The Energy Charter Treaty in the Light of the Electricity Price Brake: An opportunity for investors to litigate?

Introduction

On 30 November 2022, the German Federal Government officially decided to withdraw the country from the Energy Charter Treaty (ECT). Almost no other international treaty has caused such a political stir in recent years. “The Energy Charter Treaty was and is an obstacle to the energy transition and is simply not compatible with the goals of the Paris Climate Agreement,” emphasised Federal Economics Minister Robert Habeck (Green Party). Due to the investment protection for fossil energy projects, the ECT has long been criticised by the Greens and environmental organisations. The ECT gives investors of a contracting party the right to sue other contracting parties if they see themselves or their investments injured by measures taken by that contracting party. The ECT is on the brink of collapse, and not just since Germany’s decision to withdraw. Spain, Poland, France, Belgium, the Netherlands, Luxembourg and Slovenia had also recently announced their withdrawal. Italy has already left the ECT. In addition, it was recently reported in the media that the EU Commission, at the instigation of the EU Member States, had been working on a reformed version of the ECT over the past four years, which should have been adopted on 22 November in Ulan Bator during the annual meeting of the contracting parties. After the EU Parliament voted 303 to 209 in favour of a resolution calling for the withdrawal of the European Union from the ECT on 24 November 2022, and the Treaty had been under criticism for some time, the necessary majority would not have been reached. The European Commission therefore took this item off the agenda again.

Parallel to this development, the Federal Government has recently launched the so-called “electricity price brake”. In accordance with EU Regulation 2022/1854 (so-called EU Emergency Regulation), the Federal Government plans to finance the electricity price brake from 1 December 2022 by skimming off surplus revenues from electricity producers. In addition, a windfall tax on excess profits for mineral oil companies in the amount of 33% is planned.

In this context, the question arises whether investors from other contracting parties of the ECT can take action against this skimming of profits due to the accusation of expropriation on the basis of the ECT. From this point of view, the Energy Charter Treaty could once again become the focus of companies as well as the public. In view of the recent case law of the European Court of Justice (CJEU), in particular the “Achmea” and “Komstroy” decisions, this question arises with regard to investors from other EU Member States. This is because with this case law the CJEU has declared the ECT arbitration clauses inapplicable in so-called intra-EU disputes, i.e. disputes between two EU Member States.

Our energy law experts Dr. Markus Böhme, LL.M. and Rebekka Ackermann (both Energy Law) now consider some essential aspects of the Energy Charter Treaty, investigate the possibilities and consequences of a withdrawal, discuss the possible relevance of the Energy Charter Treaty in connection with the electricity price cap and address further questions in this context.

Question: What is the Energy Charter Treaty?

Answer: The Energy Charter Treaty is an international treaty that was signed against the backdrop of the disintegration of the Soviet Union in December 1994 and entered into force in 1998. The aim of the ECT was to create security for cross-border investments in energy projects and to promote cooperation in the energy sector between the two sides of the Iron Curtain. More than 50 countries have now signed the ECT, including Kazakhstan, the Baltic countries, Japan, Iceland and the European Union. The ECT protects investors from discriminatory access, expropriation, nationalisation, breach of contract and other state interventions that are likely to affect their profit expectations. For this purpose, the ECT establishes a private arbitration procedure. Based on this arbitration procedure, companies and investors can sue contracting parties for compensation if political decisions change the legal framework in a way that threatens investments. Arbitration tribunals have the right to order contracting parties to pay sometimes huge damages if it is determined that investors have been harmed. Prominent examples of such arbitration proceedings are the proceedings brought by Vattenfall against Germany because of the nuclear phase-out and the proceedings recently brought by RWE and Uniper against the Netherlands because of the mandatory closure of fossil-fuel power plants.

The aforementioned criticism of the ECT is that it slows down the energy transition because it protects investments in fossil fuels. The EU Parliament also declared that this is not compatible with the Paris Agreement on Climate Change and recommended that the EU withdraw from the Treaty by adopting a resolution to this effect. The planned reforms, which the EU Commission wanted the contracting parties to vote on last week, would have significantly restricted the protection of investments in fossil energy projects. However, this did not go far enough for climate activists and other supporters of the reforms. After initially accepting the reform of the ECT as the lesser evil, a quick end to the Energy Charter Treaty now seems to be favoured.

Question: Is it possible for contracting parties to withdraw from the ECT?

Answer: The withdrawal of a contracting party from the ECT is possible in principle. According to Art. 47 para. 1 ECT, a contracting party is allowed to declare its withdrawal in writing five years after the entry into force of the Treaty. However, if no later date is specified by the withdrawing contracting party in the declaration of withdrawal, the withdrawal only becomes effective one year after receipt of the declaration of withdrawal by the depositary (as defined by the ECT), according to Art. 47 para. 2 ECT. Until then, it can be assumed that the legal obligation to the ECT continues to exist in full for the respective contracting party. Even in the event that Germany’s declaration of withdrawal is received by the depositary this year, the withdrawal would not take effect until the end of 2023. However, the German government’s draft law on the electricity price brake already provides for a skimming off of surplus revenues (retrospectively) from 1 December 2022 and (for the time being) until 31 December 2023. This measure would therefore - despite withdrawal - still fall within the temporal scope of application of the ECT.

