The 43rd session marked the first in-person meeting of UNCITRAL Working Group III (WGIII) since the outbreak of the COVID-19 pandemic. The list of topics discussed in Vienna was long. Over a 2-week session in September 2022, the WG on ISDS Reform aimed to tackle the selection and appointment of ISDS tribunal members in a standing mechanism, advisory centre on ISDS, assessment of compensation and damages, third-party-funding, other procedural and cross-cutting issues to be discussed in future sessions, draft provisions on mediation with the draft guidelines, and second reading of the draft Code of Conduct for Adjudicators.
The session was longer than the usual weeklong Working Group sessions, making the participation of government representatives more challenging and costly, posing problems for developing countries´ delegations in particular. Their situation was exacerbated because the Secretariat decided to abandon the hybrid format followed during the pandemic, disallowing delegates attending the session virtually to make interventions.
In addition, further modifications to the WGIII procedures may have an impact on the developing countries´ meaningful participation. During the 55th Commission of UNCITRAL held in summer 2022, it was decided that instead of commenting on the reports during the meetings, the WGIII reports will be adopted in a modified manner. The rapporteur and chairperson will prepare a summary reflecting the deliberations and any conclusions reached during the session, which would be circulated during and after the session for comments by delegations. Based on the comments received, a revised summary would be prepared and circulated for adoption by the Working Group as its report. The deadline set for the comments to the summaries to be made by delegations was set on September 14 for the first week of the session, and on September 27 for the summaries of the second week. While this procedure seeks to render the workflow of the WGIII more efficient, it may limit the delegations with a smaller number of delegates in allowing the necessary time and capacity to review the summaries and draft reports. The Secretariat should monitor this process with care to assess whether developing country delegations are adequately contributing.
One of the issues discussed with great interest in WG III was the issue of damages. The issue received little time on the agenda, but was identified as an important one, especially by developing country delegations. The Secretariat had developed an important background paper on damages and identified a number of issues for “consideration and possible work.”
The paper notes in paragraph 64 that:
the current practice of assessment of compensation shows a high degree of complexity, which may partially be due to the lack of regulation of the main parameters of damage calculation as well as different factual circumstances. This complexity contributes to increase in costs of ISDS proceedings and may negatively impact the correctness, consistency, and predictability of awards related to the calculation of compensation. [footnotes omitted]
The paper then proceeds, noting that WGIII could consider developing draft treaty provisions or guidelines on several issues:
– The compensation standard, in particular for cases of illegal expropriation and non-expropriatory breaches.
– The valuation method (including whether the DCF [discounted cashflow] method is appropriate and including the use of sensitivity analysis or alternative assumptions).
– The valuation date.
– Conduct of the claimant, which would limit the amount of compensation.
– Causation between the breach and the loss.
– Evidentiary requirements, including the standard of proof.
– Pre- and post-award interest (the interest rate, the mode of calculation, and whether to compound the interest).
– The appropriateness of requests for tax gross-ups to increase the amount of the award based on the assumption that tax will be collected on it.
– Potential role of national bodies and domestic law in the calculation of damages.
– Role of experts in assessing damages including means of appointment and their
– Allocation of costs where various factors might be considered such as the outcome of the case, the parties conduct, the reasonableness.
During the 1-day discussion, there was general agreement that the issue of damages was important. While some expressed a narrow view for tackling the issue in WGIII, wishing to limit the focus on issues such as the role of experts in assessing damages and the burden of proof, or even keeping the topic off the agenda altogether, many took a broader approach, wishing to address a range of issues. For example, several delegations from developing and emerging economies stressed the importance of tackling the DCF used by some tribunals, often leading to exorbitant damages awards.
At the end, the Chair instructed the Secretariat to further develop its work on damages and to draft different reform options in the form of treaty provisions, guidelines, or model clauses that tackle the issues related to compensation and damages identified in the Secretariat’s background paper.
Nevertheless, the Chair noted doubts about the feasibility of addressing all issues comprehensively given the Secretariat´s time constraints. The Chair also stated that the Secretariat´s work should stay clear of the issues that are closely intertwined with substantive treaty standards.
The Secretariat was also tasked with gathering existing examples of damages-related clauses in treaties as a basis for developing options for WGIII. As existing treaties, including more recent ones, are generally silent on the matter of compensation beyond the context of lawful expropriation, the Secretariat’s ability to rely on existing treaty drafting to develop options may be limited.
Compensation and damages in investor–state dispute settlement: Ripe for reform
The issue of damages is one of the issues on the table in WG III’s reform discussion that can make a difference and lead to more balanced and reasonable outcomes of ISDS. Multi-million-dollar damages awards were among the main drivers of many states calling for a reform of the existing ISDS regime in the first place. States have been increasingly pointing to the critical issue of compensation in ISDS and its potential to negatively impact their policy space and public spending.
