Climate change and sustainability disputes between foreign investors and states

Introduction

In the first article in this series, we offered a simple introduction to the types of climate change and sustainability disputes being brought in international arbitration, using examples from recent cases. We then explored climate change and sustainability disputes arising out of contracts. In this second article, we look at climate change and sustainability disputes that might arise between foreign investors and States and consider the role of international arbitration in resolving such disputes.

State action on climate change is increasing

In October 2021, the 26th Conference of Parties (COP26) was held. At this global summit, the State Parties to the UN Framework Convention on Climate Change (UNFCCC), convened to report on action taken and negotiate new commitments. There has already been significant action undertaken over the past decade by States and cities to respond to climate change. In the wake of COP26 and as the pressure on States to act increases, there will be a further escalation of action by all levels of governments, legislators and regulators, as nations seek to transition to low carbon, sustainable and climate resilient economies whilst ensuring access to secure and affordable energy and resources.

Some State actions could impact the profitability or even viability of commercial arrangements. When that happens, high stakes, strategically important disputes will follow.

What are climate change and sustainability disputes?

It is not easy to develop a succinct, allencompassing definition of climate change and sustainability disputes. The range of disputes brought to date is vast. It is a global phenomenon, where legal issues cross multiple fields of law and various causes of action. In addition, the risk profile is in a state of flux due to developments in technology, industry, science, regulation and law, and as society grapples with how to address these complex legal issues and who should shoulder the fiscal burden.

One helpful definition is offered by the UN Environment Programme (UNEP), which defined climate litigation as “cases that relate specifically to climate change mitigation, adaptation, or the science of climate change.” It is particularly useful in that it is a broad definition, but also expressly captures disputes arising out of the rapid and deep transitions currently underway in the energy sector especially, but all other industries as well. That is critical – as noted in a recent IEA Report, “[a]chieving Net Zero emissions [for the global energy sector] by 2050 will require nothing short of the complete transformation of the global energy system.” In the history of humanity, such deep, societal-wide change has never been attempted in such a short space of time. It will present significant opportunities but also large risks, many of which will lead to disputes.

We offer one tweak to UNEP’s definition; to include “sustainability”. These disputes often encompass issues which traditionally would not be viewed as climate change related but which are interdependent and interrelated. For example, human rights and other fundamental rights traditionally have been viewed as a distinct category of dispute and indeed legal practice; but in recent years there has been a significant increase in claims that are essentially climate change related disputes formulated as fundamental rights arguments, brought under international laws or national constitutions which enshrine such rights. Other examples include biodiversity and land degradation issues which are impacted by climate change and vice versa.

Disputes between foreign investors and States

The IPCC Special Report on the impacts of global warming of 1.5°C predicted the need for “rapid, far-reaching and unprecedented changes in all aspects of society”, which includes in particular “rapid and far-reaching transitions in land, energy, industry, buildings, transport and cities”. Transitions in these key sectors, individually and collectively, will impact every private, commercial and public endeavour.

One hundred years ago, transitions in energy, industry and transport led to fundamental societal change. The advent of the automobile, for example, transformed industry and trade, and reshaped our cities as well as our private lives. Modern transitions to limit and adapt to the changing climate (not least, the energy transition) call for an equally radical reorganisation of the way our societies, cities, industries and lives are configured and run. The difference is that these transitions are occurring at a pace never before attempted or achieved.

Significant financial investment will be required. According to a 2021 report by the International Energy Association (IEA), to reach net zero emissions by 2050, the cost of annual clean energy investment worldwide will need to more than triple by 2030 to approximately US$4 trillion. The transitions in other major industries will also require significant levels of investment. In addition, according to the 2021 UNEP Adaptation Gap Report, the costs of adaptation (i.e. measures to reduce vulnerability to climate change) are expected to reach US$140-300 billion in 2030 and US$280-500 billion in 2050. Infrastructure, agriculture, water and disaster risk management make up three quarters of quantified adaptation finance needs. In 2019, climate finance flows to developing countries for mitigation and adaptation reached US$79.6 billion.

