This post has been written by Founding Editor Saarthak Jain, and was first posted on the blog of the American Review of International Arbitration. 

Introduction

Investor-state arbitrations have been generally viewed as a one-way street, which provide foreign investors an international forum to address their grievances. The privileged position given to investors in this framework has created incentives for commercial actors to characterize their disputes as “investment disputes”, thereby falling within the scope of an investment treaty. Consequently, this has resulted in tribunals increasingly adjudicating upon “investment disputes” in which private business interests collide with public interest regulations, including actions aimed at environmental protection. This post argues that inclusion of host states’ counterclaims provides an effective procedural mechanism for the adjudication of environmental disputes in treaty arbitrations.

Background

Although the earliest investment disputes can be traced back to the early 1970s, cases concerning environmental policies have only emerged from the start of this century. For instance, in Methanex Corporation v. USA, the tribunal considered the legality of the ban on a fuel additive, which was found to be contaminating water bodies and a potential risk to human health. Similarly, in S.D. Myers, Inc. v. Canada, the issue concerned a ban on the importation of a waste material, Polychlorinated Biphenyl (PCB). Thus, environment-related disputes can be at the core of investment arbitrations. These disputes, by their very nature, involve a tension between a State’s obligation to promote foreign investment on the one hand, and to prevent environmental degradation on the other. 

Almost parallel to this development, there have been increasing demands for permitting counterclaims by host states. Inclusion of counterclaims would vastly contribute towards the efficiency and economy of the settlement of investment disputes by ensuring that all aspects of the dispute are heard and decided in one forum. But more importantly, counterclaims may potentially contribute to address the growing criticism that investment arbitration is structurally biased against host states. As was noted by the tribunal in SGS v. Pakistan: “it would be inequitable if, by reason of the invocation of ICSID jurisdiction, the [foreign investor] could on the one hand elevate its side of the dispute to international adjudication and, on the other, preclude the [host state] from pursuing its own claim for damages […]”.

International Investment Agreements (IIAs) and the Protection of Environment

IIA’s currently in force generally lack provisions reflecting environmental concerns. However, a survey conducted in OECD countries has found that “the prevalence of environmental language in IIAs is low, but growing”. Although only 8.2% of the current IIA’s were found containing environmental language in 2011, it is encouraging to note that 89% of the newly concluded agreements make reference to environmental concerns, thereby highlighting the growing importance of balancing a state’s duty to protect the environmental along with its commitment to foreign investors.

References to environmental protection and sustainable development are increasing seen in the preamble of investment treaties. For instance, the preamble of the Brazil-Mozambique BIT acknowledges the “essential role of investment in the promotion of sustainable development, economic growth, poverty reduction, job creation, expansion of productive capacity and human development.” The US-Rwanda BIT, while recognising the importance of stimulating the flow of mutual capital between the parties, notes that parties desire to achieve this goal “in a manner consistent with the protection of health, safety, and the environment, and the promotion of internationally recognized labour rights.

In some IIAs, states have gone a step further by expressly referring to environmental concerns in provisions regarding the scope of the state’s regulatory power. For instance, the Switzerland-Mexico BIT states: “The Parties recognize that it is inappropriate to encourage investment by relaxing domestic health, safety or environmental measures. Accordingly, neither Party should waive or otherwise derogate from, or offer to waive or derogate, such measures as an encouragement for the establishment, acquisition, expansion or retention in its territory of an investment of an investor. If either Party considers that the other Party has offered such an encouragement, it may request consultations.

Therefore, it is evident that some states have recognised the environmental implications of solely focussing on increasing foreign capital. Explicit reference to environmental issues and sustainable development is becoming increasingly common in BITs. However, the procedural mechanisms for the enforcement of environmental norms have not evolved simultaneously.

Counterclaims in Investment Arbitration

The Best Defence is a Good Offence”

Filing of counterclaims has been recognised as an effective mechanism to redress the asymmetry between investor’s rights and host state’s regulatory powers. Despite their promising role in enforcing investors’ compliance with environmental standards, host states have faced numerous obstacles on both procedural and substantive grounds while attempting to raise counterclaims.

