Source: https://iclg.com/practice-areas/investor-state-arbitration-laws-and-regulations/8-the-impact-of-eu-law-on-isds
Timestamp: 2019-04-23 18:24:02+00:00

Document:
On 1 December 2009 when the Lisbon Treaty entered into force, the EU obtained exclusive competence regarding Foreign Direct Investment (FDI) (Art. 207 TFEU). In the past 10 years, the EU has become a new active player in international investment law and arbitration by affecting the internal investment law policy of the Member States as well as externally by introducing modifications to substantive and procedural aspects of international investment law. The primary focus of the EU’s effort has been to modify, or as it calls it, “reform” the existing investor-State dispute settlement system (ISDS) contained in practically all bilateral investment treaties (BITs) and free trade agreements (FTAs).
In the following sections, the impact of EU law on ISDS will be reviewed by discussing the most important developments. By way of setting the scene, the following section will discuss the difficulties of demarcating the distribution of competence regarding FDI, ISDS and BITs between the EU and its Member States. Subsequently, a number of specific developments regarding ISDS will be discussed, starting with the impact of the infamous Achmea ruling of the CJEU regarding intra-EU BITs and the wider potential impact on the Energy Charter Treaty (ECT).
We will then focus on the external dimension of the EU’s efforts to modernise the ISDS by introducing the concept of an Investment Court System (ICS) in its recently concluded FTAs and within UNCITRAL.
On 7 July 2010, the EU published its first Communication “Towards a comprehensive European international investment policy” (COM(2010)343 final). In that very first Communication on its new FDI competence, the European Commission (EC) started off with the premise that the EU has, from now on, full exclusive competence over all aspects of investment law, including ISDS. Accordingly, the EC claimed that the Member States had no role to play anymore and that their approximately 1,500 BITs which they had concluded over the past 50 years would need to go away and be replaced by EU trade and investment agreements. In contrast, the Member States disagreed with the EC, arguing that the exclusive competence of the EU was limited to the FDI only and that Member States continue to have competence regarding ISDS. Similarly, Member States were not ready to simply give up their BITs, since it would take decades for the EU to negotiate so many BITs and FTAs, which in the meantime would create legal uncertainty for investors and third States.
Accordingly, the first important milestone was the adoption of the so-called grandfathering Regulation 1219/2012, which ensures the continued existence of the approximately 1,200 BITs, which the Member States have concluded with third States. These BITs continue to remain in force until they are replaced by EU BITs or FTAs with the third State concerned. For example, if and when the FTA, between the EU and Singapore, enters fully into force (including the investment protection chapter), all the BITs which Singapore has concluded with the Member States would be replaced by the EU-Singapore FTA. In that way, a clear and seamless transition would take place, which ensures maximum legal certainty and protection for investors and third States. The fact that after 10 years no EU FTA with an investment protection chapter has yet entered into force (the reasons for that will be explained below) underlines the necessity of the grandfathering Regulation.
Looking forward, the EU and its Member States also had to sort out the question of who will be respondent in investment disputes initiated on the basis of the new EU FTAs and who will be paying for any awards against them: the EU? The Member States? Or both?
The solution for these complicated questions is to be found in the so-called Financial Liability Regulation 912/2014. Simply put, this Regulation follows the basic concept that the entity which is responsible for the measure that caused the damage should act as respondent and be financially responsible for any awards. Accordingly, if the measure falls in the exclusive competence of the EU, the EU would be respondent and pay any awards, whereas if a measure falls within the exclusive competence of the Member States, the respective Member State would be respondent and financially responsible. The main problem, however, is the “grey area” where it is not clear whether the EU or the Member State is responsible for the disputed measure. This is particularly the case regarding the implementation of EU Directives where Member States are obliged to achieve the envisaged result of the Directive but have a large margin of appreciation to determine the manner how to achieve that result.
In such a situation, the question arises of whether the EU, which adopted the Directive, is ultimately responsible, or if the Member State that implemented the said Directive by adopting the disputed measure is responsible. While the Regulation gives some indications on how to decide this issue, it ultimately will be decided on case-by-case negotiations between the EC and the Member States.
