Seeing the Forest without the Trees – The Doubtful Case for Proportionality Analysis in International Investment Arbitration

Benedikt Pirker

1. Introduction

Proportionality analysis is en vogue – once again, some might say. The present contribution sceptically examines recent claims that proportionality analysis should play a vital role in international investment law, a rather new and rapidly evolving field of international economic law. Yet, in the author’s view the position of international investment arbitration somewhere between quasi-constitutional public adjudication and private commercial arbitration casts some doubt on this apparently straightforward suggestion. To put it figuratively, not every few trees make a forest, even though some may prefer to see one.

In order to explain the potential difficulties for the transplant of proportionality analysis into the context of international investment arbitration, we first present the argument in favour of the transplant upheld in particular by Professor Stone Sweet (2.). Then, the trees are scrutinized: The main questions are whether the rights of investors under investment treaties are sufficiently similar to fundamental rights and whether international investment arbitration presents features comparable to constitutional adjudication (3.). Having set out some sceptical arguments on both points, a brief analysis of case law unveils that proportionality analysis has to date only made a rather cursory appearance. Given this, it is suggested that some options that are less contentious than proportionality analysis should be open to tribunals in investment law (4.), before some conclusions are drawn (5.).

2. The Forest: Transplanting Proportionality Analysis from the Context of Domestic Constitutional Rights Adjudication to International Investment Arbitration

In order to fully understand the case made for transplanting proportionality analysis to investment arbitration, its foundation in Professor Robert Alexy’s principles theory should be set out. Alexy’s habilitation1 develops a norm-theoretic argument about proportionality analysis, or, as it is often referred to, balancing.2

According to Alexy’s theory, certain norms present a specific structure – they are principles, which means that in situations of conflict with other norms they must be realized to the

1 R. Alexy, Theorie der Grundrechte (1986); later translated into English and other languages, see R. Alexy, A Theory of Constitutional Rights (translated by Julian Rivers) (2002).2 To avoid confusing terminology, the term proportionality analysis is preferred throughout this contribution.

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highest degree possible.3 This is the process of ‘optimization’ which requires balancing taking the shape of proportionality analysis. The opposing category of norms are so-called rules, which are applied by the classic legal methodological tool of subsumption. They do not operate according to the logic of optimization, but simply apply in a yes-or-no fashion.4 In the case of subsumption, simple deduction operates: if a factual situation can be brought under the conditions set out in the legal terms a norm, the legal consequences of the norm are triggered. The balancing of principles, however, operates according to the scheme presented by the principle of proportionality as developed in particular in German administrative and constitutional law. This proportionality analysis encompasses three sub-tests: a first test of suitability, a second test of necessity and a third test of proportionality stricto sensu.5 For Alexy, constitutional rights typically enshrine a principle, which means that adjudication of such claims implies necessarily the use of proportionality analysis, as can be seen in the vast case law of the German Federal Constitutional Court.6

As other authors have provided highly accurate accounts of the characteristics of the individual sub-tests, we can leave things at this rather basic stage. It suffices to state that a vast literature has found that proportionality analysis offers both advantages and risks. Advantages, because it gives great leeway to courts to assess, weigh and balance all arguments on an equal footage without strict limitation by the text to be interpreted.7 Risks, because it calls for complex evaluations. In particular the third sub-test of proportionality stricto sensu requires a determination of the abstract value of the principles at issue, their concrete value in the specific setting of the case and a subsequent comparison between the two mentioned variables determined for the two conflicting principles.8

More recent accounts have suggested that proportionality analysis is and should continue to be used increasingly beyond the framework of adjudication of constitutional rights through constitutional courts. Stone Sweet and Mathews have presented a broad comparative study and identified various situations in which domestic, but also international adjudicative bodies have adopted reasoning resembling proportionality analysis.9 Their understanding of proportionality analysis appears quite pragmatic, as they consider it a useful ‘argumentation framework’,10 a sort of legal test which allows courts to weigh arguments on an equal footing against each other. Consequently, for Stone Sweet it should be the preferred option to resolve

3 Alexy, Theorie der Grundrechte, supra note 1, at 75.4 See closer on the distinction ibid., at 88 ff.5 See for a detailed account Alexy, ‘On Balancing and Subsumption. A Structural Comparison’, 16 Ratio Juris (2003) 433, passim.6 For more sceptical accounts of Alexy’s norm-theoretic account and the separation between rules and principles see Poscher, ‘The Principles Theory: How Many Theories and What is Their Merit?’, in: M. Klatt, Institutionalized Reason. Perspectives on the Legal Philosophy of Robert Alexy (forthcoming 2011), paper available at http://ssrn.com/abstract=1411181, and Jestaedt, ‘Die Abwägungslehre – ihre Stärken und ihre Schwächen’, in: O. Depenheuerand others (eds), Staat im Wort: Festschrift für Josef Isensee (2007) 253.7 Alexy deems proportionality analysis thus a particularly rational legal procedure well-suited for constitutional review of legislation in the light of constitutional rights, see Alexy, ‘The Construction of Constitutional Rights’, 4 Law & Ethics of Human Rights (2010) 19, at 26 ff.8 See for a powerful criticism of proportionality analysis in the context of United States constitutional law Aleinikoff, ‘Constitutional Law in the Age of Balancing’, 96 Yale Law Journal (1987) 943, at 972, who emphasizes the difficulty of finding a ‘scale’ of comparison between competing values which would be ‘external’ to individual judges subjective convictions. See also closer on the problems of incommensurability and valuation Sunstein, ‘Incommensurability and Valuation in Law’, 92 Michigan Law Review (1993-94) 779 and Schauer, ‘Commensurability and Its Constitutional Consequences’. 45 Hastings Law Journal (1994) 785.9 See Stone Sweet and Mathews, ‘Proportionality Balancing and Global Constitutionalism’, 47 Columbia Journal of Transnational Law (2008) 73.10 Ibid., at 87.

