UK: The Energy Charter Treaty and the Protection of Energy Investments

Last Updated: 11 October 2002

The Energy Charter Treaty is a multinational treaty that regulates the biggest industry in the world, energy. The Energy Charter process started just over ten years ago with the adoption of the European Energy Charter in 1991. This set out the principles and objectives that were to govern the energy industry in Europe on all issues. The Energy Charter Treaty (ECT) was negotiated at the same time as the Uruguay round of trade negotiations and was heavily influenced by them as a result. It provides significant, and in some cases unprecedented, protections for commercial players in the European energy sector. Surprisingly, to many businessmen and lawyers active in the industry, the ECT remains unknown or enigmatic at best.

Genesis of the Energy Charter Treaty

The ECT is an ambitious multilateral treaty which covers four main areas: investment, trade, transit and dispute settlement. Although the transit provisions were and continue to be somewhat hotly debated, this article will look more at the impact the investor protections and dispute settlement provisions will have on energy companies. (See separate article in this issue on energy transit.) One of the treaty’s most important features is that it affords the same type of investment protection to the energy sector as most other investors have benefited from under bilateral investment treaties. It is today the most ambitious project yet seen to set up an international investment (plus trade) regime.

The ECT was signed in 1994 and came into force on 16 April 1998. There are currently 51 signatory parties (46 ratifications) including countries from East and West Europe and the former CIS states. The European Community itself is also a signatory to the ECT, as is Australia, Iceland and Japan. The Russian Federation at present applies the terms of the treaty provisionally. Most recently Tunisia and Morocco have applied for accession. The treaty is no longer exclusively concerned with just European energy issues and in fact the reference to European was dropped at the time the ECT was adopted.

Notable absent signatories to the ECT are the US and Canada as both countries were originally very much involved in the earlier meetings concerning the European Energy Charter. The USA refused to sign the ECT because it felt that the level of protection afforded to investors under its terms did not reach the same level as that found in the US standard form bilateral investment treaty (BIT). Furthermore, there are many of the Middle- Eastern oil-producing states who have not been involved in any way with the ECT. China, however, has applied for and been granted observer status at the Energy Secretariat meetings.

The policy and effect of the ECT is clearly set out in Article 2. Its aim is to establish a legal framework to promote long-term co-operation in the energy field and to ensure an open, and non-discriminatory, energy market between the Contracting Parties. These objectives are to be implemented in accordance with the terms and conditions of the European Energy Charter. It is interesting to note that the Charter adopted in 1991 has thus been indirectly incorporated into the provisions of the ECT.

Investor protections – Part III

The ECT affords the energy investor the same type of investment protection available to other sectors of foreign investors. Energy investment was more often than not excluded from bilateral investment treaties. The ECT has redressed this balance and now energy companies benefit from the full level of protection afforded under international law, in particular the law relating to expropriation.

Part III of the ECT sets out the provisions relating to the promotion, protection and treatment of investments in the energy sector. The term "investment" is given a very extensive definition in the ECT and includes all economic activity in the energy sector including the exploration, extraction, refining, production, storage, land transport, transmission, distribution, trade, marketing or sale of energy materials and products. It also includes tangible and intangible, moveable and immovable property related to the energy industry. The provisions in Part III are divided into two parts. The first deals with the preinvestment phase. The obligations on the state at this stage impose no more than general obligations of "best efforts" at nondiscriminatory national and most-favoured nation treatment. It therefore grants to the host state a certain degree of discretion in admitting investors while at the same time imposing the duty of non-discriminatory access.

The second part is the post-investment phase (once an investment has been made). Once the investor has committed resources and taken on the investment risk, more protection is given under the terms of the ECT. The investor is protected against discrimination, expropriation, breach of contract and other commitments, destruction and impediments to transfer of earnings and capital. Furthermore, host countries are directly responsible for actions of sub-national authorities including regional and local governments and authorities.

It is anticipated that the types of contractual arrangements which would be covered by the protections in Part III include contracts for the purchase and sale of power, contracts for the supply of transit pipelines and contracts for the construction of an oil exploration plant. The AES Summit Generation Limited case was the first claim to be taken under the terms of the ECT. The dispute arose from the extent of obligations of a foreign generating company after the privatisation process in Hungary. The claimant company commenced proceeding in the International Centre for Settlement of Investment Disputes (ICSID) on 25 April 2001 based on a dispute concerning a power purchase and sale agreement. The case has since been settled so it remains to be seen how an international arbitral tribunal will interpret and apply the dispute resolution provisions of the ECT. Typical future disputes where an allegation of breach of obligation by a host state may arise include failure to allow increases in tariffs, unfair taxation systems for foreign investors, and refusal to grant normal allowances to the foreign investor.

