Draft Recommendation 5 states:

1. Where the legal systems of partner countries are relatively underdeveloped, it may be appropriate to refer cases to third party dispute settlement mechanisms.
2. However, such process should not afford foreign investors in Australia or partner countries with legal protections not available to residents.
3. Investor-state dispute settlement procedures should be subject to regular review to take into account changing international best practice and the evolving legal systems in partner countries.

As explained in my submission to the PC, I have no great difficulty with the last point, although I suggest that one way to achieve that goal would be for Australia to develop and update a Model Bilateral Investment Treaty (BIT). I have much more difficulty with the PC’s second recommendation, but I have focused on problems identified with the first as it is particularly relevant to Australia’s policy position regarding the Asia-Pacific, especially Japan.

The PC’s Draft Report (at para 3.12) expresses concern about Australia being exposed to claims if FTAs or separate International Investment Agreements (IIAs) allow foreign investors to bring arbitration claims directly against the host state (investor-state dispute settlement or investor-state arbitration (ISA)). But even without ISA, the foreign investor’s home state may bring an international law claim against the host state, with Australia’s FTAs typically providing consent and quite elaborate rules. The investor admittedly faces the disadvantage of having to persuade its home state to act, which is not always easy as the home state may have more important diplomatic agendas vis-à-vis the other state. However, if Australia leaves out ISA from its IIAs, this ‘filtering’ problem conversely afflicts its own investors encountering illegal interference by host states abroad.

A problem of equity arises too, as it has in the WTO context: big firms are more likely than smaller ones to influence the home state’s decision whether to proceed with a claim on their behalf. This implies that when negotiating IIAs, the Australian government should investigate the size and nature of Australian investors (presently or potentially) active in the other state, not just their total investments abroad compared to the total from the other state’s investors.

The Draft Report focuses on whether the host state’s legal system is underdeveloped, rather than its economy – or whether the host state is a net capital importer. An underdeveloped legal system certainly promotes the case for including ISA protections, which are provided through an international process.

But even where developed legal systems are involved, ISA can be justified. Admittedly, investors can usually bring lawsuits in the host state’s courts based on local law, but these standards may vary somewhat from the international law standards. More importantly, local law may cost more to ascertain and argue in court, and disputes will likely be heard by judges with far less expertise in complex trans-border investment disputes than international arbitrators. Further, even developed countries’ legal systems can create problems for foreign investors. Canadians experienced that in the Loewen ‘runaway jury’ claim under NAFTA, for example, and the US-based AbitibiBowater recently settled a claim against Newfoundland.

Yet how likely are investors from developed countries to claim successfully against developed host states? In the context of Australia and the US negotiating to join the Trans-Pacific Partnership Agreement (‘TPP’, which may end up including ISA), the Draft Report states (para 3.12) that the PC ‘understands that no US business has been unsuccessful in pursing [sic] an ISDS claim against a foreign government.’ In fact, the appendix to my submission lists at least 16 unsuccessful claims involving US firms or interests. US and Canadian investors have filed claims against each other’s countries, but have rarely succeeded (as ultimately in Loewen, or recently the Chemtura claim against Ontario). All this suggests, holding constant the other factors already mentioned, that Australia should be open to including ISA even in treaties with developed countries – providing further protection to investors for the most egregious cases of host state interference.

Further supporting that stance, several (more or less) developed countries with sophisticated legal systems have concluded treaties providing for ISA: the Hong Kong – Japan BIT, the Japan-Korea BIT, the US-Singapore FTA, the Hong Kong – UK BIT, the Japan-Switzerland FTA, the Australia-Singapore FTA, the Australia-Chile FTA, the ASEAN-Australia New Zealand FTA (albeit with an Australian-NZ carve-out as they complete negotiations for a bilateral FTA investment chapter), and the Energy Charter Treaty (with Japan as a member and Australia already a signatory).

Note that this list includes Asia-Pacific jurisdictions – especially Japan – and sees the emergence of regional agreements. If Australia really wants to achieve a multilateral end-game despite the WTO impasse, then ‘open regionalism’ will need to progress even further. And it will be harder to incorporate ISA into regional agreements if ISA is tainted by the idea that it is only a device for developed countries to beat up on developing countries. There is already too much criticism along those lines, often ill-informed. Already, a few South and Central American countries are stepping back from full engagement, and some now call for a return from treaties to individually-negotiated investor-state investment contracts. Yet that would dramatically increase complexity and transaction costs – good for lawyers, but probably not for taxpayers. There are instead many ways to keep improving the treaty-based investor-state arbitration system from within.

This opinion is premised on developed countries acting responsibly, keeping firmly in mind both the short-term and long-term advantages as well as the disadvantages of ISA, and addressing these concerns in treaty practice as well as by other means. From past treaty practice, as well as the fact that Japan remains a very large net FDI exporter into Australia, we can expect Japan to press for ISA to be included in the bilateral FTA under negotiation since 2007. Some good broader arguments to justify that approach have been presented here, for consideration by the Australian government as well as other policy-makers in the region.

Luke Nottage is Associate Professor at the University of Sydney Law School and founding Co-director of the Australian Network of Japanese Law (ANJeL).

This article is adapted from a post on Luke Nottage’s ‘Japanese Law and the Asia Pacific’ blog. It is based on research for the project, ‘Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific,’ supported by the Australia-Japan Foundation which is part of the Australian government’s Department of Foreign Affairs and Trade.