Withdrawals from the Energy Charter Treaty — Is Your Renewable Energy Investment Protected?

On 22 November 2022, after five years of negotiations, the Contracting Parties to the Energy Charter Treaty (“ECT” or “Treaty”) are scheduled to vote on the amended and “modernized” ECT text. The ECT is a multilateral treaty that has been protecting investments in the energy sector for over two decades. Several European countries, however, have announced their intention to leave the ECT altogether. Will the ECT “modernization” and withdrawal of its Contracting Parties affect your renewable energy investment?

If you structured your energy investments through the ECT Contracting Parties, including the countries that have announced their intention to withdraw (currently Belgium, France, Germany, the Netherlands, Poland, Slovenia, and Spain), the time is ripe to revisit your risks and ensure protection of your investments abroad. Careful (re)structuring of your investments in view of the existing international investment protections is a prudent investment practice.

The Energy Charter Treaty & Its Current Guarantees

The ECT is a multilateral treaty that over fifty countries have signed and ratified since 1994. The Treaty entered into force in 1998 and its current membership covers Europe, Turkey, Central Asia and Japan. The Treaty protects from unlawful expropriation, discrimination, unfair and inequitable treatment and provides most constant protection and security to qualifying investors and their investments in the energy sector of the ECT Contracting Parties.

An aggrieved qualifying investor who suffers losses from unlawful conduct of an ECT Contracting Party may bring an international arbitration claim against its host State under the ECT. An independent international arbitral tribunal presides over investment disputes under the ECT and may award compensation to qualifying investors if the host State is ultimately found liable for violation of the ECT.

The Protection of Renewable Investments Under the Energy Charter Treaty

Approximately 60% of ECT claims against States concern renewable energy investments. Investors have used the ECT to protect their investments from unlawful alternations of the regulatory regimes affecting their renewable energy investments in the ECT Contracting Parties. Spain, Italy, and the Czech Republic so far have been the most frequent respondents in the ECT disputes that challenge the amendments to the respective renewable energy incentive schemes.

Modernization of the Energy Charter Treaty & Withdrawals

The ECT currently protects qualifying energy investors and their investments indiscriminately. As a result, renewable energy investors are covered by the ECT alongside fossil fuel investors. After several fossil fuel companies sued or threatened to sue the ECT Contracting Parties over their climate-change regulations introducing a gradual phaseout of fossil fuels, the ECT membership called for the Treaty’s “modernization”. In June 2022, the Contracting Parties reached an agreement in principle to revise the Treaty in line with their global climate change agenda and related international commitments.

The amended text of the ECT is expected to be adopted on 22 November 2022. The text would come into force 90 days after ratification by three-fourths of the Contracting Parties. In the event the amended text is adopted, it is expected to enter into force on 22 November 2025.

Fossil fuel phaseout

The revised ECT would allow individual Contracting Parties to gradually phase out fossil fuels. The phaseout “flexibility mechanism” excludes new fossil fuel investments (with a few exceptions for low carbon investments) made after 15 August 2023 from the scope of the ECT protections in the Contracting Parties that would select the mechanism. Existing fossil fuel investments made prior to 15 August 2023 are expected to enjoy the ECT protections for 10 years after the amended text would enter into force, i.e., until 22 November 2035 but in any event no later than 31 December 2040.

The modernized ECT clarifies that it covers investments in energy transition technologies, such as the “capture, utilization and storage of carbon dioxide” to decarbonize the energy systems. Further, the sale of energy materials and products that are protected under the ECT is clarified to include renewable or low-carbon energy sources such as hydrogen, anhydrous ammonia, biomass, biogas, and synthetic fuels. The modernized ECT also introduces a regular five-year review that allows the Contracting Parties to amend the list of energy materials and products covered under the ECT.

Definition of “investor” and “investment”

Moreover, the amended text would require “investors” to satisfy the “substantial business activities” test, including demonstration of “physical presence, employment of staff, turnover generation or payment of taxes” in the host State. Nationals or “permanent residents” of the host State at the time of making an investment (including dual nationals) would be excluded from the definition of “investor”. Qualifying “investment” would be expected to possess “indicative list of characteristics” similar to a commonly known Salini test, including “the commitment of capital or other resources, the expectation of gain or profit, a certain duration or the assumption of risk.”

