American Antitrust Institute: Commentary: Could the Investor-State Dispute Settlement Chapters in the Two Pending U.S. Trade Pacts Undermine Competition Policy?

The Obama administration is pursuing two major trade agreements—the Transatlantic Trade and Investment Partnership (TTIP) with the European Union and the Trans-Pacific Partnership (TPP) with eleven countries in the Pacific Rim. Provisions in these agreements could undermine national sovereignty and a slew of regulations, including laws protecting competitive markets. These threats stem in large part from the pacts’ proposed inclusion of a controversial “investor-state dispute settlement” (ISDS) mechanism. Concluded and pending cases under ISDS provisions in other investment and trade agreements raise serious concerns that governments’ ability to create and maintain competitive markets could be weakened.

[Commentary from the American Antitrust Institute  |  Albert A. Foer and Sandeep Vaheesan  |  March 25, 2015]

In conversations with various former and current officials, we have been told that antitrust enforcement has not been endangered by previous trade agreements that included ISDS provisions within a competition-oriented context. Assuming that is correct, we nevertheless do not know how closely the current negotiations will be modeled on the past and whether protections will extend beyond antitrust enforcement and preserve governments’ ability to fashion competition policy as they see fit.

I.     Background on Investor-State Dispute Settlement

Under ISDS, foreign corporations can bring damages claims against national governments in private tribunals on broad grounds not available to domestic firms. They can allege that new domestic laws and regulations, or new applications or interpretations of longstanding domestic laws and regulations, frustrated business expectations. The private tribunals under ISDS can order taxpayer compensation for the profits that the tribunal concludes a foreign firm would have earned in the absence of the challenged policies. Because the threat of such damage awards alone can pressure countries to undo existing regulations, shelve proposed rules, or refrain from applying existing laws to foreign firms, critics complain that ISDS tribunals usurp regulatory authority from democratic governments.

While ISDS already exists in a number of trade and investment agreements, its inclusion in the TTIP and TPP would represent an unprecedented expansion of potential ISDS liability for the United States. ISDS can inhibit public efforts to create and maintain competitive markets, along with undermining regulation in areas such as environmental protection and public health. ISDS has a number of problematic features, as discussed in the following sections.

a)     The ISDS Regime Has Questionable Policy Justifications

First, the general justification for ISDS is unconvincing. Proponents have argued that ISDS is necessary to attract foreign investors who would otherwise be scared off by unstable legal and political environments and the threat of expropriation. How these concerns apply to, for example, France, Germany, Japan, and the United States is not clear. As to the supposed need for ISDS in TTIP, the total value of foreign direct investment between the United States and European Union exceeded $3 trillion as of 2012.[1] American and European businesses appear confident that courts and regulators on the other side of the ocean will protect their investments.

Even outside the leading industrialized nations, the rationale for ISDS is weak. A raft of studies on whether ISDS-enforced pacts actually boost foreign investment has produced results that are contradictory at best. In the most recent study, from September 2014, the United Nations Conference on Trade and Development (UNCTAD) found no correlation between ISDS and levels of foreign investment in developing countries.[2]

In a world of highly mobile capital, less developed countries have a powerful motive to attract investment without ISDS through the enactment of business-friendly domestic rules.[3] And as the Economist noted in an October 11, 2014 piece critical of ISDS, companies worried about their foreign investments can, for instance, purchase insurance.[4] Of course, businesses would rather shift the cost of such insurance onto the countries, just as they would rather not pay taxes, but that desire does not justify granting special privileges to them.

b)     The Broad Discretion of ISDS Tribunals

Second, existing arbitration tribunals are not bound by precedent or subject to any external appeals process. They have broad discretion to define terms such as a business’s right to a “minimum standard of treatment” and “fair and equitable treatment”—two key tests of governmental liability. Although governments that negotiated ISDS-enforced agreements (including the U.S. government) have attempted to narrow the definitions of these terms, private ISDS tribunals have ignored governments’ opinions and instead used expansive interpretations of foreign investors’ rights to rule against government policies. The interpretation of “fair and equitable treatment” used by some tribunals even makes governments liable for new policies or actions that frustrate the expectations of an existing foreign investor.