Question: What are the effects of withdrawal from the ECT on investment protection?

Answer: Art. 47 (3) ECT stipulates that the provisions of the ECT for investments, i.e. investment protection, shall continue to apply for another 20 years after the withdrawal of a contracting party in the country concerned takes effect (so-called “sunset clause” or “zombie clause”). This means that investments made by investors of a contracting party of the ECT in the territory of the withdrawing contracting party (here in relation to the electricity price brake in Germany) continue to be protected by the ECT. Sunset clauses are the rule in investment protection treaties, but vary with regard to their terms. The comparatively long term (20 years) regulated in the ECT can be explained by the fact that investments in the energy sector regularly involve large volumes and therefore only pay off in the long term. In principle, the investment protection of the ECT is still applicable 21 years after notification of the withdrawal. Investors - especially from contracting parties outside the EU (see below) - can therefore continue to take action against a contracting party by way of arbitration, even if this state has withdrawn from the ECT. However, this only applies to investments that were made in the territory of the withdrawing contracting party before the withdrawal became effective.

Question: Is there a way to avoid the 20-year extended liability?

Answer: The possibility of detaching from the ECT by means of the cessation of the basis of the transaction or the clausula rebus sic stantibus could be discussed. According to the case law of the BVerfG in its judgement of 30 January 1973 (2 BvH 1/72), a cessation of the basis of the transaction under international law is conceivable under the condition that "the contracting parties have unanimously made the continuation of a certain fact the basis of their agreement and have assumed that the jointly envisaged future change of this fact is to be regarded as the reason for the termination of the agreement". Whether climatic changes and the associated risks for the environment and humans constitute such a change could be discussed in principle. The legal institution of clausula rebus sic stantibus also states that every legal transaction is subject to the proviso that the circumstances remain as they were at the time of the conclusion of the contract. The transaction is thus invalid if things develop in such a way that the parties would not have concluded it if they had been aware of the development. This principle is anchored in international law in Art. 62 Vienna Convention on the Law of Treaties (VCLT), whereby the Secretariat of the Energy Charter recently referred in a press release to the case law of the ICJ, according to which new developments in the state of environmental knowledge and law cannot be regarded as completely unforeseeable. Against this background, a detachment from the ECT and circumvention of the "sunset clause" is rather far-fetched. The only conceivable option would be a joint or majority amendment of the ECT by the contracting parties.

Furthermore, the possibility of a so-called “inter se modification” is being discussed. According to this, the contracting parties withdrawing from the ECT could conclude an additional contract among themselves in which they agree not to apply the forfeiture clause among themselves. However, such a procedure is highly controversial with regard to Art. 16 ECT because this provision could be seen as a prohibition on putting investors at a disadvantage due to subsequent agreements.

Question: What relevance does the Energy Charter Treaty have in connection with the electricity price cap?

Answer: Against the background of the directly applicable EU Emergency Regulation ((EU) 2022/1854), the Federal Cabinet adopted the so-called gas and electricity price brake on 25 November 2022. The law is currently being discussed in the Bundestag and is expected to be passed on 15 December 2022 after consultation in the Bundesrat. The Electricity Price Brake Act is to apply from 1 March 2023 to 31 December 2023, with an option to extend it to 30 April 2024. The relief for households and companies through the electricity price brake will be refinanced to a large extent through the absorption of windfall profits in the electricity market. The Federal Government is thus implementing the requirements of the EU Emergency Regulation. Among other things, it provides for an electricity price cap of 180 €/MWh (Articles 6 and 7).

Against the background of this planned skimming of profits, the question arises whether investors from other ECT contracting parties can assert a claim for compensation against the Federal Republic of Germany for breach of the guarantees of the ECT. For example, a claim by investors for compensation due to expropriation under Art. 13 ECT could be considered. According to this provision, expropriation or measures of equivalent effect taken in the public interest are only permissible if they are accompanied by “prompt, adequate and effective compensation”. The skimming off of surplus proceeds is likely to adversely affect investors - at least indirectly through lower profit distributions. An impairment is also conceivable against the background that the upper limit for market revenues in the draft law on the electricity price brake - unlike the EU Emergency Regulation - is not linked to the actual “realised revenues”, but to the fictitious spot market revenue, which is calculated from the average spot market price and an upper limit. As a result, operators of so-called Power Purchase Agreements (PPAs) in particular are skimmed off a revenue that they have never actually earned and which is all the higher the higher the prices on the spot market. If spot market prices rise, the plant operators would receive fictitious revenues above the fixed prices of their PPAs, which they have never actually earned. Against this background, a claim by investors - at least investors from non-EU Member States (see below) - for compensation before an arbitration court on the basis of the ECT would be quite conceivable.