According to Bonnitcha and Brewin, “In the early 2000s, awards of compensation in the tens of millions of USD were considered large. These sums seem quaint in retrospect.” IISD research has found over 50 known cases in which an investor–state tribunal has awarded a foreign investor over USD 100 million in compensation. In at least eight claims, the award reached over USD 1 billion.
In contrast with the nationalization disputes of the decolonization era, many contemporary ISDS cases arise from regulatory interactions between the state and the investor rather than from an outright seizure of the investment. Large amounts have been awarded in such regulatory disputes, heightening concerns that the ISDS system can unduly restrict the ability of states to regulate in the public interest.
Another problem in recent arbitral practice is arbitral tribunals’ growing willingness to grant large amounts in compensation for state interference with planned investments that never entered the implementation or operation phase. The possibility of large payouts of compensation—particularly for interference with planned investments that are never built—also risks encouraging corruption. “This is because the possibility of large awards of compensation increases the potential payoffs for an unscrupulous investor to enter into corrupt investment contracts with a host state, even if the investor never intends to perform the contract.”
A related issue is that arbitration tribunals have been inconsistent regarding the use of valuation principles and techniques, leading to considerable uncertainty, incoherence, and unpredictability in this important area.
As the WGIII discussions continue, delegates will need to determine what reform options best address the challenges, considering lessons learned from arbitral jurisprudence and how arbitral tribunals may apply the reforms in practice. WGIII could, along the lines proposed in the Secretariat’s paper, tackle the use of income-based valuation techniques, such as DCF. The use of DCF could be restricted in certain factual situations, thereby offering a clear and straightforward way to avoid unduly high and speculative damages awards. This approach would be consistent with international law, improve coherence and predictability of ISDS practice, and make the proceedings less costly.
A straightforward reform option: Limiting the use of the DCF method
There are several ways to tackle the issue of excessive compensation in ISDS. Some of them require more detailed elaboration and treaty reform; others can be tackled by WGIII as part of the reform package. It should be noted that the strategies to advancing reform may be pursued beyond the WGIII reform process, at the national, bilateral, and regional levels.
Several factors are responsible for the increase in the amount of compensation being awarded in investment treaty arbitrations. But the most significant factor is probably tribunals’ increasing willingness to base compensation on projections of an investment’s expected future income across its entire life cycle. The most common valuation technique used to calculate compensation on this basis is the DCF method. Several high-damages awards were directly related to the application of DCF to projects that did not have an established record of profitable operations or that had not even commenced operation.
A straightforward yet effective way to limit excessive compensation in ISDS through WGIII would be to regulate the use of DCF and rule it out in specific situations. This issue can be addressed in a bilateral or regional investment treaty, in a multilateral reform agreement developed by Working Group III, or through interpretive guidance. Illustrative language may involve the following:
For the purposes of making an award of compensation [under this Agreement], a tribunal shall not apply an income-based valuation technique, including inter alia the discounted cash flow method, to an early-stage investment which does not have an established track record of profitable operations.
Increased correctness of ISDS decisions
The proposed provision would increase the correctness of ISDS awards by realigning arbitral practice with existing customary international law. The widespread use of DCF, including for early-stage investments, contrasts with the rules of customary international law. For example, the International Law Commission’s Commentary to the Articles on Responsibility of States for Internationally Wrongful Acts states that DCF models are based on “a wider range of inherently speculative elements, some of which have a significant impact upon the outcome” and cautions that their use is only appropriate in a narrow range of circumstances, such as when an investor has a contractual entitlement to a defined income stream. In addition, the 1992 World Bank Guidelines on the Treatment of Foreign Investment are clear that the DCF method should only be used for valuing going concerns.
Increased consistency of ISDS decisions
The proposed provision would increase the consistency of ISDS practice by providing clear guidance to arbitral tribunals regarding the use of valuation methods. Current arbitral jurisprudence on compensation is inconsistent, especially in terms of the circumstances in which it is deemed appropriate to calculate compensation based on an investment’s expected future income; the evidence needed to back up the projections that underpin future income-based calculations of compensation; and the way tribunals account for risks to an investment’s projected income stream across its entire life cycle.
Lowering the costs of arbitration proceedings
The proposed provision is also expected to make arbitral proceedings less costly. The DCF method is particularly complex, as it relies on a set of interlocking forecasts and assumptions about the future of the investment over its entire lifespan. This places the countries that lack in-house capacity at a disadvantage when engaging in detailed arguments about valuation methods. It also drives up arbitration costs, by requiring the parties to rely on expert witnesses.