Some of that investment will be made by States. The gap will be filled by private investment, including foreign direct investment (FDI). Reports are already showing a significant rise in FDI in low carbon initiatives and climate financing. However, UNEP, the IEA and other stakeholders are calling for an urgent scaling up of both public and private sector investment, along with measures to overcome barriers to private investment.

Transitions are occurring at a pace never before attempted or achieved.

With a rapid increase in new FDI, there will be an increase in disputes between foreign investors and host States. In part, this is a numbers game – a proportion of all investments end up needing to navigate some form of dispute, and with a steep and rapid rise in foreign investment, we should expect a concordant rise in investor-State disputes. But many of these investments carry an increased risk of disputes due to their particular characteristics; for example, involving novel innovations (technologies, products or processes), new infrastructure and systems, new collaborations (including with State representatives), new markets and new competitors. Many will be subject to a changing regulatory environment as new regulatory regimes are introduced or old regimes adapted to be fit for purpose.

In parallel, States are more broadly imposing legal, regulatory, and other changes in response to climate change or sustainability issues. Legislative change has been happening at an unprecedented rate, and further rapid change is to be expected. States might change licencing, tariffs, subsidy or taxation regimes. Key assets or infrastructure might be privatized or nationalized, or States might expropriate assets belonging to investors. A number of investments will be heavily dependent on State behaviour, whether that be ensuring access to infrastructure or resources, or in more challenging jurisdictions it may be ensuring protection and security of foreign investments or the ability to take capital out of the jurisdiction.

Significant unilateral changes to the investment environment could be made in the name of climate change which could seriously impact the profitability or even viability of existing investments. Investors might face losing the entire value of their investment or asset. Where States do not take steps to mitigate the impacts of those changes on existing investors or fail to offer adequate compensation then high stakes, strategically important disputes could follow.

States are more broadly imposing legal, regulatory, and other changes in response to climate change or sustainability issues.

Investment arbitration

Investor-State dispute settlement, or ISDS, is a mechanism that enables foreign investors to resolve disputes with host States. ISDS mechanisms are commonly found in international agreements between States such as bilateral investment treaties (BITs) or multilateral agreements (MITs), sector-specific treaties such as the Energy Charter Treaty (ECT) or free trade agreements (FTAs) (such as Chapter 11 of the North American Free Trade Agreement, NAFTA). They may also be found in domestic legislation or in contracts between investors and States.

These instruments typically set out substantive protections that the States agrees to give foreign investors in their countries. Common protections include: fair and equitable treatment, full protection and security, national treatment, most favoured nation treatment, no expropriation without full (and prompt) compensation, and free transfer of capital.

ISDS provides the mechanism for enforcing those commitments. If a State breaches its commitments, the investor has a right to bring a claim directly against the State, typically in international arbitration. This allows investors to have their disputes adjudicated in a neutral forum, before impartial arbitrators and in accordance with transparent institutional rules. Monetary compensation is the most common remedy. But other remedies may be available, such as declaratory relief and restitution, or interim relief to preserve the status quo while proceedings are ongoing.

States offer these protections to encourage FDI. In many sectors, such as energy and resources, foreign investments involve significant upfront investments in exploration, R&D, and infrastructure, and a long term commitment before profits are even seen by investors. Foreign investors also often bring not only the capital but the required technical skills and know-how to set up and run these major projects. States’ investment treaty commitments give foreign investors comfort that they will be treated fairly and have a means of protecting their investment – otherwise, investors may have no meaningful remedy in the face of arbitrary, capricious or other unfair treatment by a host State.

Prior to ISDS, foreign investors had to resolve disputes before the States’ own local courts. Investors often found themselves unable to obtain full – or indeed any – recovery. Obstacles included an absence of protections under the local law, sovereign or crown immunity rules, or a lack of judicial independence. Diplomatic intervention, to the extent available, was inconsistent and usually ineffective given the politicization in direct discussions between sovereigns. ISDS emerged in the wake of World War II in part due to a desire to depoliticize investment disputes by removing them from the realm of diplomacy and inter-State relations, as well as to stimulate foreign investment. In many ways, ISDS has been the backbone of global foreign investment.