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rights conflicts also in international investment arbitration.11 A substantial part of the argument is based on the potential of proportionality analysis to improve the often rather poor reasoning which investment tribunals provide for their decisions.12 Other observers of the case law have also welcomed this potential effect of proportionality analysis.13

At this point, we suggest that a more powerful justification for proportionality analysis is needed than merely its potentially positive effect. One may already wonder whether the cure for unsatisfactory reasoning and incoherent legal tests must necessarily be one specific legal test, here proportionality analysis – other sophisticated legal tests may also do a better job without entailing the difficulties connected with proportionality analysis. Linked to this are also doubts on the strict separation between proportionality analysis and tests based on subsumption suggested in Alexy’s account mirrored by Stone Sweet. In adjudicative reality, there is probably rather a continuum of interpretative solutions between the two poles rather than a sharp dividing line.14

Furthermore, from a separation of powers perspective proportionality analysis constitutes a shift of power away from the legislative, norm-setting power towards the judiciary. It allows the latter to reassess whether the former has found the appropriate balance between competing claims. Why courts with their limited resources should be entitled to this exercise of power has already been questioned in the context of domestic constitutional law.15 The argument applies all the more in the context of international investment arbitration where a tribunal is not part of an institutional setting based on a specific form of checks and balances, i.e. a historically grown separation of powers. Such a tribunal’s decisions stand on its own and no easy ‘reversal’ by means of legislation is possible if an erroneous judicial decision is taken.16

As a consequence, it is suggested that in order to justify the use of proportionality analysis with its potentially far-reaching consequences in international investment arbitration, a close look is needed as to whether the field of international investment law truly is framed as a ‘rights’ regime and as to whether international investment arbitration as the mechanism of adjudication corresponds sufficiently in its rationale to constitutional systems of adjudication. Only if the justification of proportionality analysis in the context of domestic constitutional adjudication can be transferred to investment arbitration, its use can be considered justified.

To put it differently, only if we find a certain number of trees, we can legitimately speak of a forest. The picture of the forest is appealing in the present context, because the inquiry can of course only deliver a weighing of arguments and no sharp conclusion such as the full

11 Stone Sweet, ‘Investor-State Arbitration: Proportionality's New Frontier’, 4 Law & Ethics of Human Rights (2010) 46, at 24.12 Stone Sweet and Grisel, ‘Transnational Investment Arbitration: From Delegation to Constitutionalization?’, in: P.-M. Dupuy, F. Francioni and E.-U. Petersmann (eds), Human Rights in International Investment Law and Arbitration (2009) 118, at 131.13 See e.g. Xiuli, ‘The Application of the Principle of Proportionality in Tecmed v. Mexico’, 6 Chinese Journal of International Law (2007) 635, at 642 or Krommendijk and Morijn, ‘'Proportional' by What Measure(s)? Balancing Investor Interests and Human Rights by Way of Applying the Proportionality Principle in Investor-State Arbitration’, in: P.-M. Dupuy, F. Francioni and E.-U. Petersmann (eds), Human rights in international investment law and arbitration (2009) 422, at 442.14 Poscher, supra note 6, at 29, demonstrates this point by examining closer the examples given by Alexy for rules and principles, suggesting that both are rather extreme norms, while more typical norms expose both rule-like and principle-like elements. 15 See in United States constitutional law Aleinikoff, supra note 8, at 985-986.16 See on this last point of errors in adjudication Kingsbury and Schill, ‘Investor-State Arbitration as Governance: Fair and Equitable Treatment, Proportionality and the Emerging Global Administrative Law’, New York University School of Law Public Law & Legal Theory Research Paper Series Working Paper (2009) No 9-46 1, at 39.

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exclusion of proportionality analysis from the context of investment arbitration. Rather, the arguments set out in the subsequent sections should serve as indicators for adjudicators whether to lean towards one or the other side of the continuum between pure norm-subsumption and full scale proportionality analysis.17

3. The Trees: the Features of International Investment Arbitration

In order to make the subsequently uttered doubts on constitutional explanations of investment arbitration more transparent, we provide a brief historical insight which shows that the development of investment arbitration oscillates between two conflicting narratives (I.). Before this background, the arguments on international investment arbitration as rights adjudication (II.) and as constitutional adjudication (III.) become easier to understand.

