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[This is based on research for the project, “Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific”, supported by the Commonwealth through the Australia-Japan Foundation which is part of the Department of Foreign Affairs and Trade. An edited and updated version is also on the East Asia Forum.]

The Productivity Commission (PC) released on 16 July a Draft Report for its Review of Bilateral and Regional Trade Agreements, commissioned by the Assistant Treasurer to reconsider the Australian Government’s policy in negotiating Free Trade Agreements (FTAs). It acknowledges the inefficiencies of preferential agreements compared to multilateral approaches. However, given the persistent impasse in WTO negotiations, the Report pragmatically suggests various means to maximise benefits in the short-term, which may also lead to longer-term multilateral solutions. Unfortunately, that ideal is unlikely to be achieved – risking perverse implications throughout the Asia-Pacific, where Australia has concentrated its FTA activity – if the PC’s Final Report ends up including all these suggestions in its Draft Recommendation 5:

1. “Where the legal systems of partner countries are relatively underdeveloped, it may be appropriate to refer cases to third party dispute settlement mechanisms.
2. However, such process should not afford foreign investors in Australia or partner countries with legal protections not available to residents.
3. Investor-state dispute settlement procedures should be subject to regular review to take into account changing international best practice and the evolving legal systems in partner countries.”

As explained in my Submission to the PC (reproduced here), I have no great difficulty with the last point, although I suggest that one way to achieve that goal would be for Australia to develop and update a Model Bilateral Investment Treaty (BIT). I have much more difficulty with the PC’s second recommendation, but I focus now on problems with the first as it is particularly relevant to Australia’s policy position in regard to the Asia-Pacific, and especially now Japan.

The PC’s Draft Report (at para 3.12) expresses concern about Australia being exposed to claims if FTAs or separate International Investment Agreements (IIAs) allow foreign investors to bring arbitration claims directly against the host state (investor-state dispute settlement or investor-state arbitration: ISA). Adverse awards are ultimately paid by taxpayers (and voters), so the Finance Minister understandably would want to minimise financial (and electoral) risk. But even without ISA, the foreign investor’s home state may bring an international law claim against the host state, with Australia’s FTAs typically providing consent and quite elaborate rules. The investor admittedly faces the disadvantage of having to persuade its home state to act, which we know from WTO trade disputes is not always easy because the home state (particularly the Foreign Ministry) may have more important diplomatic agendas vis-à-vis the other state. However, if Australia leaves out ISA from its IIAs, this “filtering” problem conversely afflicts its own investors encountering illegal interference by host states abroad.

A problem of equity arises too, as it has in the WTO context: big firms are more likely than smaller ones to influence the home state’s decision whether to proceed with a claim on their behalf. This implies that when negotiating IAAs, the Australian government should investigate the size and nature of Australian investors (presently or potentially) active in the other state, not just their total investments abroad compared to the total from the other state’s investors.

Relative exposure to claims and therefore adverse awards, especially through ISA where no “filtering” problem arises, will also generally diminish where Australia is a net FDI exporter. This is likely to be the case for most developing economies, but there may well be exceptions among them – either now or in the foreseeable future (over the duration of the IIA). There may also be developed economies in respect of which Australia is a net capital exporter, implying more need for ISA protections. But this also depends on the nature of the investments made in each country; some sectors (eg complex infrastructure developments) tend to generate more disputes and claims. So government negotiators need to take these factors into account too.

The PC’s Draft Report, by contrast, focuses on whether the host state’s legal system is underdeveloped. This factor certainly promotes the case for including ISA protections, which are provided instead through an international process (although any execution against assets held world-wide by the losing host state still depends mainly on national laws).

However, even where developed legal systems are involved, ISA can be justified. Their courts may have no jurisdiction to hear treaty-based claims, for example. This is true in Australian and US courts, yet both governments professed their trust in each other’s judicial system as the rationale for not including ISA in their FTA. Admittedly, investors can bring lawsuits in the host state’s courts based on local law, but these standards may vary somewhat from the international law standards. (That point is suggested in the PC’s own Draft Report, although my full Submission calls for more detailed analysis and more focused counter-measures, where found to be truly necessary.) More importantly, local law may also cost more to ascertain and argue in court, and disputes will likely be heard by judges with far less expertise in complex trans-border investment disputes than international arbitrators. Ironically, any resultant judgment may be less readily enforceable (especially beyond the host state’s borders) than an ISA award. And claims brought against the US under NAFTA since 1994, such as the “runaway jury” case in Mississippi (Loewen, 42 ILM 811), reveal that even “developed” legal systems can cause problems for foreign investors.

Anyway, how likely is it that developed countries incorporating ISA protections in IIAs will generate successful awards? In the context of Australia and the US negotiating to join the Trans-Pacific Partnership Agreement (“TPP”, which may end up including ISA), the Draft Report states (para 3.12) that the PC “understands that no US business has been unsuccessful in pursing [sic] an ISDS claim against a foreign government”. In fact, the Appendix to my Submission lists at least 16 unsuccessful claims: two versus Canada and six versus Mexico under NAFTA, and eight versus other countries under different treaties. US and Canadian investors have filed other claims against each other’s countries, but so far these have rarely succeeded. All this suggests, holding constant the other factors already mentioned, that Australia should be open to including ISA even in treaties with developed countries – providing further protection to investors for the most egregious cases of host state interference.

Further supporting that stance, several (more or less) developed countries with sophisticated legal systems have concluded treaties providing for ISA: the Hong Kong – Japan BIT, the Japan-Korea BIT, the US-Singapore FTA, the Hong Kong – UK BIT (albeit with the interesting compromise of allowing direct claims only after exhausting local court remedies in the host state), the Japan-Switzerland FTA, the Australia-Singapore FTA, the Australia-Chile FTA, and the ASEAN-Australia New Zealand FTA (albeit including mostly developing countries, and with a Side Agreement excluding ISA and investment provisions between Australia and New Zealand as they are negotiating a protocol to their longstanding FTA).

Particularly noteworthy in this list are Asia-Pacific jurisdictions – especially Japan – and the emergence of regional agreements including such countries. If Australia really wants to achieve a multilateral end-game despite the WTO impasse, then “open regionalism” will need to progress even further. And it will be harder to incorporate ISA into regional agreements if gets tainted with the idea that it is only a device for developed countries to beat up on developing countries. (After all, if we had insisted on a WTO dispute resolution system that only allowed developed countries to sue developing countries, none would have signed up!) There is already enough talk along such lines, underpinning steps back from full engagement with the ISA system particularly on the part of some South American states. That is an over-reaction, in my view; various measures are available to improve the system from within.

However, this is premised on developed countries acting responsibly, keeping firmly in mind both short-term and long-term advantages as well as disadvantages of ISA, and addressing these concerns in treaty practice as well as other means. The Japanese government already seems to understand this, perhaps reflecting its deeper-rooted preference for multilateral solutions – especially after the bilateral friction experienced with the US over the 1980s. From past treaty practice, as well as the fact that Japan remains a very large net FDI exporter into Australia, we can expect Japan to press for ISA to be included in the bilateral FTA under negotiation since 2007. And some good broader arguments to justify that approach have been presented here, which the Australian government (as well as the PC) should at least consider.

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Japanese Law in Asia-Pacific Socio-Economic Context