DISPUTE RESOLUTION: International Arbitration: Threats to Investment Protection in the EU Energy Sector by John Gaffney

by King & Spalding
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This article examines threats to the investment protections afforded by bilateral investment treaties (“BITs”) between EU Member States (“intra-EU BITs”) in the energy sector and suggests ways in which these threats may be managed to reduce the resulting risks.

Context

BITs are treaties between two states that protect investments made by investors from one state (i.e., the home State) in another state (i.e., the host State). BITs protect home State investors from government action, such as expropriation or unfair or inequitable treatment that affects the value of the protected investments. BITs also typically provide for the reference of investment treaty disputes to international arbitration.

EU Member States have concluded over 1,400 BITs, but mainly with non-EU Member States (“extra-EU BITs”). However, following the accession of former socialist states (Hungary, Slovakia, Bulgaria, the Czech Republic, Estonia, Latvia, Lithuania, Poland, Romania, and Slovenia) to the EU, almost 400 of these treaties became intra-EU BITs. Recent cases before investment treaty tribunals and other judicial fora, as well as recent activity by the European Commission, call into question the extent of the substantive and procedural protections afforded by these intra-EU BITs.

Notably, many of these cases involve the energy sector. This is not surprising when one considers the extent of EU regulation of the sector, which is intended to ensure full competition and avoid discriminatory treatment of market participants. In addition, the energy sector is governed by the rules on state aid, which prohibit EU Member States from conferring any advantage on a selective basis to market participants. Investment-related agreements in the energy sector, which may favor foreign investors, thus may contain provisions that conflict with provisions of EU law.

In order to avoid an actual or indeed potential conflict with EU law, an EU Member State may take action that is adverse to protected investments or their value. Nonetheless, EU Member States and the European Commission (which enforces EU law) have taken the position that in taking such action, the host EU Member State ought to avoid the imposition by investment treaty tribunals of sanctions for breach of the relevant BIT provisions. Indeed, they have even questioned the jurisdiction of investment treaty tribunals to determine disputes arising under intra-EU BITs. These issues are examined in more detail in the following section, which provides some brief case studies.

Potential threats

Recent case law indicates a number of potential threats to the protections afforded by intra-EU BITs, as follows:

  • The ability of EU Member States to defend measures that adversely impact investments by relying on the application of EU law:
    • For example, Hungary introduced a pricing regime that fixed electricity tariffs, thereby terminating long-term Power Purchase Agreements (“ PPAs”). Hungary claimed it had faced “serious pressure from the European Commission to take action at least to minimize the effects of what the EU considered to be unlawful state aid, if not to terminate the PPAs outright.” This action led to three investment treaty actions (EDF v. Hungary, Electrabel v. Hungary, and AES v. Hungary).
       
    • In AES v. Hungary, Hungary argued that the agreements violated EU state aid regulations and thus AES “could have had no ‘legitimate’ expectation that Hungary would blithely ignore [EU] demands to minimize or eliminate prohibited state aid.” (The European Commission intervened in the case and submitted amici curiae, in which it opposed the PPAs protected by the investment treaty on the basis of its potential to restrict competition that violated EU law.) The investment treaty tribunal concluded that Hungary’s decision to introduce administrative pricing was not motivated by pressure from the Commission, and the claim was dismissed on another ground. Nonetheless, the Tribunal noted that “[h]ad Hungary been motivated to reintroduce price regulation with a view to addressing the Commissions’s state aid concerns, there is no doubt that this would have constituted a rational public policy measure.” In other words, it may otherwise have provided Hungary with a valid defense to the investor’s claim.
       
    • Likewise, benefits provided under energy-related agreements may constitute discrimination in violation of EU law. In European Commission v. Slovakia, the Commission commenced an infringement proceeding against Slovakia on the basis that priority access rights granted to a Swiss company for electricity transmission for a period of 16 years violated an EU directive that prohibited discrimination. In the proceedings before the EU Court of Justice (“CJEU”), it was noted that “allowing investors to be treated differently would amount to [discrimination], which is against the very aims of Directive 2003/54 and of EU energy policy in general.”
       