Despite the adoption of these two Regulations, which set the foundations for the EU’s investment policy, the thorny question of the exact demarcation of the competence between the EU and the Member States remained unresolved.
Eventually, in late 2014, the EC asked the Court of Justice of the EU (CJEU) to resolve that issue when it requested an opinion on the EU-Singapore FTA. In its Opinion 2/15, the CJEU determined that the EU’s exclusive FDI competence does not extend to the ISDS provisions and to non-direct FDI. Consequently, the EU-Singapore FTA as well as CETA are mixed agreements, which must also be signed and ratified by all Member States. While this opinion clarified some of the competence issues, the EC obviously was disappointed by the outcome. Indeed, the EC has now changed gears and does not include ISDS provisions in its newest FTA with Japan and neither in the current FTA negotiations with New Zealand and Australia. Effectively, the EC now prefers to conclude trade agreements without an investment chapter in order to be able to conclude them without the Member States. Consequently, investment protection and ISDS provisions will only be part of EU FTAs if all Member States sign up to it.
As is apparent from the above, the process of developing and shaping the EU’s investment law competence has been a cumbersome process, which – as will be explained below – is still ongoing.
By far the most far-reaching effect of EU law on ISDS has been caused by the Achmea ruling of the CJEU delivered in March 2018. The background of the Achmea case is as follows.
Achmea, a Dutch health insurance company, initiated arbitration proceedings against Slovakia based on the Netherlands-Czechoslovakia BIT of 1991, after Slovakia had adopted a legislation which re-nationalised the health insurance sector and thus effectively expropriated Achmea. Frankfurt was the seat of the arbitration. In 2012, Achmea won the arbitration proceedings and was awarded €22 million plus interest. Subsequently, Slovakia initiated setting aside proceedings before the Frankfurt Court, claiming that the arbitral tribunal lacked jurisdiction – this intra-EU BIT no longer being applicable since Slovakia’s accession to the EU – and in any case, EU law prohibits the use of international arbitration within the EU. The Frankfurt Court rejected said application, which Slovakia then appealed before the German Federal Civil Court (the Bundesgerichtshof). Not convinced by the Slovak arguments, it nonetheless felt obliged to request a preliminary ruling from the CJEU to answer the question on the (in)compatibility of international arbitration based on intra-EU BITs with EU law.
The CJEU declared the arbitration provision in the BIT incompatible with EU law, the main reason being that arbitral tribunals operate “outside” the domestic legal system of the Member States and therefore cannot request preliminary rulings from the CJEU whenever EU law is at issue.
In other words, arbitral tribunals operate outside the control of the CJEU, which might endanger the uniformity and consistency of EU law and undermine the final authority of the CJEU. It is worth noting that the CJEU in Achmea did not make any distinction between UNCITRAL and ICSID arbitral awards. Neither did the CJEU distinguish between arbitral tribunals seated within the EU – as was the case in Achmea – and arbitral tribunals seated outside the EU. Arguably, these differences could lead to different conclusions.
In any event, the implications of the Achmea judgment are difficult to predict. First of all, it should be emphasised that the CJEU did not declare the whole Netherlands-Czechoslovakia BIT incompatible with EU law, but solely the particular ISDS provision contained therein. Neither did the CJEU say anything more general regarding the other approximately 190 existing intra-EU BITs. However, it should be noted that CJEU judgments have a generally binding effect within the EU. Therefore, it remains questionable whether European investors could still use the ISDS provisions in the other intra-EU BITs. Second, it should be emphasised that despite the announcement of, for example, the Netherlands as now being obliged to terminate all its intra-EU BITs, no termination of intra-EU BITs following the Achmea judgment has ostensibly taken place so far. Accordingly, prima facie, European investors are still able to bring cases against EU Member States based on intra-EU BITs. This is particularly the case since the arbitration provisions in the other intra-EU BITs differ from the one that has been declared incompatible with EU law. Whether that is indeed the case will have to be tested by future intra-EU BIT disputes and ultimately decided by the CJEU.
