A. Introduction
International investment law is different from other areas of law in that its very existence is called into question.Footnote 1 This is true of both its substantive and procedural aspects. Some examples from 2024 demonstrate the legitimacy crisis that has engulfed international investment law: The European Union withdrew from the Energy Treaty Charter;Footnote 2 Honduras denounced the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States (ICSID Convention);Footnote 3 and Ecuadorians confirmed their opposition to investor-state dispute settlement (ISDS) in a referendum.Footnote 4 Under an ISDS mechanism, covered foreign investors are entitled to bring legal action against host state measures before an international tribunal.Footnote 5 Even the United States is moving away from ISDS.Footnote 6 Historically, the United States, as well as European states, have been architects of the international investment system.
Several strategies, economic and legal, have been put forward in defense of the international law protection of foreign investments.Footnote 7 The economic rationale in a nutshell goes as follows: The greater legal certainty that ensues from international investment protection, the greater a host state’s inflow of foreign capital, which, in turn, contributes to greater economic development, broadly understood—that is, including technology transfer, higher tax income, and increased competitiveness.Footnote 8 Although there may be countries that attract foreign capital regardless of international investment protection,Footnote 9 there are others in which it would be ill-advised to invest without the added protection of international investment law. So, for those countries, the first prong of the above equation seems plausible.Footnote 10 The empirical evidence concerning the second prong, however, that is, whether foreign capital also leads to greater economic development, is inconclusive.Footnote 11 Still, the Preamble to the ICSID Convention reaffirms “the need for international cooperation for economic development, and the role of private international investment therein.”Footnote 12
Because of the shaky empirical grounding, proponents of the status quo strive to detach the justification of international investment protection from econometric analysis and instead turn to the concept of rule of law—not just in the sense that international investment protection may be conducive to the domestic rule of law,Footnote 13 but in the sense that it would further the international rule of law.Footnote 14 Economic development as the ultimate objective of international investment law is, in other words, supplanted by a new objective, namely the realization of the international rule of law. Against this backdrop, the International Law Association had dedicated a committee to the “Rule of Law and International Investment Law,” which completed its work at the Athens conference in June 2024.Footnote 15 Whether this legitimation strategy to draw upon the international rule of law holds water is the subject of the present article.
The author is sanguine that the international investment system can be salvaged, but not in the way its proponents propagate. The current level of international investment protection hinges upon three core principles—the two substantive investment protection standards of fair and equitable treatment (FET) and indirect expropriation, found in many international investment agreements,Footnote 16 plus ISDS. Although certainly one of the most controversial aspects of international investment law, it is not ISDS that is at the root of the legitimacy crisis. In the author’s view, it is rather a broad, substantive understanding of the international rule of law, combining the doctrine of legitimate expectations with strict proportionality testing. Instead of doing away with ISDS—and with it the effective control of misuse of public powerFootnote 17 —this author proposes a re-calibration of the standard of review applied by investment tribunals, and following from this, the level of scrutiny of domestic regulatory changes.Footnote 18 At first blush, the question of standard of review seems rather technical, but as will be elaborated, it is of huge practical importance.
The analysis proceeds as follows: Section B seeks to reify the international rule of law as a theoretical framework. In particular, the distinction between “thin” and “thick” understandings of the rule of law will be explored. Section C expounds upon the ramifications for democratic decision-making of adopting a thick rule of law understanding and the consequent broad reading of substantive investment protection standards. The doctrine of legitimate expectations, as read into the FET standard as well as indirect expropriation, facilitates the scrutiny of domestic regulatory changes. This being the case, it is only in combination with strict proportionality testing that that scrutiny threatens to undermine democratic decision-making processes at the domestic level. Section D explains that what really matters from a democratic vantage point is the standard of review employed and rejects strict proportionality testing by investment tribunals. Under a strict proportionality test, it is examined whether the protection of the stated public welfare objective(s) is excessive or not in light of investor rights. In other words, the level of protection pursued by the host state is challenged, with the consequence that arbitrators make prioritization decisions in lieu of legislatures. Not only does this compromise legal certainty and the predictability of the dispute resolution system—themselves bedrock elements of the rule of lawFootnote 19 —but also results in a systematic re-prioritization of policy objectives, with proprietary interests favored over other interests.Footnote 20 Section E finally concludes.
That the rule of law is key to a functioning legal system and to a democratic state order has become axiomatic.Footnote 21 History teaches us that “the rule of law can exist without democracy,” but not the other way around.Footnote 22 As this Article explicates, in an investment context, rule of law principles can be in conflict with democracy. Doubtless it is not a bad thing per se to curb the tyranny of the majority, but a question of calibration. The Article, therefore, submits that only a thin understanding of the international rule of law is acceptable from the vantage point of democratic theory. For some investment lawyers, this might be perceived as bordering on heresy. However, an investment system thus curtailed is defensible in light of both principles—democracy as well as the rule of law.
