Our Arbitration lawyers at Al Tamimi & Company discuss The Modernization of Energy Charter Treaty and provide updates on the latest trends
Thomas Snider Partner, Head of Arbitration
John Gaffney Senior Counsel, Arbitration
The Energy Charter Treaty (ECT) is a multilateral framework for East-West policy cooperation in the fields of energy, investment protection, trade and transit. The ECT was signed in December 1994 and entered into force in April 1998. Currently, there are 53 Signatories and Contracting Parties to the ECT.
The protection of foreign investments;
The resolution of disputes between participating states and between investors and host states involving the use of international arbitration mechanisms;
Non-discriminatory conditions for trade in energy materials, products and energy-related equipment based on WTO rules; and
The promotion of energy efficiency and attempts to minimise the environmental impact of energy production and use.
The ECT was crafted after the fall of the Soviet Union (USSR), when many Western countries and their companies were keen to invest in modernising the energy sectors of Eastern Europe but were concerned about the legal protection of their investments.
The ECT framework was devised for energy systems driven largely by fossil fuels. Hence, by protecting existing energy investments, there has been a concern, particularly within the European Union (EU), that the ECT could make it harder and riskier for Contracting Parties to embark on a green transition.
In addition, the ECT’s investment protection provisions had not been updated since the 1990s and were the subject of must criticism. Furthermore, the EU Court of Justice has ruled that the investor-state dispute settlement (ISDS) mechanism provided for by ECT is not applicable to intra-EU disputes.
Concerns over the compatibility of the ECT and achievement of Contracting Parties’ climate goals and criticisms of the ISDS mechanism had therefore prompted calls for modernisation of the ECT.
On 24 June 2022, following 15 rounds of negotiations, agreement was reached in principle among the 53 Contracting Parties on the modernisation of the ECT. The modernised ECT will enter into force 90 days after the ratification by three-fourths of the Contracting Parties.
If approved and ratified, the modernised ECT will introduce a number of significant changes.
The modernised ECT will facilitate sustainable investments in the energy sector in a number of respects. It reaffirms the respective rights and obligations of the Contracting Parties under multilateral environmental and labour agreements, such as the UN Framework Convention on Climate Change (UNFCCC), the Paris Agreement and the fundamental conventions of the International Labour Organization (ILO), as relevant to the energy sector.
It will also reiterate the Contracting Parties’ commitment to promoting international trade and investment in the energy sector in a manner that will contribute to the objectives of sustainable development and responsible business practices.
The modernised ECT will also further clarify and strengthen the provisions on environmental impact assessment of energy investment projects in accordance with the laws and regulations of Contracting Parties thereby ensuring higher levels of environmental protection and wider public participation.
A novel “flexibility mechanism” will allow Contracting Parties to exclude investment protection for fossil fuels in their territories, considering their individual energy security and climate goals.
For example, the EU and the United Kingdom will carve-out fossil fuel-related investments from investment protection under the ECT for existing investments after 10 years from the entry into force of the relevant provisions and for new investments made after 15 August 2023 from that date with limited exceptions.
The application of the flexibility mechanism will be reviewed five years after the entry into force of the modernised ECT and thereafter every five years. This will give Contracting Parties the possibility to react to technological and political developments.
The modernised ECT will contain the following substantive provisions:
New definitions of “investment” and “investor” so that only investors with substantive economic interests will enjoy investment protection. In order to be covered by the modernised ECT, an investment will have to be made or acquired in accordance with the applicable laws of the host Contracting Party and fulfil an indicative list of characteristics, such as the commitment of capital, the expectation of gain or profit, a certain duration or the assumption of risk.
A new provision on ‘fair and equitable treatment’, which will provide for a list that designates certain measures or series of measures that constitute a violation of this standard.
A new provision on ‘indirect expropriation’, which will clarify the notion of ‘direct expropriation’, and a definition of ‘indirect expropriation’, together with a list of factors that are required to be considered for the determination of the existence of an indirect expropriation in each case (such as economic impact and character of the measure).
A most-favoured-nation treatment clause that will not extend to dispute settlement procedures in other international agreements and that will provide that the substantive provisions in other international agreements in and of themselves do not constitute “treatment” to be accorded under this clause.
Additional wording in the preamble and throughout that will reaffirm the Contracting Parties’ right to regulate vis-a-vis investments and investors in the interest of legitimate public policy objectives. Such objectives may include the protection of the environment, including climate change mitigation and adaptation, protection of public health, safety and public morals.
An umbrella clause, which will provide that a breach of specific written commitments through the exercise of governmental authority will be covered.
Relevant dispute settlement rules will also be modernised:
The UNCITRAL Rules on Transparency in Treaty-based Investor-State arbitration will apply to arbitral proceedings in ISDS disputes with further additions envisaged in the modernised ECT.
Mechanisms will be established for dismissal of claims that are manifestly without legal merit as a matter of substance or jurisdiction at the outset of proceedings and for expedited dismissal of claims unfounded as a matter of law on the merits.
A special provision is envisaged for dismissal of claims submitted as a result of investment restructuring for the sole purpose of submitting a claim under the ECT.
A new provision will give a Contracting Party the possibility to request a claimant to post security for costs in certain cases, such as when there is a risk of not honouring an adverse decision on costs.
A new provision will require both disputing parties to disclose information on a third party financing its litigation costs.
A new provision that will clarify that an arbitral award may provide for monetary damages or restitution in case of expropriation.
The ECT will provide that an investor from a Contracting Party that is part of a regional economic integration organisation (REIO), like the EU, cannot bring an ISDSclaim against another Contracting Party member of the same REIO. This will bring an end to intra-EU claims under the ECT.
It remains to be seen if the requisite number of Contracting Parties will ratify the modernized ECT. There has already been some criticism that it is insufficient for ambitious climate action. However, if ratified, the modernized ECT, in the words of the European Commission, “will facilitate sustainable investments in the energy sector by creating a coherent and up-to-date framework”.
For further questions, please contact John P Gaffney or Thomas R Snider.
Published in August 2022
