DISPUTE RESOLUTION: International Arbitration: EU Member State Defends Measures Adverse to Energy Sector Investments on the basis of EU law

by King & Spalding
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A recent decision in the investment treaty case, Electrabel S.A. v. the Republic of Hungary, represents an important contribution to the rapidly-growing case law concerning the relationship between EU law and intra-EU investment treaty arbitration (where both the investor’s home State and the host State are EU Member States). In the August edition of the Energy Newsletter (Threats to Investment Protection in the EU Energy Sector, available at (www.kslaw.com/library/newsletters/EnergyNewsletter/2012/August/article1.html), John Gaffney examined the threats in the energy sector to the investment protections afforded by bilateral investment treaties (“BITs”) between EU Member States (“intra-EU BITs”), including the ability of EU Member States to defend measures that adversely impact investments by relying on EU law. We turn now to the latest decision on this issue, and, while it involved an intra-EU dispute based on the Energy Charter Treaty (“ECT”), rather than an intra-EU BIT, the Electrabel decision has important implications for intra-EU BIT and intra-EU ECT claims alike.

Factual Background

On October 10, 1995, MVM, a Hungarian State-owned electricity supply company, entered into a Power Purchase Agreement (“PPA”) with Dunamenti, a Hungarian generator that owned and operated the Dunamenti power plant. MVM also entered into PPAs with other Hungarian generators. The PPA provided for the supply of capacity in return for the payment of a capacity fee until December 2010 (later extended to December 2015). Electrabel, a Belgian energy generation and sales company, invested substantially in Dunamenti from 1995 to 2001, ultimately acquiring 74.8 percent of Dunamenti’s shares in late 2001.

Hungary joined the EU in May 2004. A year later, the European Commission (“Commission”) initiated an investigation of the PPAs as possibly providing State aid contrary to EU law. Hungary reintroduced regulated pricing in 2006, forcing a 40 percent reduction in Dunamenti’s prices.

The Commission subsequently issued a Final Decision in June 2008 in which it held that MVM’s purchasing obligations under the PPAs constituted State aid to the Hungarian generators, which was incompatible with EU law. The Commission requested that Hungary refrain from providing such State aid within six months of the Final Decision’s notification. Hungary terminated Dunamenti’s PPA with MVM on January 1, 2009, i.e., before the term of the PPA was due to expire.

On April 27, 2010, the Commission approved Hungary’s scheme to compensate Dunamenti for “stranded costs” (i.e., the difference between Dunamenti’s investment costs and operating revenues generated in the past and to be generated in the future up to the notional end of the PPA’s term).

The Tribunal’s Decision

Electrabel initiated arbitration proceedings against Hungary in 2007. Electrabel claimed that Hungary’s actions, but not those of the EU, violated the protections under the ECT against, inter alia, expropriation and unfair and inequitable treatment. It claimed that Hungary’s termination of the PPA and corresponding compensation scheme constituted an unlawful expropriation of Electrabel’s investment, as well as a breach of other protections provided under the ECT, including the right to fair and equitable treatment. The European Commission intervened as a non-disputing party in the proceedings.

The Arbitral Tribunal confirmed that it had jurisdiction over the merits of the dispute, rejecting the European Commission’s argument that Electrabel, in its capacity as an EU investor challenging an EU measure, should have brought its case before EU courts.

The Arbitral Tribunal rejected Electrabel’s expropriation claim. The Tribunal found that Electrabel needed to establish that its investment had lost all significant economic value as a result of the PPA’s early termination. The Tribunal held that Electrabel had not met its burden of proof, as it had failed to show that Hungary’s termination of the PPA had either substantially deprived Electrabel of its rights in connection with its investment or destroyed its investment altogether.