A. A Brief History of International Investment Arbitration

The history of international investment law can be read in various ways. A first narrative suggests a progressive development.18 The starting point is always a foreign investor suffering undue treatment in a host state, often resulting in expropriation. In the old days of international law, only the tool of diplomatic protection was available in such a situation. The home state thus had to espouse the investor’s claim of violation to bring it before international arbitration or the International Court of Justice. A wave of expropriations in the era of decolonization provoked fear among investors and prompted capital-exporting states to the increased conclusion of international treaties which should protect investments and ensure that compensation had to be paid in cases of expropriation.19 These emerging ‘bilateral investment treaties’ (BITs) such as the 1959 treaty between Germany and Pakistan still did not contain provisions on investor-State dispute settlement, but served rather as political documents providing for the continuation of diplomatic protection by means of a treaty.20 The subsequent increase of conclusions of bilateral investment treaties has been constant until the early 2000s and has led to the impressive number of about 2676 BITs by the end of 2008.21 Later, as the second crucial development in a paradigmatic change the introduction of dispute settlement provisions gave teeth to such treaties which were not necessarily initially foreseen for the purpose of adjudication and interpretation.22 As central elements of the institutionalization of international investment arbitration, BITs typically provided for the general and prospective consent of the host state to arbitration and excluded the need to exhaust local remedies.23 As a consequence, an investor protected by the provisions of a BIT can – by consenting to arbitration – directly bring a claim against the host state before an 17 Conceptually, the picture of the number of trees for a forest is also appealing because it reminds us of the concept of vagueness underlying the rather fictitious boundary between proportionality analysis and subsumption. No one can say from what number of trees onwards exactly we may speak of a forest, as much as no one can fully exclude or always prescribe proportionality analysis as a legal test. For conceptual insights on vagueness and so-called sorites paradoxes see T. Williamson, Vagueness (1994), at 22 ff.18 See for an opposition of the ‘progressive’ against the ‘conflictual’ account highly insightful Mills, ‘Antinomies of Public and Private at the Foundations of International Investment Law and Arbitration’, 14 Journal of International Economic Law (2011) 469, at 471 ff.19 See on these expropriations Vandevelde, ‘A Brief History of International Investment Agreements’ 12 UCDavis Journal of International Law and Policy (2005-2006) 157, at 166, in particular footnote 52.20 Waelde, ‘Interpreting Investment Treaties: Experiences and Examples’, in: C. Binder and others (eds), International Investment Law for the 21st Century - Essays in Honour of Christoph Schreuer (2009) 724, at 748.21 United Nations Conference on Trade and Development, ‘Recent Developments in International Investment Agreements (2008-June 2009)’ UN Doc UNCTAD/WEB/DIAE/IA/2009/8 (2009), at 2. 22 Waelde, supra note 20, at 749.23 Wouters and Hachez, ‘The Institutionalization of Investment Arbitration and Sustainable Development’, in: M.-C. Cordonier Segger, M.W. Gehring and A. Newcombe (eds), Sustainable Development in World Investment Law (2011) 615, at 618-619.

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international arbitral tribunal assembled ad hoc for the dispute, without having to turn to local courts or to ask for diplomatic protection of his or her home state.

This institutionalization was coupled with the increasing breadth of claims brought in arbitration against host states and the increasing amount of case law which has more recently seen a tendency of tribunals to rely on precedent. Following the ‘progressive’ narrative, scholars have thus suggested that investment arbitration has undergone a process of ‘judicialization’24 and that it has gained a quasi-constitutional character because it subjects host states’ power to regulate to the disciplines of investment law.25 Investment law as a discipline is, according to this first narrative, on a continuous path towards coherent, universal standards of investment protection and the strengthening of the rule of law, enforced in this process by the increasingly self-stabilizing mechanism of investment arbitration.26

Yet, a less straightforward reading is also possible. The development of BITs and investment arbitration can also be understood as the entrenchment of one legal point of view against an opposing position. The latter would not grant generous protection for international investment, but instead foresee that states may very well provide for expropriation without compensation and similar potentially harmful treatment for foreign investors based on their national interest and economic sovereignty.27 Multilateral attempts to create norms of investment protection have not without reason constantly failed, which is a testimony to the opposition of such rather sovereignty-focused and more investor-friendly points of view.28 While the initial conflict setting could be described as North vs. South,29 more recently also developed countries have started to reconsider their investment law policies in the light of the constraints that are imposed on their regulatory sovereignty.30 The system of investment arbitration is thus denounced in the second narrative as problematic because of its private commercial arbitration features which are not suitable for the adjudication of public law issues.31

To conclude, these two conflicting narratives suggest that also the topic of proportionality analysis can be read in fundamentally two ways, depending on how the system of international investment law with its fragmented regime of bilateral treaties and powerful ad hoc arbitration is understood. A straightforward claim to use proportionality analysis in investment arbitration as a quasi-constitutional system of adjudication must therefore be read with caution. It operates well if we adopt the first narrative on the continuous development of

24 Schill, ‘System-Building in Investment Treaty Arbitration and Lawmaking’, 12 German Law Journal (2011) 1083, at 1088.25 Newcombe, ‘Sustainable Development and Investment Treaty Law’, 8 Journal of World Investment & Trade (2007) 357, at 366. An even stronger claim on the constitutionalization of investment law can be found in Behrens, ‘Towards the Constitutionalization of International Investment Protection’, 45 Archiv des Völkerrechts (2007) 153, passim.26 See also for an account based on the concept of global administrative law Kingsbury and Schill, supra note 16, passim.27 See on these conflicting opinions concisely M. Sornarajah, The International Law on Foreign Investment (2010), at 18. See also on the famous Calvo doctrine ibid., at 21.28 E.g. the proposed International Law Commission project to codify a minimum standard of treatment for foreign nationals in the 1950s, the failed 1967 OECD Draft Convention on the Protection of Foreign Property or the collapsed negotiations of a Multilateral Agreement on Investment in the 1990s, see Mills, supra note 18, at 474.29 As a powerful statement on the views of the newly independent countries after decolonization often the norms enshrined in the New International Economic Order is referred to.30 Mills, supra note 18, at 489.31 G. Van Harten, Investment Treaty Arbitration and Public Law (2007), at 180 ff., has even gone as far as to request the abandonment of the current system of investment arbitration and a return to permanent, public courts.