Depending on the host State’s legal regime, treaty protections and remedies can be more favorable than local law protections. For example, some domestic laws permit the State to expropriate property without providing any compensation or for less than full compensation – in the absence of treaty protections, investors would have no recourse should a State expropriate their investment.

The mere availability of treaty protections can also offer powerful disincentives for State misconduct. It can also facilitate a settlement where disputes do arise, preventing escalation and associated risks to unique often inter-depended, long-term relationships.

Examples of climate change and sustainability investment arbitration

Investment arbitrations have been commenced in relation to renewable energy investments, in particular, solar, wind and hydropower. Many investments in renewable energies have been driven by government incentives such as subsidies or attractive tariffs, and the profitability of those investments (at least in the interim) may be reliant on those regimes. It is therefore unsurprising that a substantial number of investment arbitrations to date involve changes to renewables subsidy regimes. The claims (40 at last count) against Spain under the ECT following reforms Spain made to its renewable energy policies are a good example. Other European countries which pursued similar regimes have also faced ECT claims, and similar types of claims have been brought against Canada under NAFTA. There have also been claims against States for alleged expropriation of renewable energy assets, or reneging on deals with investors in joint ventures for renewables projects. In some of those, the State was found to have breached its treaty commitments to the detriment of investors and substantial damages were awarded, in others, the State’s defence prevailed.

Investment arbitrations have also been brought in relation to fossil fuel investments, including disputes concerning infrastructure, exploration and exploitation. In addition, a small number of claims have been brought in response to States’ decisions to phase out nuclear power or the use or extraction of fossil fuels (in particular coal), ban mining of certain materials, or deny permits to allow construction of pipelines.

Research is being undertaken by Climate Change Counsel on ECT awards to assess the interaction between investor protection, energy policy and the clean energy transition. According to their preliminary findings, the fossil fuel cases studied to date generally addressed isolated issues which had nothing to do with climate change or the energy transition, whereas the renewable energy cases tended to be more systematic in character and concerned changes to the States’ entire energy mix (Annette Magnusson, Climate Change Counsel, “Energy Charter Treaty Arbitration and the Paris Agreement: Friends or Foes?”, 7th EFILA Annual lecture, October 28th, 2021).

Is international arbitration an appropriate forum for resolving such disputes?

Anti-ISDS advocates warn of the “chilling effect” of ISDS on public interest regulatory action. That chilling effect is often wrongly blamed on ISDS as a system, and is often misstated or exaggerated.

Most BITs preserve States’ rights to pursue legitimate policy objectives, such as the protection of public order, security, morality and health, and taxation, amongst others. More recent BITs, such as the Netherlands’ draft model BIT, expressly reference States’ rights to regulate and address to deal with environmental and human rights issues.

ISDS awards do not interfere with States’ rights to regulate nor do they invalidate the legislation or State conduct in question – they simply award compensation to investors where both State breach and damage is proved. ISDS offers investors a minimum safety net, to hold States to their commitments to act in good faith and not discriminate or expropriate private property of foreign investors without fair compensation.

On the whole, there is little evidence to support the allegation that companies are abusing ISDS. Of the 767 known ISDS arbitrations, only 32 awards dealt with State measures to protect the environment and public health (statistics reported in Annette Magnusson, “New Arbitration Frontiers: Climate Change”, in Evolution and Adaptation: The Future of International Arbitration, ICCA Congress Series no. 20, Kluwer). Moreover, the statistics generally show ISDS outcomes are largely even and do not tend to favour either States or investors.

Concerns over the transparency of public interest disputes can also be dealt with, such as by States signing up to initiatives such as the Mauritius Convention on Transparency in Treaty-Based Investor- State Arbitration. Concerns over the ability of public interest groups to play a role in such disputes, can be addressed by amicus curiae interventions.

Anti-ISDS proponents warn of the “chilling effect” of ISDS on public interest regulatory action.