B. Concepts of Rule of Law
Let us start at the beginning, with the concept of “rule of law” as a guiding principle of international lawmaking, and the “rule by law” as the first step towards its actualization.Footnote 23 The existence of an international rule of law concept must be considered as settled now,Footnote 24 although “there are varying degrees of adherence” thereto.Footnote 25 The international rule of law can be distinguished from the domestic concept:Footnote 26 “the rule of law primarily regulates the relations between the national government and individuals under its jurisdiction,”Footnote 27 while “the international rule of law concerns three levels of relations: [A] horizontal state-to-state relations, [B] authority exercised by the government against individuals and non-state entities, and [C] authority exercised by international institutions . . . .”Footnote 28 International human rights law and international investment law come under situation [B] of the above categorization.Footnote 29 It is here, with the overlap of domestic and international rule of law, that the conflict arises which this article seeks to resolve.
The rule of law generally has many facets, ranging from simply having access to legal texts to demands for the organization of the state. Whereas some commentators consider the elements that make up the international rule of law to be consubstantial with their domestic counterparts,Footnote 30 this author has his doubts. The International Court of Justice (ICJ) famously underlined in ELSI that:
[T]he fact that an act of a public authority may have been unlawful in municipal law does not necessarily mean that that act was unlawful in international law . . . . Nor does it follow from a finding by a municipal court that an act was . . . arbitrary, that that act is necessarily to be classed as arbitrary in international law, though the qualification given to the impugned act by a municipal authority may be a valuable indication.Footnote 31
Another example where the international rule of law falls short of its domestic permutations is the right to a fair trial. As to the question of whether an international court needs, under Article 14(1) of the International Covenant on Civil and Political Rights,Footnote 32 to be “established by law” in the same way as a domestic court would, the International Criminal Tribunal for the Former Yugoslavia stated that “the principle that a tribunal must be established by law . . . is a general principle of law imposing an international obligation which only applies to the administration of criminal justice in a municipal setting.”Footnote 33 By the same token, the European Court of Justice in Kadi I justified its review of the lawfulness of domestic acts implementing international law—United Nations Security resolutions—on the basis that it “must be considered to be the expression, in a community based on the rule of law, of a constitutional guarantee stemming from the EC Treaty as an autonomous legal system which is not to be prejudiced by an international agreement.”Footnote 34
The inference that can be drawn from those rulings is that between the international rule of law, on the one hand, and its domestic counterparts, on the other hand, there is not just a relational difference but also one in substance.Footnote 35 This is not surprising considering the diversity of political systems that operate under an international rule of law. We can further ascertain that the two levels cross-fertilize each other, but not to the extent of assimilation.Footnote 36
Although a universally accepted definition of the rule of law does not exist,Footnote 37 its rationale seems clear, namely the exclusion of arbitrary power exercise.Footnote 38 This can be understood in a formal and substantive sense.Footnote 39 The former is captured in the principle of legality, that is, government respecting the law and governing through law.Footnote 40 According to Rawls, “the conception of formal justice, the regular and impartial administration of public rules, becomes the rule of law when applied to the legal system.”Footnote 41 On that basis, the international rule of law is tantamount to the rule of international law.Footnote 42
Former United Nations Secretary-Generals Annan and Ban Ki-moon advocated a substantive understanding: The “rule of law” refers to
a principle of governance in which all persons, institutions and entities, public and private, including the State itself, are accountable to laws that are publicly promulgated, equally enforced and independently adjudicated, and which are consistent with international human rights norms and standards. It requires, as well, measures to ensure adherence to the principles of supremacy of law, equality before the law, accountability to the law, fairness in the application of the law, separation of powers, participation in decision-making, legal certainty, avoidance of arbitrariness and procedural and legal transparency.Footnote 43
The primary difference between the two approaches, which is of interest to our analysis, is that a formal or thin understanding of the rule of law would not put demands on the content of laws,Footnote 44 whereas a substantive or thick understanding would screen their substantive content.Footnote 45 That screening would need to be carried out against certain benchmarks, such as human rights and principles of justice, which entails value judgments.Footnote 46 As per Dworkin, the rule of law “requires . . . that the rules in the rule book capture and enforce moral rights.”Footnote 47 This is at the same time the main merit and the main point of contention of the substantive understanding, encapsulated in Raz’s metaphor of the law being a knife: “[T]he fact that a sharp knife can be used to harm does not show that being sharp is not a good-making characteristic for knives.”Footnote 48 On the plus side, screening provides a mechanism to filter out oppressive laws.Footnote 49 The other side of the coin is the key question: Whose values, whose morals are imposed? For there is a distinct risk that the applied law will be imbued with the screeners’ values if the rule of law concept is converted into the “rule of the good law.”Footnote 50 Chesterman, consequently, warns against expanding the international rule of law, as this risks reducing the concept “to a rhetorical device at best, a disingenuous ideological tool at worst.”Footnote 51
From a substantive understanding, the proportionality principle and the protection of legitimate expectations can be inferred.Footnote 52 In which guise, however, is disputed. It is conceivable, for instance, to recognize the doctrine of legitimate expectations in principle while at the same time leaving sufficient policy space for host states to regulate in the public interest. As we will see later, the distinction between general law changes and the host state reneging on a specific promise made to a foreign investor becomes relevant in this connection.Footnote 53
The main conclusion from Section B is that the international rule of law does not prescribe a thick understanding.Footnote 54 Crawford provides an explanation: “[T]he application of the basic value of the rule of law at the international level is conditioned by certain facts of life, notably the absence of legislative power such as exists in internal legal systems.”Footnote 55 This may account for the thickening of the rule of law within the European Union as the European integration process progressed.Footnote 56 In international investment law, the two main setting screws in a substantive sense are legitimate expectations and proportionality. In the next Section, we will canvass the doctrine of legitimate expectations, as embodied in the FET standard and as a factor to determine indirect expropriation, before addressing the principle of proportionality in Section D.
