Five-Year Long Consultations on Modernization of the Energy Charter Treaty Conclude with Agreement in Principle

Dechert LLP

On June 24, 2022, the Contracting Parties to the Energy Charter Treaty (“ECT” or “Treaty”) reached an Agreement in Principle on the Modernization of the ECT (“Modernization Agreement”). Once approved at the Energy Charter Conference in November 2022, the Modernization Agreement will introduce major changes to the current framework for the protection of investments in the energy sector.

Key Takeaways

  • The Modernization Agreement introduces far-reaching amendments to the ECT’s current investment protection regime.
  • The modernized ECT will:
    • Broaden the scope of investment protection to cover additional clean sources of energy;
    • Emphasize and strengthen the State’s right to regulate;
    • Reaffirm the rights and obligations of the ECT’s Contracting Parties under multilateral environmental and labor agreements; and
    • Introduce new provisions on sustainable development and corporate social responsibility.
  • The modernized ECT will have a particular impact on European investors and investments in Europe:
    • With limited exceptions, fossil fuel investments will not enjoy investment protection in the European Union and the United Kingdom; and
    • Investors from an EU Member State will not be able to resort to international arbitration against another EU Member State.

Dynamic Scope of Coverage

The Modernization Agreement revises the ECT’s basic building blocks.

Protected investors. The modernized ECT will protect only investors with substantial business activities in the host State, as measured against an indicative list (e.g., physical presence, employment of staff, turnover generation, or payment of taxes in the host State). In addition, individuals who are nationals or permanent residents of the host State at the time they make their investment will not be protected under the modernized ECT.

Protected investments. Investment protection will extend to new sources of clean energy, such as hydrogen, anhydrous ammonia, biomass, biogas and synthetic fuels, as well as new activities in the energy sector, such as the capture, use and storage of carbon dioxide for purposes of decarbonization. Conversely, investments that are not made or acquired in accordance with the host State’s laws or do not exhibit certain characteristics (e.g., a commitment of capital, risk, and a certain duration) will be disqualified from protection under the modernized ECT.

Fossil fuel carve-out. A “flexibility mechanism” permits the ECT’s Contracting Parties to opt out of investment protection for fossil fuels based on their specific energy security and climate goals. New investments may be excluded if made after August 15, 2023, and existing investments 10 years from the entry into force of the modernized ECT. The European Union and the United Kingdom have already excluded both new and existing fossil fuel investments from protection.

Denial of benefits. The ECT’s Contracting Parties will be permitted to deny the benefits of the ECT, without advance formal notification and even after the commencement of an arbitral proceeding, including for the protection of human rights.

Exclusion of Intra-EU Disputes

The modernized ECT will not be applicable among EU Member States. Accordingly, EU investors will not be able to resort to international arbitration against an EU Member State.

More Legal Certainty, but More Restrictive Substantive Protections

The Modernization Agreement provides for detailed clarifications and guidance on the substantive protections offered by the ECT.

Substantive protections. In the case of the fair and equitable treatment standard and the prohibition on expropriation, new provisions will include a list designating the measures that constitute a violation of the respective standards. Non-discriminatory measures adopted to protect legitimate policy objectives, including to mitigate climate change, will not constitute indirect expropriation. In the case of other protections, such as full protection and security or most-favored-nation treatment, the modernized ECT will codify a restrictive interpretation commonly adopted by investment treaty tribunals.

The State’s right to regulate. Additional wording in the preamble and throughout the Treaty will be introduced to emphasize and strengthen the State’s right to regulate. In addition, the modernized ECT will reaffirm the respective rights and obligations of the ECT’s Contracting Parties under multilateral environmental and labor agreements, such as the UN Framework Convention on Climate Change, the Paris Agreement and ILO conventions. New provisions on sustainable development and corporate social responsibility will clarify and strengthen existing provisions on environmental impact assessment of energy investment projects.

Valuation of damages. A new provision will provide guidance on the valuation of damages, which must be limited to the loss actually suffered by the investor and exclude punitive damages.

Greater Transparency, Early and Expedited Dismissal of Claims, and Inter-State Dispute Settlement Mechanism for Sustainable Development Disputes

The Modernization Agreement provides for a number of procedural innovations.

Transparency. The modernized ECT will incorporate the 2014 UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration, require disclosure of third-party funding, and introduce specific transparency obligations (e.g., publicly accessible procedural documents and hearings) in the context of arbitrations between Contracting Parties.

Expedited Proceedings. The modernized ECT will also include new procedures aimed at reducing the duration of arbitral proceedings, namely dismissal of claims that are manifestly without legal merit at the outset of the proceedings, as well as expedited dismissal of claims that are manifestly unfounded on the merits or submitted as a result of a restructuring for the sole purpose of bringing a claim under the Treaty.

Inter-State dispute settlement of sustainable development disputes. The modernized ECT will provide for a settlement mechanism for disputes between the Contracting Parties regarding the interpretation and application of the new provisions on sustainable development.

Implications for Investors and Investments

Upon approval of the Modernization Agreement at the Energy Charter Conference in November 2022, the modernized ECT will enter into force within 90 days of ratification by three-fourths of the ECT’s 53 Contracting Parties.

In seeking to accommodate the environmental and climate change priorities of the Contracting Parties, the modernized ECT seeks to adapt a leading multilateral treaty to the reality of the climate emergency. The modernized ECT will leave investment tribunals with considerably less discretion in the interpretation of the substantive protections offered by the Treaty. However, increased legal certainty comes at the expense of more restrictive investment protection.

In view of the exclusion of all intra-EU disputes and the exclusion by the European Union and the United Kingdom of new fossil fuel investments from August 15, 2023, and existing fossil fuel investments within 10 years, the ECT will redefine the landscape for the protection of investments in the European energy sector.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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