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international investment law towards global standards ensured by an ever-better institutionalized judiciary. Taking aboard the second narrative, however, a more comprehensive and detailed assessment of the individual features of the system is needed to give appropriate consideration to potential inconsistencies in that story.

B. The Nature of Investors’ Rights and Rights Conflicts in International Investment Arbitration: Towards Property Rights Protection?

To assess the number of trees as initially set out, as a first step we must test the assertion that the system of international investment arbitration serves to adjudicate rights claims comparable to a domestic constitutional or international system of protection of human rights. The crucial point of justification for proportionality analysis in such a system lies in the argument of ‘virtual representation’. A priori there is no specific reason why courts should be called to reassess a question of competing rights claims after the legislature or an administrative decision maker has taken a measure. There can, however, be value to that claim if certain important interests have been overheard in the legislative or administrative decision-making process. A court would thus, through judicial review by means of proportionality analysis, give such interests a second opportunity to be heard and taken into account, at worst striking down the measure under review because it fails to consider certain claims in an appropriate manner.32 The typical situation of constitutional law or international human rights law would see a minority of persons suffering a violation of fundamental or human rights because of a decision taken by a majority. The system of protection offered by such virtual representation for certain highly important claims operates, however, by definition in a subsidiary manner. If we take the example of the European Convention on Human Rights (ECHR), judicial protection by the European Court of Human Rights (ECtHR) is only granted as an additional, subsidiary check: Domestic remedies have to be exhausted before an individual can turn to the (ECtHR),33 and the underlying rationale of the Convention also points towards the subsidiary character of the system.34 The ECHR system appears thus vested with a rather strong mandate for virtual representation of the rights it enshrines.

The tribunal in Tecmed has put international investment arbitration on similar conceptual grounds when it referred to ECtHR case law and stated in the perhaps most explicit reference to proportionality analysis in investment case law to date:

‘[I]n addition to the negative financial impact of such actions or measures, the Arbitral Tribunal will consider, in order to determine if they are to be characterized as expropriatory, whether such actions or measures are proportional to the public interest presumably protected thereby and to the protection legally granted to investments, taking into account that the significance of such impact has a key role upon deciding the proportionality [...] On the basis of a number of legal and practical factors, it should be also considered that the foreign investor has a reduced or nil participation in the taking of the decisions that affect it, partly because the investors are not entitle [sic] to exercise political rights reserved to the nationals of the State, such as voting for the authorities that will issue the decisions that affect such investors.’35

32 See e.g. Waldron, ‘The Core of the Case against Judicial Review’, 115 Yale Law Journal (2005) 1347, at 1402, who defends this function of judicial review in case of a failure of the democratic process of decision-making.33 See Article 35(1) ECHR.34 See the preamble of the ECHR which states that the rights enshrined in the Convention ‘are best maintained on the one hand by an effective political democracy and on the other by a common understanding and observance of the Human Rights upon which they depend’.

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At a practical level, one may already wonder whether investors as often locally influential companies could only influence the decision-making process if they had the right to vote. But even at a more conceptual level, there remain serious difficulties with the equation between investors’ rights and human rights that seems to be established in Tecmed.

As a starting point, the very standards enshrined in BITs do not necessarily reach as far as corresponding human rights provisions. Typical obligations on host states are national treatment or fair and equitable treatment towards foreign investors, the latter constituting a sort of international minimum standard of treatment and due process that should be respected in all situations by host states. The corresponding provisions are typically broadly worded and their interpretation requires the demarcation of a careful balance between investor protection and legitimate regulation by the host state, but based on the text of BITs and not necessarily on an assumption of proportionality analysis.36 BIT provisions on expropriation, on the other hand, perhaps come closest to the content of a right to property, as they typically prescribe compensation in the case of expropriation.37 Scholars have identified that a veritable ‘property discourse’ has developed among investment tribunals.38

Yet, even if it is accepted that the latter standard could qualify as an equivalent to the right to property, other difficulties remain.

Crucially, international investment arbitration does not offer access to justice in a way comparable to human rights or constitutional rights adjudication. Individuals only may bring claims before tribunals because of their capacity as investors, which requires them to have an investment. While in substance claims may resemble human rights claims, in practice only a small minority of economic actors enjoys additional protection and virtual representation of their interests under a BIT.39 With this in mind, the justification for proportionality analysis as virtual representation of minority interests ignored in a domestic legislative or administrative process is significantly weakened.

