Investor-State Dispute Settlement: A Barrier to Climate Policy?

Article by Vincent Guereca-Adair.

This article will discuss investor-state dispute settlement and suggest that it could act as a barrier to policies aimed at remedying the climate crisis.

What is Investor-State Dispute Settlement?

Investor-state dispute settlement (ISDS) is a mechanism that allows foreign investors in a country to bring legal claims against a host state.

International investment agreements (IIAs) will often include a mechanism for dispute resolution. This is true for both large multinational agreements, such as the North American Free Trade Agreement (NAFTA), and small bilateral investment treaties between individual states. The purpose of these provisions, as well as the various obligations for states that the IIAs contain, is to ensure stability and encourage investment in each state. Investors include companies, and the IIA ISDS provisions allow these companies to bring claims against a host state for compensation if the actions of the host state have caused the company to incur a loss.

A loss could be in the form of a direct expropriation by the host state, such as a seizure of assets, or in a more indirect form, such as a policy that causes those assets to lose value. The company would then enact the ISDS provision in the relevant IIA and the parties would go to arbitration, the outcome of which (a compensatory award) would be binding.

Current Examples

There is a concern that ISDS will discourage states from implementing policies that are necessary to counter the climate crisis, due to a concern about incurring significant loss through arbitral awards. It is notable that 70% of the highest awards ever recorded (each in excess of $1 billion) related to fossil fuels. In addition, at the end of 2017, the average award to foreign investors from ISDS was $504 million.

There are a number of ongoing cases which demonstrate how fossil fuel companies are using ISDS in response to climate change policy.

In RWE v. Kingdom of the Netherlands [2021], RWE claims (using the Energy Charter Treaty) that the Netherlands’ plan to phase out coal by 2030 does not include sufficient compensation for the loss of value of their coal-fired power plant in the region. As such, they are seeking $1.4 billion in compensation. A similar claim has been brought by the energy company Uniper for $1 billion, under the same treaty and for the same reasons.

In Rockhopper v. Italy [2017], the UK company and its Italian subsidiary brought a claim for actual and potential losses incurred from the Italian government’s reintroduction of a ban on oil and gas exploration within 12 miles of the Italian coast. The decision is currently pending; however a potential award could be between $200-300 million.

The Effect on Climate Policy

The climate is in crisis. This is an established consensus now, so this article will not discuss the concerning data. Governments around the world have therefore committed in the Paris Agreement to limit global warming to below 2 degrees Celsius. It has been suggested that meeting this target globally requires 33% of oil reserves, 50% of gas reserves and more than 80% of coal reserves to remain unused between 2010 and 2050.

Essentially, we must stop using fossil fuel and it needs to happen quickly. It was a recognition of this that prompted the Netherlands’ 2030 target, which triggered the RWE and Uniper cases.

However, there is a clear risk that states will face significant claims from multiple fossil fuel companies if they take this action. It is reasonable to consider that, faced with losing hundreds of millions, if not billions, of pounds in compensation payments, a state might choose to limit the action it takes to prevent the climate crisis.

This potential international chilling effect on regulation is evident in the use of ISDS by tobacco companies. ‘Big Tobacco’ have used ISDS to challenge various public health policies brought in by states, such as plain labelling in Australia. The purpose of these disputes is both to challenge the specific policies, but also to deter other states from taking similar action. Even if the state’s defence is successful, the legal costs incurred could run into the millions.

ISDS therefore has the potential to discourage states from implementing the necessary policies for fixing the climate. States that want to transition from coal will be warned by the RWE and Uniper cases; act too fast and you might get sued. Understandably, policy makers around the world might therefore be discouraged from acting fast.

What can be done? There are calls for states to withdraw from the Energy Charter Treaty, which RWE and Uniper are both based on. There are also suggestions that climate change policy should be excluded from ISDS mechanisms. Whatever is done will be the outcome of intense debate between lawyers, politicians, activists, and corporations. Ultimately, we need to decide who bears the cost of the climate response.