Marios Tokas*
I. Introduction
At the end of ‘Τhe Graduate,’ the protagonist duo happily sits in the back of the bus together. As the music plays on, the duo starts becoming less and less happy as they think about their future and the repercussions of their actions, since Elaine has just fled her wedding to run out with Benjamin to an uncertain future.
The ending scene of ‘The Graduate’ resembles the situation in the aftermath of the denunciation of the Energy Charter Treaty (ECT) by various E.U. member states (including France, Germany and the Netherlands) and the proposal for a so-called coordinated exit together with the E.U. This move radically differs from the E.U.’s previous stance. The E.U.’s previous position, based on a 2022 agreement in principle, favored the adoption of a ‘modernized’ version of the ECT which purported to reduce the protective scope for ‘climate-dirty’ investors.
The coordinated exit will entail two parts: 1) denunciation of the ECT by the E.U., as a member of the ECT, and of the E.U. member states; and 2) an inter se agreement between the E.U. and its member states intended to terminate the 20-year sunset clause in the ECT concerning existing covered investments.
This move has been met with enthusiasm by climate think-tanks which have been advocating for an exit from the ECT for quite some time, calling the ECT a ‘climate-wrecking treaty.’ However, this enthusiasm has gradually faded as disputes continue to arise, politicians with anti-climate agendas are elected, and many states exploit the climate emergency to pursue a protectionist agenda which includes export controls, restrictions in critical raw materials trade, and nationalizations of investments.
Without getting into the debate over the impact of the ECT on the E.U.’s climate goals and the climate policies of the E.U. member states, it is useful to examine what happens next. No politically viable legal instrument is available to replace the ECT at the moment. Meanwhile, the old ECT remains relevant due to its 20-year sunset clause (Article 47.3 ECT), which extends protection to covered investors and investments for 20 years after a party’s denunciation of the ECT. Any investment made before the end of the withdrawal notification’s one-year notice period is also protected under the sunset clause.
In the present article, I provide some reflections on the legal and policy considerations of the uncertain future of investment arbitration in the E.U. in light of the ECT’s apparent collapse.
II. Reasons for the Coordinated Exit
The first argument in favor of the coordinated exit is that it will ensure legal security and predictability within the E.U. and boost climate change cooperation among the E.U. member states. This argument is premised on the fact that many E.U. member states’ energy and environmental policies have given rise to numerous large investor-state dispute settlement (“ISDS”) claims by E.U. investors. The E.U. has recently ramped up its policy interventions on climate change as part of its Green Deal; new initiatives include mandatory emissions reduction targets, stricter environmental regulations, and subsidies for renewable energy. The E.U. and its member states want to ensure that the Deal is not derailed by ISDS claims. In other words, the elimination of such claims will prevent regulatory chill that could hamper the carbon neutrality targets set by the bloc.
This leads to the second main argument for an exit: after the Achmea and Komstroy judgements from the Court of Justice of the European Union, and the decisions of several E.U. domestic courts, any new intra-E.U. claims would now be incompatible with E.U. law. Despite these proclamations, all but one arbitral tribunal have rejected all jurisdictional objections based on the various intra-E.U. allegations. Investors simply enforce their intra-E.U. awards in other jurisdictions. Indeed, investors have traditionally had no issue in resorting to U.S. courts to enforce intra-E.U. claims, aside from one recent and heavily criticized exception, and have also enforced awards in the U.K. and Australia. With the coordinated exit, the E.U. and its member states want to ensure that no new claims will be made.
The last argument in favor of the coordinated exit is the desire to avoid claims from carbon-intense industries. Even if these claims fail at the merits stage, they have significant costs. The costs of the proceedings have frequently angered E.U. member states.
III. Much Ado About Nothing?
However, the real question lies in whether the coordinated exit can in fact achieve these three objectives.
A. Application of the Coordinated Exit in the Intra-E.U. regime: Uncertainty Remains
The legal effects of the coordinated exit are twofold. First, the exit will be considered an inter se modification of the ECT under Article 41 of the Vienna Convention on the Law Treaties (“VCLT”) with regards to the ECT sunset clause. Second, the exit will be considered a withdrawal from the ECT (in light of VCLT Article 54 and ECT Article 47) for the rest of the ECT’s provisions. The second effect is not contested. By contrast, the effects of an inter se modification to the sunset clause have stirred substantial debate.
The first legal question is whether the inter se modification would be in accordance with Article 41 of the VCLT. Article 41 introduces two requirements:
- The modification should “not affect the enjoyment by the other parties of their rights under the treaty or the performance of their obligations” (VCLT Article 41(b)(i));
- The modification should “not relate to a provision, derogation from which is incompatible with the effective execution of the object and purpose of the treaty as a whole” (VCLT Article 41(b)(ii)).
Academic discourse on whether the inter se modification would meet these criteria remains divided.
