A legal look at EU plans to end ECT investment protection for Russia and Belarus

The ECT is an international treaty that requires contracting parties, among other things, to provide fair and equitable treatment to investors, to avoid discrimination and to compensate investors in case of expropriation. It also provides investors with a right to seek damages through international arbitration where host government actions violate the minimum standards set out in the treaty.

Amidst criticism that the ECT has not been modernised sufficiently to align with climate targets – its protections apply to fossil fuel investment as much as they do to clean energy – some contracting parties have been evaluating their membership. Earlier this year, the UK gave notice of withdrawal from the ECT, and late last month the EU notified its withdrawal from the treaty too – decisions that will take effect after a one-year period.

The separate proposal tabled by the Commission to deny ECT benefits to Russian and Belarussian owned or controlled companies raise questions of both EU and public international law that we explored in a recent article published by the Kluwer arbitration blog, repurposed below with permission.

Structure and content of the proposal

In structural terms, the proposal consists of two parts: an explanatory memorandum, in which the background and motivation of the proposal are set out, and the “Proposal for a Council Decision” itself.

The proposal by the Commission to the European Council is that the Council direct the Commission to issue a declaration in the form annexed to the proposal. If implemented, this will have the international legal effect of denying the investment protection advantages of Part III of the ECT – apparently to the maximum extent legally permissible – with respect to investments owned or controlled from Russia and Belarus. Notably, the proposal purports to deny investment protection on behalf of not only the EU and Euratom but also the EU member states which are also contracting parties to the ECT.

The proposal and declaration are based on a possibly debatable assumption that neither Russia nor Belarus is a contracting party to the ECT.

Does the proposal have a sound basis in EU law?

The proposal purports to be based on Articles 207 and 218(9) of the Treaty on the Functioning of the European Union (the TFEU). Article 207 provides that the EU’s competence with respect to “common commercial policy” includes “foreign direct investment”. This provision has been invoked as a basis for numerous EU initiatives with respect to investor-state dispute settlement in the past.

Article 218(9) provides that the Council can, on a proposal from the Commission, decide to suspend application of an agreement.

Under the proposal, a “partial suspension” of the ECT with respect to Russia and Belarus is envisaged. This constitutional basis to suspend an agreement to which the EU is a party has been exercised before, notably in relation to the agreement between the EU and Russia on facilitation of issuance of visas.

Is a denial of benefits a suspension?

It may be questioned whether, in exercising its undoubted right at international law to deny benefits pursuant to Article 17 of the ECT, the EU is in fact partially suspending the ECT or rather merely exercising a right conferred on all ECT contracting parties. Even after its Article 17 notice takes effect, the EU will still be applying the ECT according to its terms, as it was before.

It is true that Part V of the 1969 Vienna Convention on the Law of Treaties (the VCLT) refers to the possibility of suspending the operation of a treaty in accordance with its own terms, as well as on other grounds, but many of these references contemplate the suspension of a treaty as a whole, or with respect only to certain clauses or to certain contracting parties.

Furthermore, the notion of “suspension” intuitively implies an action of a temporary nature. By contrast, Article 17 does not explicitly offer the possibility of a temporary denial of advantages. Nor does anything in the proposal or declaration suggest that the effects of the EU’s proposed Article 17 notice are intended to be anything other than permanent.

Moreover, it does not appear that the Commission intends that the EU follow the procedure set out in Section 4 of Part V of the VCLT with respect to suspension – notably, notifying the other ECT contracting parties of its intention and offering them a period of at least three months to object, with possible dispute resolution proceedings in case of disagreement.

For all these reasons, the Commission’s intention that the EU deny benefits to certain investors under the ECT sits uncomfortably with the notion of “partially suspending” the operation of the ECT, as the proposal’s cited legal basis sets out.

Can the EU deny benefits on behalf of EU member states?

The declaration purports to deny benefits pursuant to ECT Article 17 on behalf of the EU, of Euratom and of all EU member states which are also contracting parties to the ECT. It may be questioned whether the EU is in fact competent to exercise Article 17 on behalf of its member states, or rather only on its own behalf, with its relevant member states retaining competence to exercise Article 17 for themselves. Certainly Germany, having issued its own similar Article 17 notice on 15 March 2023, might take the view that it retains full competence in this regard.

