Dispute Settlement Mechanisms in Free Trade Agreements

September 22, 2016

As the world economy becomes more integrated, more complex Free Trade Agreements (FTAs) have emerged. A FTA is an arrangement in which states agree to give each other mutual preferential treatment, with regard to the trade of goods and services originating in their territories, by reducing tariff barriers and other trade restrictions. Most contemporary FTAs include goods and/or services, and often cover questions regarding investment, government procurement and competition. Despite the low number of disputes between governments, one of the core features of FTAs is that they almost always include a dispute settlement chapter of some sort. This guide explains what a Dispute Settlement Mechanism (DSM) is, why it should be included in a FTA, what the key elements of a DSM are, and which factors should be taken into consideration when designing one. 
 

 

What is a DSM?

 

A DSM is a means to rapidly and effectively settle disagreements on whether a country has acted in conformity with its international obligations. It provides a venue for states or/and private investors to bring their complaint to an impartial body that will settle their dispute based on the agreement under which the complaint is brought. The mechanism also provides a chance to develop the interpretative understanding of the agreements in order to tackle situations unthought-of or overlooked at the time of negotiations.[i] These mechanisms come in several forms such as: a permanent court, similar to the Court of Justice of the European Union, or an arbitral tribunal or panel with possibly an appeal body, similar to the World Trade Organization (WTO). However, the most common form of dispute settlement in FTAs is based on a panel nominated by the parties without any appeal mechanism.[ii]

 

[i] European Comm'n, Dispute Settlement in a Nutshell, at http://ec.europa.eu/trade/policy/accessing-markets/dispute-settlement/
 

[ii] Edna Ramírez Robles, Politial & Quasi-Adjudicative Dispute Settlement Models in European Union Free Trade Agreements: Is the Quasi-adjudicative Model a Trend or Is It Just Another Model? (Staff Working Paper ERSD-2006-09 ed., World Trade Org. Econ. Research & Statistics Div. 2006), at https://www.wto.org/english/res_e/reser_e/ersd200609_e.pdf.

 

Why is a DSM important in FTAs?

 

FTAs create trade forums for closer and deeper integration among member states, but their economic benefits can only be realized if they are faithfully implemented. [i]

 

As disputes will inevitably arise regarding the scope, nature and interpretation of the agreement, a DSM is necessary to resolve conflicts. DSMs help to maintain congeniality among member states, and help to avoid unresolved disputes from festering, which can lead to a reduction of the FTA’s benefits. Moreover, most of the benefits of an integration platform come from non-tariff obligations, which need to be backed up, by clarification and enforcement to produce gains. FTAs therefore typically include some mechanism incorporating elements of compliance, enforcement and dispute settlement.[ii] Even if no disputes are anticipated, enforcement provisions in a FTA reinforce the commitments of the governments, make their promises more credible, and signal that the FTA is a solid platform for investment that will create jobs and economic growth.[iii]

 

[i] Amelia Porges, Dispute Settlement, in Preferential Trade Agreement Policies for Development: A Handbook Part 2. pp. 467–497 (2011), at http://siteresources.worldbank.org/INTRANETTRADE/Resources/PTAch22.pdf

[ii] Ibid.

[iii] Ibid.

 

What are the key elements of a DSM?

 

In theory, the negotiators of a FTA are free to design the mechanism as they wish, but there are many specific questions that must be answered upon negotiating a dispute settlement chapter. This section outlines the key elements that must be taken into consideration.

 

Type of DSM

 

In practice, DSMs in FTAs fall into three broad groups: political or diplomatic dispute settlement, systems based on a standing tribunal, and referral to an ad hoc arbitral panel. Political or diplomatic dispute settlement means that the disputes will be settled by negotiation and agreement between the parties. A system based on a standing tribunal, such as the Court of Justice of the European Union, consists of a court composed of judges nominated for a certain length of time who will be adjudicating the dispute between the parties. Finally, in a system based on a referral to an ad hoc arbitral panel, such as in the WTO, a panel is convened for one dispute, with terms of reference limited to that dispute.  In such a case, the panel hears the written and oral arguments of disputing parties, issues a written decision applying the trade agreement’s law to the dispute, and then disbands.[i] Deciding on the type of DSM might be the most important question to be answered as it will impact the efficiency, cost and independence of the DSM.