C. Protection of Legitimate Expectations
I. Legitimate Expectations in International Investment Law
1 . Legal Nature and Function
The significance of the doctrine of legitimate expectations for international investment law can hardly be overstated. This is because of its relevance to the two most invoked causes of action in investment disputes, FET and indirect expropriation,Footnote 57 resulting in an overlap between those investment protection standards.Footnote 58 Given its support in domestic law,Footnote 59 some commentators rank the doctrine of legitimate expectations among the general principles of law in terms of Article 38(1)(c) of the Statute of the International Court of Justice.Footnote 60 In addition, because the doctrine is concerned with protecting trust in public authority,Footnote 61 it is considered a rule of law requirement. In consequence, the FET standard, since it protects foreign investors’ expectations, has been dubbed an “expression of the rule of law.”Footnote 62
One of the leading cases on FET is Saluka v. Czech Republic. In that case, FET was in issue because the host state had initiated a forced administration on the investor’s banking business. The tribunal held that the FET standard is “closely tied to the notion of legitimate expectations which is the dominant element of that standard.”Footnote 63 That is to say, if the notion of legitimate expectations is not ruled out, but even then it would be a factor to be taken into account.Footnote 64 The same holds true for the determination of indirect expropriation. The United States-Mexico-Canada Agreement, for instance, provides that:
The determination of whether an action or series of actions by a Party, in a specific fact situation, constitutes an indirect expropriation, requires a case-by-case, fact-based inquiry that considers, among other factors: . . . the extent to which the government action interferes with distinct, reasonable investment-backed expectations . . . .Footnote 65
The Agreement goes on to clarify that the reasonableness of expectations “depends, to the extent relevant, on factors such as whether the government provided the investor with binding written assurances and the nature and extent of governmental regulation or the potential for government regulation in the relevant sector.”Footnote 66 In the context of the doctrine of legitimate expectations, the terms “reasonable” and “legitimate” are used interchangeably.Footnote 67
A formulation of that doctrine can be found in Article 8.10(4) of the Canada-European Union Comprehensive Economic and Trade Agreement:
[T]he Tribunal may take into account whether a Party made a specific representation to an investor to induce a covered investment, that created a legitimate expectation, and upon which the investor relied in deciding to make or maintain the covered investment, but that the Party subsequently frustrated.Footnote 68
The scope of the doctrine largely hinges upon the concept of “legitimate expectations,” that is, the kind of expectations deemed legitimate in a particular case. It bears emphasizing that only regulatory changes can be challenged; a foreign investor must accept the law of the host state as found when making the investment.Footnote 69 This is part of the investor’s due diligence obligation.Footnote 70
2. Legitimacy of Expectations
According to the prevailing view, representations made by the host state to the foreign investor need to be “specific” enough in order to generate legitimate expectations.Footnote 71 If this is given too expansive a reading, the investment protection standards that incorporate legitimate expectations become problematic from the vantage point of national sovereignty. This brings us to the crux of the matter: When is a representation “specific” in that requisite sense? In particular, would the host state’s regulatory framework meet this criterion?
Some tribunals answer this in the affirmative, thus subjecting changes to the regulatory framework to international scrutiny.Footnote 72 The ruling in Suez and Vivendi v. Argentina (II), which was about a concession in Argentina “for water distribution and waste water treatment services,” is exemplary in that respect:
When an investor undertakes an investment, a host government through its laws, regulations . . . creates in the investor certain expectations about the nature of the treatment that it may anticipate from the host State. The resulting reasonable and legitimate expectations are important factors that influence initial investment decisions and afterwards the manner in which the investment is to be managed.Footnote 73
Importantly, the democratic legitimation of the rule change, as the case may be, is secondary: As per Article 27 of the Vienna Convention on the Law of Treaties, “[a] party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.”Footnote 74 Democratic credentials of the internal law do not detract from this obligation.Footnote 75
On the other end of the spectrum, several investment tribunals were called to assess whether modifications to solar energy regimes which harmed foreign investments in that sector—for example, a reduction in subsidies, an increase in taxation—were consistent with the Energy Charter Treaty, notably the FET standard in Article 10(1). One such case was Blusun v. Italy. Italy had decided to decrease the level of feed-in-tariffs to be paid in the future. The key question was whether the host state’s renewable energy regime was capable of generating legitimate expectations in the continuance of the feed-in-tariffs as before the modification. In this regard, the tribunal stressed that “there is still a clear distinction between a law, i.e. a norm of greater or lesser generality creating rights and obligations while it remains in force, and a promise or contractual commitment.”Footnote 76 Against that background, the tribunal in Masdar v. Spain—a case concerning Spain’s withdrawal of support measures for renewable energy producers—concluded that there are two schools of thought:
[O]ne school of thought considers that such commitments can result from general statements in general laws or regulations . . . . The second school of thought considers that a specific commitment giving rise to legitimate expectations cannot result from general regulations and that something more is needed.Footnote 77
A corollary of the first-mentioned school is that states face a liability risk whenever they alter the regulatory framework in a way that may negatively affect foreign proprietary interests. Legislatures and regulators, being aware of this, might under-regulate in an attempt to assuage that risk.Footnote 78 The delayed introduction of plain packaging legislation is probably the best-known example of this phenomenon, often couched as “regulatory chill.”Footnote 79
As the following section will demonstrate, the protection guaranteed under the doctrine of legitimate expectations in domestic law as well as other international contexts stays well below its application in international investment law. Investment case law has derogated from certain important limitations, thereby expanding the doctrine’s scope. Those limitations have been put in place because, without them, the doctrine would unjustifiably restrict, even paralyze, decision-makers.