Furthermore, also the rationale of subsidiarity of virtual representation set out for example in the ECHR does not find its match in international investment protection. First, as mentioned BITs frequently do not require the exhaustion of domestic legal remedies. They provide rather for a shortcut to avoid the domestic judicial system altogether than for an additional safeguard for particular rights claims.40

Second, the rationale of subsidiarity of instruments such as the ECHR is based on the development of common standards of protection coupled with a project of political integration which should emerge and be fostered by the judicial activity of the ECtHR.41 There is no 35 Tecnicas Medioambientales TECMED, SA v. United Mexican States, ICSID Case No ARB/AF/00/2, Award (29 May 2003), at para 122. For references to ECtHR case law see the footnotes 140 and 141.36 See on the difficulty to strike this balance with the mentioned two examples Miles, ‘Sustainable Development, National Treatment and Like Circumstances in Investment Law’ and Kläger, ‘“Fair and Equitable Treatment” and Sustainable Development’, in: M.-C. Cordonier Segger, M.W. Gehring and A. Newcombe (eds), Sustainable Development in World Investment Law (2011), 265 and 241, respectively.37 See also, though with mild reservations Paparinskis, ‘Regulatory Expropriation and Sustainable Development’ in M.-C. Cordonier Segger, M.W. Gehring and A. Newcombe (eds), Sustainable Development in World Investment Law (2011) 299, at 323.38 Lehavi and Licht, ‘BITs and Pieces of Property’, 36 Yale Journal of International Law (2011) 115, at 131.39 Taillant and Bonnitcha, ‘International Investment Law and Human Rights’ in M.-C. Cordonier Segger, M.W. Gehring and A. Newcombe (eds), Sustainable Development in World Investment Law (2011) 57, at 76-77.40 See also Wouters and Hachez, supra note 23, at 635.41 This argument is also used by scholars to reject all too easy inspiration from ECtHR case law by investment tribunals, see Alvarez and Khamsi, ‘The Argentine Crisis and Foreign Investors: A Glimpse into the Heart of the

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conceptual parallel in international investment law. BITs do not seem to aim for a minimum standard of protection of political rights of investors or some political integration among the various host states. On the contrary, the very fragmentation of international investment law in a multitude of BITs and the ad hoc setting of dispute settlement institutions demonstrate that international investment law is caught in the middle somewhere between claims for the development of universal standards of investor protection by some states and disagreement from other states, with the lines of the conflict continuously evolving, as has been discussed in the previous historical section.

To sum up, some of the standards in BITs could thus at least conceptually be read in a similar way to property rights as classic human and constitutional rights. However, the argument of virtual representation that justifies the claim for judicial review by means of proportionality analysis in the human rights and constitutional rights context is difficult to transpose to the setting of international investment law. The latter only provides access to justice for some privileged few in order to evade the domestic judicial system, and in addition there is hardly any project of political integration visible which could justify subsidiary protection of important interests as in the human rights context. If proportionality analysis were used in this light, the resulting risk is an overemphasis on standards of investor protection without a visible justification for such far-reaching protection as is granted to human or constitutional rights.

C. The Nature of International Investment Arbitration: Caught Between Quasi-Constitutional Adjudication and Commercial Arbitration

Having discovered rather thin vegetation testing the rights enshrined in BITs, we now turn to the comparability of international investment arbitration with constitutional adjudication. The most immediately striking feature is the setting of private commercial arbitration which investment arbitration still exhibits, although the public law features of its substance have already been highlighted. Many authors thus denounce that these features are inappropriate. In particular, the confidential setting is criticized and more transparency during the proceedings is called for.42 An even more problematic aspect is the low security of tenure that arbitrators as adjudicators possess. They are chosen by the parties for each individual dispute, the tribunal disappearing after an award has been rendered. Parties could of course choose arbitrators based on their familiarity with the normative and factual situation surrounding a particular dispute. In practice, however, the choice of arbitrators is heavily conditioned upon the positions which the latter have taken earlier in their judicial activity or academic writings, i.e. whether they have sided with host states or investors in the past.43 Even ignoring issues of independence of adjudicators,44 the problem arising for the use of proportionality analysis by the arbitrators is a lack of ‘embeddedness’, of knowledge of the legal, political and social context of a dispute. For an informed use of proportionality analysis, however, the determination of abstract values of the rights concerned as well as the concrete determination of the contribution brought towards a right or the negative impact upon it require a context-sensitive determination.45

Investment Regime’, in: K.P. Sauvant (ed), Yearbook on International Investment Law & Policy (2008-2009) 379, at 444-445, or Ratner, ‘Regulatory Takings in Institutional Context: Beyond the Fear of Fragmented International Law’, 102 American Journal of International Law (2008) 475, at 500.42 See e.g. Mills, supra note 18, at 485, or Wouters and Hachez, supra note 23, at 630.43 Wouters and Hachez, supra note 23, at 628.44 See concisely on this point Van Harten, ‘Five Justifications for Investment Treaties: A Critical Discussion’, 2 Trade, Law and Development (2010) 14, at 36-37.45 See on this point Burke-White and von Staden, ‘Private Litigation in a Public Sphere: The Standard of Review in Investor-State Arbitrations’, 35 Yale Journal of International Law (2010) 283, at 336.

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Another point of concern frequently addressed by scholars who deny constitutional character to the investment arbitration system is the potential fragmentation of the case law by a myriad of independent tribunals deciding cases ad hoc without any coordinating instance. This setting appears particularly troubling in light of the nature of the disputes which potentially limit host states’ regulatory autonomy combined with the broadly phrased standards of most BITs, which effectively lend to the activity of tribunals a ‘law-making’ quality.46

More recent contributions have, however, suggested that this effect is to some extent off-set by the increasing role that precedent plays in the argumentation of investment tribunals. The increasing amount of case law can exercise a stabilizing effect which supports the creation of a system of international investment law.47 Simultaneously, based on this case law tribunals rely more and more on precedent, citing each others’ awards and deviating from it only based on a different argumentation, but not because of the fundamentally bilateral nature of the underlying disputes.48 This shift in the ‘burden of argumentation’ encourages tribunals to engage with each others’ case law49 and can lead to the formation of ‘normative expectations’ of how the case law will deal with future cases.50

Still, the equation with constitutional adjudication remains difficult, even if these claims of an increasing consolidation of international investment arbitration are accepted.

