State Consent, Power to Regulate, and Renewable Investments: A Perspective on the Limits of Expropriation under the Energy Charter Treaty

By:

The realm and domain of sovereign States underwent a significant shift in recent years, partly because of the increasing interactions between international and municipal legal orders. Traditionally, if a State was defined by authors such as Bodin as an abstract and permanent sovereign entity, the history of international law in the post-Westphalian era has progressively developed a series of legal norms limiting the powers of sovereigns. Both common and civil law systems have tackled this issue, and are confronted today with a fundamental problem in the context of international investment law. As investors from capital exporting States transfer their funds and investments to capital importing States, the international legal system must deal with the increased risk of political and economic expropriations. The need to preserve the stability of the global economy has indeed given birth to the current international investment dispute resolution scheme, which focuses on international treaties such as the ICSID Convention or the Energy Charter Treaty. According to Joffe and Stevens, these treaties have created a set of legal means aimed at curtailing the expansion of a new phenomenon – “resource nationalism”.

The prohibition of a certain form of expropriation under these treaties has prompted scholars to reconsider the viability of the doctrines of eminent domain (dominum eminens) and sovereign immunity, as applied to the international context. Scholar Stephan Schill thus argues that the current media and public interest in ISDS clauses inserted in regional agreements like NAFTA or the TTIP makes it important to reconsider the effect of regional agreements on the power of sovereigns.

The Energy Charter Treaty recently gained importance in the wake of the Yukos award, which was the largest award ever issued by an arbitral tribunal. The award called into question the legitimacy of State consent to regional agreements – as the tribunal found on jurisdiction that Russia had only consented to the provisional application of the Energy Charter Treaty – and detailed the conditions under which an indirect expropriation would warrant compensation under article 13 (1) of the ECT. This article considers the current expropriation regime under the ECT, and focuses on the recent arbitrations brought in the context of the Spanish “tariff deficit” crisis, in order to assess the current limits to a State’s power to regulate its own energy resources.

  1. Defining expropriation in public international law

The principle of expropriation in international law limits a State’s power to acquire rights on a property without providing adequate compensation. Historically, the power to expropriate was the monopoly of the State and was considered to be a corollary of a State’s right to exercise its police power. These municipal principles, detailed by the jusnaturalist movement and jurists like Grotius in the early 17th century, were quickly turned into principles of international law. The relationship between expropriation and the theory of acquired rights was mentioned early on by the Permanent Court of International Justice in 1926 (Case Concerning Certain German Interests in Polish Upper Silesia (Germany v. Poland) (1926) P.C.I.J.). This origin has been generally recognized and expanded by international investment law tribunals: it is a customary principle of international law that States have a “clear right to regulate commercial and business activities” (Saluka Investments BV (The Netherlands) v The Czech Republic, Permanent Court of Arbitration, Partial Award (17 March 2006) at [306] (‘Saluka’; Tecnicas Medioambientales Tecmed SA v The United Mexican States (2004) 43 ILM 133 at [115] (‘TECMED’)).

According to scholar Christoph Schreuer, if direct expropriation was historically recognized as a legal principle, the law of public domain still lacked a principle dealing with a State’s indirect interference with the property right of a third party. In cases where this interference was substantial enough so as to prevent a third party from enjoying the use of its property right (its fructus), courts developed a theory of indirect expropriation to deter States from abusive conduct. For Hertz, the first definitions of indirect expropriations nevertheless remained vague, and were highly unpractical, as they required an inquiry as to “whether or not … the limits of usual interference have been reached or transgressed so as to warrant a finding of expropriation” (A.Z. Hertz, “Shaping the Trident: Intellectual Property under NAFTA, Investment Protection Agreements and at the World Trade Organization” (1997)).

Different international law instruments soon addressed this problem, and detailed a series of standards governing the expropriation of international investments. The 1959 Abs-Shawcross Draft Convention on Investment Abroad stated that the due process rights of investors should be generally guaranteed, and prohibited any form of discrimination against foreign investors. In 1967, Article 3 the OECD’s Draft Convention on the Protection of Foreign Property stated that “[n]o Party shall take any measures depriving, directly or indirectly, of his property a national of another Party unless the following conditions are complied with (. . .).” These criteria were later detailed by several arbitral decisions, the most important one being the METACLAD arbitral award, where a NAFTA tribunal stated that “expropriation … includes not only open, deliberate and acknowledged takings of property, such as outright seizure or formal or obligatory transfer of title in favour of the host State, but also covert or incidental interference with the use of property.”

But the main area in which the principle of State sovereignty conflicts with modern expropriation case law is that of regulatory takings. This concept appeared early on in U.S. law due to the Supreme Court’s decision in Penn Central, where the Court laid out a 3-factor balancing test meant to determine the legality of a regulatory taking. The Penn Central test requires courts to look at the nature and purpose of the government activity, the economic impact of the regulation, and the extent to which this regulation interferes with investment-backed expectations. This test has not prevailed in the international context, where international tribunals have mainly resorted to the sole effects doctrine, which considers only the impact of the governmental measure – not its asserted purpose or rationale (Tippetts v TAMS-AFFA Consulting Engineers of Iran (1984) 6 Iran-US CTR 219 (‘Tippetts). This effects test has been included in the language of several bilateral treaties, which prohibit a State from regulating a sector prone to investments in a way that would be “tantamount” to an expropriation (see NAFTA article 1110).

