Norton Rose Fulbright LLP

12/01/2021 | News release | Distributed by Public on 11/30/2021 05:14

Important developments in the application of the Energy Charter Treaty within the EU



In September 2021, the Grand Chamber of the Court of Justice of the European Union (CJEU) published a much-anticipated decision in Moldova v Komstroy (Case C 741/19) (Moldova) concerning the validity of the investor-State dispute settlement mechanism in the Energy Charter Treaty (ECT). Shortly thereafter, another important CJEU decision was published in Poland v. PL Holdings Sàrl (Case C 109/20) (PL Holdings). With these decisions, the CJEU has continued the trend of removing from EU investors their treaty-based rights to refer disputes with EU Member States to investment arbitration.

Key findings - the ECT's intra-EU investment arbitration mechanisms are incompatible with EU law

The preliminary reference by the Paris Court of Appeal to the CJEU in the Moldova matter did not raise questions related to the validity of the investor-State dispute settlement (ISDS) mechanism in the ECT (as discussed further below, the questions referred, inter alia, to the scope and meaning of the term "investment" under the ECT). But at the request of interveners, including the European Commission and a number of EU Member States, the CJEU took the opportunity to address the outstanding question of the validity of the ISDS mechanism in the ECT (Article 26(2)c) under EU law.

In its reasoning, the CJEU largely followed its prior controversial decision Slovak Republic v Achmea BV (Case C 284/16) (Achmea).

The CJEU determined that international agreements concluded between EU Members States containing provisions allowing EU investors to bring proceedings against an EU Member State before an arbitral tribunal, so-called "intra-EU arbitration", are precluded by the Treaty on the Functioning of the European Union (TFEU), one of two treaties forming the constitutional basis of the European Union (the other being the Treaty on European Union (TEU)).

The ECT may permissibly require EU Member States to comply with the arbitral mechanisms in their relations with investors from third States who are also ECT Contracting Parties. But preservation of the autonomy and of the particular nature of EU law precludes the same obligations under the ECT from being imposed on EU Member States as between themselves, and therefore Article 26(2)(c) ECT must be interpreted as not applicable to intra-EU disputes.

Analysis of the CJEU's reasoning

In Achmea, the CJEU determined that intra-EU investment arbitration provisions, such as the one found in the bilateral investment treaty (BIT) between the two EU Member States at issue in that case, are incompatible with EU law. However, the CJEU did not express an opinion in Achmea on whether the ruling also applied to multilateral treaties, such as the ECT, that involve multiple EU Member States and other States, leaving tribunals and courts to grapple with this important issue of jurisdiction, with varying results.

Shortly after Achmea, the European Commission weighed in, issuing a nonbinding communication setting out its opinion that all intra-EU BITs and intra- EU investor-state arbitrations under the ECT were incompatible with EU law. The European Commission also sought to intervene in a number of intra-EU investment arbitrations arguing that position.

However, until a binding opinion was rendered by the CJEU, the question as to the applicability of Achmea to the ECT remained live. The CJEU's decision in Moldova has addressed that question.

In a nutshell, the CJEU's reasoning in Moldova is as follows: ECT tribunals may be required to interpret and apply EU law. But tribunals constituted under the ECT's dispute resolution mechanism do not fall under the umbrella of the judicial system of the EU and ECT tribunals cannot make a reference to the CJEU for a preliminary ruling on points of EU law (that right is limited to a 'court or tribunal of an EU Member State' which definition does not include international arbitration tribunals). The preliminary reference procedure is the keystone of the EU judicial system, safeguarding the consistency, effectiveness and autonomy of EU law. As such, because the ECT arbitration mechanism circumvents that oversight procedure, the CJEU held it to be incompatible with EU law in respect of intra-EU disputes.

In Moldova, the CJEU noted that the fact that the ECT was a multi-lateral treaty was irrelevant, because in reality the treaty (and dispute resolution provisions) governed bilateral relations between two Contracting Parties, in an analogous way to a bilateral treaty.

The CJEU's decisions in Achmea and Moldova sit uneasily with prior CJEU case law confirming the validity of intra-EU commercial arbitration - which tribunals, the CJEU accepts, also may interpret and apply EU law and also sit outside the EU judicial regime. In prior decisions, the CJEU held that commercial arbitration was compatible with EU law and that the requirements of efficient arbitration proceedings justify limiting the scope of review of commercial arbitral awards by EU national courts, provided that the fundamental provisions of EU law can be examined in the course of that review and be the subject of a preliminary reference to the CJEU (by the EU national court), if necessary.