The fact remains that there is both space for a perspective on investment law as a process of ‘global harmonization and systematization’, as well as an account which perceives the system of BITs and arbitration rather as ‘essentially bilateral’ and ‘quasi-contractual’.51 The second argument can be fleshed out by some additional features of international investment arbitrations which defy the first perspective and simultaneously cast doubt on comparisons between investment arbitration and constitutional adjudication.

The differing rationale of investment arbitration in comparison to constitutional or human rights adjudication can be shown by a closer look at the consequences of a finding of violation of a norm. If we take again the example of the ECHR, Article 41 of the ECHR prescribes that in case of a violation, ‘if the internal law of the High Contracting Party concerned allows only partial reparation to be made, the Court shall, if necessary, afford just satisfaction to the injured party’. The range of possible consequences is large; first, it depends on the internal law of the concerned state whether for example restitutio in integrum should be granted. Only if internal law does not grant full reparation, the ECtHR will speak an award of damages, which must, however, be shown to have been directly caused by the violation at issue. 52 In practice, thus, often a judgment contains mainly the declaration of violation and only awards compensation for the cost of proceedings to the applicant. This feature points towards the rationale of the ECtHR as a standard setter for the future, which should partly compensate individuals for their losses, but simultaneously through its case law guide states behaviour for the future.

46 See on this point Schill, supra note 24, at 1092, and Burke-White and von Staden, supra note 44, at 336.47 Wouters and Hachez, supra note 23, at 634.48 Schill, supra note 24, at 1104.49 Kleinlein, ‘Judicial Lawmaking by Judicial Restraint? The Potential of Balancing in International Economic Law’, 12 German Law Journal (2011) 1141, at 1143.50 Schill, supra note 24, at 1106.51 Mills, supra note 18, at 480.52 See instructive on this topic F.G. Jacobs, R.C.A. White and C. Ovey, The European Convention on Human Rights (2010), at 44-45.

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In contrast, in international investment arbitration compensation is key to understand the system’s political economy. The setting of investment arbitration is based on an ex post declaration of a violation which then typically leads to an award of compensation for the damages suffered. It is instructive to note that the question of whether investment tribunals may prescribe other remedies than compensation has not met much interest.53 In practice, BIT violations are in most cases detrimental to the investment at issue and the investor usually brings its claims before a tribunal after the termination of business activities in the host country, which renders other remedies obsolete and of rather theoretical interest. This setting can best be explained by the often cited obsolescing bargaining theory as an important underlying economic rationale for the emergence of BITs. According to this theory most prominently developed by Vernon there are conflicts of interest between the national interest of the host state and the global interests of investors, typically multinational companies. Over time, the power balance between the two parties shifts: Before the investment the company is in a strong bargaining position, as the host state needs its investment of capital, technology, expertise or other resources. After its investment the regulatory power of the host states gives the latter a strong position which could lead to deteriorating regulatory conditions for the company to the benefit of the rent-seeking host state.54 To reduce the latter risk for the investor and sweeten the initial deal, BITs are added to the package of investment conditions. They operate thus as a sort of insurance which strengthens the host state’s credible commitment for future fair treatment of the investor.55 This insight helps to understand the ex post perspective of international investment arbitration. In case of a breach of a BIT obligation, investors do not aim for restitutio in integrum or are ask for guarantees of non-repetition. They simply want to cash in the insurance premium granted to them by the BIT and investment arbitration. This rationale is, however, difficult to compare to constitutional or human rights adjudication, where the element of possible individual compensation is typically combined with the development of generally applicable minimum standards of treatment, which is again reflected in the mentioned characteristics of the remedies provided in such legal regimes.

A further argument reinforces this point. As previously mentioned, a large number of BITs remove the requirement to exhaust domestic legal remedies before turning to international investment arbitration. This has been denounced as an over-inclusive standard: While the usual justification advanced for such treaty clauses is that the allegedly biased domestic judiciary of the host state should be avoided, in practice such a clause applies for both states party to a BIT, thus including developed countries with high standards of administration of justice.56 If we understand BITs, however, through the ‘insurance’ lens just suggested, one could also read the relevant clauses as simply removing cumbersome obligations before a claim for the insurance premium can be filed. This makes also sense taking into account the ‘one way’ setting of investment arbitration, where only the investor can bring a claim, while the host state is limited to a passive role.57

As a last point, observations on the effects of investment arbitration on domestic institutions and the rule of law in the host state strengthen the ‘insurance’ perspective. It is often claimed that the decisions of investment tribunals and the monetary sanctions imposed by them have 53 See e.g. Sornarajah, supra note 27, at 412 ff., who dedicates a comprehensive chapter to the topic of compensation for the nationalisation of foreign investments without paying similar attention to alternative remedies for breaches of BIT obligations.54 R. Vernon, Sovereignty at Bay: The Multinational Spread of U.S. Enterprises (1971); often also cited T. Moran, Multinational Corporations and the Politics of Dependence: Copper in Chile (1974).55 Lehavi and Licht, supra note 37, at 125.56 Van Harten, supra note 43, at 34.57 Ibid., at 37.