II. Legitimate Expectations in Other Forums
Global administrative law distinguishes between acquired rights and promises made, and attaches different legal consequences to these categories. A comparative study has revealed that only the former remain unaffected by regulatory changes.Footnote 80 In addition, “a clear and effective promise” is required.Footnote 81 What the first school of thought from the above Masdar ruling has done is ascribe to legitimate expectations the status of rights, thereby conflating those two categories. Moreover, in domestic systems, the protection of legitimate expectations is weighed up against the public interest.Footnote 82 That is, even when assuming legitimate expectations, a certain outcome is not guaranteed in light of a conflicting public interest.
In international investment law, it is not clear whether a frustration of legitimate expectations amounts to a violation of the FET standard eo ipso,Footnote 83 or whether the frustration, for example the reversal by the host state of undertakings made,Footnote 84 must have been caused by arbitrary government conduct—in other words, whether arbitrariness is an additional requirement under that element of FET.Footnote 85 By the same token, some domestic jurisdictions only infer procedural, not substantive, guarantees from the doctrine of legitimate expectations.Footnote 86
Domestic law further clearly distinguishes between claims directed against the executive, the legislative, and the judiciary, with the consequence that protection against law changes and new interpretations of existing law, in other words claims against the legislature and the judiciary as opposed to the executive, is more restricted. Under international law, the conduct of all branches of government is treated as acts of state.Footnote 87 In German law, for instance, protection against prospective law changes is foreclosed, barring the requirement of transitional provisions, as the case may be.Footnote 88 The same holds true for changes in the case law.Footnote 89 Likewise, under European Union law, a beneficiary—in our context an investor—“cannot rely on there being no legislative amendment, but can only call into question the arrangements for the implementation of such an amendment.”Footnote 90 On that basis, a claim as brought by Eli Lilly against Canada—challenging new case law relating to Canadian patent law that had tightened the patentability requirement that an invention must be “useful”—would have been precluded a priori.Footnote 91 Finally, the doctrine of legitimate expectations is subject to a legality requirement in some jurisdictions.Footnote 92
In summary, we find ourselves in the uneasy situation whereby the application of the doctrine in its investment guise seems excessive as compared to its domestic provenance as well as its equivalent in other international fields, for example employment with an international organization, where changes of the regulatory framework would not be considered to frustrate legitimate expectations.
III. Scope vs. Standard of Review
As seen, to what extent regulatory changes can frustrate legitimate expectations of foreign investors—advanced as either an FET claim and/or indirect expropriation—remains contested. Be that as it may, international scrutiny of domestic regulatory changes is not problematic per se from the point of view of democratic theory.Footnote 93 At the end of the day, it all depends upon how deferential the scrutiny is towards regulatory autonomy, in other words, the standard of review.Footnote 94 Standards range from non-justiciability to de novo review,Footnote 95 and investment tribunals have taken varied approaches.Footnote 96 The most intrusive standard of review is a strict proportionality test, which will be the topic of Section D.
