Energy Charter Treaty Reform: Fresh Start or Time to Say Goodbye?

by | Sep 5, 2022 | Editorial | 0 comments

Abstract

The Energy Charter Treaty (hereinafter “ECT” or “Treaty”) is a multilateral agreement that was signed in the early 1990s. The ECT guarantees protection to investments in the energy sector and provides for a dispute resolution mechanism between Contracting Parties. It has been “tested” in a number of large-scale disputes, including the Yukos case, which concerned, inter alia, the issue of provisional applications of the ECT by the Russian Federation. From the application of the ECT in the past, it was seen that the functioning of ECT-based tribunals lacked predictability and certainty. Therefore, it was decided that the Treaty needed to be reformed to address the concerns of Contracting Parties with respect to consistency in dispute resolution, the right to regulate such issues as environmental protection, as well as Fair and Equitable Treatment (FET) and the Most-Favoured Nation (MFN) clauses.

Timeline of the Reform 

The discussion on the potential reform of the ECT commenced in 2017 at the Energy Charter Treaty Conference. The Strategy Group was established to handle discussions on the reform.

In 2018, the Conference approved a list of topics for the modernization of the Treaty, which included, inter alia, pre-investment, the definition of the word “charter”, definitions of “investment” and “investor”, right to regulate, MFN and FET clauses, transparency, third-party funding, etc.

In 2019, some policy options for modernization were approved. Later, in 2020, the discussion took an active turn, and four rounds of negotiations were held. After the last round, when the Modernisation Group finalized the discussions on the abovementioned issues, the Energy Charter Conference was held in December 2020. In 2021, the Modernisation Group further held nine rounds of negotiations, advancing the aspects of the reform in connection with the definition of “investment”, the MFN clause, frivolous claims, security for costs, and third-party funding. In 2022, six additional rounds were held. Finally, on 24 June 2022, the Contracting Parties reached an agreement regarding the upcoming reform by issuing thePublic Communication on the finalization of the negotiations.

Main Achievements 

As a result of the discussions held in the previous years, in June 2022, the Commission came to an agreement to build the modernization in three directions, called the“three pillars”, which are as follows:

  • The first pillar is to introduce the updated list of Energy Materials and Products,
  • The second pillar is to implement a novel “flexibility mechanism” which allows parties to regulate and exclude fossil fuels from investment protection, and
  • The third pillar is to launch a “review mechanism” which enables parties to determine the list of Energy Materials and Products. 

The most significant changes were made to the definitions of “investor” and “investment”. The drafters of the amendment decided to introduce a criterion that assets need to comply with for them to constitute “investments” under the ECT. The criterion resembles that of the Salini test and includes the commitment of capital, gain or expectation of profit, duration, and assumption of risk. Furthermore, investments are now to be made expressly in accordance with the laws of the host Contracting Party in order to be protected under the ECT. The new version of the definition of “investor” excludes individuals with the nationality or permanent residence of the Contracting Party at the time of the investment. Moreover, an investor must now comply with the requirement of having “substantial business activities” by showing that it has a physical presence, staff, generation of profits, or payment of taxes in the area of a host Contracting Party. Investment, in its turn, excludes administrative or judicial decisions, as well as arbitral awards from the scope of the protection. Additionally, the category of claims for money, contained in Art.1(6), is limited to exclusively those claims which do not arise from solely commercial transactions. The changes also concern specificpublic debt instruments, which are also excluded from the scope of investment protection. 

In order to add certainty to the definition of “Fair and Equitable Treatment”, a new article on FET has been added, and it provides a list of specific measures that can be considered violations of FET. The list will include, inter alia, thefrustration of an investor’s legitimate expectations. 

The amendment provides clarifications on the notion of “Direct Expropriation”, and incorporates a proper definition of the term “Indirect Expropriation”, specifying the list of factors that assist in drawing a line between the two concepts. The MFN clause has also been modified, and the new provision stipulates that the MFN treatment clause shall not extend to dispute settlement procedures.