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an impact on domestic decision-making at the legislative, administrative and judicial level, i.e. that they create an incentive to improve domestic governance.58 However, a dissenting scholar draws a different picture, as far as judicial reform is concerned: The evasion from domestic justice facilitated by BITs and their exclusion of the requirement to exhaust local remedies in fact leads to a situation where improvement of domestic justice becomes much less of a necessity. Judicial quality in a host state does not improve simply because courts are less frequented, it even has less incentive to do so if investors as some of the most influential players are offered alternative dispute settlement mechanisms and local political forces accordingly see no need to engage in judicial reform.59

To conclude, a closer look at the institutional features of investment arbitration reinforces the impression that comparisons to systems of constitutional or human rights adjudication are ill-suited. With the economic features of investment arbitration prevailing, the system instead seems to follow the logic of an insurance policy scheme which provides for ex post compensation of investors in cases of BIT violations. These features of commercial arbitration are admittedly to some extent countered by recent attempts at system-building by tribunals relying on precedent. Yet, the focus of remedies on compensation and the rule excluding the need to exhaust local remedies have been shown to support a reading of investment arbitration as a system for the remediation of contractual breach situations rather than a system of permanent adjudication aimed both at the remedial of concrete violations and the creation of minimum standards for the future comparable for example to the ECHR.

4. If not Proportionality Analysis, What Else? A Stroll Through the Grove

The previous two sections have reinforced the doubts on the use of proportionality analysis in international investment arbitration. Neither the substantive obligations for host states contained in BITs nor the system of investment arbitration seem to support it. If proportionality analysis should thus be rejected, what could be an alternative test for tribunals?

Looking at the case law, to date arbitral tribunals have not yet extensively engaged in proportionality analysis. The previous quote taken from Tecmed, a case concerning an expropriation measure for regulatory purposes, continues to be the most explicit reference. But not only under the standard of expropriation has the case law at some points vaguely pointed in the direction of various sub-tests of proportionality analysis.

The last years have seen less claims on expropriation and brought a new focus on the very broadly phrased obligation of host states to grant ‘fair and equitable treatment’ to investors.60 Some elements of proportionality analysis seemed to appear at least between the lines when tribunals discussed the ‘reasonableness’ of the conduct of an administrative agency61 or the weighing exercise undertaken between a host state’s interest in the stability of the financial sector and an investor’s legitimate expectations in a stable regulatory environment.62

58 See e.g. Schill, supra note 24, at 1085.59 Ginsburg, ‘International Substitutes for Domestic Institutions: Bilateral Investment Treaties and Governance’, 25 International Review of Law and Economics (2005) 107, at 119.60 A development already recognized by Schill, ‘Fair and Equitable Treatment under Investment Treaties as an Embodiment of the Rule of Law’, 6 International Law and Justice Working Papers (2006) 1, at 2.61 Pope & Talbot Inc. v. Government of Canada Merits, Phase 2, Award (10 April 2001) UNCITRAL (NAFTA), at paras 123 ff.62 Saluka Investments BV v. Czech Republic Partial Award (UNCITRAL Rules, 17 March 2006) 18(3) World Trade and Arbitration Materials 166, at paras 304 ff.

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Under the obligation to grant national treatment to foreign investors, tribunals have generally been open to examine whether less favourable treatment for foreign investors is based on general regulatory policy or undue discrimination.63 To distinguish between the two cases, tribunals have examined the difference in treatment as to whether it bears a ‘rational relationship’ to legitimate government policies,64 in one instance even expressly using the term of ‘proportionality’ for this relationship.65

Ultimately, some vague references to proportionality analysis can be found in the interpretations of non-precluded measures clauses by arbitral tribunals. Typically, such clauses permit emergency measures ‘necessary’ to tackle some urgent threat, which mainly consisted in the case law of the economic crisis which Argentina faced in the early 2000s. While many tribunals have opted for a restrictive interpretation based on the condition that measures must be the ‘only means’ at disposal,66 one tribunal opted for a more relaxed interpretation following a somewhat blurred necessity test,67 while another one even imported the rather obscure ‘weighing and balancing’ formula adopted by the WTO Appellate Body.68

If tribunals thus have not yet fully opted for proportionality analysis and it is argued that they should not do so, alternative approaches ought now to be scrutinized as to their suitability.

In a recent contribution, Burke White and von Staden have offered a comparative overview on legal tests which could be applied by investment tribunals apart from proportionality analysis, having uttered doubts on the latter because of the ill-suited position of investment tribunals for such far-reaching balancing exercise.69

Reviewing WTO and ECHR law as well as United States and German constitutional and administrative law, they find three other potentially applicable interpretative solutions: First, tribunals could opt for a least restrictive means test as in WTO law.70 Second, a test based on the margin of appreciation doctrine used by the ECtHR could be adopted.71 Third, adjudicators could opt for deference and only review measures based on whether the host state has acted in good faith, a standard used in domestic constitutional law.72

