OpinioJuris | 14 July 2022
Is investor-state dispute settlement an appropriate forum for the resolution of investment disputes arising from armed conflicts? Part 1: normative conflicts and consequences
by Amanda J. Lee and Naimeh Masumy
[Amanda J. Lee, FCIArb is an International Arbitrator and Consultant at Costigan King, and the Founder of Careers in Arbitration and ARBalance. Naimeh Masumy is a research fellow at the Swiss International Law School and a dispute resolution expert specialized in energy and investment disputes.]
There is, regrettably, a high likelihood that Ukraine will find itself facing a disproportionate number of investment disputes as a result of the widespread destruction and dispossession of private property caused by the ongoing hostilities.
Since the war began, apartment buildings, hospitals, shopping centers, and critical infrastructures such as oil refineries and fuel storage depots have been destroyed by Russian forces. According to a recent report by Reuters, Russia’s invasion has damaged up to 30% of Ukraine’s infrastructure at a cost of $100 billion. Destruction on such a massive scale will inevitably lead to a wave of investment disputes against Ukraine, imposing financial and political burdens on the economy of this conflict-ridden country, at a time when it has already been weakened by war.
The looming prospect of investment disputes has turned the spotlight on the ability of investor-State dispute settlement (ISDS) to provide a just and equitable remedy for investors whose investments have been destroyed, and a just outcome for States whose landscapes and economies have been scarred, by armed conflict.
Against this background, the first part of this two-part blog series addresses the absence of a coherent legal framework for the protection of foreign investments in times of armed conflict (I). It then critiques the suitability of ISDS as an adjudicative forum for disputes of this nature, with particular focus on the war between Russia and Ukraine, exploring whether it is capable of properly accounting for the realities of armed conflict, taking account of fundamental principles of international law (II).
The second part will propose the creation of an alternative comprehensive remedial adjudicative tribunal—the ‘Remedial Tribunal’—poised to overcome some of the shortcomings associated with the ISDS regime. The Remedial Tribunal offers the potential for adjudicators to reconcile the disconnect between existing international law and the harsh reality of the destruction and dispossession of investments in conflict-affected areas . We conclude by briefly identifying some of the challenges presented by such proposal.
I. The Protection of Investments: A Tale of Two Diverging Legal Paradigms
A great deal of uncertainty surrounds the legal regime that governs the obligation to protect foreign investment from the effects of armed conflict. Leading scholar Christopher Schreuer has noted that investment, almost by definition, requires stability to thrive, a state threatened by violence and political volatility. The obligation to protect investments fairly and equitably is a central norm in international law that has attained customary status.
This norm has also been crystalized as a basic standard of protection in a number of investment treaties. According to a recent UNCTAD report, Ukraine is party to 65 Bilateral Investment Treaties (BITs) that are in force today, as well as the Energy Charter Treaty. These treaties provide comprehensive and extensive protection for foreign investments against legislative changes, nationalization, the termination of investment activities, reparation of profits and expropriation without compensation.
Further, Ukraine is party to several Free Trade Agreements, including the EFTA-Ukraine Free Trade Agreement, which contains several provisions on investment protection subject to state-to-state dispute settlement.
Accordingly, exploring how foreign investment is protected in times of armed conflict, and the extent to which the outbreak of armed conflict affects the continued application of treaties relating to the protection of foreign investments, is of growing relevance. Growing uncertainty surrounds the established obligation to protect foreign investments from the effects of armed conflict. This uncertainty stems from the fact that the extent to which the interests of foreign investors are protected in times of armed conflict has been shaped by the interaction of international investment law with international humanitarian law (IHL).
As discussed below, overlaps between the investment law regime and IHL norms have historically given rise to a norm conflict, whereby two regimes, with different norms, functions, and objectives, may regulate the same conduct, albeit with different objectives and standards of review, leading to divergent results.
The Genesis, Objective, and Nature of IHL Norms
IHL norms are one of the oldest legal paradigms governing the conduct of hostilities. Such norms comprise a set of rules that seek to limit the detrimental effects of armed conflicts by setting out the responsibilities of States and non-State armed groups during times of armed conflict. These norms recognize a wide array of lawful interferences with private property such as destruction, seizure or confiscation during the time of hostilities. To this end, the destruction of private property is deemed justified under IHL rules, provided that such destruction is considered to be imperative and necessary based on military considerations.