Finally, a provision on the Contracting Parties’ “right to regulate” is to be incorporated into the ECT, in order to reaffirm the Parties’ rights to safeguard public policy objectives, such asclimate change mitigation, protection of public health, safety, or public morals, etc. 

The dispute settlement area is also to be modified and supplemented by the following mechanisms: 

  • First of all, the UNCITRAL Rules on Transparency in Treaty-based Investor-State arbitration will be made applicable to arbitral proceedings in disputes under the ECT.
  • Secondly, a mechanism of dismissal of frivolous claims will be introduced, in particular, for claims without legal merits – in terms of matter or jurisdiction. Such claims will be dismissed, alongside those that are unfounded on merits. The Conference is additionally contemplating a mechanism allowing the dismissal of those claims submitted as a result of investment restructuring made for the sole purpose of submitting a claim under the ECT.
  • A new provision has been introduced for the valuation of damages, providing that monetary damages are to be limited to the loss suffered by an investor, without any punitive damages. 

The amended version of the ECT will finally resolve the issue of whether the dispute settlement mechanism and other provisions of the ECT apply to Member-States of the same Regional Economic Integration Organization (REIO) – the drafters have highlighted that Articles 7 (Transit), 26 (Investment Dispute Settlement), 27 (Disputes between Contracting Parties), and 29 (Trade with non-WTO members) shall not apply to the members of the REIO in their mutual relations. 

The other agreed changes concern some general principles on transit, sustainable development, corporate social responsibility, and pre-investment. 

The final draft text of the updated ECT is expected to be communicated to the Contracting Parties for review on 22 August 2022 and for further adoption by the Energy Charter Conferenceon 22 November 2022.

Definition of “Investment” 

It is hard to disagree with the opinion of D. Geraets and L. Reins, as expressed in the Commentary to the ECT, that the“key to any investment treaty is the definition of ‘Investment’”. Indeed, the definition of investment in the Bilateral Investment Treaty (BIT), or any other instrument, is crucial to ensure certainty and predictability in international arbitration awards. If we turn to the ECT,Art. 1(6) provides the following definition of investment: 

“Investment” means every kind of asset, owned or controlled directly or indirectly by an Investor and includes:

(a)  tangible and intangible, and movable and immovable, property, and any property rights such as leases, mortgages, liens, and pledges;

(b)  a company or business enterprise, or shares, stock, or other forms of equity participation in a company or business enterprise, and bonds and other debt of a company or business enterprise;

(c)  claims to money and claims to performance pursuant to contract having an economic value and associated with an Investment;

(d)  Intellectual Property;

(e)  Returns;

(f)  any right conferred by law or contract or by virtue of any licences and permits granted pursuant to law to undertake any Economic Activity in the Energy Sector.

A change in the form in which assets are invested does not affect their character as investments and the term “Investment” includes all investments, whether existing at or made after the later of the date of entry into force of this Treaty for the Contracting Party of the Investor making the investment and that for the Contracting Party in the Area of which the investment is made (hereinafter referred to as the “Effective Date”) provided that the Treaty shall only apply to matters affecting such investments after the Effective Date.

“Investment” refers to any investment associated with an Economic Activity in the Energy Sector and to investments or classes of investments designated by a Contracting Party in its Area as “Charter efficiency projects” and so notified to the Secretariat.” 

Several international investment tribunals have highlighted, in a number of cases, that the definition is broad and leaves room for interpretation, which is, in fact, a blessing and a curse. On the one hand, such a wide definition allows the demonstration of an inclusive approach to investors’ assets. However, on the other hand, the non-exhaustive asset-based definition usually creates a problem for the tribunal when it comes to interpretation. Usually, while constructing the provisions of a Treaty, arbitrators turn to theVienna Convention on the Law of Treaties (VCLT), which provides that, as a general rule, the “ordinary meaning” of the term is to be given to the term of the instrument. Consequently, the set of tools available to tribunals is rather limited, which makes the task of arbitrators more difficult, especially taking into consideration the broadness of the definition and the variety of forms that the investments might take. Therefore, the decision to draw a line and limit some of the categories that should not fall within the scope of the protection of the ECT might enhance legal certainty when it comes to the interpretation of the definition of investment. 