Tribunal members are compensated by the hour and so have an economic incentive to prolong cases and even deny dismissals of frivolous claims. And many are private-sector attorneys who cycle between arbitration associations and corporate law firms, raising concerns about conflicts-of-interest among tribunal members.

c)      The Dramatic Increase in ISDS Claims in Recent Years

Third, ISDS essentially represents the privatization of justice at the international level. In the United States, the Supreme Court has held that corporations can enforce arbitration clauses in standard-form contracts with customers and employees and transfer legal disputes out of court and into private arbitration. Arbitration in the United States typically has a number of features that make it difficult for individuals to vindicate their rights.

Just as corporations use arbitration as a shield against consumers and workers in the United States, they can employ ISDS as a sword against governments. Instead of seeking judicial review of public law enforcement and regulation, foreign businesses can go directly to a more favorable private forum. ISDS presently exists in a number of agreements, and businesses are increasingly using it to attack national laws and regulations including a widening array of energy, environmental, financial, and public health policies.

The number of ISDS cases filed annually has risen greatly in recent years, which suggests that businesses increasingly recognize the power of ISDS in challenging “unwelcome” regulations. Indeed, although just 50 known ISDS cases were filed in the regime’s first three decades combined,[5] corporations have launched more than 50 ISDS claims in each of the last three years.[6] Just under U.S. pacts with ISDS, tribunals have ordered governments to pay more than $3.6 billion in compensation while more than $38 billion is at stake in pending claims.[7]

d)     Multinational Corporations Can Engage in “Treaty-Shopping” to Launch ISDS Claims Against Governments

Finally, although only foreign companies covered by an ISDS-enforced pact can use ISDS, multinational businesses have found a simple work-around—their foreign subsidiaries. For example, consider Philip Morris’s ISDS challenge against Australia’s plain-packaging rules for cigarettes. Philip Morris has alleged that Australia’s labeling rules, which deprive the company of its brand advantages (and ultimately discourage smoking), have denied it fair and equitable treatment. After months of Philip Morris protesting Australia’s plans to implement plain packaging, the corporation’s Hong Kong subsidiary acquired shares in the company’s Australia subsidiary. Four months after this legal restructuring, the Hong Kong subsidiary notified Australia that it would be launching an ISDS claim against the tobacco control law under an ISDS-enforced treaty between Australia and Hong Kong.

This “treaty shopping” is not an option for most small and medium-sized businesses. Given the absence of evident need, it appears contradictory to sound competition policy to give the largest—and most difficult to regulate—companies yet another advantage over their smaller rivals.

II.   How ISDS Could Threaten Competition Policy

How does ISDS relate to competition policy? We can start with a current example involving a patent monopoly—the ISDS case that U.S. pharmaceutical company Eli Lilly has launched against Canada.

a)     Challenges to More Balanced Intellectual Property Policies

Through the ISDS process, Eli Lilly has placed Canada’s patent standards in its cross-hairs and, in effect, claimed that, despite those standards, the firm is entitled to monopoly profits. Under the doctrine of “sound prediction,” Canadian courts invalidated Eli Lilly’s patents on the drugs Strattera and Zyprexa. They found that the factual bases in Eli Lilly’s patent applications were not sufficient to infer that these drugs would offer greater clinical benefits or fewer side effects than existing medications for ADHD and schizophrenia. The Supreme Court of Canada has stated “the doctrine of ‘sound prediction’ balances the public interest in early disclosure of new and useful inventions . . . and the public interest in avoiding cluttering the public domain with useless patents, and granting monopoly rights in exchange for misinformation.”[8]

In 2013, Eli Lilly, using the ISDS provisions of the North American Free Trade Agreement, filed a complaint against the Canadian government for the invalidation of its patents. It is demanding $500 million in damages for lost monopoly profits. The outcome is pending, but the fact that Lilly could bring such an ISDS complaint is in itself important.

Because courts and regulators in the United States are curtailing unduly expansive patent protection, Eli Lilly v. Canada has great significance for Americans. Our Supreme Court in recent years has narrowed the scope of patent protection, halting a thirty-year trend in which the courts indiscriminately recognized patents and, in the words of the Canadian high court, “clutter[ed] the public domain with useless patents.”[9] And the Federal Trade Commission has challenged exclusion payments in pharmaceutical markets—a practice in which branded drug companies whose patents may be either invalid or non-infringed pay generic rivals to stay out of the market. This anticompetitive arrangement allows drug manufacturers to extract and share monopoly profits at the expense of the public. Rejecting blind deference to patent owners, the Supreme Court has held that the antitrust laws can be used to contest exclusion payments.