Shirlow explains that “[d]eference assists international adjudicators to determine whether to assert their own authority over that of domestic decision-makers or, instead, to recognise the authority of domestic actors.”Footnote 97 On that score, Fahner attaches a lot of importance to the distinction between how narrowly an investment protection standard is interpreted, on the one hand, and the standard of review, on the other hand.Footnote 98 However, the intensity of scrutiny adopted by arbitral tribunals perforce corresponds to the level of investment protection, which, in turn, calls for more or less legitimation: The stricter the scrutiny of domestic law the higher the level of investment protection, and the greater the legitimacy concerns raised.Footnote 99
D. Proportionality
I. Proportionality as Standards of Review
When subscribing to the first school of thought from Masdar,Footnote 100 the issue of the indeterminacy of the substantive investment protection standards, most notably the FET standard, is exacerbated because of the wide discretion that investment tribunals enjoy.Footnote 101 It is an important premise for our analysis to acknowledge that investment tribunals make law in defining vague concepts such as what is “fair and equitable”Footnote 102 and in balancing competing societal values and interests,Footnote 103 prompting in turn the need for legitimization from a democratic theory point of view.Footnote 104
With a view to rationalizing the legal analysis, that is, the scrutiny of the domestic regulatory change, tribunals employ the principle of proportionality as a yardstick.Footnote 105 It bears recalling that the principle is germane to both the FET standard and indirect expropriation.Footnote 106 As to its elements, the ruling in RWE Innogy v. Spain is paradigmatic:
[T]he question of disproportionality in the current context entails a consideration as to whether the changes were suitable and necessary to achieve the legislative intent, and whether an excessive financial burden was shifted to the Claimants who had committed very substantial resources . . . .Footnote 107
The context referred to concerned an appraisal of the legitimacy of investors’ expectations as to the stability of Spain’s renewable energy regime. In the same vein, the tribunal in PL Holdings v. Poland, which had to assess whether the forced sale of the investor’s shareholding in a bank in the host state was proportionate, found that:
To satisfy the principle, a measure must (a) be one that is suitable by nature for achieving a legitimate public purpose, (b) be necessary for achieving that purpose in that no less burdensome measure would suffice, and (c) not be excessive in that its advantages are outweighed by its disadvantages.Footnote 108
What the tribunals set out here is the most stringent version of the proportionality test. This so-called strict proportionality test includes an examination of whether the government acted excessively.Footnote 109
Its components can be broken down and exist as separate tests in the guise of a suitability and a necessity test.Footnote 110 Put differently, there are various versions of proportionality testing. A suitability test is confined to step (a); all that needs to be shown is that the government measure at issue is capable of furthering a legitimate public welfare objective. A necessity test combines steps (a) and (b) and involves a least-restrictive-means test: If there is an alternative measure that achieves the same level of protection of the stated public welfare objective but is less restrictive on, in the present context, foreign proprietary interests, the government must adopt that alternative.
In terms of scrutiny, a hierarchy of tests can be ascertained, with strict proportionality being the most exacting one and suitability testing being most deferential towards host states.Footnote 111 The difference between those levels of scrutiny is significant, and indeed may be dispositive of a case.Footnote 112 The next section expounds upon the democratic concerns raised when a tribunal ventures into strict proportionality testing.
II. Democratic Concerns
Von Staden identifies “self-government” as the core democratic principle.Footnote 113 It is undisputed that a state may domestically regulate the use of property in the public interest.Footnote 114 That national bargain struck between property rights and other competing societal values is conditioned by the state’s international obligations vis-à-vis foreign investors. For some countries, the domestic law protection of property rights of nationals will, commensurate with the tenet of equality before the law, be brought into line with those international obligations.Footnote 115 For other countries, foreign property interests will enjoy stronger protection than like domestic ones, resulting in the discrimination of nationals.Footnote 116
In light of scarce resources, legislatures have to make prioritization decisions. Political parties, be they from the left or the right of the political spectrum, generally agree what legitimate public welfare objectives include—public order, raising living standards, environmental protection, public health, etcetera. Where they differ is how to achieve those objectives and how to prioritize—in general and specific terms. In democracies, voters express their prioritization preference in general elections.
The regulation of tobacco products is a good example to illustrate this point.Footnote 117 Some countries might require plain packaging in addition to health warnings;Footnote 118 some might feel that health warnings suffice; others might pass smoking bans and/or restrict tobacco sales.Footnote 119 Wherever a country sits on that spectrum between commercial interests and public health will represent a societal compromise, reflecting that country’s preference as to tobacco control measures.
Under a strict proportionality test, the question would be whether the protection of the stated public welfare objective(s)—here public health—is excessive in light of investor rights.Footnote 120 This results in a weighing of interests between investor rights and the host state’s right to regulate, meaning that the level of protection pursued by the host state is called into question.Footnote 121 According to Kleinlein, and this author agrees, this limits “the legitimizing potential of this methodology.”Footnote 122 The problem is compounded by the fact that the hurdle to react to rogue investment rulings is high: Unless the respective international investment agreement allows for authoritative interpretations by the contracting parties,Footnote 123 the treaties would need to be amended, precipitating domestic ratification processes.