The CJEU sought, in Achmea and again in Moldova, to address this seeming conflict, albeit briefly and not entirely comfortably. The CJEU explained that the distinction turned on the fact that commercial arbitration "originates in the freely expressed wishes of the parties", whereas ISDS provisions such as found in the ECT derive from a treaty by which EU Member States agreed to remove disputes from the jurisdiction of their own courts and thus from the required EU judicial oversight system. In those circumstances, the CJEU was unwilling to apply the considerations afforded to commercial arbitration to investor-State arbitration.

The CJEU unfortunately did not choose to elaborate much further. But the crux of the CJEU's objection appears to turn on that, in agreeing to ISDS, EU Member States choose to establish a mechanism that avoids the EU judicial oversight system- a system which Article 19(1) of the Treaty of European Union (TEU) requires EU Member States to establish. Such a possibility, the CJEU said, would "call into question not only the principle of mutual trust between the Member States but also the preservation of the particular nature of the law established by the Treaties… and is not therefore compatible with the principle of sincere cooperation".

The CJEU provided further comments which appear intended to harmonize its decisions in Achmea and Moldova with the EU's plan to replace the investor-State arbitration system with an Investment Court System (ICS) as found in the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada, and prior CJEU case law confirming the compatibility of ICS with EU law.

The CJEU noted that according to settled CJEU case law, an international agreement establishing a court responsible for the interpretation of its provisions and whose decisions are binding on EU institutions, including the Court of Justice, is not in principle incompatible with EU law: the EU's competence and capacity to conclude international agreements necessarily entail the power to submit to the decisions of a court created or designated by such agreements, provided the autonomy of the EU and its legal order is respected. But that competence cannot extend to permitting, in an international agreement, a provision that allows an intra-EU dispute that may concern EU law to be removed from the EU judicial oversight system.

What effect is there on investors?

EU investors with pre-action disputes or involved in ongoing ECT proceedings against EU Member States, whether in the briefing or hearing phase, awaiting an award or awaiting enforcement, will be impacted. They should be taking advice on their positions in those proceedings.

The crux of the CJEU's objection appears to turn on that, in agreeing to ISDS, EU Member States choose to establish a mechanism that avoids the EU judicial oversight system

There will be some uncertainty due to the potential for conflicting decisions. We saw this in the wake of Achmea as regards intra-EU BIT claims. Tribunals and national courts may take different views - both on jurisdictional challenges and enforceability of intra-EU ECT awards. We may see a divergence of treatment by courts within the EU and those outside the EU.

Should investors continue to pursue intra-EU proceedings, EU Member states will likely challenge (or seek to reopen challenges) to the jurisdiction of the tribunal, and the European Commission will likely seek to intervene in support of such challenges in some cases. Prior to this decision, such challenges had only spotted success, and EU investors continued to bring ECT claims against EU Member States and some tribunals have found jurisdiction and in some instances rendered significant awards in favour of investors. Albeit, this was when it was not clear whether the Achmea reasoning applied to the ECT. Post-Moldova, we may see more jurisdictional challenges succeed and certainly a more aggressive approach by the European Commission.

Further bolstering the European Commission's position is yet another important recent CJEU decision in PL Holdings which was published a mere two months after Moldova. In PL Holdings, the CJEU held that ad hoc arbitration agreements between EU investors and EU Members States are also invalid under EU law as they too undermine the autonomy of EU law by circumventing the EU oversight mechanisms. So jurisdictional challenges should now also be expected in ad hoc intra-EU arbitrations.

But more significantly, the CJEU stated in PL Holdings that pursuant to the EU Treaties, the principles of the primacy of EU law and of sincere cooperation, the decision in Achmea, and the Agreement for the termination of BITs between the EU Member States, all EU Member States are required to challenge the validity of such arbitration agreements that are invalid under EU law, before the tribunal and before any competent national court, and ask any competent national court to set aside, annul or refrain from recognizing and enforcing the award. EU national courts also must uphold an application to set aside an intra-EU investment arbitration award.

Further, any attempt by an EU Member State to remedy the invalidity of an intra-EU investment arbitration clause by means of a contract with an EU investor runs counter to the EU Member State's obligation to challenge the validity of the arbitration clause, and would thus "be liable to render the actual legal basis of that contract unlawful, since it would be contrary to the provisions and fundamental principles governing the EU legal order".