International legal aspects

In international legal terms, the proposal is based on both paragraphs of Article 17 of the ECT. These two paragraphs have significantly different objects and purposes.

Paragraph 1 of Article 17 is intended to enable ECT contracting parties to prevent free-riding by denying benefits to claimants owned or controlled from a third state, where the claimant has no substantial business activities in the contracting party of its incorporation.

Paragraph 2 is intended to enable ECT contracting parties to deny benefits to investments owned or controlled from a third state with which the denying contracting party does not maintain diplomatic relations, or as to which it has implemented sanctions which would be violated or circumvented if such benefits were granted.

Paragraph 1: preventing free-riding by mailbox companies

The invocation of paragraph 1 has not in itself raised any particular legal issues of principle in the past, although it is debatable whether, in the case of the proposal and declaration, the object and purpose referred to by the Commission in the accompanying explanatory note is consistent with the broad and unqualified use of paragraph 1 in relation to all investors – and not just sanctioned investors – which are ultimately owned or controlled from Russia or Belarus.

Over the life of the ECT, several respondents have sought to invoke paragraph 1 retrospectively, after an investor has initiated investment arbitration proceedings. This gives rise to a timing question – whether retrospective or only prospective invocation is permissible – which we address below. Paragraph 1 can also give rise to an issue whether the claimant has substantial business activities in the contracting party of its incorporation. Tribunals have generally treated this as a relatively straightforward question of fact.

Paragraph 2: giving effect to sanctions

The invocation of paragraph 2 is a little more complex, assuming that the denying contracting party sanctions only some, but not all, investors from the relevant third state, as is the case with the proposal. Specifically, it may be questioned whether a denial under paragraph 2 of benefits to all investors from the third state, where only some such investors are sanctioned, goes beyond the object and purpose of that paragraph.

Three other ECT contracting parties – Ukraine, Germany, and the UK – have issued Article 17 declarations with regard to Russian investors.

Ukraine’s declaration is based on paragraph 2 only and denies benefits to all Russian investors; the declaration also implies that Ukraine in fact sanctions all Russian investors.

Germany’s declaration invokes both paragraphs 1 and 2 and it is unclear whether Germany’s invocation of paragraph 2 is intended to apply to all or only to sanctioned Russian investors.

The UK’s declaration also invokes both paragraphs and clearly provides that the denial of benefits under paragraph 2 applies only to Russian investors named in the UK’s sanctions list, as that list may evolve from time to time.

The EU proposal

The proposal and declaration are based on paragraphs 1 and 2. As with Germany’s declaration, it is unclear whether the EU’s proposed denial of benefits pursuant to paragraph 2 is intended to apply to all Russian and Belarusian investors or only to those subject to EU sanctions. Assuming that the EU issues an Article 17 declaration on the basis of the proposal, this issue will no doubt be addressed by a competent arbitral tribunal, should it ever arise. By invoking both paragraph 1 and paragraph 2, the EU could give respondents an alternative basis, assuming appropriate facts, on which to argue that the benefits of Part III of the ECT have been validly and effectively denied.

When does an Article 17 denial of benefits take effect?

ECT Article 17, like other denial of benefits clauses, gives rise to a timing issue. At least three views may be distinguished from ECT and other arbitral case law.

At the most restrictive, investors have argued, and some tribunals have held, that a denial of benefits clause may be invoked only before the investor makes its investment, as otherwise the investor’s detrimental reliance on the non-invocation of the clause at the date of investment would be frustrated. An intermediate position, which other tribunals have supported, is that a denial of benefits clause may be invoked at any time before a dispute crystallises, but not thereafter. These positions generally lead investors to argue that an Article 17 notice can be effective only in relation to future investments or disputes and that such a notice cannot apply in relation to existing or clearly foreseeable disputes.

On the other hand, respondents generally argue the most expansive view – i.e. that a denial of benefits clause may be invoked even after a dispute has arisen, so long as it is done within a reasonable time.

Conclusion

For all these reasons, the proposal gives rise to many complex issues of international and European law which – assuming it is implemented as proposed – we can expect to see extensively discussed, litigated and arbitrated before relevant tribunals and institutions for years to come.