Initial Stages of a Dispute: The State’s Perspective

Introduction

Twenty or 30 years ago, if a state received a notice of dispute or request for arbitration from a foreign investor claiming the state had violated an international treaty, civil servants might understandably have been perplexed. It might well have been the first time that the state had ever dealt with such a claim.

In these circumstances, states lost opportunities to resolve disputes quickly and relatively inexpensively. Through simple inaction, they could even damage their prospects of defending the claims in arbitration.

Now, states are more aware of investor–state dispute settlement (ISDS) through their own experience or through news of cases against neighbouring states. They are more sophisticated respondents than they were a generation ago. Many have developed in-house expertise and have lawyers in the relevant ministries who can handle some or all aspects of a dispute with an investor, especially in the pre-arbitration phase. For states with less internal legal support, non-governmental organisations conduct education and training. States have also become more savvy clients when it comes to seeking external legal representation, both in deciding when to do so and in assessing potential representatives.

Today, if a state responds passively to a notice of dispute, that will likely be a conscious decision, taking into account all relevant strategic considerations. More often, however, today’s state officials will see opportunities to benefit the state through active management of a dispute from the outset.

Responding to a notice of dispute or request for arbitration must be approached in the same way as any other important state business. There must be clear allocation of responsibility: who is accountable for handling the dispute? With accountability must come the necessary authority, for example, to enable those in charge of the matter to gather information from other ministries and to engage external consultants as necessary. And, of course, there must be adequate funding from the state budget. With those elements in place, states will find that they can take advantage of opportunities to resolve disputes early and cheaply where appropriate, reject claims with confidence when that is the right course, and defend themselves rigorously in arbitration.

Against this background, this chapter aims to shed light on the initial stages of investment arbitration, with a focus on responding to two key milestones in most investor–state disputes: the claimant’s notice of dispute and the claimant’s request for arbitration. Starting by elucidating the conceptual framework of ISDS, this chapter highlights the importance of dispute prevention and of alternative dispute resolution (ADR) such as mediation and conciliation, also describing other procedural avenues open to states during the course of investment arbitration, including the possibility of advancing counterclaims and the strategy behind the preparation of the response to the notice of arbitration. The chapter concludes by urging states to start preparing on all fronts as quickly as possible and to proactively use all means available to avoid and manage disputes before an arbitral tribunal adjudicates an investor’s claims.

The state as a respondent in ISDS

While, in principle, states and state entities could initiate arbitral proceedings against investors, they tend to act as a respondent in virtually all cases.^[2] Therefore, states are often in the position of having to react to a formal or informal notice of dispute or a request for arbitration. To do so, states need to be aware of who they are dealing with and what ministries may have to be involved with the response.

Investors present a range of profiles. An Organisation for Economic Co-operation and Development (OECD) study conducted in 2012 showed that 22 per cent of ISDS claimants were either individuals or very small corporations with limited foreign operations, 50 per cent were medium or large multinational enterprises, and 8 per cent were extremely large multinationals.^[3]

In relation to the distribution of cases by economic sector, the International Centre for Settlement of Investment Disputes (ICSID) Caseload Statistics show that the most active sectors in terms of investment disputes are those of oil, gas and mining (25 per cent), electric power and other energy (17 per cent), and construction (9 per cent), with transportation, finance, information and communication, water, sanitation and flood protection, agriculture, fishing and forestry, tourism, and services and trade coming next.^[4] Therefore, states should be aware that ISDS cases could arise from mining operations regulated by the ministry of mining, power plants overseen by the energy ministry, hotels regulated by the tourism ministry, and so on. They may also arise from general regulations issued by those ministries as well as environmental or public health regulations originating with ministries that do not ordinarily deal directly with foreign investors or consider investment and economic development to be within their remit. They may come from specific regulatory actions directed at a particular investment; for example, issuance or cancellation of a construction permit or prosecution of a tax case against a foreign-owned business. And they often may come from an alleged breach of an agreement with the specific investor, such as a mineral concession or a contract with the highway agency to build a road or bridge.

In short, while certain ministries are more likely than others to be involved in an investor–state dispute, claims can arise from the actions of almost any branch of the government, not to mention parastatals, specialised agencies, state-owned corporations, and other persons and entities for whose actions an investor might claim the state is internationally responsible. Further, disputes can be triggered by the actions of local authorities, even though it will usually be central state organs that are in charge of defending against the claim, and those local authorities may have independent power bases and agendas at cross-purposes with central authorities; for example, elected mayors might use their planning authority to stop construction of a ‘dirty’ power plant in their city, even though the central energy ministry has granted permission and genuinely wants the plant to be built. In a federal state, local units may be controlled by political parties opposed to the party running the federal government, with similar tensions in how willing they are to help the state avoid or defend against international claims.