The following introduced measures are aimed at achieving exactly these goals – in the new version of Art. 1(6), an investment shall comply with the list of characteristics (which are, in fact, the criteria of the Salini test), namely, the commitment of capital, the expectation of gain or profit, certain duration, or the assumption of risk. This amendment will definitely change the approach of the arbitrators to the interpretation of investment under Art. 1(6) of the ECT, since previously, the position of the arbitrators in the matter of whether an investment shall be construed in accordance with its meaning under international law, can be summarized in the approach taken by the tribunal in Luxtona Limited v. Russia – herein, the arbitrators highlighted that Art.1(6) contains a “wide and open-ended” definition of investment and that there had been no instances when any tribunal had suggested that an investment should be interpreted in accordance with the concept of investment under general international law. Moreover, it was stated that the Salini test was irrelevant for the purpose of attributing an investment under ECT. Such an approach was upheld by a number of tribunals, including those in Plama v. Bulgaria, Petrobart v. Kyrgyz Republic, Kardassopoulos v. Georgia, Amto v. Ukraine, Veteran Petroleum v. Russia, Electrabel v. Hungary, and Stati v. Kazakhstan. 

It was agreed to expressly exclude from the scope of the definition of investment, the following categories:

  • judicial and administrative decisions, arbitration awards,
  • claims to money and credit that arose from commercial transactions (sales of goods), and
  • public debt. 

The decision to exclude those precise categories has a practical background, dictated by recent practices. For example, in Petrobart Ltd. v. The Kyrgyz Republic, the tribunal considered that, under Art.1(6) of the ECT, the Claimant’s claim for payment under the sales agreement for gas could constitute an investment, as it falls within the category of“right conferred by […] contract”.

Another example is when a Swiss company was claiming that an arbitral award might be considered an investment under the BIT, with the asset-based definition of investment. In particular, in the case Romak v. Uzbekistan, which dealt with the issue of whether an arbitration award can be considered an investment under the definition of an investment contained in the BIT. Although the mentioned case was not ECT-based, the definition of investment in theSwitzerland-Uzbekistan BIT was an asset-based definition, similar to the ECT’s Article 1(6), which went as follows: 

“Article 1

Definitions

[…]

2. The term “investments” shall include every kind of assets and particularly:

(a) movable and immovable property as well as any other rights in rem, such as servitudes, mortgages, liens, pledges;

(b) shares, parts or any other kinds of participation in companies;

(c) claims to money or to any performance having an economic value;

(d) copyrights Industrial property rights (such as patents, utility models, industrial designs or models, trade or service marks, trade names, indications of origin), technical processes, know-how and goodwill;

(e) concessions under public law, including concessions to search for, extract or exploit natural resources as well as all other rights given by law, by contract or by decision of the authority in accordance with the law.

[…]” 

The tribunal in that case brought up the concept of the “inherent meaning of investment”, pointing out that the mere fact that an asset in dispute might fall into one or more of the categories listed in the definition, is not enough to consider such an asset as an investment because the term investment“has a meaning in itself and cannot be ignored […]”. The tribunal further examined the Claimant’s assets, relying on the criteria of contribution and assumption of risk, and concluded that the arbitration award could not be considered an investment since, firstly, the Claimant had made no contribution to the territory of Uzbekistan, and, secondly, the Claimant had never assumed any“investment risk” (here, the arbitrators drew a line between ordinary “commercial” risk and “investment” risk). 

Therefore, the new version of the definition of investment under the ECT will limit the scope of assets, providing a mechanism aimed at limiting the possibility of intentionally using the broad definition contained in Art.1(6) to extend the protection of the ECT to an unpredictable variety of assets.