Even taking account of a general trend to delegate political decisions to the judiciary,Footnote 124 it is a fine line that needs to be walked: On the one hand, “[t]he independence of the judiciary is implicit in the function of judicial bodies.”Footnote 125 That is, the legitimacy of investment tribunals does not hinge upon some form of control, even a democratic one, for this would be at odds with the rule of law ipso facto.Footnote 126 On the other hand, “[t]he deference to democratic legitimacy is one way to alleviate the democratic deficit in the operation of international judicial bodies themselves.”Footnote 127 Although heralded by some commentators as the solution to the legitimacy crisis of international investment law,Footnote 128 this author submits that it is strict proportionality testing, and the ensuing balancing of interests, that is at the root of the crisis. The reason is the restricted perspective under which international arbitrators labor. This is most acute when weighing up conflicting interests.Footnote 129
To elaborate on this, it is important to recall that investment tribunals “exercise delegated authority.”Footnote 130 Arbitrators are generally appointed by the disputing parties,Footnote 131 leading to unease about personal legitimation.Footnote 132 But this is not our primary concern here. Our concern is: Not all relevant interests are equally present before an arbitral tribunal—for example indigenous interests when a foreign-owned mining company operates on indigenous land—but rather are mediated by the host state government, vel non,Footnote 133 which makes the tribunal a forum less legitimate for the reconciliation of conflicting interests than a parliament where those interests can be aggregated.Footnote 134 This problem is heightened in polycentric disputes, such as when investment tribunals review climate change measures,Footnote 135 or cases of grand-scale resource re-allocation.Footnote 136
Output legitimacy—here the successful resolution of an investment dispute—cannot remedy the lack of input legitimacy; the two are mutually dependent.Footnote 137 To use Benvenisti’s taxonomy,Footnote 138 investment tribunals, when reviewing government measures, tend to attach weight to the externally disregarded—the investor claimant—while being generally indifferent towards the internally disregarded, barring the occasional amicus curiae brief.Footnote 139
It is true that, unlike World Trade Organization (WTO) law, international investment law does not provide any remedies to reverse the regulatory change in question.Footnote 140 Modern international investment agreements explicitly restrict remedies to monetary damages.Footnote 141 Therefore, legally speaking, an investor claimant could not force the host state to change its policy; a host state can buy its way out of the investment commitments at issue. However, given the sums at stake, the burden on the national purse would be felt even by wealthier nations. Bonnitcha and Brewin have identified “50 known cases in which a tribunal has awarded compensation over USD 100 million, including eight known cases in which a tribunal has awarded more than USD 1 billion.”Footnote 142 As a result, poorer nations may have no choice but scrap an envisaged regulatory change.
The above has wider implications. The arguments that militate against strict proportionality testing in an investment context hold equally true for other international law contexts. Because of the link between international investment law and international human rights law,Footnote 143 it would appear equally incongruous for international human rights bodies to review domestic law under a strict proportionality test. Against this background, we will next draw a comparison between the standards of review in international investment law and the cognate areas of international trade and European human rights law.Footnote 144 Both areas have been seen as benchmarks by investment tribunals.Footnote 145
III. Standards of Review in Cognate Areas of Law
The now defunct Appellate Body has long recognized, for purposes of WTO law, that “the fundamental principle is the right that WTO Members have to determine the level of protection that they consider appropriate in a given context.”Footnote 146 In relation to the Agreement on the Application of Sanitary and Phytosanitary Measures (SPS Agreement), the Appellate Body stressed “the balance established in that Agreement between the jurisdictional competences conceded by the Members to the WTO and the jurisdictional competences retained by the Members for themselves.”Footnote 147 The Appellate Body concluded that “[t]o adopt a standard of review not clearly rooted in the text of the SPS Agreement itself, may well amount to changing that finely drawn balance; and neither a panel nor the Appellate Body is authorized to do that.”Footnote 148 Early on, the Appellate Body stated that whether or not a panel made an objective assessment of the matter before it commensurate with Article 11 of the Dispute Settlement Understanding “goes to the very core of the integrity of the WTO dispute settlement process itself.”Footnote 149
Furthermore, bearing in mind the differences to investment dispute resolution,Footnote 150 it is worth noting the pronouncement from the European Court of Human Rights with respect to the limitations of freedom of expression under the European Convention on Human Rights,Footnote 151 which propelled the development of the Court’s “margin of appreciation” jurisprudence; this is often amalgamated by investment tribunals with the “right to regulate”:Footnote 152
By reason of their direct and continuous contact with the vital forces of their countries, State authorities are in principle in a better position than the international judge to give an opinion on the exact content of these requirements as well as on the “necessity” of a “restriction” or “penalty” intended to meet them.Footnote 153
Gerards notes that “the scope of the margin of appreciation corresponds with a certain intensity of the Court’s proportionality review.”Footnote 154
Some investment tribunals have shown sympathy towards this jurisprudence.Footnote 155 The tribunal in Chemtura v. Canada, for instance, took into account “the fact that certain agencies manage highly specialized domains involving scientific and public policy determinations.”Footnote 156 The case was about the banning of an agricultural pesticide due to health concerns. Along the same lines, the tribunal in Philip Morris v. Uruguay, which dealt with tobacco control measures imposing a single presentation requirement and large graphic health warnings, accepted that “[h]ow a government requires the acknowledged health risks of products, such as tobacco, to be communicated to the persons at risk, is a matter of public policy, to be left to the appreciation of the regulatory authority.”Footnote 157
The conclusion that can be drawn is that the ultimate question is one of separation of powers.Footnote 158 Von Bogdandy and Venzke point out that the “oversight function [by international courts] vis-à-vis the bearers of public authority must be calibrated in light of the democratic principle,”Footnote 159 and Lanovoy reminds us that “[t]he determination of what standard of review should be applied . . . often resembles a policy choice between activism and self-restraint.”Footnote 160 How to make that choice as far as international investment law goes will occupy us in the next section.