An additional lingering issue lies in the operation of ECT Article 16. This provision prohibits the conclusion of a subsequent agreement by parties to the ECT concerning the subject matter of investment protection (ECT Part III) and dispute settlement (ECT Part V) that is less favorable for the covered investors than the protections conferred by the ECT. Several investment tribunals have confirmed that an inter se agreement between E.U. member states cannot restrict access to dispute settlement for investors in intra-E.U. cases. However, ECT Article 16 does not apply to sunset clauses: the sunset provision, ECT Article 47, is not situated in Parts III or V of the ECT.
Still, arbitral tribunals have reiterated that ECT Article 16 evinces an intent by the ECT’s parties to preserve the rights of investors and investments to access dispute settlement—a major plank of the Treaty. Therefore, restrictions such as the removal of the sunset clause could be considered “incompatible with the effective execution of the object and purpose” of the ECT, contrary to VCLT Article 41. It cannot be taken for granted that tribunals will consistently side for or against view. As long as inconsistency will persist, investors will keep bringing claims.
While the coordinated exit is unlikely to prevent investors from pursuing ECT claims in the coming years, legal uncertainty will remain. This is particularly due to the absence of a mandated consistent approach among investment treaty tribunals. In addition, various factors such as the relevance of the law of the seat may play a crucial role in reaching divergent conclusions. For instance, the Green Power v. Spain tribunal, when accepting the intra-E.U. objection, placed considerable importance on the fact that the law of the seat for a Stockholm Chamber of Commerce (“SCC”) arbitration and the applicable law was Swedish law, which recognizes the primacy of E.U. law. To the contrary, ICSID arbitration is ‘delocalized’ (i.e. there is no ‘seat’); thus, the analysis of the Green Power tribunal is not transposable, as demonstrated by a recent decision.
Hence, the inter se modification, at least prima facie, does not ‘remedy’ the dissatisfaction of the E.U. member states with the intra-E.U. claims. Claims will continue to be submitted at the intra-E.U. level, since as previously explained, investment tribunals remain largely unaffected by the Achmea or Komstroy decisions and the coordinated exit will not necessarily nullify the sunset clause. Tribunals are generally not persuaded by the arguments of primacy of E.U. law over the ECT, and tend to dismiss the relevance of E.U. law in establishing jurisdiction— especially in ICSID arbitrations. Even a recent SCC award recently rejected the intra-E.U. objection, despite the respondent’s reliance on Green Power.
The only real disincentive for claims seems to be legal actions taken in the domestic courts of E.U. member states to ensure non-enforcement. However, as previously mentioned, non-E.U. jurisdictions still remain an option for enforcement.
Further, most intra-E.U. claims raised under the ECT were submitted by renewable energy investors and related to governmental incentives granted and then revoked by E.U. member states. Thus, the goal of avoiding intra-E.U. claims does not necessarily go hand in hand with the promotion of decarbonization. It can hardly be argued that providing additional procedural avenues for costly renewable energy investors would interfere with the E.U. Green Deal.
B. The Coordinated Exit does not Stop Extra-E.U. Claims
In case of a coordinated exit, the ECT sunset clause remains in place and effective between the E.U./member states and third parties. Specifically, the coordinated exit will only apply between the E.U. and member states that have signed up for the exit, leaving third parties’ rights and obligations unaffected.
A few authors argue that the sunset clause could be set aside by virtue of a ‘fundamental change of circumstances’ argument. However, the legal standard to invoke this defense is rather high. Article 62 of the VCLT, which sets out the fundamental change of circumstances standard, has been consistently interpreted by international courts and tribunals, including the International Court of Justice (ICJ). The defense requires the cumulative fulfilment of strict conditions. Notably, the change should be ‘fundamental’ to the circumstances that constituted the essential basis of the consent of the parties to be bound by the treaty. Moreover, the change’s impact must drastically transform the scope of the obligations that are still to be performed under the treaty. The ICJ in Gabčíkovo-Nagymaros denied that progress in environmental knowledge and the emergence of new norms in international environmental law constituted a fundamental change of circumstances. Generally, the ICJ has reiterated that the stability of treaty relations requires that Article 62 VCLT be applied only in exceptional cases.
For these reasons, a fundamental change of circumstances defense by the E.U. and its member states before investment treaty tribunals would likely fail. At a minimum, the defense will not yield a consistent outcome. In other words, the goal of reducing the costs related to arbitral proceedings by preventing the filing of new claims will not be met, even if a very genuine and convincing argument can be made with regards to the fundamental change of circumstances.
The power of the ECT sunset clause means that the ECT will continue to protect ‘dirty’ investments made by third-country investors in the E.U. (and vice versa) for 20 years. Thus, any alleged regulatory chill will continue to occur, especially given the fact that Switzerland and Japan remain parties to the ECT. At the same time, the decision by the U.K. to exit the ECT means that existing U.K. investments in the E.U. will be protected until 2045. Indeed, the 20-year sunset clause will continue to protect existing investments unless the U.K. agrees with the E.U. and its member states to join the coordinated exit, which seems to be a politically difficult decision post-Brexit. Additionally, ISDS mechanisms may see increased use given the World Trade Organization system deadlock, because ISDS provides an effective and enforceable alternative to challenge the E.U.’s trade-restrictive climate measures. Recently, a national court reiterated that extra-E.U. ISDS cases are compatible with E.U. law.