This rule was articulated in Article 53 of the 1907 Hague Regulations concerning the Laws and Customs of War on Land, which provides that “[a]n army of occupation can only take possession of cash, funds, and realizable securities […] which may be used for military operations.” The notion of necessity is echoed in Article 38 of the 1983 Lieber Code, which provides that “[p]rivate property […] can be seized only by way of military necessity, for the support or other benefit of the army …”
IHL norms have a distinct genesis, legal status, and function, as explained below:
IHL norms derive their intellectual underpinning from the principle of State responsibility for damage to foreign property, recognizing a State’s prerogative to interfere with the established right to own or enjoy private property during hostilities. This right recognizes that the destruction of property in armed conflict will not automatically be construed as an arbitrary destruction. Such destruction may, in fact, be deemed to be legal in light of certain military considerations.
The Law of The Hague codifies the principle that enemy property may be lawfully and deliberately destroyed during hostilities by outlining several permitted measures, each of which will result in the deprivation of property during armed conflict. In essence, the Hague Conventions of 1899 and 1907 recognize a number of derogations from the fundamental principle that private property must be respected and protected at all times. Wanton property destruction is classified as a war crime.
IHL norms have attained customary status and the scope of their application is shaped by consensus among the international community. Both the so-called Law of the Hague and Law of Geneva codify these norms and standards, imposing restrictions on the means and methods of lawful warfare available. These norms are anchored in core humanitarian principles and are formulated in absolute terms. They prescribe certain uniform minimum standards and are construed as non-derogable obligations and standards, to be automatically applied in all situations of armed conflict.
IHL norms enjoy a wide scope of application; applying from the initiation of armed conflicts and extending even beyond the cession of hostilities. Despite the prohibitive nature and customary status of such norms, their scope is not unfettered. Rather, the discretion to interfere with private property during the outbreak of hostilities is primarily demarcated by the principles of military necessity and proportionality. IHL norms regulate conduct with specific objectives, and therefore, in the context of the investment protection framework, IHL norms serve as a legal basis to exempt and excuse, justify or carve out investment obligations during armed conflicts.
For instance, in the case of William Hardman, in which a military tribunal was established to hear a claim for reimbursement for the loss of personal property by a British subject in Cuba, it was held that measures taken by American forces to maintain sanitary conditions, which resulted in the destruction of private property, constituted military necessity. No compensation was therefore due.
In summary, under the IHL paradigm States have a broad, but not unlimited, discretion to interfere with private property, subject to established military and humanitarian considerations.
To this end, investment tribunals are typically required to award claimants the Fair Market Value (FMV) of their investment in the case of dispossession of an investment. However, dispossession of an investment might be construed as a lawful act during armed conflict, when determined based on the application of an IHL standard of review; rendering FMV compensation inappropriate. Simply put, the application of IHL norms instead of international investment law norms may produce a significantly different—and potentially unjust —result.
The Genesis, Nature, and Function of the Investment Law Regime
The IHL regime is not the only legal paradigm that governs the extent to which foreign investments must be protected during times of armed conflict. As explained below, States’ obligations to protect investments will not ipso facto be terminated by armed conflict. A brief analysis of the genesis, nature, and function of the investment law regime shows that when this legal regime encounters IHL norms, normative tension will result: what one norm prohibits or restricts; the other permits.
It has long been theorized that international investment law was primarily conceived to protect foreign investors while promoting investment flow. As Mascio and Pauwelyn noted, investment law is fundamentally concerned with “fairness grounded in customary rules on treatment of aliens, not efficiency”. This understanding has been echoed by many commentators, reinforcing the notion that investment law is about ‘protection’ and ‘individual’ rights, not ‘liberalization’ and ‘state-to-state exchanges of market opportunities’.
It may accordingly be inferred that International Investment Agreements (IIAs) are not corrective tools intended to compensate for the absence of a conventional framework regulating conduct taking place during hostilities, but are instead simply designed to guarantee protection to foreign investors. Hence, since the protection of investments is the guiding principle of many investment agreements, such agreements fail to effectively engage with the State’s right to safeguard its public policy and interests.
Numerous international investment law principles have obtained characteristics of a customary nature as they recognize and crystalize a minimum set of standards. In 1949, Leiden observed that these minimum standards are derived from one particular norm of general international law, namely that aliens are entitled to treatment that is free from intervention. This rule was traditionally regulated by the Law of Nations.
The customary nature of this set of norms is reinforced by the International Law Commission (ILC) in the First report of the Special Rapporteur, in which the late Sir Ian Brownlie reaffirmed the presumption of continuity of treaties, noting that the outbreak of an armed conflict does not per se suspend or abrogate the operation of investment treaties. The draft articles on the effects of armed conflicts on treaties laid out a non-derogable obligation, implying that violation of these norms is the responsibility of host States and may entitle the injured alien to recourse under international law.
