Climate Protection vs. Profits - Trade Deals Can Force Regulating Countries to Pay

Oct. 21, 2023

A Shadowy Corner of International Law Is Threatening Climate Action, U.N. Expert Warns

An obscure but far-reaching system allowing corporations to sue governments is being “weaponized” by the fossil fuel and mining industries, according to a new U.N. report, jeopardizing progress in developing nations.

Soon after Italy approved a ban on offshore oil drilling, in 2015, the country received some alarming news: A British oil company that had been planning to drill was suing the government, seeking hundreds of millions of dollars in compensation.

The company, called Rockhopper, brought its claim not in Italian courts but through a system of international arbitration that allows foreign investors to sue governments. Last year, the company won the case along with an order that the Italian government pay Rockhopper about $200 million.

On Thursday, a United Nations expert warned that cases like these could be the beginning of a wave of litigation that threatens to undermine climate action as nations look to phase out fossil fuel development.

David Boyd, the special rapporteur on human rights and the environment, told a committee of the U.N. General Assembly that governments are being targeted with dozens of legal claims seeking hundreds of millions or even billions of dollars, with many of those suits brought by oil and mining companies.

“Please consider how crazy this system is,” Boyd told delegates from scores of nations attending the hearing. “States that are trying to tackle the climate and environmental crisis and safeguard the human rights of their people are being forced to pay billions of dollars in compensation to the very corporations that have caused this crisis. Instead of making polluters pay, states are paying polluters.”

Boyd was presenting the findings of a report about a corner of international law known as investor-state dispute settlements, or ISDS, which has been enshrined by a web of some 3,000 investment treaties and trade agreements, many of which date to the 1990s. The agreements generally offer protections for foreign investors and allow them to file arbitration claims if government actions harm their interests.

Corporations have filed more than 1,250 claims since the 1990s, with the number accelerating over the last decade along with a rise in foreign investment, although the true number of cases is unknown because many remain secret. Their claims are typically heard by three-member arbitration panels made up of attorneys, with each side nominating one member who, together, pick the third. Arguments are then heard behind closed doors by the arbitrators, whose awards are binding on the parties. 

Pakistan was ordered to pay nearly $6 billion to a joint Canadian-Chilean mining company in 2019 after declining to issue it a license. After a protracted legal battle, the parties reached a settlement last year that waived the award in exchange for allowing the mine to proceed.

The Democratic Republic of the Congo is currently facing claims from three foreign mining companies seeking more than $30 billion, twice the nation’s gross domestic product.

Oil, gas and mining companies have lodged more claims than any other industry, with many of the awards reaching into the billions of dollars. The 12 largest awards alone, 11 of which have gone to fossil fuel or mining companies, totaled more than $95 billion, according to Boyd’s report, a figure that “likely exceeds the total amount of damages awarded by all courts to victims of human rights violations in all States worldwide, ever.”

While the system was intended to help protect companies when governments nationalize their assets, the report and many other critics of ISDS say that multinational corporations have “weaponized” these protections to challenge new environmental regulations, taxes and other policies that cut into profits.

Because the majority of cases have been filed by corporations from the United States, Europe and Canada against developing nations, many advocates and academics have warned that the ISDS system could further cripple those countries’ ability to address climate change by deepening their foreign debts and constraining their ability to enact environmental protections.

One study published last year in Science identified some $340 billion in potential ISDS claims from oil and gas companies if governments were to begin limiting production. The fear is that countries faced with the threat of lawsuits will either back down from restricting development or will proceed and be forced to pay sometimes crippling sums, said Kyla Tienhaara, an associate professor at the School of Environmental Studies at Queen’s University in Canada and the paper’s lead author. 

The United States currently faces a $15 billion claim from TC Energy, the Canadian firm behind the Keystone XL oil pipeline, after the Biden administration canceled a permit for that project. The Netherlands faces a $1.5 billion claim from the German utility RWE, which sued over the Dutch government’s plan to phase out coal by 2030.

Denmark, New Zealand and France have limited their own climate policies because of the threat of ISDS claims, according to Boyd’s report, and the Spanish government told him that the system discourages countries from transitioning off fossil fuels.

