Damages and Climate Change Investment Arbitration (Webinar Climate Change and Investment Arbitration - 15 November 2023)
17 March 2024
In a pivotal webinar held on 15 November 2023 organized by Nivalion and Wöss & Partners, titled "Climate Change and Investment Arbitration", moderated by Prof. Don Wallace, Jr. (Chairman, International Law Institute), one of the great American professors and long-term representative of the US at the UNCITRAL, Dr. Herfried Wöss (Founding Partner, Wöss & Partners) gave valuable insights in how to resolve climate-change related damages claims in investment arbitration.
In his introduction, Prof. Wallace focused on the evolving landscape of international investment law in the context of climate change and ESG claims. He highlighted the anticipated changes over the coming decades, including shifts in investment treaties, such as the EU's withdrawal from the Energy Charter Treaty ("ECT") and the introduction of ESG obligations via the Investment Protocol to the African Continental Free Trade Agreement. Prof. Wallace raised critical inquiries about the future of investment treaties in imposing ESG obligations, the specificity required for litigating often vague soft law obligations, and the defence mechanisms available to investors against potential claims. These questions aimed to delve into the complexities that investment arbitration faces due to climate change, setting the tone for a comprehensive exploration of these pivotal issues by the panel experts.
In his presentation on "Damages in Climate Change Investment Arbitration", Dr. Wöss started with a reference to his recent chapter on Damages in Investment Treaty Arbitration he co-authored with Adriana San Román, and to the joint expert comments on the UNCITRAL Working Group III note on damages both of them based on their OUP monograph Damages in International Arbitration.
He then commented on the 2023 thematic report of the UN Special Rapporteur "Paying polluters: the catastrophic consequences of investor-State dispute settlement for climate and environment action and human rights", which suggested that foreign investors "use the dispute settlement process to seek exorbitant compensation from States that strengthen environmental protection, with the fossil fuel and mining industries already winning over $100 billion in awards", which creates regulatory chill. This is supported by Annex 1 to the report which refers to 12 largest known ISDS awards but seems to ignore the reasons for and benefits of a functioning ISDS system and fundamental issues of international and comparative damages law.
The famous economist Jagdish Bhagwati, who provided the scientific foundation to development of the GATT and the WTO system in the 1980s and 1990s, has purportedly said that "treaties serve to protect people against their own populist leaders". The more is true with respect to investment treaties that set a rather minimum protection through international investment protection standards. Damages are the consequence of the violation of these standards. Dismantling the ISDS system based on some outlier cases dealing with natural resources that have an intrinsic value, seems to lead to an erosion of the international rule of law.
Dr. Wöss underlined that the principal function of damages is to provide a fair and just compensation for the violation of an investment protection standard that is to avoid over or under compensation, which is a principle that derives from Aristotle's Nicomachean Ethics under the notion of "commutative justice", and St. Thomas Aquinas' "Summa Theologica", as refined by the late scholastics and comparative law damages doctrine developed in England and Germany in the 19th century that was transformed into customary international law through the Factory at Chorzów case as confirmed by Prof. Hersch Lauterpacht, which reflects modern international damages law.
In this respect, Dr. Wöss clarified that it is the investment protection standard that determines liability through the so-called illegality threshold, in particular, as regards the Fair and Equitable Treatment ("FET") standard and Indirect Expropriation. By raising the illegality threshold, liability may be severely reduced or eliminated. By lowering the illegality threshold, liability is being found much easier which increases damages. Therefore, it is the investment protection standard that limits the regulatory powers of States and defines when regulation becomes illegal, which triggers damages, but it is not the damages that cause a regulatory chill. Damages are a mirror image of the regulatory illegality threshold. This also means that only the illegal portion of the State's conduct exceeding the illegality threshold are subject to damages but not the legal portion of such conduct as clearly shown in Murphy v. Ecuador. This is often overlooked and means that it is not the Fair Market Value of the investment that has to be compensated, save in case of total destruction of the investment, but what results from the application of the but-for premise or differential hypothesis that leaves untouched the legitimate regulatory powers of States.