If that were not complex enough, the state’s judiciary may be involved, with investors claiming that court decisions (or failures to decide) breached the state’s treaty obligations. In these cases, the executive ministries and agencies dealing with the international claim may be frustrated that the courts’ independence makes it difficult or impossible to control what they do or to get much cooperation from them in defending the case.

So those managing the state’s response to a claim often have a formidable task.

But the state has no choice. It must defend itself, and that includes early action to head off or resolve disputes. Even if one puts aside unquantifiable state interests, such as maintaining a reputation as a law-abiding, investment-friendly jurisdiction and not damaging bilateral relations with the claimant’s home state, there is a huge amount of money at stake. The average amount awarded to a successful investor has risen from US$110.9 million in June 2017 to US$315.5 million in May 2020, which represents a 184 per cent increase in only three years.^[5] One important factor that is not unique to investor–state arbitration but is associated with international arbitration in general, is the cost of the proceedings. This is an important factor for the state to take into consideration during the initial stages of the dispute as it can have a dissuasive effect. These costs have skyrocketed in recent years,^[6] with the average cost for parties now at over US$8 million and costs exceeding US$30 million in some cases.^[7]

On top of these important costs, states are wary of the flexible rules on the allocation of costs, as they can be perceived as a source of uncertainty. The ‘traditional’ position until relatively recently was that each party bore its own cost.^[8] This has changed over the years. In June 2017, a British Institute of International and Comparative Law study found that both ICSID and United Nations Commission on International Trade Law tribunals have awarded adjusted costs to follow the ‘loser pays’ principle in around 75 per cent of cases under both sets of arbitration rules.^[9] That means there is even more at stake in winning the case, as the state may recoup some of its expenses if it does so, while it may be on the hook for millions – or tens of millions – of dollars of costs run up by claimants if it loses.

Steps following notice of dispute – internal case management and preparation

Time is the most valuable asset to a state in investment arbitration, meaning that preparation is key.^[10] To ensure the best possible outcome, states, just like investors, should start preparing as soon as possible and, in any case, as soon as they receive a formal or informal notice of dispute.^[11] To do what many states appear to have done in bygone decades – ignoring a notice of dispute and doing nothing until a request for arbitration is received – is not a sensible policy. Even if there seems to be little hope of settling the dispute short of arbitration, the state needs to engage with the claim immediately, so that when the request for arbitration arrives, it is ready to respond in a timely fashion and does not, for example, lose its right to participate in the formation of the arbitral tribunal while it belatedly tries to retain external legal advisers.

Lead agency within the state

Internal preparation often entails the involvement of all state entities, authorities and sub-divisions that are either directly or indirectly associated with the dispute, thus adopting the ‘whole government approach’.^[12] States that work to identify all relevant entities and in turn identify people within them capable of assisting – both managerially and substantively – in the handling of potential ISDS claims will have the best chance of successfully resolving the dispute in hand. An internal team, once in place, will need to develop a strategy, often with legal counsel, covering all aspects of the dispute, including gathering evidence, identifying potential fact witnesses and experts, devising a case theory and handling the political and media issues.^[13]

Legal representation

Some large states that have participated in a large number of cases, such as the United States and Canada, have specialised in-house legal teams that deal solely with investment arbitration. This, however, is not the case for all states. For states with little to no investment arbitration experience, the guidance of external counsel from the initial stages of the dispute is invaluable. When considering instructing external counsel, states may either use counsel they have previous experience with or call for tenders from different law firms. It is also possible for states to use a combination of in-house and outside counsel.

States may resist retaining external counsel at the notice of dispute stage because of the cost. This may be a mistake in many instances. If a state has internal ISDS expertise – in the justice ministry or attorney general’s chambers, for example – external advice may not be necessary. Some disputes may appear to be easily resolvable without a significant prospect of going to arbitration. Finally, those in charge of responding to the notice of dispute may find that there is no budget that can be used for external counsel. But if the dispute does eventually go to arbitration, the state will be better off having engaged external counsel early. It will be in a better position to respond in a timely manner to the early stages of arbitration. If there is no budget available when the notice of dispute arrives, it will often be advisable to start the sometimes lengthy process of requesting funding immediately, as it will be too late to do so after an arbitration has begun.