In WGIII, states will need to prioritize the reforms that have the most impact in addressing their key concerns with the ISDS system. Tackling the issue of compensation, including by limiting the use of DCF, would have significant impact on ISDS reform and address many concerns relating to correctness, consistency, and cost, as well as effects on policy space. Developing countries’ delegations have recognized this and expressed their strong desire to keep the issue on the agenda. This has been achieved for the time being, with the Secretariat instructed to develop options on compensation for further discussion. Whether WG III delegations will be able to come together on the issue of compensation and agree on reforms that matter will be seen in the coming months and years. It will depend on the coordinated action of those delegations who wish to advance this issue within WGIII.
Nathalie Bernasconi-Osterwalder is Executive Director of IISD Europe and Senior Director, Economic Law and Policy, IISD.
Josef Ostřanský is Policy Advisor for Sustainable Investment for the Economic Law and Policy Program, IISD, and Managing Editor of ITN.
 A Secretariat Note from the 36th session in 2018 first identified the “growing concern” about the excessive nature of damages that were being awarded (A/CN.9/WG.III/WP.153 – Possible reform of ISDS – Cost and duration, para. 5). A WGIII report from the 37th session in 2019 reiterated concerns about the “high amount[s] of damages awarded by tribunals” in the context of the regulatory chill they could cause (A/CN.9/970 – Report of Working Group III (Investor-State Dispute Settlement Reform) on the work of its thirty-seventh session (New York, 1–5 April 2019), paras. 36–38). Concerns about damages were linked to the issue of consistency of ISDS decisions (A/CN.9/WG.III/WP.150, Possible reform of investor-State dispute settlement (ISDS): Consistency and related matters, para. 18).
 Submissions referring to damages in the context of UNCITRAL WGIII have been made by the following states: Indonesia (A/CN.9/WG.III/WP.156), European Union and its Member States (A/CN.9/WG.III/WP.159/Add.1), Colombia (A/CN.9/WG.III/WP.173), Ecuador (A/CN.9/WG.III/WP.175), South Africa (A/CN.9/WG.III/WP.176), Chile, Israel, Japan, Mexico and Peru (A/CN.9/WG.III/WP.182), and Burkina Faso (A/CN.9/WGIII/WP.199).
 See Bonnitcha, J. & Brewin, S. (2020a). Compensation under investment treaties, p. 1. International Institute for Sustainable Development Best Practices Series. https://www.iisd.org/publications/guide/iisd-best-practices-series-compensation-under-investment-treaties
 For an emblematic regulatory dispute with high amount of compensation awarded see, for example, NextEra Energy Global Holdings B.V. and NextEra Energy Spain Holdings B.V. v. Kingdom of Spain, ICSID Case No. ARB/14/11. Decision on Jurisdiction, Liability and Quantum Principles.
 Tethyan Copper Company Pty Limited v. Islamic Republic of Pakistan, ICSID Case No. ARB/12/1, Award (July 12, 2019).
 For a case in which allegations of corruption did not have an impact on the awarded damages see, for example, Unión Fenosa Gas, S.A. v. Arab Republic of Egypt, ICSID Case No. ARB/14/4, Award.
 See Bonnitcha, J., & Brewin, S. (2020b). Compensation under investment treaties: What are the problems and what can be done? (Policy brief). International Institute for Sustainable Development, p. 3. https://www.iisd.org/publications/compensation-under-investment-treaties
 Compare, for example, the valuation approaches used by two tribunals dealing with in Tethyan Copper v. Pakistan and Bear Creek v. Peru. In both cases, the dispute concerned a mine that had never been built. The Bear Creek tribunal awarded USD 18 million in compensation, whereas the Tethyan tribunal awarded USD 4 billion plus interest. The difference boiled down to different valuation techniques adopted. Bear Creek Mining Corporation v. Republic of Peru, ICSID Case No. ARB/14/21, Award (Nov 30, 2017).
 Bonnitcha and Brewin (2020b, supra note 8) suggest balancing rules for compensation, capping compensation at the amount actually invested, integrating gain-based considerations into the calculation of compensation, and requiring the tribunal to apply the law of the host state in determining compensation.
 For example, Tethyan Copper v. Pakistan, supra note 6.
 International Law Commission. (2001). Text of the articles on the responsibility of states for internationally wrongful acts. Yearbook of the International Law Commission, 2001, II (Part Two). UN Doc. A/56/10, art. 36, cmt. 26.
 General Counsel of the World Bank. (1992). Legal framework for the treatment of foreign investment: Volume II. World Bank, p. 26. http://documents1.worldbank.org/curated/en/955221468766167766/pdf/multi-page.pdf
 Bonnitcha & Brewin (2020b), supra note 8, p. 4.