While it is primarily wealthy nations that have faced claims directly tied to climate action, developing nations are far more exposed. According to Tienhaara’s research, Mozambique has the highest potential liability from limiting oil and gas development, up to $31 billion, followed by Guyana and Venezuela.

“Something has to be done,” Boyd said in an interview with Inside Climate News in advance of his presentation. “Governments have to take action to protect themselves from these cases and to stop this before it gets worse.”

Encouraging Foreign Investment? 

Many industry groups insist that criticism of ISDS are overblown, arguing that national courts discriminate against foreign investors and that the system provides “neutral” forums to resolve disputes.

“ISDS procedures ensure that other countries treat U.S. investors fairly,” U.S. business groups have argued, and “do not seize their property without compensation.”

High profile nationalizations have taken place in Argentina, Bolivia and Venezuela, among other countries, and remain a prevailing risk for investors in the natural resources sector. 

Business groups also argue that ISDS protections are necessary to attract foreign investment, improving developing countries’ economies. At least one study from the U.S. International Trade Commission concluded that binding ISDS guarantees resulted in increased foreign investment in both developed and developing countries. 

A growing number of research studies from academics and advocacy organizations contradict that finding, indicating that there is no link between ISDS and increased foreign direct investment. Those studies point to South Africa, Brazil and India as examples of nations that have resisted or limited enmeshment in ISDS while continuing to draw investment from abroad. 

Meanwhile, lower- and middle-income countries have been defendants in about two-thirds of all publicly reported ISDS cases, according to the Columbia Center on Sustainable Investment. Latin American countries alone have paid out over $33 billion in damages or settlements. 

That imbalance, coupled with the fact that the majority of claimants are from Europe and North America, has provoked allegations that ISDS promotes “economic colonialism.” 

Lisa Sachs, director of Columbia University’s Center on Sustainable Investment, and other critics of the system say multinationals have other options for protecting their investments, including political risk insurance. Sachs said international investment law should focus on how to drive financing into climate-friendly sectors rather than perpetuating a system that is being used to protect the economic interests of fossil fuel companies. 

Critics have identified a host of problems with the system beyond its impact on environmental protections, including that it prioritizes the economic rights of companies over human rights of local communities. Others say ISDS lacks transparency and that protections are based on vague standards like “fair and equitable treatment” that lead to inconsistent outcomes and give private arbitrators sway over public policy. 

ISDS cases have been lucrative for law firms, which have begun advising clients on how to preemptively structure themselves to take advantage of the ISDS system. The U.S. law firm Jones Day, for instance, issued a client newsletter in 2022 advising fossil fuel companies to review their operations to ensure they had access to ISDS protections: “Such restructuring should take place before any climate-related dispute with the State has arisen or is reasonably foreseeable,” the newsletter said. 

Withdrawal and Reform

Wealthy countries have recently begun shielding themselves from ISDS. 

Within the United States, calls to remove ISDS from free trade agreements have found common cause on both sides of the political spectrum. In renegotiating the North American Free Trade Agreement, the Trump administration dropped ISDS between the United States and Canada based in part upon the belief that the system infringes on U.S. sovereignty and encourages American companies to invest, and move jobs, abroad. On the left, Senator Elizabeth Warren (D-Mass.) has long argued against international arbitration. 

Like the United States, European countries have taken steps to protect themselves, with many withdrawing from the Energy Charter Treaty, a 90s-era multilateral free trade agreement aimed at promoting investment in energy development. The Energy Charter Treaty has spawned billions of dollars in ISDS claims over governments’ decisions to phase out fossil fuels. So far, Italy, Spain, France, the Netherlands, Germany and Poland have either withdrawn or given notice of their intended withdrawal from the treaty, which has been widely maligned as incompatible with global climate goals.

[Top photo: Shacks of planks and metal sheets and houses under construction in Nyakaliba, a poor neighborhood in Bukavu, eastern Democratic Republic of Congo, in May 2023. The country is currently facing claims through the investor-state dispute settlements process, or ISDS, from three foreign mining companies seeking more than $30 billion, twice Congo's gross domestic product. Credit: Alexis Huguet/AFP via Getty Images.]