The threat of ISDS damages actions could subvert this necessary and overdue break from the relentless expansion of patent rights. Following the lead of Eli Lilly, could AstraZeneca, Novartis, and other foreign pharmaceutical companies claim that more limited patent protection or antitrust scrutiny of patent licensing arrangements violates their right to fair and equitable treatment by frustrating their expectations? Would the United States be liable for damages on account of the Supreme Court and FTC reestablishing balance between free competition and government-sanctioned patent monopolies?

b)     Attacks on Antitrust Enforcement

The danger to competitive markets extends beyond patents. In 1995, a Mississippi jury imposed $500 million in damages on Loewen, a Canadian funeral home chain operating in the United States, for predatory acts against a local funeral and insurance business. Loewen sought to appeal but took issue with the (standard) requirement to post bond pending an appeal. Instead, Loewen settled the case for a small fraction of the jury award. In 1998, however, the company filed a $725 million ISDS claim against the United States. It alleged that the jury verdict, punitive damages, and the requirement to post bond deprived it of rights protected by NAFTA, including fair and equitable treatment. Because Loewen had subsequently reorganized as a U.S. corporation, thereby losing its foreign investor status, the arbitration tribunal dismissed its claim on narrow standing grounds—but not before criticizing the civil process against Loewen and indicating that ISDS challenges against unfair competition actions, including U.S. court decisions, could succeed in the future.

The Loewen case suggests that antitrust enforcement could be vulnerable to ISDS attack. Could an ISDS tribunal find that the Sherman Act’s unique treble damages provision violates a corporation’s right to fair and equitable treatment? And the risk applies not just to remedies. Congress intended the Federal Trade Commission Act to be broader than the Clayton and Sherman Acts. Since its enactment, however, the FTC Act has been applied in a manner virtually identical to the other antitrust statutes. Could the risk of ISDS suits effectively prevent the FTC from applying the statute in a more expansive fashion? More generally, could ISDS deter future administrations from strengthening enforcement against mergers and monopolies and permanently freeze the current application of antitrust law?

c)      Challenges to Publicly-Owned Competitors and Public Utility Regulation

In early 2010, the Detroit International Bridge Company—the owner of the only bridge between Detroit and Windsor, Ontario—filed an ISDS action against the Canadian government, for enacting safety and toll regulations and also proposing to build a parallel crossing. In the still pending case, the company has asserted that it has an “exclusive” right to operate a bridge across the Detroit River and seeks $3.5 billion in damages.

Outside the United States and Canada, TCW, an American investment firm that owns an electric utility in the Dominican Republic, filed a claim against the Dominican government in 2008, using the ISDS chapter in the Central America Free Trade Agreement. TCW alleged that the Dominican utility regulator, by declining to raise electricity rates and also refusing to subsidize rates for the poor (as a measure to discourage power theft), deprived the company of fair and equitable treatment. TCW sought more than $600 million, and the Dominican government settled the matter for $26 million instead of incurring additional legal fees.

The Detroit International Bridge Company and TCW cases could, for instance, have negative ramifications for domestic efforts to introduce broadband competition and check the power of incumbent cable and telecom providers. AT&T, Comcast, and Time Warner have already used their political might to suppress municipally-owned broadband networks in many states.[10] Will Detroit International Bridge Company embolden these giants, through their foreign affiliates, to open an “ISDS front” against public rivals in the United States? What are the implications of the TCW case for public utility regulation, including network neutrality? Even if its regulations are upheld in federal court, should the Federal Communications Commission be worried that net neutrality rules could expose the government to ISDS damages actions?

III.Conclusion

The TPP and TTIP negotiations are being conducted behind closed doors and requests for release of the exact ISDS terms being negotiated have been denied. We therefore cannot predict with certainty what the competitive consequences will be. Nonetheless, the proposed inclusion of ISDS in two major trade agreements raises alarming possibilities. U.S. trade negotiators are seeking to expand a private arbitration system that, in the absence of appropriately limiting language, could, among other ill effects, promote patent monopolies, weaken merger enforcement, and hobble domestic efforts to prevent dominant firms from engaging in predatory or exclusionary conduct.