Ground-breaking referral: Are arbitration clauses in BITs between EU Member States void?

by Reed Smith

In recent years, the number and economic relevance of bilateral investment treaties (“BITs”) has significantly increased. BITs are international treaties which provide for assurances in favour of investors from the contracting states, such as freedom from expropriation and for fair and equitable treatment. Another important feature of BITs is that they usually provide for disputes to be resolved by way of arbitration. Investment disputes can come more into the public spotlight if and when a contracting state or investor asks a state court to quash a final award.

One such case recently caused a stir, because the respondent, Slovakia (the Slovak Republic), resorted to an innovative line of reasoning under EU law. Slovakia sought to avoid liability for damages to the tune of € 22 million by arguing that the arbitration clause in the BIT at issue is incompatible with EU law and thus void. In an as yet unpublished decision of 3 March 2015, which is summarised in an official press release of 10 May 2016, the German Federal Supreme Court highlights that there is no established case-law and so the European Court of Justice (“CJEU”) in Luxemburg will have to provide guidance.

The underlying investment dispute Czechoslovakia and the Netherlands concluded a BIT in 1992. Only a few months later the two constituent parts of Czechoslovakia went their separate ways. Slovakia, one of the legal successors and the respondent in the arbitration proceedings at issue, became an EU Member State in 2004.

In that same year, Slovakia decided to de-regulate the insurance sector. This motivated a Dutch insurance company to set up a subsidiary in Slovakia and start doing business in the country. However, following a change of government Slovakia made a U-turn in 2006 and introduced several pieces of legislation that provided for strict regulation of the insurance sector. Under the new legal regime, it was not permissible to retain the services of policy brokers, to distribute profits or to sell insurance policy portfolios. Eventually the constitutional court held that the ban on distributing profits was illegal. Slovakia accordingly amended its laws in 2011.

The applicant Dutch company brought arbitration proceedings against Slovakia. It argued that Slovakia was in breach of the guarantee of fair and equitable treatment. Further, under the BIT, it argued that Slovakia was obliged to allow a distribution of profits. As a result of the regulations imposed on the insurance sector the applicant contended that it had suffered significant losses. In its reply, Slovakia argued that the arbitral tribunal lacked jurisdiction. The arbitration clause in the BIT at hand was allegedly incompatible with EU law and therefore void. The tribunal, however, took the view that it had jurisdiction, and it awarded the applicant damages of more than € 22 million.

Implications of EU law Slovakia did not accept that decision and initiated proceedings before the Higher Regional Court of Frankfurt asking it to quash the arbitral award. When the Frankfurt judges refused to do this, the respondent filed an appeal. So the German case is currently pending before the Federal Supreme Court in Karlsruhe (I ZB 2/15).

In its press release of 10 May 2016, the Federal Supreme Court highlighted that this is the first known case relating to a BIT between two EU Member States. According to the doctrine of dominance of EU law, if there is a collision between provisions in an international treaty between Member States and EU law the latter will prevail. However, there is no established case-law regarding the specific arguments raised by the respondent Slovakia. Accordingly, the Federal Supreme Court referred the case to the CJEU asking for guidance on whether the arbitration clause in the BIT is void.

The line of reasoning of Slovakia is three-fold. First, it argues that the arbitration clause is not compatible with Art. 344 of the Treaty on the Functioning of the EU (“TFEU”). That article reads as follows: “Member States undertake not to submit a dispute concerning the interpretation or application of the Treaties to any method of settlement other than those provided for therein”. The Federal Supreme Court takes the view that Art. 344 is not relevant in the current circumstances. That is because the EU Treaties do not provide for proceedings in which an investor from a Member State may bring damages claims against another Member State. Hence Art. 344 TFEU does not bar contracting Member States from providing for alternative dispute resolution in a BIT.

Slovakia’s second argument is under Art. 267 TFEU according to which the CJEU is entrusted with the task of safeguarding the uniform interpretation of EU law by issuing preliminary rulings. According to Slovakia, the CJEU cannot fulfil its task if an investment dispute is decided by an arbitral tribunal which cannot refer the case to the CJEU. Slovakia did, however, concede that it was possible to ask a state court to quash a final award and that the state court could then refer the case to Luxembourg. The obvious counter argument is that the review of the final award by a state court will be limited to violations of the ordre public, i.e. particularly important principles of law. In its press release, the Federal Supreme Court indicates that the possible review of final awards by state courts (and, in effect, the CJEU) may nonetheless be sufficient to safeguard the uniform interpretation of EU law.

The third argument raised by Slovakia relates to Art. 18 TFEU, which prohibits any discrimination on the ground of nationality. If a BIT between two Member States provides that only investors from the contracting Member States may bring arbitration proceedings against the other contracting state, this arguably has a discriminatory effect. That is because the BIT only confers advantages on investors from the contracting states, none of the other Member States. The wording of the press release of the Federal Supreme Court is cautious. The Karlsruhe judges tentatively indicated that there may be a way to avoid discrimination in terms of Art. 18 TFEU. It might be possible to bring the arbitration clause in line with EU law by giving it an extremely broad interpretation. According to that broad interpretation, the arbitration clause does not only allow investors from the Netherlands but investors from any Member State to bring investment disputes against Slovakia. From a German perspective, it is conceivable to “interpret” clauses against their literal meaning so as to safeguard compliance with EU law. Judges from other Member States, such as the UK, are much less inclined to do this. It remains to be seen whether the CJEU is prepared to accept this solution.

Outlook and implications The referral of the Federal Supreme Court has potentially significant implications for parties to BITs. For the first time the CJEU will have an opportunity to decide whether, and under which circumstances, EU Member States can conclude BITs that include a standard arbitration clause. The line of reasoning of Slovakia in the underlying investment dispute is innovative and it throws up several important issues under EU law. In particular, the risk of discriminating investors from non-contracting EU Member States cannot be ignored. Whether the CJEU will concur with the views of the German judges is far from clear. It may take up to two years to receive answers from the Luxembourg court.

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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