This article was written for the University of Westminster.
International law on the protection of foreign investment may impose excessive constraints on the freedom of states. But without international treaties, global companies may not invest in foreign countries – think about security, change in political administrations, shift in public perception, etc. This applies especially for the energy industry where contracts are signed for long-term periods. So: Are International Investment Treaties (IITs) a curse or a blessing for the governments and their plans for the energy revolution?
By signing the Paris Agreement at the United Nations Framework Convention on Climate Change (UNFCCC) Conference of the Parties 21 (COP21) in 2015, the majority of states committed themselves to actively combat climate change and to limit global warming to a maximum of 2° Celsius above pre-industrial levels. To achieve this goal, most signatories agreed that renewable, clean energy sources should be promoted while the use of hydrocarbon products ought to be reduced. This impacts energy producers who will have to reshape their business model if they seek to maintain their market position despite the planned energy turnaround. However, not all players seem to be affected equally. While domestic companies have to implement national laws immediately, foreign investors are to a certain extent subject to international laws. The only requirement is that both the host country and the investor’s country of origin signed bilateral or multilateral investment treaties, so-called IITs (international investment treaties). For government and national courts, this is a tough nut to crack, considering that the investments rely on long-term contracts that legitimize current business practices and guarantee security. Hence, the energy transformation can either become a very expensive undertaking or may be implemented with severe delays. This can be very unsatisfactory for states and implies that the international law on the protection of foreign investment imposes excessive constraints on the freedom of states. The most recent developments show that the concern of states is indeed justified; the number of claims from foreign investors has risen steadily during the last decade, the outcome of court cases is uncertain, and the potential awards are exorbitantly high. This essay discusses this proposition and is therefore split into four parts. The first chapter tells the story of bilateral investment treaties (BITs) and multilateral investment treaties (MITs) and illuminates the most important treaty in the energy industry; the Energy Charter Treaty. The second chapter looks at the securities and options for the foreign investor, while the third chapter explains the opportunities of foreign direct investment and the implications of BITs and MITs for the host country. Those two chapters are accompanied by a prominent case study, the case “Vattenfall AB against the Federal Republic of Germany”. The last chapter discusses the essay question and argues that international law indeed imposes constraints on the freedom of states – but that there are a number of arguments why this will not change soon.
International treaties and agreements protecting foreign investors
If companies are to invest for the long term, they need a guarantee that they can actually make their business a success. However, what at first glance sounds elementary quickly turns into a very complex situation, especially if the investment takes place in a foreign country. In that case, the protection and interests of the own country disappear, and one is dependent on the host country, hoping that it pursues the same political, economic and social goals. Question marks may arise quickly when thinking about a change in political leadership or changing environmental conditions. If the risk is perceived as too high, the investor will not be willing to set up business or, if the operation is already ongoing and gets tough, may think about leaving the country. For the host, this implies that the investment and foreign knowledge will either never reach its country or that it will be deducted at unfavourable times. For the company, in contrast, this often comes with an (existential) financial loss. This is where international law steps into the game; for more than a century, countries have been trying to mitigate this threat through mutual agreements.
Historically, the development of international agreements and treaties can be divided into three phases. As Kenneth J. Vandevelde writes in “Brief history of international investment agreements”, published by (Suavant and Sachs, 2009), the first agreements were already in place in the 18th century, for example the bilateral treaties of “Friendship, Commerce and Navigation”, which were applied by the United States to guarantee “special protection” for national companies working in the territory of a host country. Interesting to note; already these first contracts contained a clause for “compensation for expropriation”, which plays a central role in today’s treaties. This first phase, the so-called Colonial Era, was followed by the Postcolonial Era after the Second World War. The General Agreement on Tariffs and Trade (GATT) was established by the Allies in 1947 to liberalize world trade. This shifted the focus of legal frameworks from the previous bilateral agreements to multilateral agreements (Suavant and Sachs, 2009). A new challenge arose in the early 1970s. During the UN General Assembly 1974, socialist and developing countries demanded the right to expropriate foreign companies without having to pay compensation or an appropriate acquisition price. These states were in the majority. Consequently, and in the same year, the Charter of Economic Rights and Duties of States (CERDS) was adopted. The Charter declared that each state has the right “[t]o nationalize, expropriate or transfer ownership of foreign property, in which case appropriate compensation should be paid by the state adopting measures, taking into account its relevant laws and regulations and all circumstances that the state considers pertinent” (United Nations, 1974). This statement contained two key elements; the wording “should be paid” instead of “must be paid” and the fact that national law was responsible for the definition of the compensation rather than an international court (Brower and Tepe, 1975). In order to counter the risk of expropriation, the developed countries decided to conclude further BITs to protect their national companies. Those treaties dealt exclusively with investments and were largely negotiated between a developed and a developing country. Between 1959 and 1989, 386 such agreements were concluded (Ricupero, 2000). The fall of the Soviet Union, global market liberalization and rising powers in Asia signalled a further tipping point with a major impact on BITs. The number of bilateral investment treaties exploded, increasing from less than 400 treaties to over 2800 by the mid-2000s (Suavant and Sachs, 2009). Along with a number of other trade agreements, such as the North American Free Trade Agreement (NAFTA) between Mexico, Canada and the US, agreements for industry-specific topics popped up such as the European Energy Charter (EEC) which was signed in 1991. The EEC, however, was a political declaration only and did not constitute a binding international treaty. Yet, it paved the way for another highly influential treaty; the 1994 Energy Charter Treaty (ECT). As this essay deals with the energy industry, the general focus lies – especially in the following paragraphs – on explaining the ECT as well as outlining the implications this treaty has for its signatories.