He mentioned that the UN report seems to be misleading by underlining the 12 largest cases but ignoring recent statistical analyses. For instance, Tim Hart and Rebecca Vélez in Transnational Dispute Management ("TDM") analyzed 241 awards until March 2020 and concludes that three awards alone accounted for 81.7% of the awarded damages and the remaining average damages awarded were US$55.2 million. The British Institute of International and Comparative Law ("BIICL") analyzed 433 ISDS awards issued until May 2020, and concluded that the median amount awarded was US$21.4 million, representing a mean of 33% of the amounts claimed. He further explained that the roughly 15 outlier cases with very high amounts of damages resulted from ISDS arbitrations involving natural resources where the mere existence of oil, gas, gold and, in the future, lithium, proved with reasonable certainty, represents a considerable value that when transferred to the State through the violation of the FET standard or indirect expropriation, leads to corresponding high damages awards, whereby the State would normally receive the corresponding value of such natural resources duly discounted. The increase in the value of damages in awards is explained by the overall increase in project values carried out by private investors rather than States since the first Build-Operate-Transfer (BOT) projects in the 1970s, as recognized by the UNCITRAL in its Legislative Guide on Public-Private Partnerships and explained in Chapter 3 on complex long-term contracts of our OUP monograph on Damages in International Arbitration.
The issue with respect to damages in investment treaty arbitration is not the fact that international law contains a modern compensation standard in the form of the Chorzów formula that follows to a certain extent the hypothetical normal course of events causation theory as expressly mentioned by the PCIJ and cited in our publications, but an apparent lack of a thorough understanding of comparative and international damages law by arbitrators, party counsel and experts with respect to the notion of "income generating investments, assets and contracts" or "triallagmatic synallagmas". This notion is rarely subject to further analysis under comparative law beyond our OUP monograph and mostly limited to references to company and business valuations which is not the same thing as damages valuation, where the notion of the measure of damages, which is a normative notion, plays an important role that limits the compensation to be awarded.
Dr. Wöss added that the legitimacy check of the ISDS system is found in the Vattenfall German Federal Court constitutional judgment issued in March 2016 which compares to the Vattenfall v. Germany ECT/ICSID arbitration in its reasoning on the measure of damages, i.e. the question "what has to be compensated", and led to the settlement of both the court cases and the investment arbitration for roughly EUR 2.5 billion for all affected companies. That means that Vattenfall would have likely obtained the same compensation for expropriation under German law as it would under the ICSID arbitration, which proves that the ISDS system corresponds to a modern compensation and damages regime based on reasonable standards.
As regards climate change and the Paris Agreement, he mentioned that the last generation of IIAs do carve out the protection of health and environment from liability. If there is no carve out, then a modern and dynamic interpretation of the FET and indirect expropriation standards should take into account the standards under the Paris Agreement. This would be in accordance with Article 31(3) of the Vienna Convention on the Law of Treaties which requires a tribunal to take into account "any relevant rules of international law applicable in the relations between the parties" when interpreting international investment standards as stated in the Philipp Morris v. Uruguay award.
Furthermore, there are different ways in which measures aimed at the combat against climate change can be shielded against unjustified ISDS claims through treaty negotiation and authentic interpretation by the contracting parties. One example is the modernized but not adopted ECT, which limits the protection of fossil fuel investments to ten years. The other one is defining the scope of investment protection standards through authentic interpretation by the contracting parties as provided for in CETA and commented by Dr. Wöss in his seminal article on "Systemic Aspects and the Need for Codification of International Tort Law Standards in Investment Arbitration" (TDM Special on CETA).
A recording of Prof. Don J. Wallace, Jr.'s introduction and the presentation by Dr. Herfried Wöss at the conference can be watched here. (https://www.youtube.com/watch?v=DjghYa1SVmE&t=2971s)
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