Drawing reference from the genesis of international law, the function of the investment law regime was historically considered to be the realization of economic development in host States through foreign investment, sometimes to the detriment of a host State’s policy space, particularly in conjunction with provisions to ensure the protection of investments during armed conflicts
It is accordingly clear that there are significant and fundamental differences between the two systems.
II. The (Un)Suitability of ISDS as an Adjudicative Forum for Investment Disputes Arising from Armed Conflicts
Against this background, it should be noted that despite the divergent functions and objectives of these two legal paradigms, they cover the same substantive subject matter, and their nature imposes exclusive and independent obligations, leading to normative conflicts.
Consequently, investment tribunals are left with the task of reconciling two diverging norms. To resolve such conflict effectively, they must establish the primacy of one set of norms over another, while ensuring that measures designed to safeguard against the unlawful destruction of private property during times of armed conflict comply with well-established and internationally recognized international investment rules.
Nevertheless, this post posits that investment tribunals are ill-equipped to strike a reasonable balance between these diverging regimes. Our contention is threefold:
- Firstly, procedural limitations imposed by the narrow and limited jurisdiction afforded to tribunals by underlying IIAs prevent tribunals, especially those operating under the auspices of ICSID, from fully accounting for the realities of armed conflict when addressing investment disputes.
- Secondly, the BITs that govern the nuances of investment disputes arising from armed conflicts operate with a degree of abstraction, whereby certain State responsibilities are not expressly addressed, and provisions concerning compensation for destruction lack clear specification of the rights of States in the circumstances.
- Finally, the institutional framework underpinning ISDS mechanisms ensures that investment tribunals effectively operate as a private system of adjudication, with limited deference to fundamental rules of international law.
Investment tribunals’ power to adjudicate is directly derived from party consent; namely, the scope of tribunals’ subject matter jurisdiction is determined by the express wording of the underlying treaties. In other words, treaty parties serve a crucial role in determining the scope of such subject-matter jurisdiction.
For instance, Article 17 of the 2015 Japan–Ukraine BIT limits jurisdiction to disputes “as to the interpretation or application of this Agreement”, while Article 10 (1) of the 2017 Turkey-Ukraine BIT confers broader jurisdiction, permitting tribunals to adjudicate over disputes “concerning an alleged breach of an obligation […] under this Agreement.” The narrow jurisdiction of investment disputes is also encapsulated in Article 25 of the ICSID Convention, which recognizes parties’ consent as an overriding condition of jurisdiction.
A narrow and limited application of jurisdiction clauses imposes two distinctive limitations on the equitable resolution of investment disputes arising from armed conflicts. Firstly, the varied scope of tribunals’ jurisdiction will unavoidably and inevitably lead to inconsistency in the approach tribunals adopt to addressing such disputes.
Secondly, while procedural objections are normatively allowed and policy-orientated objections may be raised, jurisdictional limitations may allow tribunals that seek to do so to avoid examining the merits of specific cases or addressing important underlying issues, such as the lawfulness of an outbreak of hostilities and the extent of non-compliance. In particular, when confronted with IHL considerations, tribunals may exercise judicial self-restraint (which is normatively allowed), enabling them to refrain from identifying and isolating important issues such as whether International laws have been breached.
In parallel, the narrow jurisdictional scope of many BITs leads to the fragmentation of disputes, whereby only the investment aspects are properly addressed. Intertwined dispute components relating to the destruction and dispossession of investors’ private property will remain unsettled, undermining the principles of causation and State responsibility. This enables the ISDS system to turn a blind eye to the complexities of conflict-related treaty violations.
Perhaps most importantly, ISDS tribunals lack the capacity to attribute blame to a third-party aggressor State. They have no jurisdiction over such States. This is deeply unsatisfactory and represents a clear barrier to achieving justice as between investors and States.
Broadly worded BITs
BITs lack the necessary elasticity to equip tribunals with the appropriate tools to safeguard State parties’ interests during armed conflict.
As discussed below, many investment treaties do not contain provisions that explicitly address the effect of armed conflict on investments. Treaties often include largely symbolic boilerplate language that only formulates customary standards of investment protection. Little specification is provided for emergency situations. There are many similarities in the formulation of IIAs, which largely extend broad protections to investors, leaving the scope of the State’s policy mostly unsettled.
The Absence of Robust General Security Clauses
General security clauses preserve the right of States to take measures to safeguard essential interests in emergency situations, such as times of armed conflict. However, a cursory look at the BITs to which Ukraine, by way of example, is party reveal that the provisions providing for general security have been thinly incorporated into the treaties. As a result, Ukraine cannot avail itself of public policy tools to preclude compliance with any obligation to take precautionary efforts to protect investments from the effects of hostilities.
