Shearman And Sterling

European Commission

September 13, 2021

EU Court Undercuts Investment Protections in the Energy Charter Treaty for Intra-EU Investors

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EU COURT UNDERCUTS INVESTMENT PROTECTIONS IN THE ENERGY CHARTER TREATY FOR INTRA-EU INVESTORS

Judgment of the Court of Justice of the European Union in Moldova v. Komstroy

Overview and Key Takeaways

On September 2, 2021, the Court of Justice of the European Union delivered a judgment in Republic of Moldova v Komstroy LLC (C-741/19) which held that Article 26(2)(c) of the Energy Charter Treaty is incompatible with European Union law insofar as it provides for investment arbitration proceedings between a Member State and an investor of another Member State.

The CJEU’s judgment in Komstroy is only the latest measure in the EU’s recent efforts to reform investor-State dispute settlement within the EU. In broad terms, the EU institutions consider that intra-EU investment treaties undermine the European legal order and discriminate among European investors within the internal market. As such, the EU’s goal appears to be to clear the internal market of intra-EU investment treaties and to regulate the protection of investments through Member States’ courts or, potentially, a new permanent EU investment court.

The ECT—an international investment agreement that establishes a multilateral framework for investment protection in relation to the energy industry, including in Europe—is the latest investment treaty to come under fire. The ECT was signed in December 1994 and entered into force in April 1998. There are current 53 Contracting Parties to the ECT, including both the EU and Euratom. It therefore operates both as an international investment treaty and, in the view of EU courts and agencies, as part of EU law. As of late last year, the ECT had been relied upon no less than 83 times by intra-EU investors.

The Komstroy decision, much like the earlier Achmea decision (see below), is problematic. In asserting its position as final arbiter of any and all legal decision-making processes which might raise questions of EU law, the CJEU has concluded that even intra-EU investment arbitrations which do not call into question any substantive application or interpretation of EU law are incompatible with the EU treaties. In many such arbitrations, EU law will not be implicated, but the mere theoretical possibility that EU law could apply is sufficient to prohibit them from proceeding. Yet, at the same time, the CJEU still allows commercial arbitrations between EU Member States and EU investors pursuant to commercial contracts—even if these do implicate EU law. The result is a clumsy patchwork of national and international law rights for EU-based investors.

The key takeaways for investors from the Komstroy judgment are as follows:

  • EU institutions will oppose any arbitral awards—both under the ECT and intra-EU bilateral investment treaties—that do not accord supremacy to EU law. This is so even if such opposition places an EU Member State in breach of its other public international law obligations under those treaties.
  • Investors from within the EU should take great care before relying on the ECT or BIT protections when investing in another EU Member State. Member States may rely on Komstroy to have claims by EU investors under the ECT dismissed or set aside or to resist the enforcement of any resulting award.
  • Intra-EU investments in the energy sector now carry a heightened degree of risk. Potential investors may be able to mitigate this risk by structuring their investments via non-EU Member States (such as the United Kingdom, Switzerland or United States).
  • Alternatively, intra-EU investors may be able to mitigate some of their risk by bringing any arbitration proceedings under the ICSID Convention, which operates as a self-contained legal system. However, this will not eliminate all risk involved.
  • In either case, intra-EU investors with existing or planned investments should identify whether the Member State in which they are considering an investment has assets outside the EU, where enforcement of an arbitral award is less likely to be resisted on EU law grounds.

Background

Over the last half century, there has been a significant increase in foreign direct investment, as governments around the world have embraced globalisation and economic liberalisation by encouraging foreign companies to invest in their economies. At the same time, there has been a proliferation of bilateral and multilateral investment treaties entered into between sovereign States, under which host governments enter into international law obligations for the protection of foreign investors and their investments.

Under such treaties, the protections afforded to investors are independent, international law rights which are additional to any rights they may have under national law. Crucially, host States cannot unilaterally undermine these international law rights by changing their national law. Furthermore, by entering into investment treaties, host States typically bind themselves to resolve disputes with investors through international arbitration, rather than in a domestic court.

Recently, the primacy of investment treaty obligations within the EU has been increasingly undermined by the European Commission and the CJEU, which regard EU law as supreme. The Commission and CJEU take the view that legal obligations owed to EU investors by Member States under BITs between Member States (so-called “intra-EU BITs”) should be subordinate to applicable EU rules, and have issued a number of decisions that undermine the effectiveness of intra-EU BITs.

The first significant decision came in 2018, when the CJEU in Slovak Republic v. Achmea (C-284/16) held that the Treaty on the Functioning of the European Union precludes provisions in intra-EU BITs providing for arbitration between a Member State and an investor of another Member State. The CJEU’s reasoning was that a reference to arbitration between disputants of two Member States 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,” because arbitral tribunals constituted under BITs—intra-EU or otherwise—do not operate within the judicial system of the EU and cannot use the preliminary ruling procedure provided for in Article 267 TFEU. As such, the EU would have no means of ensuring an accurate and consistent application of EU laws.