No intra-EU arbitration

The modernized ECT would not apply among member States that belong to the same Regional Economic Integration Organization, such as the European Union (“EU”). The EU member States are expected to conclude an agreement that would include “a confirmation that the ECT has never, does not and will not apply intra-EU, that the ECT cannot serve as a basis for intra-EU arbitration proceedings, and that the sunset clause does not apply intra-EU”.

Substantive protections

The modernized ECT would continue protecting investors from unlawful expropriation and would accord investments of qualifying investors fair and equitable treatment standard and full protection and security. The Contracting Parties, however, ensured that the provided protections are more granularly defined.

The standard of most contract protection and security would be replaced with “full protection and security”, which refers to “physical security” of the investors and their investments. The most favoured nation clause would explicitly exclude importation of either more favorable dispute resolution provisions or substantive protections from third treaties.

Fair and equitable treatment standard would refer to measures that constitute:

“(i) arbitrariness, such as blatant unreasonableness;

(ii) targeted discrimination on wrongful grounds, such as, gender, race or religious belief;

(iii) fundamental breach of due process, including a fundamental breach of transparency in judicial and administrative proceedings;

(iv) denial of justice in criminal, civil or administrative adjudicatory proceedings;

(v) abusive treatment such as harassment, duress or coercion; or

(vi) frustration of an Investor’s legitimate expectations where these were central to its Investment, and arose from a clear and specific representation or commitment by that Contracting Party upon which the Investor reasonably relied in deciding to make or maintain the Investment.”

Moreover, the amended text clarifies that the term “legitimate expectations” does not cover “general expectations, such as an expectation (in the absence of clear and specific representations or commitments to that effect) that a Contracting Party’s legal or regulatory framework will not change”. Assessment of representations requires a “case-by-case, fact-based inquiry that considers, among other factors, laws and regulations and the Contracting Party’s relevant publicly known policies and their objectives”.

Further, the amended text clarifies that indirect expropriation, to be considered unlawful, must “substantially deprive[] the Investor of the value of its Investment or of the fundamental attributes of property in its Investment, including the right to use, enjoy and dispose of its Investment”. The factors that may be considered in the assessment of an expropriatory measure include:

“(a) the economic impact of the measure or series of measures, although the sole fact that a measure or series of measures of a Contracting Party has an adverse effect on the economic value of an Investment does not establish that an indirect expropriation has occurred.

(b) the character of the measure or series of measures, including its objective and context.”

The amended ECT would address potentially frivolous claims, providing for a mechanism for early dismissal of claims that are manifestly “without legal merit”. It also explicitly precludes abusive restructuring of an investment with the sole purpose of gaining jurisdiction and at the time when the dispute arises or becomes “foreseeable on the basis of a high degree of probability”. Moreover, consistent with the most recent edition of the ICSID Arbitration Rules, the amended ECT text requires disclosure of third-party funding.

Overall, substantive protections and procedural provisions reflected in the amended text are consistent with the language of other modern investment agreements.

Intention to withdraw

Despite the efforts to amend the Treaty in line with the Contracting Parties’ climate policy concerns, several countries have announced their intention to withdraw (or consideration of withdrawal) from the Treaty altogether. At the moment such countries include Belgium, France, Germany, the Netherlands, Poland, Slovenia, and Spain. Italy withdrew from the ECT on 1 January 2016. The Contracting Parties preparing to leave the Treaty may also decide to ratify the Treaty’s modernized text first and withdraw later.

Switzerland has confirmed its intention to ratify the modernized text later this month. Aside from the countries mentioned above, other Contracting Parties have not announced their intention to either phase out fossil fuel or withdraw. The EU and the UK intend to subscribe to the fossil fuel “flexibility mechanism”. Fossil fuel investments by investors from the EU and the UK are expected to continue enjoying ECT protections in the Contracting Parties that decide not to invoke the “flexibility mechanism”.

