Free trade agreements between developed countries now frequently contain provisions on investor protection, but the resolution of disputes remains problematic. Chapter 11 of the North American Free Trade Agreement (NAFTA) allows investors to bring direct claims against a host state before an international tribunal without exhausting domestic remedies. This has resulted in a number of claims against the United States by Canadian investors and against Canada by U.S. investors. Chapter 11 of the Australia-United States Free Trade Agreement (AUSFTA) does not permit direct claims, relying instead on a state-to-state dispute resolution mechanism.
This Article reviews the evolution of investment-dispute resolution from diplomatic protection to NAFTA and A USFTA. It suggests that because developed countries have developed legal systems capable of resolving investment disputes expeditiously and without bias, it should be possible to marry the advantages of direct claims with those of the local remedies rule, allowing investors to enforce their own rights under a treaty but requiring them to do so in domestic courts first.
TABLE OF CONTENTS I. FROM DIPLOMATIC PROTECTION TO BITs A. Diplomatic Protection B. Direct Claims C. Treaties II. NAFTA III. AUSFTA IV. THE BEST OF BOTH WORLDS A. The Advantages of Direct Claims B. Requiring Exhaustion of Local Remedies 1. Preserving Sovereignty 2. Allowing Appeals 3. Providing a Single Forum 4. Responses to Some Anticipated Objections V. CONCLUSION As Sherlock Holmes knew, sometimes the best clue is the dog that doesn't bark. (1) In the case of the Australia-United States Free Trade Agreement (AUSFTA), (2) that dog is the mechanism for settling investor-state disputes. Chapter 11 of AUSFTA, like its North American Free Trade Agreement (NAFTA) (3) counterpart and the investment chapters of other recent free trade agreements (FTAs), contains substantial protections for nationals of one signatory country who invest in the other. (4) In contrast to these other agreements, however, Chapter 11 of AUSFTA does not allow investors to bring claims directly against a host government before a panel of arbitrators. The Australian Department of Foreign Affairs and Trade explains that "[t]his outcome recognises the fact that both countries have robust and sophisticated domestic legal systems that provide adequate scope for investors, both domestic and foreign, to pursue concerns about government actions." (5) Foreign investors may not submit their AUSFTA claims to these "robust and sophisticated domestic legal systems," however, for in neither the United States nor Australia may private parties bring suits to enforce AUSFTA. (6) Thus, the only way of enforcing the agreement's investment provisions is through Chapter 21's state-to-state dispute settlement provisions, (7) a throwback to the era of diplomatic protection.
The likely reason for the absence of investor-state dispute settlement provisions in AUSFTA is a desire to avoid the experiences of the United States and Canada under NAFTA Chapter 11. NAFTA Chapter 11 allows investors of one NAFTA party to bring claims directly against the government of another NAFTA party before an international panel of arbitrators. (8) Moreover, because NAFTA Article 1121 waives the local remedies rule, investors are not required to exhaust their remedies in domestic court before filing Chapter 11 claims. (9) Although both the United States and Canada had entered bilateral investment treaties (BITs) providing for immediate, direct claims by investors before NAFTA, such treaties had always been with less developed countries that made few investments in their more developed partners. (10) The obligations of such treaties are reciprocal in theory but not in fact, for it is generally only the less developed country that bears the risk of being sued. (11) NAFTA Chapter 11 marked the first instance of an investment treaty between two capital-exporting states allowing for immediate, direct claims, (12) and both the United States and Canada have been unpleasantly surprised to find themselves on the receiving end of such claims for the first time. (13)
As NAFTA and AUSFTA illustrate, the question of how to resolve investment disputes between developed countries is a vexing one. (14) Investment agreements between developed countries are different from those between developed and developing countries in at least two respects. First, as NAFTA has shown, allowing direct claims in agreements between developed countries inevitably results in claims against those countries (although it is difficult to find much sympathy for developed countries that are simply held to standards they have long pressed on developing countries). Second, as the Australian government points out, (15) developed countries have developed legal systems that are capable of handling international investment disputes expeditiously and without bias. This Article suggests that the best way to resolve investment disputes between developed countries is to marry the advantages of direct claims with those of the local remedies rule, allowing foreign investors to enforce their own rights under a treaty but requiring them to do so in domestic courts first.
Part I reviews the evolution of investment-dispute resolution from diplomatic protection to the advent of direct investor claims and BITs. Along the way, it discusses the advantages traditionally associated with the local remedies rule, as well as some of the considerations that led to the development of direct claims. Part II describes the system of dispute resolution established in NAFTA Chapter 11, with particular attention to the unintended consequences of waiving the local remedies rule including the impact on state sovereignty. AUSFTA's quite different system of dispute resolution is considered in Part III. AUSFTA solves some of the problems of NAFTA, but only by returning to a system of diplomatic protection that is unlikely to provide any real help to investors.
Part IV proposes a new system for the resolution of investment disputes between developed countries that combines the advantages of direct claims with those of the local remedies rule. Under this proposal, investors would be permitted to bring both international and domestic claims directly against a host state, but would have to bring these claims in the domestic courts of the host state first. Only after exhausting these domestic remedies would investors have recourse to an international arbitral tribunal. Such a system would protect sovereignty, reduce errors, and allow for the resolution of all claims--international and domestic--in a single forum.
FROM DIPLOMATIC PROTECTION TO BITS
The resolution of international investment disputes has changed over the past century or so. Disputes that were once handled only on a state-to-state basis are now commonly resolved through arbitrations in which private parties bring their own claims. The evolution of dispute resolution from diplomatic protection to direct claims involves two related developments: first, the establishment of fora for direct claims; and second, the growing use of treaties, breaches of which might be raised either in those fora or sometimes even in domestic courts.
The traditional means of obtaining redress for foreign investors harmed by breaches of international law is known as "diplomatic protection." (16) The Permanent Court of International Justice in the Mavrommatis case noted: "It is an elementary principle of international law that a State is entitled to protect its subjects, when injured by acts contrary to international law committed by another State, from whom they have been unable to obtain satisfaction through the ordinary channels." (17) Such protection could take the form of "consular action, negotiation, mediation, judicial and arbitral proceedings, reprisals, retorsion, severance of diplomatic relations, economic pressure and, the final resort, the use of force." (18)
Whatever the form, though, diplomatic protection could be exercised only after the private party had tried and failed to obtain relief through "ordinary channels" (19)--that is, through the domestic courts of the host state. "The rule that local remedies must be exhausted before international proceedings may be instituted is a well-established rule of customary international law," the International Court of Justice observed in the Interhandel case. (20) "Before resort may be had to an international court ..., it has been considered necessary that the State where the violation occurred should have an opportunity to redress it by its own means, within the framework of its own domestic legal system." (21)
The local remedies rule has many advantages. On the most abstract level, and from the host state's point of view, the rule shows respect for its "sovereign character." (22) "IT]he right of sovereignty and independence warrants the local State in demanding for its courts freedom from interference, on the assumption that they are capable of doing justice." (23) But the host state benefits from the local remedies rule in more practical ways as well. The rule recognizes that a state does not exercise complete control over every actor that may engage its international responsibility and gives the state an opportunity to redress violations by individuals or low-level officials before the dispute is taken to an international level. (24) It generally allows disputes to be settled at a lower cost to the host state and with less publicity than an international adjudication. (25) And it protects the host state against at least some abuses of diplomatic protection. (26)
The investor's home state shares with the host state an interest in avoiding international disputes if possible. (27) The local remedies rule also relieves the home state of the burden "of espousing claims that might be resolved at a lower level or...