Evidence and document collection

Documents are an essential component of ISDS as they help support and establish a state’s defence strategy and counterclaim (if any), while also playing an important role during the document production stage. Loss or destruction of documents, after the investor has given notice of a claim, may not only mean the state has lost evidence that could have been used in defence, it can also become the basis for a tribunal to draw inferences against the state, in which it is assumed that the lost or destroyed documents would have helped the investor’s case. Early document collection enables the state to have a clear picture of the dispute, assess the risk of escalation, monitor time constraints and undertake the steps and procedures set out in the investment treaty, the contract or the legislation.^[14] Therefore, it is of the utmost importance that states prioritise document compilation and preservation at an early stage, irrespective of whether they plan to try to settle the dispute or not.

Document collection and preservation is commonly a lengthy and complicated exercise for states to undertake. States often face obstacles, given that documents relevant to their defence can be spread among different state entities and offices. In addition, the degree of file keeping will vary widely in the different relevant state entities, and some ministries may have little desire to go to the effort of gathering documents or may even be secretive and unwilling to share their information with civil servants from other state organs that are responsible for defending against the claim.

To avoid delays in collecting evidence and information, certain states have put in place inter-institutional arrangements or systems within the host government. For example, Peru has created a Commission and Colombia has a system in place to ensure an efficient flow of information for arbitrations.^[15]

Funding

To meet costs without delay and to organise a proper defence, safeguarding a source of funding and the accessibility of funds must be ensured by the state. Special requests for the necessary budget may need to be made. A budget should be prepared in advance of commencing the proceedings based on the expected costs. It is important that the budget has some leeway for unexpected matters but also that it is updated as the proceedings advance to ensure the state manages costs in an efficient manner.

Dispute prevention, consultations and ADR

The dramatic increase of ISDS claims, coupled with the significantly high compensation awarded to successful claimants, has made it critical for states to devise strategies to settle potential claims before disputes are brought before and become adjudicated by arbitral tribunals. To this end, this section analyses how states may rely on and take advantage of the existing variety of dispute prevention and ADR processes.

Dispute prevention policies

Dispute prevention is a means ‘to improve the business environment, to retain investments and to resolve investors’ grievances swiftly’.^[16] The purpose of dispute prevention policies (DPPs) is, inter alia, to timely alert government authorities as to the existence of emerging conflicts and disputes with investors. DPPs may include measures taken at the national level through the utilisation of institutional mechanisms within the host state for the prevention of the emergence and escalation of disagreements, thereby ensuring that investors’ grievances do not culminate into disputes. These measures may include, without limitation: (1) the assignment of a lead agency that would serve as a one-stop shop^[17] with the task of establishing a communication channel with investors and the governments of the contracting state parties; (2) the systematic compilation and evaluation of investment contracts, treaties and cases, and making these available to the public; (3) the identification of sensitive sectors (i.e., sectors where investment disputes are more likely to arise) and the provision of ‘investment aftercare’ to support investors engaging in these sectors; and (4) the establishment of an early grievance-detection mechanism that will allow the state to conduct early settlement discussions with the affected investor.^[18] Additionally, DPPs may also include measures taken at the international level. These measures may include, inter alia, state-to-state cooperation through institutionalised dialogue, and capacity-building and training with the purpose of narrowing the knowledge gap between states in relation to the identification and management of ISDS.^[19]

Juxtaposed with ADR, which attempts to settle conflicts that have climaxed into disputes, DPPs endeavour to prevent the emergence of disputes in the first place. DPPs may also be useful where an investor serves the respondent state with a notice of dispute before commencing an arbitration. The notice of dispute usually apprises the host state of how a certain policy or measure has adversely affected the investor’s rights under an investment treaty or other legal instrument. The existence of robust and proactive DPPs would enable the state to direct the investor’s notice to the relevant government officials so that they may examine the investor’s claims and find means to resolve them without resorting to arbitration.