The CJEU is clearly not messing around anymore - it is closing its fist on intra-EU investment arbitration.

In practice, the CJEU's decisions will likely affect the protections available to EU investors under the ECT and other multilateral treaties and investment agreements with EU Member States. After all, the ISDS provisions are what give real teeth to those protections. The number of claims against EU Member States is proof enough that investors need these protections as much as they do when investing in emerging markets. The CJEU's insistence that investors seek recourse in national courts overlooks the history of investor-State disputes and the reasons why investor-State arbitration evolved - namely that recourse to domestic courts was often not effective, and State to State intervention politicized what would otherwise be commercial disputes. ISDS offered foreign investors certainty that disputes with host States could be resolved in a neutral forum, and this was the backbone in many ways for the proliferation of foreign direct investment around the globe.

Investors with legacy investments should accordingly consider their position and risk profile, including what other mechanisms might be available to them in the event of objectionable host State conduct. Investors considering new intra-EU investments should likewise consider alternative protections well as considering whether to structure their investment via non-EU Member States (such as the UK, US or Switzerland). In light of the PL Holdings case, attempts to contract around the issue are unlikely to succeed so should be approached with caution.

It is unclear what impact, if any, the CJEU's decisions will have on the current renegotiation or "modernisation" of the ECT process which, as of March 2021, has entered a fourth negotiation round. No doubt the issue will come up, but exactly how it will be navigated by Contracting Parties and stakeholders is currently unclear - particularly given the EU's hostility to investment arbitration.

A strict reading of the term "investment"

It is also worth covering the CJEU's findings in Moldova on the question the CJEU was in fact asked to address - the scope of the term "investment" under the ECT, specifically whether a claim arising from a contract for the supply of electricity constituted an "investment" for the purposes of the ECT.

Article 1(6) of the ECT defines an investment as every kind of asset, owned or controlled directly or indirectly by an Investor and includes, inter alia, claims to money and to performance pursuant to contract having an economic value and associated with an investment (Article 1(6)(c) ECT), and rights conferred by contract which were granted to undertake economic activity in the energy sector (Article 1(6)(f) ECT). Investment is defined as "any investment associated with an Economic Activity in the Energy Sector and to investments or classes of investments designated by a Contracting Party in its Area as "Charter efficiency projects" and so notified to the Secretariat.".

The CJEU held that a claim arising from a contract for the supply of electricity does constitute an asset held directly by an investor, and could in principle come within the scope of Articles 1(6) (c) and (f) ECT. However, the CJEU found that, on the facts of this case, it did not constitute an investment.

As regards Article 1(6) (f), 'investment' includes any right conferred by contract to undertake any economic activity in the energy sector - a claim may be regarded as a right conferred by contract, but the CJEU said a claim arising from a mere contract for the sale of electricity cannot, in itself, be regarded as having been granted in order to undertake an economic activity in the energy sector.

As regards Article 1(6)(c), 'investment' includes claims to money and claims to performance pursuant to a contract having an economic value and associated with an investment. The claim at issue in the proceedings had an economic value (being a claim for money and arising from a contract with an economic value), but the CJEU held that it was not associated with an investment - the CJEU said there was nothing that showed that the contract for the supply of electricity was connected with any other transaction, whether or not that transaction constitutes an investment. The contractual relationship concerned only the supply of electricity, and the electricity in question was generated by other operators that merely sold it to the on-selling contracting party. The CJEU held that a mere supply contract is a commercial transaction which cannot, in itself, constitute an 'investment' within the meaning of Article 1(6) ECT, regardless of whether an economic contribution is necessary in order for a given transaction to constitute an investment.

The CJEU noted that one of the main reasons for the existence of special protective rules for foreign investors arises from the fact that investment transactions involve the immobilisation of resources abroad which generally cannot easily be repatriated in the event of a dispute. It said that there was no such immobilization in this case.

Again, it will be interesting to see whether this decision has any ripple effect on the renegotiation process of the ECT.

Concluding thoughts

With these latest decisions, the CJEU has further empowered the EU's position adverse to intra-EU investment arbitration, enabling it to continue its strategy of gradually eliminating traditional investor- State arbitration in favour of investment court systems as found in CETA. Given the evolving state of investors' rights under EU law, investors in the EU, whether proposed or existing, should be particularly mindful of these issues when considering the risk profile of their investment and take all available steps to mitigate the risks. That may include considering how to structure their investments to benefit from investment treaty protections without falling foul of the CJEU's decisions.