Any possible chilling effect would not be the result of arbitration as a process, rather it would be the result of the substantive terms agreed by the State in the treaty. In the rare instance that older treaties do not provide exceptions for States to pursue legitimate policy objectives, then there may be a case for renegotiation of those terms. But there is little benefit in a wholesale abandonment of the dispute resolution process that helps States and their investors resolve disputes. Especially where no viable alternative dispute resolution mechanism is currently in place.

The use of international arbitration to drive “climate-positive” policies

Often overlooked is the potential for BITs and ISDS to facilitate and enforce sustainable development and “climatepositive” policies. As noted above, a significant proportion of claims to date have related to investments in renewable energies. In addition, some BITs impose obligations on States to promote sustainable development, climatepositive trade or sharing of environmental technologies.

The Netherlands’ draft model BIT is again a good example – States must ensure “high levels of environment and labor protection” and “reaffirm their commitment” to international human rights and environmental treaties, including the Paris Agreement. It also allows tribunals to take into account investors’ conduct where they have not complied with the UN Guiding Principles on Businesses and Human Rights and the OECD Guidelines for Multinational Enterprises.

ISDS tribunals have already shown a willingness to engage with such issues. In Urbaser SA & Ors v Argentina, in the context of investor claims under the Spain- Argentina BIT, Argentina counterclaimed that the investors had breached international human rights obligations (the asserted right to water). The tribunal held that it had jurisdiction over the counterclaim and that consideration of international human rights obligations was within its competence. Ultimately, Argentina failed to establish any breach of obligations owed by the claimants, but the tribunal’s willingness to accept jurisdiction was a significant development.

Some BITs impose obligations on States to promote sustainable development, climate positive trade or sharing of environmental technologies.

Claims in other international fora

There has been a notable increase in climate change and sustainability claims being brought before other international adjudicatory bodies, often by activists (despite anti-IDS sentiment) challenging conduct by States, companies and investors.

Some international bodies are viewed as offering favourable “soft law” and procedure for climate change and sustainability claims as compared to domestic courts which may be actively unfriendly or impose difficult evidential and legal burdens (especially as regards jurisdiction and standing).

In particular, litigants are looking to bring claims under international law, treaties and conventions related to human and fundamental rights. Key treaties include, the UN Declaration on Human Rights, UN Convention on the Rights of the Child, International Covenant on Economic, Social and Cultural Rights, International Covenant on Civil and Political Rights, Rio Declaration on Environment and Development, UN Declaration on the Rights of Indigenous Peoples, and the OECD Declaration on International Investment and Multinational Enterprises. Claims may also be brought under regional treaties such as the European Convention for the Protection of Human Rights and Fundamental Freedoms, the American Convention on Human Rights, or the African Charter on Human and Peoples’ Rights.

In October 2021, in a landmark move, the UN Human Rights Council (UN HRC) recognised, for the first time, that having a clean, healthy and sustainable environment is a human right. The UN HRC called on States to work together and with other partners to implement this newly recognized right. At the same time, through a second resolution, it increased its focus on the human rights impacts of climate change by establishing a Special Rapporteur dedicated specifically to that issue. Developments like this will encourage further claims. The general view is that, unlike States, companies do not have direct obligations under international law to protect human rights. But there is a growing recognition that they have a responsibility to respect human rights, to avoid causing harm or contributing to adverse human rights impacts, and to seek to prevent or mitigate adverse impacts directly linked to their operations, products or services. See for example, the UN Guiding Principles on Business and Human Rights (UNGPs).

Decisions under these conventions are generally not mandatory nor binding. But they are often influential – they influence how judges, governments, regulators, investors and other stakeholders, and the general public view the issues. And a number of such claims have resulted in a mediated settlement agreement.

Conclusion

Climate change is leading to new economic realities and legal frameworks to which all State and corporate entities must adapt. It is a challenging environment in which foreign investors encounter both significant opportunities as well as risks. In this environment, investors should undertake careful assessment of the risk profile of new and existing investments and implement mitigation measures, including dispute resolution strategies. For foreign investors, this includes considering whether a new investment can be structured so as to benefit from investment treaty protections. These may offer investors safeguards against host State conduct (especially where no domestic recourse is available), serve as a powerful deterrent against misconduct, and facilitate settlement before a dispute escalates.