The Tribunal also denied that Hungary’s early termination of the PPA had breached any of the ECT’s standards of protection, including the right to fair and equitable treatment. Electrabel had argued that, by failing to seek an exemption from EU law in relation to Dunamenti’s PPA in its EU Accession Treaty and by failing to notify existing State aid to the Commission, Hungary had failed, in breach of the ECT, to take timely and reasonable steps to protect Electrabel and its investment in Dunamenti before the Commission’s Final Decision. The Tribunal rejected Electrabel’s claim, finding that it had adduced no evidence establishing that Hungary had acted unfairly towards Dunamenti or Electrabel in its dealings with the Commission before or after its accession to the EU. The Tribunal also considered that Hungary could not be found liable under the ECT for terminating the PPA since it was required to do so pursuant to the Final Decision. The Tribunal nevertheless reserved for a later stage any decision as to whether Hungary’s compensation scheme breached Electrabel’s right to fair and equitable treatment under the ECT.

Comment

The Arbitral Tribunal’s acceptance of jurisdiction over the dispute appears to confirm that investment treaty tribunals are unlikely to refuse jurisdiction in a dispute involving two EU Member States simply on the basis of EU law-related arguments (see Threats to Investment Protection in the EU Energy Sector). The Tribunal’s decision on jurisdiction in this case should thus be welcome news for investors contemplating a claim against an EU Member State under the ECT.

The Tribunal noted, however, that if the ECT and EU law were incompatible, notwithstanding all efforts at harmonization, EU law would prevail over the ECT’s substantive protections (i.e., EU law, and not the ECT, would apply between EU members; the ECT would remain applicable in relations between EU Members and non-EU Members). In such circumstances, investors would be deprived of investment protection rights that they are afforded under the ECT but not under EU law to the extent that such rights conflict with EU law.

Perhaps a greater concern for investors may be the Tribunal’s findings concerning the compatibility of the ECT and EU law. The Tribunal found that the ECT and EU law had one identical objective, namely the fight against anti-competitive behavior or State aid. As such, it reasoned that foreign investors in EU Member States cannot have acquired any legitimate expectations that the ECT would necessarily shield their investments from the effects of EU law regarding anti-competitive conduct.

Legitimate expectations, broadly defined as the basic expectations on the basis of which investors decide to invest (such as due process, or consistency and transparency in the functioning of public authorities), has long been viewed in international investment law as an element of the fair and equitable treatment standard, which is enshrined in the ECT and in most, if not all, BITs, including intra-EU BITs.

As noted above, the Tribunal concluded that to the extent that the Commission’s Final Decision required Hungary, under EU law, to terminate prematurely Dunamenti’s PPA, the Commission’s “act” could not give rise to liability for Hungary under the ECT. The Decision may thus be interpreted to mean that an investor whose ECT-protected investment in an EU Member State was affected by an adverse regulatory change may no longer be able to obtain compensation on the basis that his or her legitimate expectations were breached, where that change was required by EU law.

One interesting question raised by the Tribunal is whether Electrabel should have instituted proceedings against the EU in addition to or in the alternative to Hungary. Throughout the Decision, the Arbitral Tribunal repeatedly noted that Electrabel had not impugned the validity of the Commission’s Final Decision, nor had Electrabel attacked any act of the Commission by alleging that the EU was liable. The Tribunal added that it would be absurd for Hungary to be liable under the ECT for doing precisely that which it was ordered to do by a supranational authority whose decisions the ECT itself recognizes as legally binding on Hungary.

The Tribunal thus raises the possibility that an investor may initiate arbitration proceedings against the EU under the ECT (the EU is a contracting party to the ECT) in circumstances where a measure ordered by the Commission and enforced by a Member State has adversely affected that investor’s protected investment. While it is unclear at this stage whether suing the EU on its own would be sufficient, investors should certainly consider the possibility of pursuing both the EU Member State and the EU where a contested action of an EU Member State is linked to an EU measure on the basis that the measure and consequent action form a composite act giving rise to an ECT claim. However, this is a novel strategy that needs to be carefully considered on a case-by-case basis. Such a course of action, for instance, would not be possible where the proceedings were conducted under the ICSID Convention, since the EU is not a party to the Convention.

Conclusion

In light of the growing importance that is being placed on the relationship between EU law and intra-EU investment arbitration in the context of newly-joining EU Member States, investors would be well advised to monitor further developments affecting investments protected by the ECT and intra-EU BITs and any potential EU law threats they may face.


 Cedric Soule
 Paris
 +33 1 7300 3931

 csoule@kslaw.com
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