Significantly, the ECT imposes obligations on all Member States. Thus, for example, it will not only protect British investment in Eastern Europe. It may, also, potentially protect, say, Japanese investment in the UK energy sector. This raises the possibility of the treaty’s investment arbitration provisions being invoked against Western states (a phenomenon already being experienced in the United States under the North American Free Trade Agreement).

Dispute resolution provisions – Part V

The ECT has a very innovative regime for dispute settlement. It creates a direct investor/state obligation of compulsory arbitration. Although, to a certain extent, there have been precedents in recent BITs and in NAFTA, the scale and extent of the dispute provisions in the ECT are entirely novel. It encourages the parties to negotiate and reach an amicable settlement to their dispute. If not, there are three distinct provisions relating to dispute settlement under the treaty, namely (1) interim provisions for trade dispute settlement set out in Annex D; (2) investor/state dispute provisions in Article 26; and (3) state/state disputes in Article 27.

The interim measures set out for trade related disputes will not be reviewed in detail in this article. It is worth noting, however, that they do provide for a WTO-type panel to consider the particular trade dispute between the parties. The panel will be composed of three members who sit in their individual capacities and do not take instructions from any government or other body. To date no such panel has been constituted to deal with any trade-related disputes. There are also detailed provisions for arbitration of state/state disputes.

However, for present purposes, the most significant innovations in the ECT are in the extent to which the treaty gives investors direct rights of recourse against host states to enforce the treaty’s investment provisions, whether or not there is a concession agreement in place.

Investor/state disputes

Article 26 of the ECT sets out the provisions relating to settlement of disputes between an investor and a contracting party. It is a ground-breaking provision in that it provides to an investor the right to choose to go to arbitration. The primary focus of the provisions in Part V is to encourage the parties to reach an amicable settlement. If this is not achieved within the initial cooling-off period of three months, the investor may choose to submit the dispute for resolution in (a) the national courts; (b) a previously agreed dispute settlement procedure; or (c) in accordance with the treaty provisions.

The treaty provisions give the aggrieved investor a number of international arbitration options, including:

1 ICSID or ICSID Additional Facility Rules;

2 UNCITRAL arbitration rules; or

3 Arbitration Institute under the Stockholm Chamber of Commerce.

An investor may commence arbitration proceedings against a state for an alleged breach of treaty obligations at its preferred international arbitration institution. There is no restriction as to where the arbitration should be held, but the parties can request that it take place in a country that is a signatory to the New York Convention. The arbitral award is final and binding on the parties and each contracting party is obliged under the ECT to make provision for the effective enforcement of the award.

The ECT makes it explicit that the governing law in any such arbitration is the treaty itself and international law (and not the national law of any of the states concerned): Article 26(6).

Investors protection survives state withdrawal

In order to protect long-term investments, the ECT provides extraordinarily for long tail protection even after a state has withdrawn from the treaty. The contracting party can only withdraw after the treaty has been in force in the state for a period of five years. The withdrawal notice becomes effective one year from the date of notification. However, all of the obligations and protections provided for in the ECT do not cease at the end of that year. The obligations continue to apply to investments made in that state prior to the date of withdrawal for another 20 years. Essentially, investments made within the first six years of a state having signed up to the ECT are protected under the ECT for a period of 26 years.

Conclusion

Investments in the energy industry require enormous up-front capital expenditure. This investment may take years to be recovered and for any profit to be made. A prudent investor will seek to reduce his long-term risk exposure. Arbitration provides the investor with a certain degree of comfort against actions and political risk falling directly under the control of the host state. The ECT gives to the investor the option to choose arbitration when seeking redress against a state which they believe has breached the ECT obligations. There does not have to be a contractual relationship between the investor and the host state. The dispute resolution provisions will automatically apply. Although no case has yet been decided under the dispute resolution procedure of the ECT, it is anticipated that this will change when investors become aware of the protective regimes available.

(The Energy Charter Treaty and materials relevant to its operation can be found at www.encharter.org/index.jsp.)

© Herbert Smith 2002

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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