Further, the ECT Secretariat has opined that the Contracting Parties are permitted to terminate or withdraw from a treaty due to the unforeseen “fundamental changes of circumstances” in accordance with “a well-established rule under customary international law” enshrined in Article 62(1) of the Vienna Convention of the Law of Treaties. The unforeseen “fundamental changes of circumstances”, opined the Secretariat, require (i) a showing of the changed circumstances that were “essential” for the decision to enter into the treaty, and (ii) a demonstration of a “radically” transformed obligations that the changes of circumstances brough about that render further implementation of the treaty unduly burdensome. The test articulated by the ECT Secretariat would be relatively hard for the Contracting Parties to meet.

Implications of Withdrawal for Renewable Energy Investments

Qualifying renewable energy investors who have already made their investments through or in the Contracting Parties that intend to withdraw from the ECT (currently Belgium, France, Germany, the Netherlands, Poland, Slovenia, and Spain) are expected to enjoy ECT protections for 20 years after the respective Contracting Party withdraws from the Treaty. This 20-year term is established in the sunset clause of the ECT, Article 47(3).

Moreover, any withdrawal from the ECT takes effect one year after the ECT Depositary receives notification of withdrawal from the respective withdrawing State. Therefore, assuming the notification reaches the Depositary on 1 January 2023, the withdrawal would come into force on 1 January 2024. Qualifying investors from or to the withdrawing ECT Contracting Party who make their investments within a year after the notification is received, i.e., by 1 January 2024, are therefore also expected to enjoy ECT protections for the next 20 years, i.e., until 1 January 2044.

New renewable energy investments made from or to the withdrawing ECT Contracting Party after the notification of withdrawal comes into effect, 1 January 2023, would be excluded from ECT protections. Other international agreements, including numerous bilateral investment treaties (“BIT”), however, may provide a comparable level of protection for renewable energy investors.

(Re)structuring of Foreign Renewable Energy Investments

Structuring or restructuring of foreign investments, taking advantage of the protections provided by international agreements, before a dispute has arisen, is generally permitted under international law. Such (re)structuring is often referred to as nationality planning or “treaty shopping”, and it has specific limitations.

The tribunal in Aguas del Tunari v Bolivia stated: “It is not uncommon in practice and — absent a particular limitation — not illegal to locate one’s operations in a jurisdiction perceived to provide a beneficial regulatory and legal environment in terms, for examples, of taxation or the substantive law of the jurisdiction, including availability of a BIT”.

That said, where the dispute has already arisen or a specific dispute was foreseeable, nationality planning may constitute impermissible abusive behavior. In Cementownia v Turkey, the claimant engaged in nationality planning by transferring shares 12 days before Turkey terminated its concession agreements, which the claimant alleged was a violation of the ECT. The tribunal denied jurisdiction and noted: “Even if they did occur, the share transfers would not have been bona fide transactions, but rather attempts (in the face of government measures dating back some years about to culminate in the concessions’ termination) to fabricate international jurisdiction where none should exist.”

The amended ECT text likewise explicitly states that the tribunal shall decline jurisdiction “if the dispute had arisen, or was foreseeable on the basis of a high degree of probability, at the time when the claimant acquired ownership or control of the Investment subject to the dispute and the tribunal determines, on the basis of the facts of the case, that the acquisition of such ownership or control of the Investment was for the main purpose of submitting a claim under Article 26(4)” (emphasis added).

It is therefore imperative to ensure that nationality planning occurs at the right time — before the dispute arises or becomes foreseeable.

States may also try to limit the scope of permissible nationality planning by inserting specific language in the definition of “investor” or “investment” in the relevant treaty. For instance, as stated earlier, the amended text of the ECT would include the language that requires a showing of “substantial business activities” at the home State to be protected under the ECT. Applicable BITs may include equivalent language and therefore their text must be carefully consulted.

Investors who have made or are contemplating making renewable energy investments in the ECT Contracting Parties (or elsewhere for that matter) are therefore strongly encouraged to plan their nationality with caution, taking legal advice whenever necessary.

Disclaimer:

The information on this page is for general information purposes only. Nothing on this or associated pages, comments, answers, emails, blogs, inquiry requests and replies or other communications should be taken as legal advice for any individual case or situation.

The information on this page is not intended to create, and receipt or viewing of this information and any communication submitted or received by means of this page do not constitute an attorney-client relationship.