Beyond intra-EU BITs, the Achmea judgment could also affect the use of the ISDS provisions contained in the ECT. In fact, the Achmea judgment has been used by several States as an argument to annul or set aside intra-EU awards rendered under the ECT. In particular, Spain, which is facing more than 30 intra-EU ECT claims, has been attempting to use the Achmea judgment to vacate awards that have been rendered against it. However, various ECT arbitral tribunals have not been impressed by Spain’s attempt and concluded that the Achmea judgment has no bearing on their ECT cases (notably in Masdar). Indeed, most recently (in September 2018), the Vattenfall arbitral tribunal issued an extensive decision in which it rejected the objections against its jurisdiction raised by Germany based on the Achmea judgment. In particular, it did not consider that the Achmea judgment has any impact on the ECT or the jurisdiction of ECT arbitral tribunals, nor did it see any conflict between EU law and the ECT.
Meanwhile, in one of the Spanish setting aside cases, the Stockholm Court has reportedly asked preliminary questions to the CJEU on whether the ISDS provision in the ECT is compatible with EU law. Depending on the CJEU’s conclusion, the impact for European investors could be significant, in particular if the CJEU would conclude that also intra-EU ECT ISDS arbitrations are incompatible with EU law. This would force investors to rely on domestic courts in the Member States, which would be less than ideal because of their perceived lack of independence and impartiality.
Finally, the Achmea judgment (and the Micula case, still pending before the CJEU) could have negative implications for the recognition and enforcement of investment treaty awards within the EU. A domestic court in a Member State, asked to recognise and enforce an award that has presumably been rendered based on an incompatible ISDS clause, would most likely refuse such a request. While only the coming years will provide clarity on how the domestic courts in the Member States will handle this issue, it seems safe to assume that the recognition and enforcement of awards within the EU is facing increasing difficulties.
In short, the impact of the Achmea judgment could be far-reaching depending on the future decisions of the CJEU and arbitral tribunals confronted with the objection that ISDS provisions are incompatible with EU law. So far, the arbitral tribunals have not been convinced that EU law prevents them from exercising their jurisdiction. Irrespective of that, it seems likely that the EC will increase its pressure on the Member States to terminate their intra-EU BITs. Similarly, it can be expected that the EC will propose to the Member States to issue a declaration, which would effectively exclude the application of the ECT ISDS provision in intra-EU disputes, i.e., a so-called disconnection clause. Another option would be that the other Member States follow Italy and withdraw from the ECT, which would leave the EU as the only party to act as a respondent for the EU and its Member States.
Already in its Communication of 2010, the EC identifies several shortcomings of the existing ISDS system, which it aims to address in its new FTA with third States. Notably, the EC identified the lack of transparency of ISDS proceedings and the lack of consistency and predictability of the ISDS system, as important issues. In that Communication, the use of quasi-permanent arbitrators and/or appellate mechanisms was already mentioned as possible remedies.
Regarding the issue of increasing the transparency of ISDS proceedings, the EC has been one of the main driving forces of the UNCITRAL Transparency Rules which entered into force in 2014. These rules significantly expand the publication of ISDS awards and related submissions of the parties, expert opinions, etc. The UNCITRAL Transparency Rules also expand the possibility of non-disputing third parties to submit amicus curiae briefs to arbitral tribunals, thereby increasing the possible participation of NGOs in ISDS disputes, which in turn could lead to further politicisation of ISDS disputes.