Similarly, other provisions that may help States to avoid certain responsibilities arising from precautionary obligations, namely the right to necessity, are largely undefined, lacking clear elucidation. The opacity of these provisions has one major implication; they cannot offer a roadmap for investment tribunals seeking to strike a balance between these two norms: the obligation to take precautionary efforts and the breach of international law.
The Under-Theorized Notion of Compensation
Tribunals are further restricted from taking IHL considerations into account by provisions concerning compensation. As the following examples show, the formulation of expropriation obligations places emphasis on compensation and the date of repayment. As such, expropriation is treated as ipso facto illegal conduct, irrespective of whether it was triggered by a lawful or unlawful act.
Provisions concerning compensation typically establish that the failure to make full, effective, and adequate payment for an expropriation will amount to a treaty breach, without distinguishing between lawful and unlawful expropriation. For instance, Article 5(1) of the 2002 Syrian Arab Republic–Ukraine BIT provides that “[…] The expropriation shall be carried out under due process of law, on a non-discriminatory basis and shall be accompanied by provisions for the payment of prompt, adequate and effective compensation.”
Similarly, Article 5(1) of the 2018 Ukraine–Qatar BIT, despite making a distinction between legal and illegal expropriation by carving out a space for public interest, contains an obligation to make effective and adequate compensation. The Article provides that:
“[n]either of the Contracting Parties shall take measures of expropriation […] unless the measures are taken in the public interest, on a non-discriminatory basis in accordance with the legislation of the Contracting Party state making the expropriation and upon the payment of effective and adequate compensation.”
Further, Article 4(1) of the 2010 Israel–Ukraine BIT, while acknowledging the notion of armed conflict, imposes an unequivocal obligation to pay compensation. The Article uses prohibitive language, noting that:
“[i]nvestors […] whose investments […] suffer losses owing to war or other armed conflict, revolution, a state of national emergency […] shall be accorded treatment, as regards … compensation or other settlement, not less favorable than that which the Host Contracting Party accords to its own investors or to investors of any third state.”
Thus, equating the obligation to compensate with the obligation to make full, prompt, and effective payment may absolve a tribunal of the need to make inquiries or declarations in respect of the lawfulness of the expropriation. Instead, tribunals are empowered to treat claims of expropriation mechanically, adopting a purely factual approach, whereby any destruction of private property, even destruction resulting from emergencies such as armed conflict, will give rise to a separate and independent obligation to provide full reparation.
Many tribunals exhibit a tendency to treat expropriation mechanically, conducting simplistic financial assessments. The tribunal in ADC v Hungary drew no distinction between lawful and unlawful dispossession of an investment, simply recognizing that obligations are triggered when property is destroyed. In a similar vein, in Rumeli Telekom v Kazakhstan the tribunal drew no distinction between lawful and unlawful dispossession of investments, applying Fair Market Value reflexively in its award. Further, in Gemplus and Talsud v Mexico, the tribunal noted the difference between lawful and unlawful takings, but did not consider this difference to be relevant when assessing damages.
It is noteworthy that many tribunals exhibit a tendency to treat the duty to repair not as an ancillary obligation predicated on the lawfulness of the conduct under consideration, but as a primary obligation. Such a narrow formulation means that tribunals typically regard the destruction of property as the sole ground on which to invoke the repair obligation and will only investigate payments made, their adequacy, and their effectiveness.
As a result of this conflation between breach of obligation and failure to pay compensation, many investment tribunals unsatisfyingly favor the application of investment protection standards to disputes before them. The unavoidable result is that such tribunals will hold States that are the victims of aggression accountable for any resulting breaches of their obligations under international investment law, despite the prevailing circumstances.
The current ISDS arbitrator appointment process makes it particularly unsuitable to deal with complexities of claims arising from armed conflicts. It (inevitably) emphasizes the role of tribunals as the servants of private (including State) parties rather than the wider international community. This status quo was reinforced by Van den Berg, who noted that nearly all dissenting opinions issued in ISDS proceedings were issued by party-appointed arbitrators.
In instances of normative conflict, justice may require tribunals to acknowledge the need to uphold IHL, adopting a role akin to trustee or guardian of the greater good. However, by design, ISDS is primarily positioned to safeguard the freedom of contracting parties, reinforcing the role of party-appointed arbitrators as quasi-advocates for the parties, or for the ISDS process itself, rather than as professionals tasked with applying transnational norms and public international law rules.
Unsatisfyingly, ISDS permits international investment law to exist in a vacuum that enables those tasked with adjudicating disputes to turn a blind eye to IHL norms. In part two, we propose a potential solution to address such injustice.