IV. Need for Calibration
On the basis of the law as it stands, there are two main calibrating techniques. First, the scope of “legitimate expectations” can be interpreted narrowly. As seen above, even some domestic courts have qualms about interfering with other branches of government and so confine legitimate expectations to procedural fairness.Footnote 161 Second, proportionality testing in an investment context can, and should, stop at the necessity step. Such an approach would align two pillars of international economic law, namely international investment law with international trade law, and also bring the application of the proportionality test in international investment law closer to the reasonableness test known.Footnote 162 The ICJ, too, explicitly adopted a reasonableness standard in the Whaling in the Antarctic case,Footnote 163 whereas in Certain Iranian Assets, which concerned the lawfulness of United States economic sanctions against Iran under the United States-Iran Treaty of Amity,Footnote 164 the Court read the proportionality principle into the reasonableness test while at the same time qualifying that principle: “[A] measure is unreasonable if its adverse impact is manifestly excessive in relation to the purpose pursued.”Footnote 165
At a minimum, such a test calls for a rational basis for state conduct.Footnote 166 In Glamis Gold, the tribunal had to assess the legality of regulatory changes to open pit mining operations, including backfilling and grading requirements for operations in the proximity of indigenous sacred sites, which allegedly harmed a proposed gold mine in the host state. The tribunal laid down this yardstick: “The sole inquiry for the Tribunal . . . is whether or not there was a manifest lack of reasons for the legislation.”Footnote 167 In addition, arbitral tribunals oftentimes require “an appropriate correlation between the state’s public policy objective and the measure” at issue.Footnote 168 Following this, the tribunal in RREEF v. Spain, which presented another legal challenge against Spain’s renewable energy regime, conflated the concepts of reasonableness and proportionality, but in a different way from the aforementioned Certain Iranian Assets case. Instead of qualifying the strict proportionality step—“manifestly excessive”—the tribunal expunged it: “[R]easonableness in the exercise of regulatory power includes: Legitimacy of purpose . . . Necessity . . . Suitability . . . .”Footnote 169
International trade law adopted this development before international investment law when it became apparent that “[t]rade policy limited to liberalization no longer was sustainable and undermined the rule of law.”Footnote 170 By way of example, in EC—Asbestos, the Appellate Body was called to adjudicate whether France’s ban on asbestos could be justified on public health grounds. Applying the exception clause in Article XX(b) of the General Agreement on Tariffs and Trade,Footnote 171 the Appellate Body held that the—only, one might add—“remaining question . . . is whether there is an alternative measure that would achieve the same end and that is less restrictive of trade than a prohibition.”Footnote 172
The outcome of a necessity test is far more predictable and, therefore, manageable for domestic regulators. Not having to worry about strict proportionality allows domestic regulators and lawmakers to experiment with regulations, the cost-benefit ratio of which is not clear (yet).Footnote 173 This is particularly important in the area of climate change regulation. Framers know this and choose their words carefully, for example “necessary” instead of “proportionate,” with a view to signaling interpreters which level of scrutiny they prefer.
Strict proportionality undermines the very regulatory autonomy that the police powers doctrineFootnote 174 and, if codified, the corresponding carve-out relating to the definition of indirect expropriation seek to guarantee in the first place.Footnote 175 Reading fully-fledged proportionality tests into substantive investment protection standards disregards, in the author’s view, the common intentions of the contracting parties and is thus at variance with the rules of treaty interpretation as set out in Article 31 of the Vienna Convention.Footnote 176 Considering its stark consequences, it seems appropriate to rule out strict proportionality testing whenever it is not expressly stipulated. Absent such stipulation, a less intrusive test should be applied by treaty interpreters, which better attests to the mutual respect of the actors involved at different layers of governance.Footnote 177
E. Conclusions
The question of legitimacy goes to the very core of any legal regime. Whether it survives, and in what form, depends thereupon. Because the economic case for the international protection of foreign investments is shaky, its proponents have been looking elsewhere and found as an alternative rationale the concept of the rule of law. This Article has critically appraised that attempt to vindicate investment protection through the invocation of an international rule of law.
Strong rule of law protections may be a contributing factor to economic development and that has not been disputed here, although contrary examples could be cited, and what is more, it remains questionable what is cause and what is effect.Footnote 178 It is equally clear that effective investor rights alone cannot guarantee economic development without addressing other obstacles to development such as corruption.Footnote 179 Good governance seems more crucial for economic development than a particular rule of law approach; the two are not congruent.Footnote 180
In the author’s view, the legitimacy crisis faced by international investment law can be explained by the tension that exists between the rule of law and democracy—in concreto the right to regulate in the public interest—when the former is deployed to restrict the latter.Footnote 181 The international scrutiny of regulatory changes is not problematic per se from the vantage point of democratic theory. In fact, the right to regulate and international (investment) law obligations limit each other. Although “the rule of law, which includes treaty obligations, provides . . . boundaries” upon the host state’s right to regulate,Footnote 182 those treaty obligations themselves are to be interpreted in the light of the right to regulate.Footnote 183 This is most obvious in relation to indeterminate protection standards such as FET.Footnote 184
In order to futureproof the international investment regime, the tension outlined above will need to be addressed. It is, however, not through a thickening of the rule of law, for this would exacerbate that tension and, therefore, the legitimacy crisis. What this Article has sought to show is that there can be an excess of rule of law protection on the international plane. Put plainly, what is the purpose of elections if the newly elected government could not change direction?Footnote 185 In other contexts, lawyers draw upon standards of review as a technique to manage the tension between rule of law, on the one hand, and democracy, on the other hand.Footnote 186 This is where a solution to the legitimacy crisis of international investment law must also start.