The ECT is a multilateral framework which is currently ratified by 52 parties, amongst which the European Union and Euratom. It is worldwide the only multilateral framework covering exclusively the energy sector, was developed in 1994 in Lisbon and entered into legal force in April 1998. One of its main goals was to integrate the energy markets of the former Soviet Union states into the world market. In summary, the Treaty covers four key areas: 1) The protection of foreign investments, based on the extension of national treatment, 2) Non-discriminatory conditions for trade in energy materials, products and energy-related equipment, 3) the resolution of disputes between investors and host states, and 4) the promotion of energy efficiency and attempts to minimise the environmental impact of energy production and use (International Energy Charter, 2019). The framework is set up according to the rules of GATT (today World Trade Organization) in order to cover trade aspects, but it is also responsible for foreign direct investment (FDI) issues.
Under what circumstances an investor may pose a claim is defined in Part III of the ECT, which explains the investment promotion and protection. An investor thereby is defined as a “natural person having the citizenship or nationality of, or is a permanent resident in, a contracting state in accordance with its applicable law, or a company or other organization organized in accordance with the law applicable in that contracting state” (Hobér, 2010). Article 10(1) of the ECT explains the minimum standard of investment protection after the post-investment phase and sets out basic principles.
- The first principle says: “Such conditions shall include a commitment to accord at all times to investments of investors of other contracting parties fair and equitable treatment” (Energy Charter Treaty, 1994) ,whereby “such conditions” are defined as an environment that encourages and create stable, equitable, favourable and transparent conditions for Investors (Energy Charter Treaty, 1994). Hobér (2010) describes that despite the fact that fair and equitable treatment (FET) are frequently applied in BIT tribunals and NAFTA arbitrations, the exact scope is not clearly defined and may lead to a flexible standard. This challenges both arbitrators and counsels in order to establish a source for good-government conduct – and not being alleged to decide on an individual perception of what is fair and equitable (Hobér, 2010).
- The second principle says that “investments shall also enjoy the most constant protection and security” (Energy Charter Treaty, 1994) which, again, is not clearly defined. Academic literature argues that, amongst other things, it shall protect the investment against physical attacks.
- The third principle is the discrimination clause, which is defined by the ECT (1994) as followed: “No contracting party shall in any way impair by unreasonable or discriminatory measures their management, maintenance, use, enjoyment or disposal. In no case shall such investments be accorded treatment less favourable than that required by international law, including treaty obligations.” This principle sometimes overlaps with the principle of FET.
- The fourth principle is the so-called umbrella clause which tells each party to “observe any obligations it has entered into with an investor or an investment of an investor of any other contracting party” (Energy Charter Treaty, 1994). This principle refers to pacta sunt servanda which is often applied in international treaties.
One of the most important substantive rules of the ECT is addressed in Article 13; expropriation. The ECT determines that “investments of investors of a contracting party in the area of any other contracting party shall not be nationalized, expropriated or subjected to a measure or measures having an effect equivalent to nationalization or expropriation […]” (Energy Charter Treaty, 1994). If expropriation occurs nonetheless, states are requested to compensate with the fair market value of the investment. Hobér (2010) notes that Article 13 does not differentiate between a “lawful” and “unlawful” expropriation as in a “lawful” case compensation would be seen as a precondition in order to be lawful, whereas in the latter case “compensation is equivalent to damages for the loss suffered by the investor” (Hobér, 2010). In case of a dispute, article 26 provides the arbitration rules for the investor-state dispute settlement (ISDS). Article 26, paragraph 4(a) defines the International Centre for Settlement of Investment Disputes (ICSID) as arbitration court for investor-state disputes, if both the contracting party of the investor as well as the contracting party are members of the ICSID Convention. Paragraph 4(b) claims that the dispute may also be submitted to “a sole arbitrator or ad hoc arbitration tribunal under the rules of the United Nations Commission on International Trade Law (UNCITRAL) or an arbitral proceeding under the arbitration institute of the Stockholm Chamber of Commerce” (Energy Charter Treaty, 1994). ICSID was established as an entity of the World Bank in 1966 and has become the world’s leading institution devoted to international investment dispute settlement.
In conclusion, this chapter presented the history of foreign investment law and outlined the framework of the ECT in depth. It showed the most important substantive rules which are treated in Article 10 and Article 13, as well as the dispute settlement provision which is defined in Article 26 and 27. A major takeaway is to understand that both BITs and MITs give foreign investors the right to bring claims directly against the host state, which is called investor-state dispute settlement (ISDS). While many ISDS cases are dealt under ICSID rules, it is not a must and there are other rules and institutions which could be applied. Vice-versa, the host state cannot claim its rights against a foreign investor in front of international courts but has to sue an investor at the own national court. The reason for this is that BITs and MITs are signed by countries only and not by the companies, which means that firms are protected by the treaties but are not a party of them. This has recently led to critical voices arguing that the ECT, for instance, does not guarantee an equal treatment but rather supports foreign investors. Critics also point out that only 19 claims were registered between 1998 and 2008, but that the number of claims has risen sharply since 2012, surpassing 110 claims by the end of 2017 (ECT’s dirty secrets, 2019). The next two chapters discuss the implication of the ECT for the signatories of the treaty (countries) and foreign investors under the perspective of climate change and energy transition. The theoretical description will be illustrated with the Vattenfall AB and others v. Federal Republic of Germany II case which started in 2012 and was still pending in April 2019.
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