The CJEU’s decision in Achmea cast serious doubt on the status and effect of the 196 intra-EU BITs in force at the time. Shortly thereafter, on May 5, 2020, 23 of the EU Member States (excluding Austria, Finland, Ireland and Sweden) signed an agreement to terminate their intra-EU BITs (the “Termination Treaty”).

The CJEU in Achmea was careful to distinguish between intra-EU BITs and the ECT, to which the EU was itself a signatory. However, a second significant step towards the CJEU’s decision in Komstroy was taken by the Commission earlier this year.

As we highlighted in our prior briefing on this topic, the Commission took aim at an ICSID arbitration award rendered against Spain in Antin Infrastructure Services Luxembourg S.à.r.l. and Antin Energia Termosolar B.V. v. Kingdom of Spain, in which Spain had been ordered to pay EU-based investor Antin more than €100 million in damages for breaches of the fair and equitable treatment provision at Article 10(1) of the ECT. Following an unsuccessful attempt by Spain to annul the award, the Commission expressed its view that: (i) payment of the award would fall foul of the EU’s State aid rules; and (ii) the Achmea judgment precludes the intra-EU application of the investor State arbitration provisions in the ECT, despite the distinctions drawn by the CJEU in Achmea. The Commission has since taken steps to prevent payment of the award by intervening in various enforcement proceedings brought by Antin against Spain.

The Judgment in Komstroy

The CJEU’s judgment in Komstroy originated from a proceeding before the Paris Court of Appeal to set aside an ECT award rendered in Energoalians (now Komstroy) v Republic of Moldova. The award itself related to the sale of electricity by Energoalians, a Ukrainian entity, to a State-owned entity in Moldova back in the 1990s.

The Paris Court of Appeal requested a preliminary ruling from the CJEU under Article 267 TFEU on the question of whether the term “investments” in the ECT covered credits arising in the context of commercial transactions. The CJEU engaged in a relatively brief analysis of the ECT to conclude that the term “investments” did not cover such credits, pointing in particular to a distinction in the ECT between “investments” and “trade”.

Neither Moldova nor Komstroy, nor indeed the Paris Court of Appeal, asked the CJEU to consider the status or application of the ECT to intra-EU disputes. This was not surprising, as the dispute was not an intra-EU dispute—neither Ukraine nor Moldova is an EU Member State. However, the Commission and several Member States nevertheless requested a ruling on the compatibility of the ECT arbitration provision with intra-EU disputes.

The CJEU obliged (despite the Council of the European Union, and the Swedish, Finnish and Hungarian governments, arguing that the CJEU did not have jurisdiction over the dispute). The CJEU asserted jurisdiction on the basis that: (i) the ECT forms “an integral part” of the EU’s legal order in which the CJEU has a fundamental interest; and (ii) the parties chose their arbitral seat as France, an EU Member State.

In considering the compatibility of the ECT arbitration mechanism with intra-EU disputes, the CJEU ignored the distinction which had been drawn in Achmea between BITs entered into by individual Member States and the multilateral ECT to which the EU was itself a party. Instead, the CJEU repeated and extended its previous reasoning in Achmea to the ECT, concluding that intra-EU investment arbitrations under the ECT are incompatible with EU law.

The CJEU pointed to the following factors, which had also largely been relied upon in Achmea:

  • An arbitral tribunal constituted under the ECT is required to interpret and apply the ECT, which forms part of EU law.
  • However, an arbitral tribunal constituted under the ECT cannot be considered a court or tribunal of a Member State. An arbitral tribunal would therefore not be entitled to make a reference to the CJEU for a preliminary ruling on the meaning of a provision of EU law under Article 267 TFEU (as the Paris Court of Appeal had done).
  • An arbitral tribunal constituted under the ECT would therefore not be able to ensure the effectiveness of EU rules, nor ensure the preservation of the autonomy and particular nature of the law established in the EU treaties.
  • Furthermore, any decisions rendered by such an arbitral tribunal would only be subject to limited grounds of annulment by a court of a Member State, further reducing any opportunity for oversight by the EU.

The CJEU’s analysis is problematic in several respects, not least in the apparent distinctions it draws between different types of disputes.

For example, the CJEU drew a clear distinction between the obligations that an EU Member State may owe to investors of a non-EU Member State, and those of an EU Member State under the same treaty provisions. In the CJEU’s own words, “although the ECT may require Member States to comply with the arbitral mechanisms for which it provides in their relations with investors from third States who are also Contracting Parties to that treaty as regards investments made by the latter in those Member States, preservation of the autonomy and of the particular nature of EU law precludes the same obligations under the ECT from being imposed on Member States as between themselves.” As a matter of law and logic, it is difficult to grasp how a Member State can have intended, when entering into such treaties, fundamentally different protections for different investors under identical treaty provisions.