By contrast, getting rid of ISDS, as promoted by some,Footnote 187 is the proverbial throwing the baby out with the bathwater. The European Court of Justice stresses that “[t]he very existence of effective judicial review . . . is of the essence of the rule of law.”Footnote 188 At a conceptual level, any ISDS mechanism constitutes a form of judicial review, commonplace in administrative law,Footnote 189 and embodies the maxim of ubi jus ibi remedium.Footnote 190 There is not much point in granting investor rights without the corresponding remedies. Additionally, even without ISDS, multi-national corporations will still insert arbitration clauses in the investment contracts they enter into with host states and, consequently, can still sue those states. It is small and medium-sized foreign investors that lack the clout to negotiate contracts with such a clause that would be left without international judicial redress.Footnote 191
That being said, it is of concern when investment tribunals question the level of protection of public welfare objectives pursued by host states. In that case, instead of conducting an arbitrariness control, tribunals presume to know it better. Although it is possible to link the doctrine of legitimate expectations and the principle of proportionality to the concept of rule of law, nothing mandates that level of scrutiny on the international plane—especially when considering the concept’s rationale, which is to keep in check arbitrary government conduct.Footnote 192 From this it follows that any international scrutiny going beyond an arbitrariness control would need to be justified on a basis other than the international rule of law.
Even when accepting the sweeping scrutiny of domestic regulatory changes by investment tribunals under a broad reading of the doctrine of legitimate expectations, the ultimate standard of review is contingent upon the proportionality test employed. Proportionality is often labelled as a method to structure the legal analysis,Footnote 193 but it is more than that. In fact, the proportionality test connotes different standards of review.Footnote 194 Cottier and others underscore that “[t]hese standards strongly depend upon the authority of the judicial body and may vary.”Footnote 195 The crux of the matter is how to know which standard to apply. As a guide, Cottier submits that “[w]hile broadening the scope of review, we need to carefully calibrate standards of review at the same time,” and further “[s]tandards of review . . . are essential . . . in avoiding that the rule of law transgresses into the rule of lawyers.”Footnote 196
Investment tribunals have broadened the scope of review while not adjusting the standard of review. To correct this, investment tribunals should dismiss strict proportionality testing. The kind of value judgments required under a strict proportionality test is something reserved for domestic courts that have the legitimacy to second-guess their government’s prioritization decisions.Footnote 197 Proportionality is thus a double-edged sword: If confined to a necessity test, it is tantamount to a good governance guarantee;Footnote 198 if however construed as strict proportionality, it is at odds with the requirements of a democratic society.Footnote 199
It is telling that not even the European Court of Human Rights engages in strict proportionality testing when it comes to, for instance, “economic or social planning policy” or environmental issues.Footnote 200 On the contrary, the Court emphasized that it “must . . . take into account the fact that Europe is marked by a great diversity between the States of which it is composed, particularly in the sphere of cultural and historical development;”Footnote 201 and when adjudicating “the question of the presence of religious symbols in State schools,” it was an important consideration for the Court that “there is no European consensus.”Footnote 202 Such considerations are even more pressing in an international investment context.
On a final note, dispensing with strict proportionality does not lead to a reduction of other investor rights that do not involve a balancing test, for example regarding the repatriation of profits. Nor does it do away with rights that do involve a balancing test. Rather, it amounts to a requisite re-calibration of investment protection, prompted by democratic theory. With the leitmotif being the recognition of the level of public welfare protection as determined by the host state, the consequence of the proposed re-calibration is that the (adverse) impact of a government measure on foreign investments—key to a finding of a breach of relevant investment standards under a strict proportionality test—is reduced to a criterion for the assessment of alternative measures. Ex abundanti cautela, given the conflicting case law, it is advisable for negotiators of international investment agreements to specify in the treaty text the type of proportionality testing they wish to see employed.Footnote 203 Whether the ICJ’s middle course from Certain Iranian Assets of qualifying strict proportionality—manifest excessiveness—will be adopted by investment tribunals without any textual hook remains to be seen.
Acknowledgements
The author wishes to thank the anonymous reviewers for their feedback. All errors are his own.
Funding Statement
The author declares none.
Competing Interests
For full disclosure, the author was a member of the International Law Association Committee on the Rule of Law and International Investment Law. All views expressed are personal.
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