a number of cases involve claims for compensation following the introduction of ‘climate-justified’ policy measures, which reduce the value of existing assets or investments (stranded assets). Examples of ‘climate-justified’ policy measures at the heart of these cases include the Dutch Government’s planned phase-out of coal-fired power plants by 2030 (RWE v. Netherlands, Uniper v. Netherlands) and moratoria on hydrocarbon exploration in Alberta and Quebec (Westmoreland v. Canada, Lone Pine v. Canada).

2. Roll-back of climate legislation and policy

Secondly, we have identified a line of cases concerning the roll-back or amendment of legislation or policy originally introduced to meet climate goals. At present the majority of these cases concern changes to policies or schemes introduced by European governments providing subsidies and other incentives to encourage investment in renewable energy generation in order to meet EU-level climate targets (e.g. The PV Investors v. Spain, Eskosol v. Italy). Claims were launched after schemes were amended to reduce the level of incentives as renewables became more competitive over time. Overall, this group of cases accounts for more than 60 claims already filed before ISDS tribunals.

3. Environmental permitting

The final line of cases concerns claims for compensation arising out of environmental permitting decisions. This group includes the case of TransCanada v. USA, which was filed under the North American Free Trade Agreement (NAFTA) and involved a claim for compensation following the Obama Administration’s denial of a Presidential Permit for the Keystone XL Pipeline. The case was discontinued following the Trump Administration’s reversal of the decision. It also includes the case of Rockhopper v. Italy, which arose following the Italian parliament’s reintroduction of a moratorium on oil and gas projects within 12 miles of the Italian coast in 2015, midway through the permitting process for the development of the Ombrina Mare oil field located 12 miles off the coast of Abruzzo.

The amount of compensation claimed by the companies in ISDS cases is often extremely high. In RWE v. Netherlands, for example, the energy company RWE argues that the plant will have to close its doors due to the new legislation and estimates its damages at €1.4 billion. In Rockhopper v. Italy the claim for damages could run to between US$200–300 million. The company is aiming to recoup both existing expenditure on the project and anticipated profits, an approach for which there are several favourable precedents to be found in previous awards under ISDS provisions.

The relevance of ISDS for climate litigation and climate policies

Climate disputes in ISDS are likely to grow in the coming years and decades. The need to curb greenhouse gas emissions will lead to further asset stranding in both developed and developing countries. Indeed, the Production Gap Report 2020 estimates that countries are planning a 2% average annual increase in fossil fuel production, when a 6% annual decrease is needed to meet the goal of limiting global warming to 1.5°C. Moreover, the Net-zero by 2050 flagship report recently published by the International Energy Agency (IEA) estimates that in order to achieve the Paris Agreement temperature goal no new oil, coal or gas infrastructure should be approved for development from 2021 beyond that already committed.

Aligning national policies with climate needs will inevitably affect investments in the field of fossil fuel infrastructure right across the supply chain. Therefore, the more compelling the need to adopt ambitious and abrupt measures to pursue climate objectives, the higher the risk of ISDS cases being brought against host States.

ISDS claims do not – at least not directly – aim to suspend or overturn domestic regulation. Rather, the claims seek compensation for the detriment caused by such measures to foreign investors on a case-by-case basis. Moreover, they strictly relate to the violation of standards of protection under investment treaties for the purposes of obtaining monetary compensation. In other words, ISDS claims will never result in an imposition to amend and/or repeal domestic measures, and some even argue that arbitration may be used to foster climate change action (see a recent analysis by Thieffrey).

However, ISDS cases might have a ‘chilling’ effect on domestic measures designed to advance climate action. The risk of such a chilling effect stems from the high compensation judgments that ISDS cases could bring. States may be wary of, for example, quickly phasing out coal when doing so could bring hundreds of millions of dollars or more in liability to foreign investors. This risk is particularly high in litigation brought in the Global South, where domestic budgets are lower and high dollar judgments would have a proportionately larger impact. While so far the majority of cases have been brought in the Global North, with notable exceptions brought by oil companies against Ecuador and mining companies against Colombia, the developments in the Global South deserve close attention and scrutiny in the future.

Conclusions – risks to climate action and lessons for policymakers

The cases that we identified in this first mapping exercise of climate-related ISDS (stranded assets, roll-back or amendment of climate-justified policies, and compensation arising out of environmental permitting decisions) are considerably distinct. Yet, these cases indicate a real risk that significant resources and energy may be diverted away from climate action, impacting the popularity of pro-climate policymaking among both policymakers and the public.

Academic research is yet to explore climate-related arbitration as strictly understood, but an improved understanding of such cases is critical for ensuring effective long-term climate policy-design. As governments around the world ramp up the introduction of new policies and legislation, these cases indicate the importance of anticipating potential market shifts when deciding the appropriate policy instruments to achieve climate goals, as well as the importance of a stable domestic climate governance regime, with consistent and long-term frameworks for climate action.

Matteo Fermeglia is Assistant Professor of International and European Environmental Law in the Faculty of Law, Hasselt University, Centrum voor Overheid en Recht (CORe). Catherine Higham is Coordinator of the Climate Change Laws of the World website. Korey Silverman-Roati is a Climate Law Fellow at the Sabin Center for Climate Change Law, Columbia University. Joana Setzer is Assistant Professorial Research Fellow at the Grantham Research Institute.

 Fuente: LSE