C. Exporting E.U.-Dirty Industries and Losing the ‘Climate Champion’ Role
The rest of the ECT parties will likely be stuck in a treaty that has been considered by think-tanks as ‘climate wrecking’ in the meantime. This outcome is far from positive. Many ECT members, who already lack ambition on climate change, will be regulated by the old ECT. It is hard to see how the ECT parties will agree on a modernization without the pivotal role of the E.U. The European Commission recently admitted how important it would be for the E.U. and its member states not to block the modernization of the ECT.
Non-modernization of the ECT provides incentives for E.U. investors to invest abroad and escape the E.U.’s tight regulatory environment, furthering the carbon leakage the E.U. is desperately trying to avoid with measures like its carbon border adjustment mechanism (“CBAM”). Simultaneously, E.U. investors will likely re-structure their investments through third countries to benefit from investment treaty protection. They could use an intermediate company in another ECT country (such as Switzerland), or even through states that have comprehensive BITs with E.U. member states (like the UAE and Singapore).
Even if the CBAM or other climate change measures ensure that ‘dirty’ investors will not export back to the E.U., these investors will seek other markets. However, climate change is a global negative externality. Even if the E.U. becomes climate-neutral, the issue will persist. In addition, E.U. investors will have an additional incentive to submit their ISDS claims as soon as possible due to the 20-year sunset clause.
In light of these potential developments, it becomes clear that the coordinated exit does not address the concerns of the E.U. in relation to its Green Deal goals and plan for carbon neutrality. There is little evidence that the ECT ever stood in the way of the E.U. and its member states’ more ambitious policies. At the same time, the need for further cooperation on climate matters exists mostly with respect to non-E.U. countries, especially considering new regulations linked with climate change such as CBAM. The E.U. has been trying to build its role as climate champion; however, at the most crucial time, it has elected to exit the discussion. The exit leaves significant fossil fuel extracting countries stuck with the allegedly ‘climate wrecking’ agreement.
Finally, regarding legal uncertainty and arbitral costs, it appears that denouncing the ECT might ironically also remove one of the more familiar tools we have for managing energy transactions—one that states can monitor, comprehend, and modernize, and one that the public can access. Moving away from the ECT and towards, for example, state contracts and concessions—or even worse, state contracts with stabilization clauses, would favour private contractual obligations, that would provide less policy space than the rules set in investment treaties. Indeed, investment contracts are more problematic than international agreements in terms of transparency and bargaining power, as local politics play an even bigger influence over their terms and conclusion.
IV. Conclusion
In my view, the coordinated exit as outlined above fails to address the goal of reducing ISDS cases that could potentially derail the green transition and is akin to burying our heads in the sand. A coordinated exit will not make the ECT’s climate issues disappear. The ripple effects of the E.U.’s exit will probably lead to a stagnation in climate change discussions and policies in many smaller ECT countries. The rise of geostrategic policies including nationalization of critical raw materials supply chains will likely require the return of the traditional investment law protections that are taken as given. Major oil-producing countries that previously demonstrated active interest in joining the modernized ECT, such as Nigeria, have lost interest after the E.U. announced its plans to exit. A better option would be for the E.U. to push for a more favorable ECT, even with fewer countries. The modernized ECT should include enforceable climate change obligations, exclude intra-E.U. claims, and introduce new procedural rules (e.g., security for costs to avoid frivolous claims) and modernized substantive obligations.
A modernized ECT could ensure a ‘reverse regulatory chill’: it could ensure support towards decarbonization which will not wither or change easily due to changes in the political landscape. States would not renege on the treaty’s climate change commitments without exposing themselves to arbitration proceedings. Ahead of the 2024 elections, the potential rise to power of climate change skeptic politicians in many countries constitutes a significant source of uncertainty on green transition plans. Binding legal provisions can ensure legal stability and predictability that is a conditio sine qua non for investments investment in green technologies and industries.
The various proposals by climate think-tanks presume that states will cooperate and agree on financing and capacity-building mechanisms. As many elections since the mid-2010s have demonstrated, a country’s support towards climate neutrality cannot be taken for granted. At the same time, the need for consensus for any change incentivizes any capital-exporting country to never denounce ECT in order to ensure that its investors have the capacity to sue.
What comes next? We have to wait for the sequel!
Marios Tokas* is a Teaching Assistant and PhD Candidate at the Geneva Graduate Institute (marios.tokas@graduateinstitute.ch). He would like to thank Michail Dekastros and Natalia Mouzoula for their comments and constant support, as well as the HILJ editorial team for their comments.