Recently, Egypt has attempted to create a similar framework through amendments to its Investment Law No. 8/1997. Given the fact that at least 14 claims have been brought against Egypt since 2011, the amendment intends to reduce Egypt’s exposure to international investment arbitration. As a result, a new Chapter 7 titled ‘Investment Disputes Settlement’ has been added to the country’s arbitration law. The Chapter has established a three-pronged approach to preclude conflicts from culminating into an arbitration: first, it creates a Complaint Committee to consider challenges against administrative decisions and regulations issued by the General Authority for Investment with respect to the implementation of investment law; second, it envisages a Ministerial Committee for the Resolution of Investment Disputes to consider disputes arising between investors and a government body with respect to the implementation of the Investment Law; and third, it also establishes a Committee for the Settlement of Investor Contract Disputes for the purpose of settling disputes between investors and government bodies arising out of investment contracts.^[20]

On that basis, it becomes evident that the existence of effective DPPs allows states to avoid the risk of an unfavourable arbitral award, which may also embolden other investors to challenge the same or similar measures and policies. Moreover, protracted arbitrations between a state and investors affect the state’s credibility as a safe destination for investments, thereby hurting its ability to attract other investors. Effective DPPs are, thus, the sine qua non towards precluding conflicts from escalating into disputes and are critical, especially given that the state’s role and regulatory sphere have expanded in the aftermath of covid-19.

ADR methods

While DPPs may be useful to preclude the emergence of disputes, ADR methods such as mediation and conciliation may also assist in the settlement of conflicts that have ripened into disputes. Aiming to replace the escalation to both ISDS and national courts, ADR methods represent a less time- and cost-consuming alternative that offers a high degree of flexibility to the disputing parties, allows the preservation of long-term relationships and succeeds in ‘averting disputes and avoiding the intensification of conflicts’.^[21]

Cooling-off periods

Almost 90 per cent of all international investment agreements (IIAs) envisage a cooling-off period between the submission of a claim and the commencement of an arbitration, ranging from three to 18 months, during which the investor shall abstain from initiating arbitration, thus enabling the disputing parties to attempt the amicable settlement of the dispute through ADR processes such as consultations and negotiations, mediation and conciliation. Notwithstanding the existence of these two-tier dispute settlement clauses, data from arbitral institutions indicates that the first tier of dispute settlement is seldom used.^[22] This is arguably due to the fact that the majority of IIAs merely provide a generic instruction to the disputing parties to attempt to resolve their disputes ‘amicably’ during the cooling-off period, without elucidating the manner and procedure through which the amicable settlement may take place.^[23]

Conciliation

Conciliation is a process whereby a third person (the conciliator) provides a non-binding, independent and impartial evaluation of the rights and obligations of the disputing parties, and proposes non-binding recommendations on the appropriate settlement of the dispute. The conciliation procedure is often governed by a pre-established set of rules that, contrary to arbitration rules, give conciliators flexibility to interact with the parties – for example, to communicate confidentially with one party on an ex parte basis – to facilitate the achievement of a fair settlement.

Mediation

Mediation is a process whereby a third person (the mediator) assists the disputing parties in reaching an amicable settlement of their dispute. As a form of assisted negotiation, mediation is appropriate at all stages of the ‘investment life cycle’, both before and after the official commencement of arbitration.^[24]

Keeping in mind the fact that both conciliation and mediation may be difficult in the absence of an investment treaty expressly providing for these processes, parties should consider incorporating a detailed conciliation or mediation clause, or both, in their investment treaties, and respondent states should be open to the possibility of suggesting the settlement of investment claims through these ADR processes. This approach could shed light on, among other things, the manner in which a party may invoke ADR mechanisms and whether parties would be allowed to invoke other forms of dispute resolution while they attempt to either conciliate or mediate their disputes, and the time frame to address disputes via conciliation or mediation, or both, before resorting to other means.

With states attempting to revive their economies in the aftermath of covid-19, it is imperative that they create an environment that is conducive to foreign investments. Critical for these investments is the existence of a mechanism whereby states endeavour to, first, address investors’ grievances before they culminate, and second, ensure the resolution of these grievances amicably and in good faith if they escalate into conflicts. In the absence of these mechanisms, states and investors both continue to grapple with uncertainty.

The originating process – responding to the notice of arbitration

If the investor does start an arbitration, the state must be prepared to respond promptly. Tribunals can be sympathetic to the fact that states need more time than commercial parties to make decisions and put together written submissions. But there are limits. If a state received notice of the dispute many months before the request for arbitration, the tribunal might reasonably expect it to have worked out its defences. Even before the dispute gets before a tribunal, the state may be severely prejudiced if it misses deadlines for participating in the appointment of the tribunal. Further, an investor may seek emergency relief by way of interim or provisional measures, and the state must have a legal team in place to deal with any such requests. States can harm themselves if the claimant obtains a measure more or less by default, and then state organs – which may not even know the measure is in place – may violate the measure, painting the state as ‘rogue’, fairly or not, from the outset.