Similarly, the CJEU confirmed an awkward distinction—first drawn in Achmea—between investment arbitration proceedings (under the ECT or otherwise) and commercial arbitration. Whereas the CJEU was not prepared to accept a limited review of investment treaty awards by EU courts, the CJEU was prepared to accept the same limited review of commercial arbitration awards based on the “requirements of efficient arbitration” and a flawed distinction between commercial arbitrations, which “originate in the freely expressed wishes of the parties concerned,” and investment arbitrations, which (it appears from the CJEU’s reasoning) do not. The effect is that intra-EU commercial arbitrations which involve Member States or their state-owned entities are unaffected by the CJEU’s decisions in Achmea and Komstroy.

The Impact of Komstroy on Pending or Completed Claims

EU-based investors will now face greater legal hurdles when bringing ECT claims and enforcing ECT awards against Member States. Member States involved in pending arbitrations concerning the ECT will likely rely on the decision in Komstroy to avoid potentially liability to investors.

These objections could be raised at two stages:

  • First, during an arbitration itself, through objections to the jurisdiction of an arbitral tribunal constituted under the ECT; and/or
  • Second, following the conclusion of an arbitration, either through an application by an EU Member State for the setting aside of an award or by resisting enforcement of the award.

The degree of impact of the Komstroy judgment at these stages will likely depend on the discernible links to the EU—either through the seat of the arbitration or the location of the court in which enforcement is sought.

On the question of jurisdiction, EU investors can cautiously retain some confidence that arbitral tribunals constituted under the ECT will rule in favour of their own jurisdiction. Following the Achmea judgment, which, as noted, was decided on similar grounds as Komstroy, almost all arbitral tribunals constituted under intra-EU BITs have held that EU law does not deprive them of jurisdiction.

With respect to annulment, if an arbitration brought by an EU-based investor is seated somewhere within the EU, this may open the door to potential setting aside proceedings based on the decision in Komstroy. EU-based investors considering claims under the ECT would be well-advised to consider bringing any claims through ICSID arbitration, which operates as an independent and self-standing legal system without any arbitral seat (subject to enforcement risks, see below).

As to enforcement, the national courts of EU Member States have a duty of sincere cooperation under Article 4(3) TFEU to facilitate the achievement of the EU’s tasks and to refrain from taking measures which could jeopardise the EU’s objectives. Where enforcement is sought in a Member State’s courts, they may be reluctant to take action, which contravenes the decisions of the CJEU and Commission (particularly where the Commission has shown a readiness to intervene in enforcement proceedings).

Enforcement problems may even arise in Member State courts for intra-EU awards rendered under the ICSID regime. Whilst Article 54(4) of the ICSID Convention places an obligation on its contracting States to recognise and enforce an arbitral award rendered pursuant to the ICSID Convention as if it were a judgment of its own court, a Member State’s court asked to enforce an award could conclude that its EU law obligation to refuse enforcement overrides its ICSID Convention obligation. In this context, EU investors should consider as early as possible (and ideally before bringing a claim) whether a Member State has assets outside the EU against which an award can be enforced.

Next Steps for EU-Based Investors Considering or Reviewing Investments in the EU

EU investors considering or reviewing their investments in other EU Member States, whether in the energy sector or otherwise, should reflect on their current investment protection coverage, and consider taking steps to maximise their ability to obtain and enforce an arbitral award in the event of action by an EU Member State adversely affecting the value of such investments.

Given the significant legal hurdles involved with intra-EU arbitrations under the ECT, and the risk that the scope of the Termination Treaty might be expanded to incorporate the ECT, judicious steps might include:

  • Structuring (or restructuring) an investment through a non-EU jurisdiction which benefits from the protections of extra-EU BITs signed between the subsidiary’s State of incorporation and the EU Member State;
  • Interposing one or more subsidiaries based outside the EU in their investment structure, with a view to avoiding the characterisation of any claim as an intra-EU claim; and/or
  • Where feasible, entering into bespoke contractual arrangements with EU Member States that include specific agreements to arbitrate disputes outside of the EU, with arbitral seats outside the EU.

Where extensive restructuring of an investment is not practicable, EU investors should—at a minimum—identify whether the Member State in which they are considering an investment has assets outside the EU against which enforcement could be sought.

Authors and Contributors

Garreth Wong

Partner

International Arbitration

+44 20 7655 5879

+44 20 7655 5879

London

Alex Bevan

Partner

International Arbitration

+971 2 410 8121

+971 2 410 8121

+971 4 249 2100

+971 4 249 2100

Abu Dhabi

Jennifer Younan

Partner

International Arbitration

+33 1 53 89 48 04

+33 1 53 89 48 04

Paris

Christopher M. Ryan

Partner

International Arbitration

+1 202 508 8098

+1 202 508 8098

Washington DC

Nils Eliasson

Partner

International Arbitration

+852 2978 8005

+852 2978 8005

+86 186 1420 1488

+86 186 1420 1488

Hong Kong

Emmanuel Jacomy

Partner

International Arbitration

+65 6230 8957

+65 6230 8957

+86 10 5922 8000

+86 10 5922 8000

Singapore

Alastair Livesey

Senior Associate

International Arbitration

+44 20 7655 5530

+44 20 7655 5530

London