  • The ability of EU Member States to attack the jurisdiction of an investment treaty tribunal is based on (a) the argument that where an intra-EU BIT involves issues of EU law involving an EU Member State, the proper forum is the CJEU and/or (b) the alleged violation of EU law arising from allegedly discriminatory access to investment treaty arbitration. So far, these arguments have not prevailed, but uncertainty remains:
    • Thus, in a recent case entitled, Eureko v. Slovakia, heard by the Higher Regional Court (Oberlandesgericht) in Frankfurt, Slovakia argued that its membership in the EU deprived an investment treaty tribunal of jurisdiction because, among other things, the tribunal lacked competence to apply and interpret EU law, and hence the CJEU had exclusive jurisdiction over Eureko’s claims. The court rejected this argument. However, its judgment is currently under appeal to the German Supreme Court, so it remains to be seen if the lower court’s judgment will be upheld (or indeed if the CJEU will be asked by the Supreme Court to give its opinion under the preliminary reference system that exists under EU law).
       
    • The Commission stated in an amicus brief in a separate investment treaty case, Eureko v. Slovakia (which led to the German court proceedings referenced above), that the fact some investors are covered by a BIT and granted the opportunity to resort to investment treaty arbitration while others are not results in a “serious potential for discrimination between EU investors from different Member States, which is incompatible with EU law.” It emphasized that it is firmly opposed to extending the preferential treatment of an arbitration mechanism to all investors because it is “firmly opposed to the ‘outsourcing’ of disputes involving EU law” to tribunals outside the EU courts.
       
  • EU Member States have also argued that their accession to the EU implicitly terminated a BIT or subordinated it to EU law:
    • Slovakia made such an argument in the investment treaty case, Eureko v. Slovakia, to justify its introduction of legislative measures that allegedly systematically reversed the earlier liberalization of the relevant market and destroyed the value of Eureko’s investment. The Tribunal (and, notably, the Commission, in its amicus brief) rejected this notion. The Commission emphasized that while “both EU Member States should terminate this type of bilateral agreement,” customary international rules did not implicitly terminate the BIT. However, in its view “EU law prevails” so “private parties are not entitled to rely on EU-inconsistent provisions of this agreement.” However, European Commission v. Slovakia suggests that Art. 351(1) TFEU (formerly 307(1) EC) may justify the conflict of a pre-accession investment-related agreement with EU law. According to the CJEU, “even if it were to be assumed that the preferential access granted to [the investor] were not compliant with Directive 2003/54, that preferential access is protected by the first paragraph of Article 307 EC.”
       
  • Finally, the European Commission has stated its intention of eliminating all intra-EU BITs due to their alleged or potential incompatibility with EU law. (Global Arbitration Review, Vol. 6 Iss. 5) In the interim, the EU has made efforts to secure the renegotiation of BITs to avoid potential conflicts. While 351(1) TFEU (formerly 307(1) EC), providing that existing international obligations of a Member State prior to its accession to the EU shall not be affected by EU law, should theoretically serve to protect investment agreements, once a state accedes to the EU, 351(2) TFEU (formerly 307(2) EC) obliges it to eliminate any incompatibilities between their international obligations in favor of EU law.

The potential threats to the protections provided under the Energy Charter Treaty (“ECT”) appear to be of a different order, not least because unlike intra-EU BITs, the EU is a party to that treaty and thus bound by the protections it affords. As noted in European Commission v. Slovakia, EU law should be interpreted in conformity with the EU’s obligations under the ECT.

Managing these potential threats

Investors in the EU energy sector should consider the following steps to manage potential threats to the protection of their existing or planned investments under existing intra-EU BITs:

  • Implementing or strengthening EU law compliance programs in respect of EU energy sector investments.
     
  • Reviewing with counsel relevant intra-EU BITs for any clauses that expressly reserve a right on the part of the Member State to abide by EU law in case of conflict with a provision in the BIT.
     
  • Reviewing relevant intra-EU BITs for provisions that state that rights that accrue to the investor before termination of the treaty will continue for a period of time - often 15 years - so that the host State may still have to agree to arbitration even after the intra-EU BIT has been terminated.
     
  • Assessing whether the ECT or extra-EU BITs (e.g., BITs concluded with Switzerland and Singapore by EU Member States) would afford more effective protections to EU energy sector investments.
     
  • Monitoring developments at an EU level, as the EU emerges as a player in the investment sector, and EU investment treaties gradually replace EU Member State BITs.

Conclusion

Protections provided by existing intra-EU BITs remain uncertain. However, with careful proactive emerging risks to energy sector investments can be managed.

The author would like to acknowledge the contributions of Kayla Feld in preparing this article.


 John P. Gaffney
 Paris
 +33 1 7300 3916
 jgaffney@kslaw.com

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