Initial steps

Depending on the applicable IIA and arbitration rules, the notice of (or request for) arbitration will identify the disputing parties, the investment, the nature of the dispute, the applicable legal instruments and the manner in which the parties consented to arbitration. At this stage of the procedure, the investor needs to develop in detail its factual and legal arguments.^[25] However, if the state has actively managed the dispute resolution process since receiving the notice of dispute, it should have a reasonable idea of the underlying facts, even if the claimant’s legal theories may be as yet obscure.

Once the arbitration proceedings have commenced, the respondent state will have a relatively short period of time available to file a response to the notice of arbitration. Under most arbitration rules, this period of time is set at 30 days, with short extensions often being granted upon a reasoned request.^[26] States should be careful to make such a request if necessary, rather than simply failing to respond. Again, while an administering institution or eventual tribunal may sympathise with the state’s need for extra time, apparent disregard for the process is rarely helpful, and defaults might result in irreversible actions such as the appointment of an arbitrator on the state’s behalf.

Although the state’s response may be the first opportunity to give the state’s version of events, it can be at least equally important for its procedural content, such as the state’s proposals concerning the number and method of appointment of arbitrators, the actual nomination of an arbitrator, comments on the applicable law and the language of the proceedings, and its position on the seat of arbitration.

At this stage, the state will want to consult its legal advisers (internal or external) about important procedural matters, such as whether to seek bifurcation of jurisdictional objections. It will also need to consult with all stakeholders – through lines of communication that, ideally, will already be in place from the pre-arbitration phase – to determine a realistic procedural timetable that it can propose.

Counterclaims

Like any respondent, a state can raise counterclaims. These counterclaims may seek damages for environmental harms caused by the investment,^[27] the investor’s failure to comply with tax laws^[28] or the investor’s failure to provide the necessary level of investment.^[29] When available, counterclaims can be highly beneficial: they can increase procedural efficiency, mitigate the asymmetrical nature of the international investment regime and provide the state settlement leverage.

Generally, a tribunal’s jurisdiction over a counterclaim depends on the scope of the parties’ consent, the dispute settlement clause of the IIA and the relationship of the counterclaim with the primary claim or claims.^[30]

In relation to the parties’ consent, where the dispute settlement clause permits any and all disputes to be submitted to arbitration, tribunals tend to admit jurisdiction over the state’s counterclaim.^[31] In contrast, where the dispute settlement clause is restrictive, tribunals tend to dismiss the counterclaim.^[32]

In addition to the requirement of consent, for a counterclaim to be admitted by an arbitral tribunal it should have a sufficiently close connection with the primary claim or claims. Arbitral tribunals have adopted different approaches as to whether the test for establishing connectivity is a legal or a factual one. The tribunal in Saluka v. Czech Republic found that a legal connection was required, ruling that the counterclaim must have the same legal basis as the primary claim,^[33] while other tribunals have admitted counterclaims that arise out of the same subject matter.^[34]

When it is not possible to bring counterclaims in the proceeding initiated by the investor, a state many consider raising its claims against the investor in separate proceedings. These may be before a local court, administrative body or arbitral tribunal that has jurisdiction over the state’s claim. Often, the parties may not be precisely the same as in a case commenced against the state; for example, the claimant may be the state-owned corporation that entered into a contract with the investor, rather than the state itself; and the respondent might be a locally incorporated investment vehicle, rather than the foreign shareholder that is party to the first proceeding. Whether to commence a separate proceeding is one of the strategic decisions the state must make at the earliest stage, as it may be possible to persuade the ISDS tribunal to defer to the other court or tribunal’s findings – though, in practice, this is rare unless the separate case proceeds quickly. Similarly, if there are state judicial or administrative regulatory proceedings because of the investor’s possible violation of tax or environmental regulations, for example, the state will want to ensure that these proceedings do not prejudice the ISDS defence and that the ISDS tribunal respects the state’s right to continue with its normal processes, as the claimant may seek provisional measures to stop these proceedings.

Conclusion

While arbitration is an effective means of dispute resolution, states will save time and cost if investor disputes can be avoided altogether or resolved through negotiations or other non-contentious means. Moreover, a state may harm its reputation as a place for foreign investments if it faces multiple arbitrations from different investors. It is therefore critical to develop practices that reduce the state’s exposure to investor disputes, such as those implemented in Egypt. Nonetheless, where strategic interests, investors’ intransigence or other factors render recourse to arbitration necessary, it is imperative that states start preparing as soon as they receive notice of the dispute so as to be in control of all aspects of the arbitral process.

Notes