Question: Does the Energy Charter Treaty apply to intra-EU disputes and what is the impact of CJEU case law here?

Answer: With regard to investors from other EU Member States, a claim for compensation on the basis of the ECT is likely to be ruled out against the background of the recent CJEU case law on arbitration agreements, or at least difficult to enforce.

Already in 2018, the CJEU ruled in the Achmea case (CJEU, 6.3.2018 - C-284/16, RIW 2018, 200) that the arbitration agreement in a Bilateral Investment Treaty (BIT) between EU Member States (so-called intra-EU BIT) is incompatible with EU law. Since then, it has repeatedly concretised and extended this case law (PL Holdings, CJEU judgment of 26.10.2021 - C-109/20). In the Komstroy case (CJEU, 2.9.2021 - C-741/19, SchiedsVZ 2022, 38), for example, it ruled by way of obiter dictum that the ECT arbitration clauses (here: Art. 26(2)(c) ECT) were “inapplicable” in the context of intra-EU disputes. The reason given for this decision is that the autonomy of Union law would be violated if international (private) arbitral tribunals were to interpret and apply Union law themselves without being able to ask the CJEU for a final binding preliminary ruling. This case law is partly extended by Member State courts to ICSID proceedings based on the ECT (cf. OLG Cologne, decision of 1.9.2022 - 19 SchH 14/2). However, a state ordered to pay compensation by an ICSID arbitral award finds itself in a dilemma: Despite the inapplicable ECT arbitration clause according to the aforementioned case law of the CJEU, the arbitral award would be binding for the state under international law according to Art. 53 para. 1 and Art. 54 para. 1 of the ICSID Convention and, in principle, would have to be enforced as if it were a final judgment of a domestic court.

However, investment arbitration tribunals have so far been largely unimpressed by the Achmea jurisprudence and have continued to affirm their jurisdiction on the basis of intra-EU BITs in some cases.

Question: What effects or consequences are to be expected in the event of an arbitration award based on the ECT?

Answer: If, despite the CJEU’s case law, arbitral tribunals continue to assert their jurisdiction over intra-EU disputes on the basis of the ECT, it is likely - as in the Komstroy case - that an action for annulment of the award will be brought before a national court. If this court follows the CJEU's case law, an annulment of the award or a refusal of the declaration of enforceability is likely to be the consequence.

The EU Commission could also take action against the enforcement of investment arbitral awards. One possibility for doing so may be to pursue the fulfilment of investment arbitral awards under state aid law. In this context, it has now been clarified that the EU Commission is competent to review the fulfilment and enforcement of an investment award on the basis of state aid law. It remains to be clarified whether the fulfilment of an arbitral award constitutes state aid under substantive law. In view of its case law in recent years, however, it is hardly conceivable that the CJEU will deny this question and accept that intra-European investment arbitral awards are fulfilled or enforced. In addition, infringement proceedings on the part of the EU Commission are a possibility.

EU Member States against which an investor from another EU Member State wants to initiate investor-state arbitration proceedings can also defend themselves before the national courts against arbitration proceedings that are conducted contrary to CJEU case law. German arbitration law offers an effective way to do so with the declaratory action under section 1032 (2) ZPO. In case of non-compliance with the declaratory action by the investor, there is the additional possibility of enforcing such a declaration by an action for an injunction.

Question: Is it possible to enforce the guarantees of the ECT before national civil and administrative courts?

Answer: In principle, it should be possible to proceed before the national courts. This is because the ECT provides for recourse to the national “civil or administrative courts of the contracting party involved in the dispute” as an alternative to recourse to arbitral tribunals - and unchallenged by the CJEU - if the investor alleges that the contracting party has breached one of its substantive obligations under Part III of the Treaty (Art. 26(2)(a) ECT). The precondition is that three months have elapsed since the date on which one of the parties to the dispute requested an amicable settlement (Art. 26 para. 1 ECT). With regard to a violation of primary claims, such as the right to equal treatment under Art. 10 (7) ECT, recourse to the administrative courts under Section 40 VwGO is likely to be available. For secondary claims brought on the basis of the ECT, i.e. claims for damages or compensation, on the other hand, the question of legal recourse is more difficult to answer and not possible without a detailed examination of the individual case. In our view, however, this cannot be ruled out.

Outlook

In our opinion, lawsuits against the skimming of so-called windfall profits on the basis of the ECT are possible in principle. Against the background of the aforementioned CJEU case law, this applies in particular to claims by investors from ECT contracting parties outside the EU. With regard to intra-EU disputes, however, it is to be expected that corresponding arbitral awards on the basis of the ECT would be set aside before the national courts or their enforcement would be refused. Enforcement of the ECT’s guarantees before national courts, on the other hand, is quite conceivable, but does not offer the advantages of arbitration.