One of the primary reasons why host states remain perpetual respondents without the ability to file for claims themselves is the language and wording of IIAs, which determines the tribunal’s jurisdiction over counterclaims. Tribunals have noted that investment treaties are inherently asymmetrical” in nature, and have therefore been reluctant to permit counterclaims when the dispute resolution clause is worded narrowly.

For instance, the ICSID tribunal in Roussalis v. Romania rejected the Respondent’s counterclaim on the basis of an absence of the investor’s consent. The tribunal relied on the dispute resolution clause of the Romania-US BIT, which limited its jurisdiction to “disputes…concerning an obligation of the latter [host state]”. Furthermore, the majority held that counterclaims would fall outside the tribunal’s jurisdiction when the BIT does not impose any obligations on investors and the applicable law is the BIT itself.

Apart from the jurisdictional hurdles, counterclaims must have a “close legal and factual connection” to the claimant’s primary claims in order to be admissible before an arbitral tribunal. Tribunals have taken a restrictive approach to the connectedness requirement, thereby artificially limiting the scope of obligations that can be invoked as bases for counterclaims.

Therefore, the current legal regime poses many obstacles to the successful assertion of counterclaims in investment disputes. However, there are recent signs that suggest counterclaims could play an increasingly important role to enforce obligations on investors. 

Changing Tides

Recent developments indicate that tribunals might be more willing to permit host states’ counterclaims in treaty arbitrations. This optimism is largely on account of two recent decisions concerning environmental counterclaims: Burlington v. Ecuador and Perenco v. Ecuador. Both these cases arose out of the same factual circumstances, concerning a windfall levy of 99% on oil revenues by the Ecuadorian government. On the investor’s refusal to pay the tax, Ecuador terminated the contracts and initiated proceedings to seize its share of oil production. The investors initiated proceedings alleging expropriation of their assets. In this background, Ecuador raised a counterclaim alleging breaches of Ecuadorian environmental law by the investors’ acts of polluting soil and groundwater.

In both the cases, the tribunals held Ecuador liable for unlawfully depriving the investor of the benefit of its investment. The tribunals, however, also held Burlington and Perenco liable for the environmental harm caused to sections of the Ecuadorian Amazon. In Burlington v. Ecuador, it was held that environmental harm “is defined by reference to the regulatory criteria of the home state,” which in turn is designed to uphold the home State’s international obligations. Although the domestic law concerning environmental protection came into force after Burlington’s initial investment, the tribunal held that Burlington was still bound to abide by it.

Crucially, the Perenco tribunal also made the following observations: “Proper environmental stewardship has assumed great importance in today’s world. The Tribunal agrees that if a legal relationship between an investor and the State permits the filing of a claim by the State for environmental damage caused by the investor’s activities and such a claim is substantiated, the State is entitled to full reparation in accordance with the requirements of the applicable law. The Tribunal further recognises that a State has wide latitude under international law to prescribe and adjust its environmental laws, standards and policies in response to changing views and a deeper understanding of the risks posed by various activities…”  

Therefore, these two cases highlight the potential of investor-state arbitration to function as a mechanism to enforce international environmental norms against private investors.

Conclusion

The investor-state dispute settlement process needs to be more sensitive to environmental policy concerns. In this regard, counterclaims can play a crucial role in ensuring that a host state’s commitment to protect the environment is taken into consideration by a tribunal. Current IIA’s do not usually contain any mention of the right to raise counterclaims. An attempt was made in the initial draft of the 2015 Indian Model BIT to deviate from this by including a specific provision permitting counterclaims before investment tribunals. Further, it contained detailed provisions regarding environmental conservation, which the investors had to comply with. However, the revised model BIT released in December 2015 did not contain the reference to counterclaims and diluted the provisions relating to environmental protection. This was a huge missed opportunity to reconcile the long-standing conflict between the international investment and environmental regime.

As is indicative from Perenco and Burlington, counterclaims can serve as the vehicle to facilitate sustainable and eco-friendly development in the future. Therefore, it is proposed that future IIAs contain explicit provisions permitting host states to raise counterclaims. This would ensure that foreign investors are held accountable for the environmental damage caused by them. Such a development would be especially important for India which is a major investment destination, but at the same time, faces grave environmental threats.