Their finding that pure good faith review is a rather weak standard and may not be sufficiently stringent to provide adequate protection to investors is persuasive. More concerns arise on the suggested use of the concept of a margin of appreciation.73 The application of the margin of 63 See generally for a good overview over the case law DiMascio and Pauwelyn, ‘Nondiscrimination in Trade and Investment Treaties: Worlds Apart or Two Sides of the Same Coin?’, 102 American Journal of International Law (2008) 48, passim.64 Pope & Talbot v. Canada (Merits, Phase 2), at para 79.65 Parkerings-Compagniet v. Lithuania ICSID Case No ARB/05/8, Award (11 September 2007), at para 368.66 A concise overview of the case law emerging subsequent to the Argentinean crisis can be found in Von Staden, ‘Towards Greater Doctrinal Clarity in Investor-State Arbitration: The CMS, Enron, and Sempra Annulment Decisions’, in: A.J. Bělohlávek and N. Rozehnalová (eds), Czech Yearbook of International Law - Rights of the Host States within the System of International Investment Protection (2011) 207.67 LG&E Energy Corp. v. Argentine Republic ICSID Case No ARB/02/1, Decision on Liability (3 October 2006), at para 257.68 Continental Casualty v. Argentine Republic ICSID Case no ARB/03/9, Award (5 September 2008), at para 192. See on the conceptually obscure test developed by the Appellate Body Regan, ‘The meaning of 'necessary' in GATT Article XX and GATS Article XIV: the myth of cost-benefit balancing’, 6 World Trade Review (2007) 347.69 See already section 3.C and corresponding footnote 45.70 Burke-White and von Staden, supra note 44, at 302-304.71 Ibid., at 304 ff.72 Ibid., at 314 ff.73 Ibid., at 339 and 337-338, respectively.

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appreciation requires a determination of the appropriate breadth for such a margin, which is based on a ‘magnitude calculation’ of the weight of state public interests and investor rights at issue and a subsequent step of proportionality analysis, which is, however, merely ‘residual’, not ‘direct’.74 It appears doubtful why the very same problems identified for proportionality analysis – i.e. the lack of ‘embeddedness’ of investment tribunals, their lack of knowledge about the legal, political and social context of a host state – should be less of a concern under a margin of appreciation doctrine. The concept requires the same weighing of public interests and private rights that is operated in the framework of proportionality analysis, with the only difference that it serves to adjust the standard of review for a subsequent proportionality analysis rather than constituting the analysis itself. Not much seems to be won if the term ‘balancing’ is replaced with the more objectively sounding ‘magnitude calculation’.

On the opposite, Burke White and von Staden’s rejection of the least restrictive means analysis seems unpersuasive. In such a test, a tribunal would compare alternative measures to the one chosen by a host state to see whether the public interest furthered by the state’s regulation cannot be furthered to the same extent by a measure which interferes less with an investor’s rights. In Burke White and von Staden’s eyes, this necessarily comes down to a ‘second-guessing’ of domestic policy choices for which tribunals are poorly equipped.75

Yet, it could be argued that a deferent less restrictive means test could act as a mere additional check on domestic policies, confronting governments in something like ‘Socratic contestation’ with alternatives of action and requiring them then to justify the concrete measure they have taken against the background of other possibilities.76 Arguably, such a test could be sufficiently inclusive to sort out most measures which are unduly burdensome for investors. A carefully balanced burden of proof for such a test would have to be combined with appropriate strictness on identifying the contribution reached by the measure at issue, so that not an overbroad range of measures qualifies as an alternative. Such a test could thus achieve a satisfactory outcome in most cases and as a crucial advantage it avoids the contentious topic of attributing weight to the conflicting interests of a case. Both the margin of appreciation and proportionality analysis necessarily entail this difficult exercise which raises most concern in the light of the features of investment arbitration set out previously.

5. Conclusion

When in German law the famous principle of proportionality started to proliferate into virtually all areas of constitutional and administrative law, concerned scholars have called for a ‘re-specification’ in order not to overexploit the principle.77 In a similar spirit, the present contribution has suggested that a closer look at international investment arbitration indeed reveals some trees, but to speak of a forest appears inappropriate. As a consequence, a more careful interpretative solution has been proposed in order to strike a balance between the rather incomplete standards of protection for investors set out in BITs and the hybrid system of international investment arbitration. Transposing proportionality from the context of domestic constitutional or international human rights adjudication does not sufficiently take

74 Ibid., at 337-338.75 Ibid., at 338.76 See on the concept of ‘Socratic contestation’ and judicial review insightful Kumm, ‘The Idea of Socratic Contestation and the Right to Justification: The Point of Rights-Based Proportionality Review’, 4 Law & Ethics of Human Rights (2010) 140.77 The term of ‘Respezifizierung’ has been used by Schmidt-Aßmann (quoted in Ossenbühl, ‘Maßhalten mit dem Übermaßverbot’, in: P. Badura and R. Scholz (eds), Wege und Verfahren des Verfassungslebens: Festschrift für Peter Lerche zum 65 Geburtstag (1993) 151, at 163). See for perhaps one of the earliest and most well-known calls for caution with proportionality analysis P. Lerche, Übermass und Verfassungsrecht (1961).

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into account these differences. Consequently, proportionality analysis should be used with caution if at all. Of course, future reforms of the current, much debated system of international investment arbitration may alleviate some of the identified concerns.78

78 See in this regard the Public Statement on the International Investment Regime from August 31 2010 (available at www.osgoode.yorku.ca/public_statement), signed by a large number of scholars who call for a complete overhaul of the current system of investment arbitration.

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