  1. Expropriation claims, the ECT, and the Spanish tariff deficit saga

The evolution of common principles of State sovereignty has been central to article 13 ECT arbitration so far. The most important ECT arbitration claims were recently brought against the Kingdom of Spain, which faces close to 30 expropriation claims from investors. In 2004, Spain decided to change its investment laws regulating the production of energy in the renewable sector, in order to attract international investments. This favourable legislation made Spain a “haven” for energy investors, and substantially contributed to the growth of the Spanish economy. In particular, Royal Decree 661/2007 introduced a production based subsidy (the feed-in tariff) which guaranteed the viability of energy investments in the photovoltaic sector. Following the 2008 financial crisis – which resulted in a general lowering of energy consumption – Spain had to deal with an increasing tariff deficit, and decided to change its laws to face these budgetary concerns. Between 2010 and 2015, a series of measures aimed at eviscerating the feed in tariff subsidies caused substantial losses to investors, who decided to bring their claims under ECT article 10 (which prohibits any discrimination against foreign investors) and article 13’s expropriation provision.

Historically, early ECT tariff cases saw tribunals narrowly construct article 13’s expropriation standard. In Nycomb Synergetics v. Republic of Latvia, the investors’ loss of part of their investment because of a Latvian state-owned entity’s refusal to pay a double tariff was not considered enough to trigger article 13 liability. Rather, the tribunal looked at article 10’s non-discrimination provision, and found that the breach of this article warranted investor compensation. Nycomb was the first case brought under the Energy Charter Treaty, and strongly influenced the decisions of arbitral tribunals in the Spanish arbitration cases. An arbitral tribunal thus decided in Charanne v. Spain to adopt an extensive view of State power in the field of energy regulation, stating that “while the investor is promised protection against unfair changes, it is well established that the host State is entitled to maintain a reasonable degree of regulatory flexibility to respond to changing circumstances in the public interest.” 

This broad understanding of State sovereignty hinged on an extensive reading of the notion of public interest, which has not yet gained consensus in international investment law. More recently, in Eiser v. Spain, another seminal tariff deficit case, an investment tribunal held Spain liable for 129 million Euros under the ECT’s indirect expropriation provision. The Eiser tribunal distinguished the case from Charanne because of the different pieces of legislation involved in each case. If the Charanne tribunal found that RDs 661/2007 and 1578/2008 did not violate the ECT because they did not contradict investor expectations, the Eiser arbitration involved two other royal decrees and a ministerial order—RDL 9/2013, RD 413/2014, and Ministerial Order IET/1045/2014—which differed substantially from the 2010 measures involved in Charanne. The Eiser decrees were considered to have caused substantial losses to investors, in breach of the non-discrimination provision of article 10 of the ECT. The Eiser tribunal nevertheless accepted Spain’s objections that the investors could not bring a claim for the losses which resulted from Spain’s decision to adopt a law imposing a 7 percent tax on energy producers (the TVPEE). The tribunal agreed that under article 21 (1) of the ECT, taxation remains a core sovereign power, which is discretionary and should be subject to arbitration in only a narrow set of circumstances. This confirms the existence of what Lazem and Bankas define as a “presumption in favour of the validity of tax-related measures” in international investment law.

III. Expropriation, State sovereignty and the European legal order: which conflicts of competence for intra EU BITs?

The tariff deficit crisis also sparked a debate as to the relationship between private justice, domestic sovereignty, and federalism concerns. In several cases related to the Spanish “solar war” saga, the European Commission filed an amicus curiae submission to persuade the arbitral tribunals to decline to exercise jurisdiction because of the possible incompatibility between European law and international investment law (see Charanne; Eiser supra). The Charanne tribunal addressed this objection by holding that even though the European Union was a party of the ECT, individual Member States remain parties to the ECT – a reasoning which opens the door to the possibility of intra-EU investment proceedings. This had significant consequences on the autonomy and sovereignty of EU Member States: if the ECT was open to ratification in 1994, the Lisbon Treaty gave the European Union exclusive competence over investment treaty law, through article 3.1 (e) and 2.1 of the TEU.

The delicate question of concurrent competence also raises issues linked to the proper authority to adjudicate the tariff deficit dispute, as article 344 of the TFEU explicitly states that disputes which entail an interpretation of European law must be submitted to the exclusive competence of the European Court of Justice. The Commission tried to rely on this argument to justify the incompetence of arbitral tribunals in the Spanish arbitration saga. The ECJ expressly disagreed with the Commission on this matter and made clear in its opinion 2/15 that ISDS mechanisms are an area of shared competence between the EU and the Member States, clarifying the repartition of competence between the Member States and the EU in the area of common commercial policy (CPP).

The outcome of this debate will have a tremendous impact on the future of ECT arbitration within the European Union. At a time where the inclusion of ISDS clauses in regional agreements has drawn the attention of European citizens, the difficult balancing act between a States’ right to regulate and the stability of international commerce will in time shift to a new equilibrium, where international investment law will have to take into account the property right of States on their energy resources.

Kamyar Assari is a second year Juris Doctor student at Columbia Law School. He holds an LL.B. in Civil law and a B.A in Philosophy from the University of Paris I Pantheon-Sorbonne, and is an alumnus of the Lycée Henri IV, in Paris, where he studied for his classes préparatoires.