The Situation: In March 2021, the reform to the Mexican Electricity Industry Law (the "Electricity Reform") came into effect. It is a material modification of the sector rules that attracted national and foreign investment to Mexico's electricity generation market, clearly favoring power plants owned by the state-owned Federal Electricity Commission at the expense of private investments.
The Result: The Electricity Reform increases regulatory uncertainty, limits free competition, and deals a major blow to private investment in the energy sector and the use of renewable energy.
Looking Ahead: Several provisions of the Electricity Reform may violate the Mexican Constitution and rights afforded by Mexico to foreign investors under international investment treaties. As a result of the Electricity Reform, the Mexican energy sector is expected to be particularly active on the legal front.
On March 10, 2021, the Electricity Reform-approved by the Mexican Congress at the proposal of President López Obrador-came into effect.
The Electricity Reform (i) changes grid dispatch rules to benefit power plants owned by the Federal Electricity Commission (Comisión Federal de Electricidad or "CFE"), displacing private power plants and renewables producers; (ii) qualifies and limits free competition and open access principles in the generation and commercialization of electricity, making generation permits subject to the planning criteria of the Mexican government; (iii) eliminates CFE's obligation to acquire energy through power auctions; (iv) enables CFE's older plants to get Clean Energy Certificates, for which they did not qualify, which could lead to a decrease in the value of certificates granted to private clean energy plants, and disincentivize investment in green power; (v) instructs Mexico's Energy Regulatory Commission to revoke self-supply generation permits "obtained in violation of the law"; and (vi) orders the review of the power purchase agreements entered by the CFE with independent power producers to determine whether such agreements should be renegotiated or terminated.
How is the Electricity Reform Significant?
The Electricity Reform is the boldest action taken by the López Obrador Administration in its attempts to dismantle Mexico's 2013 energy reforms. It changes the rules of the electricity market to favor the power plants of the state-owned CFE, increases regulatory uncertainty, limits free competition, and deals a major blow to private investment in the energy sector and the use of renewable energy. It is a material modification of the sector rules that attracted national and foreign investment, and creates major solvency risks to private sector investments in electricity generation. The preferential treatment to CFE is along the lines of previous legislation that was challenged in Mexico's federal courts and declared against the Mexican Constitution, so new domestic legal challenges are already taking place against the Electricity Reform, and many more can be expected.
What Foreign Investors in Mexico Must Know to Protect Their Rights
Several provisions of the Electricity Reform may violate the Mexican Constitution, including the rights to a healthy environment, an integral and sustainable national development, and they be deemed to be against free competition, and could be challenged in Mexican courts. The Electricity Reform also potentially violates rights afforded by Mexico to foreign investors under more than 40 bilateral investment treaties, fair trade agreements, and international treaties containing investment chapters. Accordingly, when considering legal options to address the Electricity Reform, qualified foreign investors in the Mexican electricity industry can consider a two-pronged approach: domestic and international.
Local legal actions against the Electricity Reform can be pursued through a constitutional appeal (amparo), within 30 business days, counted as from March 10, 2021, the effective date of the Electricity Reform. If the Electricity Reform does not affect a participant of the Mexican Electricity sector, and the competent authorities implement the guidelines of the Electricity Reform by a concrete act, affected foreign investors have 15 business days from the date the act of authority was implemented to file their legal challenges.
Foreign investors may also initiate legal actions through the investment protection clauses provided for in international treaties, such as Annex 14-E of the USMCA-the agreement between Mexico, the United States, and Canada-and various Reciprocal Investment Promotion and Protection Treaties signed by Mexico and other countries (including Spain, the Netherlands, Germany, and France), and in the North American Free Trade Agreement, which continues to apply to some investments.
How a specific investor is affected, and what protections the Electricity Reform may have violated, requires a case-by-case analysis. The most common treaty protections that the Electricity Reform could potentially violate would be the prohibition of expropriation without fair compensation, and fair and equitable treatment.
As a matter of international law, an expropriation takes place when an investor is substantially deprived of the use, benefit, or control of his investment. This may be found even without a formal seizure of assets, where the investor retains paper title over the property. Where the state's acts deprive an investor of the ability (and not necessarily the right) to exploit and enjoy its investment, a claim for expropriation may be possible. Most of Mexico's international treaties protect qualified investments from expropriation, either direct or indirect, unless the government actions were taken for reasons of public interest, on a nondiscriminatory basis, in accordance with the rule of law or due process, and upon payment of compensation.
Fair and Equitable Treatment ("FET") is, at its core, a guarantee of good faith and due process, and is the most frequently invoked standard in investment disputes. Where available, it is likely to be the strongest claim in a dispute related to the Electricity Reform. Under the FET standard, Mexico shall ensure fair and equitable treatment of the investments of foreign investors and shall not impair, by unjustifiable or discriminatory measures, the operation, management, maintenance, use, enjoyment, or disposal thereof. Some of Mexico's treaties limit the FET standard to treatment in accordance with international law or with customary international law. The FET standard is fact-specific and may be breached by a state's actions or omissions that (i) are not transparent or consistent and create an unstable or unpredictable legal framework or business environment for the investment; (ii) violate the investor's legitimate expectations relied upon by the investor to make the investment; (iii) are discriminatory; or (iv) violate due process or results in a denial of justice, among others. The investor's legitimate expectations can be based on Mexico's legal framework, contractual undertakings, and any undertakings and representations made explicitly or implicitly to the investor by Mexico-and changes in the legal framework may also be considered breaches if they represent a reversal of assurances made by Mexico to the foreign investor.
When considering legal action against Mexico, investors should carefully examine their treaty coverage. Each treaty contains unique procedural requirements, such as the time necessary to initiate an international claim and the potential incompatibility between local and international actions, among other things. The "fork-in-the-road" provision may preclude an investor from starting or continuing certain domestic court proceedings if the investor wishes to initiate an arbitration proceeding under the relevant treaty. That is the case, for example, with the Spain-Mexico investment treaty, so Spanish investors must be careful not to waive their international law rights by resorting to domestic litigation. Notices of disputes, and cooling-off periods, can be utilized strategically, in parallel with compatible domestic court actions, and international and local counsel working collaboratively would achieve the best result.
Three Key Takeaways
- The Electricity Reform changes the rules of the Mexican electricity market, benefiting state-owned power plants and limiting free competition in the energy sector. The new regulation is expected to create solvency risks to private sector investments in electricity generation, a sector which has attracted significant foreign investment in recent years.
- When considering legal options to address the Electricity Reform, qualified foreign investors in the Mexican electricity industry can consider a two-pronged approach: domestic and international. How a specific investor is affected, and what protections the Electricity Reform may have violated, requires a case-by-case analysis. When considering legal action against Mexico, investors should carefully examine their treaty coverage.
- It will be a challenge to address these issues and successfully navigate the complex options to protect investments in the energy generation sector in Mexico. Our presence in Mexico, the United States, and all relevant European jurisdictions?as well as our strong Latin American practice and our unparalleled experience in the energy markets and in the litigation and arbitration space on both sides of the border?allows us to help in dealing with the multifaceted challenges that the Electricity Reform involves, with a cross-border, fully bilingual, multidisciplinary team ready to deliver comprehensive legal advice on the options in defense of the rule of law.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.