Disputes between Members of Regional Economic Integrational Organization 

The decision of the Court of Justice of the European Union (CJEU) in the Komstroy v. Moldova case paved the way for respondents in investment proceedings to raise an objection to the jurisdiction of the tribunals under the ECT, based on the argument that Art. 26 of the ECT shall not be applicable to disputes between EU member-states. The typical argument included the same approach to the issue as was taken by the respondent in NextEra Energy v. Spain wherein the respondent State had argued that both Spain and the Netherlands were members of the EU when they joined the ECT. Therefore, the Claimant could be considered to be the investors of “another Contracting Party”, as envisaged by Art. 26 of the ECT. Additionally, the respondent submitted that EU law, as a part of international law, shall prevail over the ECT if there is any conflict over the norms. The tribunals, in their majority, dismissed intra-EU objections on the following grounds: 

Therefore, the interpretation of Art. 26 of the ECT in accordance with its ordinary meaning does not allow one to come to the conclusion that the Contracting Partiesintended to exclude intra-EU disputes from the scope of the dispute resolution clause. However, in June 2022, the Stockholm Chamber of Commerce (SCC) tribunal in a renewables dispute against Spain, for the first time, upheld the intra-EU objection raised by Spain. The tribunal agreed that EU law should be “lex superior” and, consequently,shall override the EU members’ obligations under the ECT. Therefore, there is still room for discussion about whether the practice will take a new direction after this award. However, nevertheless, the tribunal’s approach will have an impact on further consideration of the intra-EU objections, although there is no concept of stare decisis in investment arbitration. 

Conclusion 

The ECT has recently become a target of criticism (sometimes fair, sometimes not) – thus, the present reform is an opportunity to respond to such criticism and demonstrate that the ECT can survive all the challenges it has faced to this day, from the Yukos Case and the debates on the provisional application of the Treaty by the Russian Federation, till the recent EU-countries’ concerns as to whether the ECT can be adapted to the Paris Agreement. Some countries are even considering withdrawing from the ECT – Germany, the Netherlands, Poland, and Spain, for example, recently invited the European Commissionto assess exit options since they are sceptical in terms of the possibility of aligning the ECT with the goals of climate change mitigation and prevention. This position is, obviously, shared by a number of environmental organizations which associate the ECT with the “great evil” (fossil fuels). Furthermore, the endeavours of the states to mitigate climate change and protect the environment would not be undermined by the mere fact that the ECT is still in force. In the near future, fossil fuels will continue to play a significant role in the economies of the states worldwide, which is why the ECT, in its new version, will be a useful tool in regulating investments of Contracting Parties. Nevertheless, the fate of the ECT is still unpredictable since the reform expressly states that the EU member-states cannot rely on the ECT dispute resolution clause in their internal disputes as CJEU ruled that member-states cannot resolve disputes among themselves as Art. 26 ECT is incompatible with the EU law.

Therefore, it is to be seen whether the ECT will regain its position as an up-to-date instrument or its significance will fade gradually.  

Disclaimer

The views and opinions expressed in this article represent those of the author and not the views and opinions of HKIAC.

About the Authors 

Ms. Christina Kazazaeva is an Intern at HKIAC. She is an LLM graduate of Moscow State University of International Relations in private law and international arbitration.

Editorial Team 

Managing Editor: Naman Anand 

Editors-in-Chief: Muskaan Singh and Hamna Viriyam 

Senior Editor: Hamna Viriyam 

Associate Editor: Tisa Padhy

Junior Editor: Ria Goyal

Preferred Method of Citation  

Christina Kazazaeva, “Energy Charter Treaty Reform: Fresh Start or Time to Say Goodbye?” (IJPIEL, 5 September 2022) 

<https://ijpiel.com/index.php/2022/09/05/energy-charter-treaty-reform-fresh-start-or-time-to-say-goodbye/>

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