 

Appeal Mechanism

 

The process of appeal of first instance panel or tribunal decisions is a possible component of a dispute resolution system.  Appellate provisions can play an integral part to prevent or correct judicial errors and to ensure the certainty of the system.

 

Standing

 

Standing is the legal right to initiate a lawsuit; it refers to who can bring a case in the dispute settlement system. First, states always have standing in international trade disputes and are often the only parties allowed to bring disputes. However, non-state actors such as citizens or companies can also be granted standing. In addition, bodies of the international organization hosting the trade agreement can also be granted standing. This is the case, for example, in the European Union (EU) where the European Commission brings most cases against states for non-compliance with the EU Treaties.

 

Overlap

 

Overlap in obligations between two legal regimes occurs when the same parties take part in two separate regimes and both regimes regulate the matter in dispute at the same time. Overlap can happen between the WTO Agreements and a FTA, or between different FTAs.

 

There are three possible strategies to resolve this issue. First, preference can be given to the WTO and/or other FTAs. Secondly, the FTA being negotiated could be given preference over other trade regimes. Finally, the choice can be left to the claimant to decide which forum is preferred, after which alternative fora are excluded.

 

Entry into Force

 

Once a decision has been rendered, it must be decided how it will enter into force and become legally binding.  There are two broad options: firstly, decisions can become binding automatically such as decisions of the Court of Justice of the European Union; secondly, decisions can become binding after approval by the member states such as in the WTO. The different possibilities available under this second option range from a veto right for each member state to block adoption, to adoption by negative consensus which means that decisions are adopted unless all parties agree not to adopt it.

 

Enforcement 

 

In an ideal world, parties to a FTA should comply with decisions made against them; however, compliance should be coupled with a stronger enforcement mechanism.

 

The first mechanism which can be used is compensation. Compensation is usually defined as a “mutually satisfactory” agreement between the winner and the loser where the loser either accepts to increase market access in another sector or to pay prospective monetary compensation.

 

A second mechanism that can be used independently or in combination is retaliation. Retaliation is the suspension of concessions or other obligations by one party to induce compliance by the responding state in the same sector as that in which the retaliating party has suffered damage.[ii]

 

A third mechanism is to allow the DSM to grant damages for past harm to the injured party. This approach is most commonly encountered in investor state arbitrations where the main remedy that the tribunal can order is damages for past harm. Similarly, it is possible to have a system of monetary assessment or fines in order to ensure compliance. However, those mechanisms are not commonly found in FTAs. 

 

A final enforcement mechanism is a political peer review mechanism where the defeated member must explain how it will end the breach of its international obligations.

 

[i] Ibid.

[ii] Articles on State Responsibility, annexed to UNGA res 56/83, UN Doc A/RES/56/83, 12 December 2001.

 

Which factors should negotiators take into consideration?

 

The most important thing that negotiators should keep in mind is that each FTA is different and thus requires different features. For example, a North – South FTA should have a different mechanism to settle disputes than a South – South FTA. Indeed, in a North – South FTA, funding might not be an issue, but balance of power might. Meanwhile, in a South – South FTA funding or impartiality might be problematic whereas temporal efficiency might be less relevant. It is therefore crucial that negotiators do not simply look at what the state of the art DSM is but make sure that the specific conditions of the parties are taken into consideration in the DSM chapter as well.

Negotiators should also pay particular attention to the financial means of the parties as an FTA between developing countries might not need an expensive standing tribunal. Additional considerations include: the number of FTAs that the parties already have and possible overlap, the lack of usage by certain states of international dispute settlement, the need for transparency and, importantly, the political climate and goals of the FTA.

 

Author(s)

 

Victor Crochet, LL.M, Georgetown University Law Center

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