Forced by the mounting public backlash against ISDS, which started when the TTIP negotiations were gaining traction around 2014, the EC decided to propose the investment court system (ICS) as a radical change to the existing ISDS system in the hope that this would appease the European Parliament, NGOs and the general public. In essence, the ICS – largely inspired by the WTO Dispute Settlement System – would create a semi-permanent two-tier court-like system, which would essentially be a move away from arbitration. The ICS would consist of a first instance tribunal with 15 members and an appellate tribunal of six members. The most important change is that the claimant would not have any say in the selection of the members of the tribunal. Instead, the Contracting Parties, including the Respondent in the respective dispute, would appoint all members by common agreement for several years. Consequently, the party autonomy, which is one of the hallmarks of arbitration, would be effectively eliminated. This obviously shifts the balance to the advantage of the States. In particular, it is not difficult to anticipate that States will appoint members which they consider to be more pro-State biased rather than pro-investor biased. Indeed, the damaging effect of the politicisation of the appointment of members of international courts and tribunals is currently visible regarding the WTO Appellate Body for which the US refuses to agree on the re-appointment of several WTO Appellate Body members. This could effectively paralyse the Appellate Body and prevent it from exercising its function.
The other important feature, which strongly deviates from arbitration, is the possibility of lodging an appeal on both points of law and fact. This obviously will increase the costs of the parties and extend the proceedings further. It also gives both parties a second bite of the apple, which is exactly what arbitration intends to avoid by offering only a one-shot procedure with a final binding award.
Putting aside the question of whether the ICS is the best solution to address the (perceived) shortcomings of the current ISDS system, the EU has so far successfully been able to convince Canada, Vietnam, Singapore and Mexico to accept the ICS system in their new FTAs.
However, the fate of the ICS is currently pending before the CJEU. In exchange for giving its consent to sign CETA, Belgium (on behalf of Wallonia) has requested the CJEU to determine whether the ICS system is compatible with EU law (Opinion 1/17). It remains to be seen what the CJEU will decide. However, if it determines that the ICS is incompatible with EU law, this would essentially mark the end of the EU’s effort in the area of ISDS.
Despite this looming insecurity, the EC continues its efforts to promote the ICS at an international level. The EC, together with Canada and Mauritius, convinced the UNCITRAL to set up a Working Group with a broadly formulated mandate to identify and examine any of the shortcomings of the current ISDS system and to propose possible solutions. The discussions started in late 2017 and have made significant progress in 2018. In these discussions, the EC, Canada, Mauritius and several South American States have repeatedly referred to the MIC as being the panacea that would solve most, if not all, the perceived shortcomings of the current ISDS system. However, many States are not convinced that creating a new international court would be the appropriate solution. In particular, the US, Japan and Russia, and also some Asian States are not yet convinced and instead consider reforming or modifying the existing rules and institutions, such as, for instance, the ICSID Convention or the PCA, to be a more effective and realistic option. After all, in the past 50 years more than 3,000 BITs and FTAs have been concluded and more than 800 ISDS disputes have been initiated, much to the general satisfaction of the users. Indeed, according to statistics by UNCTAD, States win more cases than claimants. Thus, States have little reason to complain about the current ISDS system, which is also confirmed by the fact that States continue to conclude BITs with ISDS provisions.
In any event, it is too early to say whether the MIC proposal will gain sufficient traction and support by all the major economies, investors and the arbitration community generally. Nonetheless, the EU managed to direct the debate towards its MIC proposal.
Over the past decade, the EU has become a new driver in shaping international investment law and arbitration. The impact of EU law on ISDS is particularly noticeable regarding the intra-EU BITs after the CJEU determined in Achmea that the relevant ISDS provision is incompatible with EU law. Besides, it seems conceivable that EU law will also affect the use of the ISDS provisions of the ECT in intra-EU disputes. It is also possible that EU law will have a negative impact on the recognition and enforcement of awards within the EU.
At the international level, the EC’s ICS proposal, if it obtains the blessing of the CJEU, would be a game changer with potentially far-reaching consequences for investment treaty arbitration. The impact would be even more sweeping if the MIC proposal were to be embraced by a significant number of States around the world.
In any event, one thing is clear: EU law will continue to impact international investment law and arbitration. Consequently, the arbitration community must engage more actively than in the past with the EU and its institutions and address more pro-actively any perceived shortcomings of the ISDS system, for example, by proposing improvements to the existing ISDS system that are credible, effective and workable.

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